our experience is not such, that looking at banks, that this diversification across businesses has been successful. The counter argument is if you are in many businesses, how many of them can you be good at? And how many management teams can you bring together to manage all of these businesses? The experience I think in the banking sector has been if one of those businesses goes down, the diversification does not seem to have any effect whatsoever. I am much more a believer in putting your eggs in the basket; and watching the basket.

Chairman SHELBY. Senator Carper.

STATEMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. Thanks, Mr. Chairman. To our witnesses, welcome and thank you for being with us today.

Mr. Raines, I walked in after you had given your testimony and Mr. Syron was just beginning his and I heard his testimony and that of Mr. Rice. I did not hear your testimony, and I am not going to ask you to give your testimony, but I what I would like for you to do is take just maybe a minute and just recap a couple of key nuggets that you would have us take out of here.

Mr. RAINES. I just tried to make four points in the testimony, that primarily we need to focus on the important goal of maintaining the best housing finance system in the world. Getting capital right is a very important part of that. Getting the receivership question resolved appropriately so it does not introduce new uncertainty into the marketplace is a very important part of that as well. And we have to make it possible to have innovation and not have it tied up in bureaucratic process.

Senator CARPER. Thank you. Yesterday, when Chairman Greenspan was here I asked him a question. I am going to ask you the same question. I asked him: What wrong are we trying to make right in this process, and what risk or what harm are we seeking to avert? Let me just ask each of you the same question. Mr. Rice, if we could just start with you.

Mr. RICE. I ask that question often, but I think what I really believe is at issue is a strong independent regulatory structure in order to manage the risk that is inherent with our business, and that by giving that regulator the powers to manage capital, to have independence, have the oversight responsibilities that are necessary, can restore a lot more confidence in this whole process.

I think that as you begin to pile on, so to speak, or look at other ancillary issues beyond, then it becomes a little more complex. I really do think that we are going to have to figure out and create a structure that allows an independent regulator to be accountable to the Banking Committee and Congress and engage in that dialogue of change rather than trying to statutorily try to make all those changes, because I think this is not just a turn of the screw and things are all right. I think it is a long-term discussion with trust and support for an independent regulator.

Senator CARPER. Mr. Syron, let me ask the same question. Again, the question is: What wrong are we seeking to make right and what harm are we seeking to avert?

Mr. SYRON. I think that is a very good question, Senator, because I think there is a confusion on it. First, in terms of what is right,

I think we have the most effective housing finance system in the world and the people in the rest of the world will tell us that. The wrong, in my mind, that we need to make right is I do not think we have an adequate regulatory structure for the GSE's, an adequately funded regulatory structure, and I do not know if it is an adequately structured regulatory structure. I think that is the issue that we need to make right.

The issue that I do not think is broken and that we do not need to make right is to reexamine the entire housing finance system of the United States to explore the issue of whether we want to privatize these organizations and radically change the way we provide housing finance in the United States.

Senator CARPER. Mr. Raines.

Mr. RAINES. I think the legitimate issue that we would encourage the Congress to look at is whether the regulatory regime for these important institutions is appropriate given the need in the future. The last time Congress did this was 1992, and in 1992 it made big changes. We did not have a safety and soundness regulator before 1992. We did not have real capital standards before 1992. We did not have housing goals before 1992. All of that happened in the 1992 Act. I think it made the system better. I think it made Fannie Mae better. I hope that through this process you prepare these companies for the task that we have going forward, which is to carry out the national policy of making homeownership and affordable rental housing more available, and to meet the needs of a growing country.

In crafting a better arrangement from a regulatory standpoint, do not harm the underlying mission of the companies.

Senator CARPER. I am sure you heard from the critics of GSE's, particularly private sector competitors of the GSE's who really believe that you have an unfair advantage here, and it is something they would like to change. What do you say to those people?

Mr. SYRON. Unfair advantage, I have found is always very much in the eyes of the different competitors. Our different competitors have advantages of their own. They have, in many cases, depository insurance. They have an ability, which we are not looking for, to come in and out of markets. They will come in and out of these markets at the excuse the expression-drop of a dime, depending on where things are most advantageous from their perspective. At least speaking for the two housing GSE's, our responsibility is to be focused on the housing industry. Business in the United States is the reason we are as effective as a Nation as we are is a very, very competitive situation. But everyone will look at their own situation and say someone else has an unfair advantage. When was the last time you heard a CEO come to you and say, "My company has an unfair advantage?"

Mr. RAINES. Senator, I think there is a lot of myth and legend about who has what unfair advantage. When you look at in terms of unfair advantages and you say, who has the best deal? I would love to have the deal the banks have. Why? We have to fund our balance sheet by issuing long-term debt in the capital markets. They fund most of their balance sheet with deposits, and those deposits are backed up by insurance and they are also backed up by the Fed window that allows them to borrow. This has a huge im

pact, and this goes to what I think is the biggest myth, that is, that Fannie Mae has the lowest cost of funds out there.

What I have plotted on this chart is since 1994 the cost of funds for commercial banks and for Fannie Mae. If you look at the cost of funds for the commercial banks, they are the low end, but it is cheating a little bit because they actually have to run branches and things to collect these funds, so it is not free. We have adjusted for that cost. As you see, throughout this entire period banks have had a lower cost of funds than Fannie Mae, and as my CFO likes to say, the real proof of this is that banks buy Fannie Mae debt. We do not buy deposits. We cannot make money buying deposits, but they make money buying Fannie Mae debt. Indeed, some people say they buy too much Fannie Mae debt, but there is no doubt that they buy Fannie Mae debt. How could they buy our debt, which is our cost of funds, if their cost of funds was higher than ours?

The great myth here is that Fannie Mae is sitting with a much lower cost of funds. Banks, if they want to grow their mortgage portfolio, do it, and we step aside. When they stop wanting to grow their mortgage portfolio, we step up. They may say, "Ah, but you can go into the agency market." I showed you before they do not use long-term debt very much in their funding, but they can go in the agency market too through the Federal Home Loan Banks. Their primary job is to fund banks out of the agency market. So they borrow at essentially the same cost that we do and pass it on to banks. So they have lower cost deposits and the same long term funding cost as we have. So that is a pretty good deal.

The tears that are shed on behalf of the banks that somehow we have an unfair advantage against them, I do not see it. I see them able to grow whenever they want to grow, to move from business to business whenever they want to, to merge into very large institutions without anyone being concerned that somehow there is systemic risk being created or the system is at risk. I think they do a great job as diversified financial institutions. We do a pretty good job as institutions who are focused on the housing market.

Chairman SHELBY. Senator Carper, could I just interject?
Senator CARPER. Sure.

Chairman SHELBY. A lot of the banks say you have, the GSE's the unfair advantage and so forth. What is your answer to that? Is that your answer?

Mr. RAINES. I say on the cost side it is pretty clear that we do not. They have never been able to explain to me why they buy our debt if our debt is lower than their cost of funds. But even on the capital side we do not have an advantage. In fact, I would be willing to trade with them. If they are willing to take our capital standard and be subject to the OFHEO risk-based capital standard where they have to have sufficient capital to withstand huge movements in interest rates and depression level credit losses

Chairman SHELBY. They are into a lot of things that you are not into in the whole panoply of financial services. You are in a specialty.

Mr. RAINES. That is one reason why they need to hold a lot more capital because most of the things they are in outside of housing are far more risky.

But our capital standard is so rigorous that we had a firm a couple of years ago look at it and see what would happen to a thrift, which was the closest comparison to us without all these other businesses. If OFHEO capital standard were applied, the thrift would have to have 50 percent more capital.

Again, there is a lot of myth and legend that has been repeated over and over again that Fannie Mae has an easier capital standard, that we have cheaper cost of funds. The fact of the matter is that we do not.

Senator CARPER. I would like to yield back the balance of my time to Senator Dodd.

Chairman SHELBY. That was kind of you.

Senator Sarbanes.

Senator SARBANES. Thank you, Mr. Chairman.

I want to ask first what your position is on whether approval from the regulator should be required with respect to new product lines or product activity?

Mr. SYRON. Senator, I think it depends on how one defines those terms.

Senator SARBANES. Let me stop you right there. Do you agree with that?

Mr. RAINES. With what he just said so far?

Senator SARBANES. Yes.

Mr. RAINES. Yes, it does.

Senator SARBANES. Do you also agree with that, Mr. Rice?

Mr. RICE. We operate under a situation today that they approve any new business activity, the Finance Board.

Senator SARBANES. And do you think the regulator should have that power?

Mr. RICE. I have no problem with it.

Senator SARBANES. Even under a new structure here, okay. Do you agree with that statement?

Mr. SYRON. As I understand the statement, I agree with it. [Laughter.]

I will not claim that I understand it, Senator.

Senator SARBANES. Rather than giving me all the qualifications, each of you tell me what power you think the regulator should have in this area?

Mr. SYRON. Can I try to answer that? Let me give you a case in which I think they should not be required to approve it and a case in which I think they should be required to approve it. Should we decide-we are not about to do this-but should we decide that we wanted to offer something like mortgage insurance or to go further toward the retail end, toward the origination end, I totally agree that the regulator

Senator SARBANES. No, no. I have to get you down into the ball game. I have to get you onto the ball field. It does not help me to get these examples that are outside of the ball park because if we are going to have a regulator, the first question is are they going to have power in this area. Everyone, as I understand it, has said, yes, but it has to be properly defined, and I am trying to get a definition out of you. I want to know where you see the line, how do you define that line?

Mr. RAINES. Let me take a crack at that. I believe that the line should be exactly where it is today, at the program level. If we are doing something brand new, then the regulator should have the ability to preapprove that.

Chairman SHELBY. Or reject it.

Mr. RAINES. Or reject it. But, for example, one of the first things I did when I came in as Chairman of Fannie Mae is we had never been in the business of helping people with impaired credit. It was within our loan limit. It was a conventional loan. It was a mortgage. We had simply set our standards at a level that made them not qualify. I do not think I should have had to go to a regulator and say: Well, what do you think? Do you think that we should be able to do that? We cut down payments. I do not think we should have had to go to the regulator with that. I announced 3 or 4 weeks ago our expansion of our American Dream Commitment, 60 different initiatives. I do not think that the regulator should have been telling me whether or not I should set a goal of increasing the minority homeownership rate to 55 percent. I do not think they should be in the business of telling me that we should or should not be able to tighten up our predatory lending standards. I think that should be left to private management.

But for example, we had never been in the business of doing acquisition, development, and construction financing, which is different. We took that to HUD and HUD looked at it and they approved it. They could have said no. But that was a wholly different thing. It was not a mortgage where we were changing around the criteria. It is a wholly different business that we had been encouraged to get into, and we experimented with in cooperation with HUD. They approved that. So that is the distinction.

If every time I have a new product or a new activity, and I have to get approval, do you have any idea how long it would take me to get the 60 initiatives approved, even just to put together the request and to have all of the evidence that a regulator would want to look at? That is not a business. That is running a bureaucracy, and I do not think that the Congress should want to turn these companies that have been innovative companies with private management, into simply an extension of a bureaucracy.

Chairman SHELBY. Excuse me. I know it is Senator Sarbanes' time. How would you compare that to a bank regulator for a bank to get into various things, do they have to deal with a regulator? Mr. RAINES. Banks do not have prior approval as long as they are within banking. Only if they are going into one of these new powers do they have to go and get approval. So it is quite similar. The term "new activity" is probably the most pernicious aspect of this because every time we change a process, we would have to go and get approval from a regulator. I think it would stifle not only these businesses but also any business. I cannot see how any entrepreneurial enterprise, public or private, could operate having to ask permission every time they wanted to have an innovation.

Senator SARBANES. Mr. Raines and Mr. Syron, everyone asserts that you get a subsidy flowing off of the implicit guarantee, and then there are various figures as to what portion of that subsidy gets passed through in order to benefit the consumer. What do you think the figure is that passes through to benefit the consumer?