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cussion, that of an independent agency that operates outside of a Cabinet-level department.

There are three key aspects of this proposed structure that I would like to address with the Committee today.

Number one, ensuring regulatory independence. A regulator lacking true independence is often subject to a wide range of demands and influences that we believe would be detrimental to the supervision, business activities, and the mission fulfillment of the GSE's. It is critically important that this new world-class regulator not be hampered by a cumbersome board structure and not be dominated by any single agency represented on the board. This new regulatory body must have the authority to govern in a truly independent manner.

Number two, agency oversight responsibilities. The Bank System believes this independent regulator should have the following authorities:

Ensuring the safety and soundness of the housing GSE's.

Overseeing all mission-based goals and programs. There are obvious differences in the mission-based goals and programs of the two housing GSE's and the Federal Home Loan Banks. However, we believe a proposed new regulator should have the authority to review, approve, and monitor all mission-based goals and programs. Our current regulator has that authority, and we believe it should be preserved.

Setting capital standards. Along with independence, any worldclass regulator must have the authority to set both leverage- and risk-based capital standards. As you know, Congress conducted an extensive review and revision of our capital structure in the Gramm-Leach-Bliley legislation, and the Finance Board was given this broad authority in the Act. We believe any new regulatory agency should have the authority to raise and lower capital requirements as deemed appropriate and necessary. And anything less, in our opinion, would be a significant step backward.

Approving new business activities and programs. We believe a world-class regulator should preserve the Bank System's ability to innovate around existing products and services. In turn, the regulator should be diligent in examining and approving these innovations and exploring areas that represent new risks to the GSE's. Speaking on behalf of the Seattle Bank, I believe our mortgage purchase program is a good example of where our regulator insisted on close oversight and examination prior to approving a new business line.

Number three, creating separate divisions for the Federal Home Loan Banks and the publicly traded housing GSE's.

While Fannie Mae and Freddie Mac and the Federal Home Loan Banks all share GSE status, we are fundamentally very different. The Federal Home Loan Banks are cooperatively owned and capitalized by our members, most of whom are community banks occupying and delivering benefits to Main Street, while the other two housing GSE's must meet the quarterly earnings expectations of Wall Street investors.

To that end, the Bank System believes that creating separate divisions within a regulatory structure would add efficiencies in the provision of oversight and supervision.

In conclusion, I want to emphasis to the Committee that the onus of strengthen our system lies not only with Congress and the regulators, but also with the housing GSE's themselves.

We must be willing to take the steps necessary to efficiently manage our financial institutions in a safe and sound manner and provide world-class financial transparency and disclosure regarding our business operations. On that point there is no debate.

Where there is a difference of opinion among the Banks, and where there has been much discussion with our regulator and others, is concerning who should have authority over the financial disclosures and transparency-the SEC or the housing GSE regulator.

From the Bank System's perspective, we believe that a worldclass regulator would potentially be better able to set the framework and supervision for the level of financial disclosure now being demanded of our system.

However, if Congress were to choose the SEC to regulate these financial disclosures, the Bank System believes some very specific accommodation are necessary.

As you move forward in this legislative process, I would ask that you keep in mind that we are a cooperative system, owned by more than 8,000 banks, thrifts, credit unions, and insurance companies. That means every dollar of value we create is passed through to our members and their communities. That is why Congress created the Bank System, and that is why we exist today.

So, I thank you for your time this afternoon, and I will be happy to answer your questions regarding my testimony.

Chairman SHELBY. Thank you, Mr. Rice.

Yesterday, as everyone knows, Chairman Greenspan recommended, among other things, that the GSE's be limited in their issuance of debt and in their purchases of assets. At the same time, he spoke favorably regarding the securitization process and its value to the housing market and to homeowners.

Would you agree that there is greater risk in holding mortgages and MBS's in portfolio?

Mr. Raines.

Mr. RAINES. I think, Mr. Chairman, the answer is it depends on how you have hedged your portfolio and that you can, in fact, reduce the risk of a mortgage portfolio

Chairman SHELBY. And the quality of the portfolio?

Mr. RAINES. It depends on the quality of the portfolio, but as well how you would hedge the portfolio in order to demonstrate the amount of risk that is actually there. And there is a simple way to illustrate that, Mr. Chairman, that I think would be useful as we discuss these issues, if I can find it.

Chairman SHELBY. Do you want to come back to that?

Mr. RAINES. It is illustrated by our risk-based capital standard because it is a very important concept that Dick Syron was pointing out and that I also think is vital in understanding this whole discussion.

Under our risk-based capital standard, how much capital we have to hold depends on how much risk we have in our portfolio, and this chart illustrates in a simple way how the amount of capital that you should have depends on the level of risk.

Chairman SHELBY. Can you speak into the mike just a little more?

Mr. RAINES. Yes, sir. So, for example, on the far left it indicates that if you match your holdings of mortgages with 80 percent callable debt, you can reduce the capital requirement down to about 1 percent, which gets you down at the same level as credit risk.

On the other hand, if you finance your mortgage assets, as most banks do, by short-funding, using primarily deposits, you need 10percent capital.

So how much capital you need to have depends on how much risk you have. Typically, Fannie Mae has a duration match and 50-percent callable debt, which requires us to have about 3-percent capital. However, if we change the risk, the capital requirement would go up.

Chairman SHELBY. But a world-class regulator, if we create one through legislation, would hopefully know all this, would they not, when they are assessing the risk that you are taking?

Mr. RAINES. They would hopefully know it.

Chairman SHELBY. Otherwise, if they were not up to the job, they would not know, but the kind we are trying to create or hopefully would create would understand these risks. And if they understood these risks, it would help them understand who they are supervising better, would it not?

Mr. RAINES. Yes, sir, I think it would help. But we have the example that the banking system to this day does not have a capital standard that takes into account interest rate risk. There is no interest rate risk included in the Basel standard that we have. Nor is there interest rate risk included in the proposed Basel standard. So this capital standard that we have is actually quite unique as being the only one that captures credit risk and interest rate risk and operations risk.

Chairman SHELBY. So why do the GSE's-I will just speak to Fannie Mae first and then call on the others-hold mortgages in the portfolio? Is it because you have a better return? There is a reason why you hold them rather than securitize them.

Mr. RAINES. Well, actually, Mr. Chairman, the reason that Fannie Mae holds them is the first thing we did as a company was hold mortgages.

Chairman SHELBY. I know that.

Mr. RAINES. When we were founded in 1938, until the 1980's, that is all we did. But our research shows that for the incremental billion dollars of securitization versus a billion dollars of purchases by our portfolio, purchases by the portfolio have a 30-percent greater impact on lowering interest rates. And it is simple to understand. It introduces new demand into the market that otherwise would not be there. People who invest in our debt have chosen that they do not want to invest in mortgage-backed securities. So we actually attract more investors into mortgages than would otherwise be there.

So it is pretty clear from our research that the portfolio has a bigger impact on reducing interest rates than our securitization program.

Chairman SHELBY. But the holding of the debt in your portfolio causes great concern to Chairman Greenspan, for whom we all have a lot of respect.

Mr. RAINES. As do I.

Chairman SHELBY. As far as risk.

Mr. RAINES. As do I, although I found it curious that although banks are the largest holders of mortgages in portfolio, and although banks have the highest ratio of mortgages on their books today that they have ever had and have been growing at the fastest rate that they ever have, that was not mentioned, even though banks do not hedge interest rate risk and Fannie Mae and Freddie Mac do.

So, I found that a curious point that the companies who, in fact, hedge the risk were viewed by the Chairman as being more risky as compared to banks who do not.

Chairman SHELBY. I am sure we will get into that when the Chairman comes back. He spends a lot of time up here. [Laughter.]

Mr. Raines, back in the early 1980's, it is my understanding that Fannie Mae experienced some problems with mortgages it had bought in portfolio. Didn't they encounter some difficulties during the early 1980's? And wasn't securitization viewed as a positive means to ensure that interest rate risk was not entirely concentrated with the GSE holding a mortgage portfolio? I think in your own organization you had some problems.

Mr. RAINES. Two things happened, Mr. Chairman. In the early 1980's, Fannie Mae operated like a big S&L. It borrowed short and lent long. And, fortunately, unlike the S&L's, it learned the lesson in time and was able to convert. And it did two things. One, it created the mortgage-backed securities program that gave it the ability to have an alternative execution. But the second and most important thing it did was create callable debt that allowed Fannie Mae to have liabilities that matched up with its assets.

And so it was those two innovations, not just the securitization but the creation of a large, liquid, viable, callable debt market that matched up with the mortgages that allowed us to move forward with an on-balance-sheet portfolio.

Chairman SHELBY. Mr. Syron, I will ask you this question, and then see whether the others have any comments. Chairman Greenspan also said yesterday most investors have apparently concluded that during a crisis the Federal Government will prevent the GSE's from defaulting on their debt, the so-called implicit guarantee.

Do you believe there is an implied guarantee backing the creditworthiness of GSE debt? Are you aware of Wall Street analysts making such claims? And if Fannie Mae or Freddie Mac were to become insolvent-which we pray they won't-would the Government have any moral obligation to make the creditors whole?

Now, I am familiar with your background as head of the Fed in Boston, so you bring that experience here. The Fed is the lender of last resort, is it not?

Mr. SYRON. First, sir, to answer your last question first, I am not sure that the Federal Government would have any moral obligation. I think in reality, to answer your question honestly, that financial markets, both domestically and internationally, tend to

know if you disagreed with what each other had to say about this. I know you agreed mostly. And, Mr. Rice, as well, if you have some thoughts on this, I would like to hear them. But if you might give us your concerns with this recommended change that has been raised. And from your perspective what are the problems with providing a future regulator with the ability to place a GSE in receivership? And what are the potential market impacts of such a change?

Mr. SYRON. Senator, if I might just start on this, I think one of the great geniuses that Congress resulted with in creating these GSE's was an ability to transfer interest rate risk, particularly interest rate risk on 30-year, fixed-rate mortgages, from the homeowner to the capital markets.

Now, with the retained portfolio, given international investors' preferences not for mortgage-backed securities but preferences for the actual debt of these institutions, the GSE's, particularly Fannie and Freddie, we have found a way to sell more and more of our debt overseas, thereby shifting the interest rate risk, if you will, from homeowners in the United States to investors in foreign capital markets. And I think that is a substantial gain to the United States at a time when we have a lot of international trade issues, and it is not something that we very lightly want to give up.

I am not implying that there are not issues that have to be faced with this, but I think the best way to facing the issues of the size of our portfolio and the growth of our portfolio is the same way that you deal with the institutions as a whole, and that is, as my colleague said, making sure that you have good capital standards, that you have a very strong regulator, the regulator is able to change the capital standards on a frequent basis if it deems necessary because of change of risk, rather than specifically coming in and saying we are going to bless certain types of obligations and we are going to prohibit other types of obligations.

Thank you.

COMMENTS OF SENATOR PAUL S. SARBANES Senator SARBANES. Did you indicate how much of your debt went overseas in your testimony?

Mr. SYRON. Yes, I think-now, Senator, I will apologize for being relatively new in this, but my understanding and I only know our recent offerings. But in our recent offerings, I think somewhere on the order of about 34 percent has gone overseas.

Senator SARBANES. Of that offering, but how about your total debt, how much of it is overseas?

Mr. SYRON. I would have to get back to you on that.

Mr. RAINES. For Fannie Mae, of our benchmark debt securities, 32 percent are purchased by investors outside the United States. It is a very large part of our funding.

But, Senator Dodd, directly to your question, I think there is a lot of misunderstanding on this issue, and I think there has been a lot of back and forth on the names receiver and conservator. The key things are the powers. Typically, a receiver's major power that is different than other powers is the ability to take a contract and say it is no longer effective. That is the big power. It is able to take

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