Mr. RAINES. I think I can illustrate it for you pretty easily because we see it every day, and we can calculate it for you, and this may be a little bit different way than you have seen it before, but it is pretty clear as to what happens. This chart compares our market, the conforming market, below the $333,700 in the jumbo market. What I am comparing at the top is the yield on a mortgagebacked security issued by Fannie Mae versus a mortgage-backed security issued by a bank or someone else in the jumbo market. You can see that the difference in the yield between the two is about 21 basis points. That is what we bring to the party. The way we reduce rates is to bring down the yield on our mortgage-backed securities. We do that by increasing liquidity and by buying them ourselves through our portfolio. That is our contribution.

Everything after that is our cost of a guarantee fee and lender costs. When you get down to the primary rate, the rate that you find out in the market, the consumer is paying 5.93 percent versus 6.19, actually it expanded. Our 21 basis points became 26 basis points. This is why we say we pass on more than all of the benefit. If you give the "implied guarantee" all the credit for that 21 basis points at the top-which we do not, we think we actually do some things here; our liquidity actually is a big piece of that. But if the Government got 100 percent of the credit for that 21 basis points, by the time it gets to the consumer it turned into 26 because our system is more efficient than the jumbo system. Ours has more liquidity. Lenders have to compete more because we have more small lenders who are competing in our market than in the jumbo market.

This is not based on some fancy equation. This is simply going into the market and looking at every element between the issuance of that mortgage-backed security, which is the cost of funds for that mortgage, and the rate the consumer gets. I offer that up to you as far better proof than econometric models that try to calculate the same thing, not by observing what happened in the market, but by running mathematical equations to simulate what happens in the market.

Senator SARBANES. Is it your position that whatever subsidy you get is entirely passed through and that none of it stays within the confines to benefit the shareholders of the company?

Mr. RAINES. That is indeed our position. The shareholders in the company are

Senator SARBANES. No one else has come here and taken that position.

Mr. RAINES. I have taken that position for years, and Fannie Mae has taken that position for years, and there are a number of studies that have been taken on, that have been conducted by conservatives, by liberals and others, who have come to exactly the same conclusion. We can provide the Committee with those studies that have examined that issue.

Chairman SHELBY. Could you do that?

Senator SARBANES. If we were to look at all these studies, your and others, and conclude that the subsidy was not being entirely passed through, what do you think should be done about that if anything?

Mr. RAINES. You have to ask the question, what is it that we do? If you believe that some of the "subsidy" was not being passed on, let us look and see where all the money that we make goes, and we can figure out where we think there is an excess. This chart shows for last year our total pretax earnings. This goes to the question, where does it go? Twenty-five percent of it the Federal Government gets in income taxes. We are a full Federal income taxpayer, probably one of the largest in the country. Twenty-five percent goes there. Fifty-seven percent goes to capital, to bolster that capital which is the safety that we have been talking about. Our shareholders only get 18 percent of it now. So if there is a dollar of subsidy that we get, this is a pretty good idea of where it goes now. The question is: Who should it be taken from if it is going to go some other place? Are we going to take it out of capital? Are we going to take it out of the taxes or are the shareholders supposed to give up of the 18 percent they get of the funding? There is no magical

Senator SARBANES. How is it your shareholders do so well on a comparative basis, double figure payoffs and

COMMENTS OF SENATOR JON S. CORZINE

Senator CORZINE. Would the Senator yield?
Senator SARBANES. Certainly.

Senator CORZINE. I do think that the build-up in capital has something to do with shareholder value. If I am not mistaken, it does increase the book, and therefore somebody has some perspective on what value is created.

Mr. RAINES. Except the only problem here is that they can never liquidate the firm. So the only way they can

Senator CORZINE. They can liquidate the stock. The marketplace has decided the value.

Mr. RAINES. Because they cannot liquidate the firm the capital is stuck inside the firm.

Senator CORZINE. That is true.

Mr. RAINES. But also with regard to the returns, let us be brutally honest here. Fannie Mae has a price-to-earnings ratio of about 9, which is half of the P/E ratio of the S&P 500 average. So we are half of the average companies' P/E. This is not a sign that shareholders think they are getting a fabulous deal. If they thought they were getting a fabulous deal, our P/E ratio would at least be equal to the average company.

I am not poor-mouthing, saying that somehow you need to help us. I am just simply saying the idea that somehow that our shareholders are getting a bonanza, when in fact, our stock has not performed even at the same level as other financials have over the last 5 years, says something about our relative position. It may be a good thing to be a financial, although all the financials have relatively low P/E's, but this is not the market indicia of a company that is collecting what economists would call rent, ordinarily having a return higher than the market, not lower.

Senator SARBANES. Is it your position that you cannot assume any greater burdens of responsibilities with respect to affordable housing because you are really stretched right out to the limit; is that right?

Mr. RAINES. No, just the opposite. I just announced the largest commitment to affordable housing any company in the world has ever made, and since I have been Chairman of this company we have committed $2 trillion. We have just committed to help create another 6 million new homeowners. I do not think there is any company who has done as much as Fannie Mae or promised to do as much as Fannie Mae, and we are not done. We believe we can do more, but we do not think it is a question of subsidies. We think it is a question of making the system work better, and if we make the system work better we can make more homeowners. I guess the proof is in the pudding, and if you would bear with me for one last chart, and I promise I will try not to do another one.

This is a comparison with our friends at the FHA, who have for years been leaders in providing service. It shows you the difference that can be made over time. I can show you this in a variety of ways. This is just looking at minority borrowers. I could show it looking at low-income borrowers or in poor areas.

Back in 2000, the FHA did substantially more service to minority borrowers than Fannie Mae, significantly more. We made a commitment that we were going to be the leaders in service to minority households. In 2001, we did 50 percent more than the FHA. In 2002, we did 2.5 times as much as the FHA. We do not where they are in 2003, but given that we increased our service by 70 percent, I daresay I do not think that they are going to be close to us there. This is real service to real people. The FHA is a Government owned, Government guaranteed, Government subsidized entity that can make loans in the same markets we make loans in, and we are able to provide dramatically more service through a private sector, private capital entity. This is a success story. This is not something for us to go and be sad about. We are serving more people than we ever were serving before. This is because we have reached out, we have tried to do more, and we keep pushing the envelope. I can pledge to you as long as I am Chairman of Fannie Mae, that we will continue to push the envelope of what we can do in the confines of private capital.

What we cannot do is be a subsidy source, where we are simply taking money and not investing in a business but giving it out as a subsidy. That will be the death of these companies and will prevent us from this type of service.

Senator SARBANES. I have one question for Mayor Rice. I want to get him into the-and I say Mayor. You know, Averell Harriman

Mr. RICE. I accept the title.

Senator SARBANES. -insisted on being called Governor, even though he had been Secretary and Ambassador and everything else.

Mayor Rice, I am going to ask you a very simple question. What do you see in the current context as the purpose of the Federal Home Loan Bank System?

Mr. RICE. First of all, we are a cooperatively owned system, 8,000 members, and we serve our members to provide housing, financing, and liquidity for those members. One of the things you said earlier, what do we do with our subsidy? I think the CBO report that was laid out in 2001, the banks are cooperatively owned by retail finan

cial institutions, they have elected to become members of the System, and they are eligible to borrow from the Federal Home Loan Bank for financing and advances.

Because the members are both owners and customers of the Federal Home Loan Banks, it is more likely that almost all the benefit of the GSE status is passed through to them either in the form of concessions on the advances or our dividends, because actually retail lending is highly competitive, and members may be forced, and often do, pass most of the benefit on to their customers in order to be competitive.

Senator SARBANES. Why do we have this facility? Why do we provide this facility to which the member banks can go and get advances at a reduced rate? Why do we do that?

Mr. RICE. Well, I think when you look at several of our members, they do not all have access to the capital markets in the same way. I think this is a way to give them liquidity. This is a way in which they can still be competitive in those smaller areas and those rural communities all throughout America where they are not large in scale, they are actually small and need that ally and that assistance. They also come to us periodically for new ideas and new opportunities such as to sell their mortgages, which we are undertaking and reviewing, and we try to respond to their needs.

Senator SARBANES. That sounds good, but then you start looking at the statistics beneath the surface. According to a report cited by the May 2001 CBO study of the housing GSE's, 52 percent of the mortgages held by FHLBank System members which are used as collateral for system advances, are jumbo loans. In fact, according to the CBO study, only 300 million out of 3 billion in total Federal subsidies received by the System benefits conforming mortgage borrowers. What is the public policy rationale for providing a Federal subsidy for jumbo borrowers?

Mr. RICE. I do not have those statistics. I do not agree with them totally, but I will say this. Remember though, you have to look at the whole range of what we are responding to do. Ten percent of our net income goes for affordable housing direct. Twenty percent of our net income goes for reducing the REFCORP debt. The sum of what we do is still intricately important in I think financing housing, financing and mortgage lending in our districts.

Senator SARBANES. If these statistics are correct, would they give you concern? Let us assume they are correct for the moment. Does that give you concern?

Mr. RICE. The jumbo loans and the 52 percent of what is held? Senator SARBANES. Yes. Why are we providing this.

Mr. RICE. I think what I would like to see with the figures is by which members of our bank, because I think there are large members and there are small members, and they may very well be held by a class of members that are not representative of all 8,000 member institutions.

Senator SARBANES. I understand the 10 top members out of the 8,000 have 25 percent of the advances in the Federal Home Loan Bank System. Is that right?

Mr. RICE. I think that if you are part of a cooperative and members can join, I do not see anything wrong with that. I think really the idea is

Senator SARBANES. Why are we providing this special status? Why do we have it if the advances are going to a concentrated number of large institutions, and if it is supporting jumbo loans, why are we doing this? What is the purpose of this?

Mr. RICE. I think the financial industry has changed drastically from when we started, and there is a barbell effect. There are large members on one side and there are small members on the other end of that barbell. I think that when you have a cooperative you cannot start discriminating between large and small. You have to afford the members of the cooperative access to the services that you have, and that is part of how we operate. I think if you start to begin to differentiate and begin to try to draw those lines, I think it become harder to manager.

Senator SARBANES. If it becomes highly concentrated, is it not reasonable for policymakers to start asking the question why do we have this system in any event? What is the purpose of it?

Mr. RICE. I still think that the purpose is to provide liquidity to financial institutions in need that do not have choice. I think it is also to offer those financial institutions choice in the marketplace, and whether size or not, that is the choice that we should offer our members.

Chairman SHELBY. Senator Corzine, you have been very patient. We should have given you most of the afternoon, given your background. Anyway, go ahead.

Senator ČORZINE. I would only make one comment, that I suspect those P/E ratios would go up a lot faster if we were not debating how they were going to be structured for the next, whatever, but I think it is also a worthwhile discussion. I thank you, Mr. Chairman, for what I think is a very thoughtful discussion that we are having about these overall issues.

It seems to me that the systemic risk question that Chairman Greenspan raised yesterday continues to linger. I am not sure that I agree with it, but it lingers in the sense that diversification of risk, by some people' views, as I think the Chairman mentioned, is one of the principles at least some of us learned in Finance 101, and that there is a concentration of risk here, and therefore does that create another type of risk, beyond interest rate and credit, such as operational risk, which maybe we have seen displayed by the current circumstances of restatements of earnings and other issues, that unintended consequences tend to get bigger in a world where you do not have

So, I guess I would like to hear whether you think the concentration of risk deserves some greater attention in the risk-based modeling than now is the case. As I see it, maybe it is what stimulated Chairman Greenspan to worry about systemic risk, if we are going to have grow $6 trillion over the next decade and mortgage debt outstanding being held. I guess not held, but creation.

I think it is a fair question. You know, is there some reductio ad absurdum number that these institutions should not grow beyond? Maybe it is not where we are today, but maybe it is some incredible number as you go on with the trillions here. I think that is the question that really is on the table, and particularly I was struck, Mr. Raines, by your comment that securities held are 30-percent more powerful in driving that 26-basis-point subsidy.