I would actually like to see the, I mean, it sounds like supply and demand being applied to the market, but I think on all of these issues, I would like to see some objective support for the arguments that one is talking about, and I accept that the 26 basis points looks like it is rational from this analysis, but we hear other people talking about maybe 10, maybe 15. Some of the studies that we have seen, I think we need to compare, and contrast and understand why there is such a broad difference and why there has-it is great that we are taking steps to help minority homeowners, those numbers look great, but what is the history and is it broadbased within the GSE's?

So all of those questions seem to me fair game in this overall discussion, but I think still the most important is the systemic risk by what is too big for any institution in the system. And I think we have gotten into "too big to fail" concepts in our financial system, whether it is GSE's or private-sector institutions. Therefore, we need, since the Government is sponsoring these institutions, the standard maybe is higher than it would be for private institutions. And so I think that is why we are having this debate about minimum capital standards or whether we have risk-based standards and are the risk-based standards appropriate for the circumstances, particularly in the concentration of risk that is ahead.

I throw this out mainly because I do think that there becomes some diminishing return in concentration at some point, being an old believer in diversification. And so I think that is the burden you all have to talk to us about with regard to the standards.

Mr. RAINES. Well, Senator, I think you posed the question very well, and it is a central issue as to does our current regime encourage the right kind of behaviors given this focus in one asset class in one company. I would argue that it does, and let me just state a couple parts of that argument.

Because we have a risk-based capital standard that punishes keeping risk and rewards dispersing risk, we, unlike banks, have a very strong incentive to disperse risk to other holders. Because banks get no credit if they use mortgage insurance, they do not use mortgage insurance, and so they take all of the credit risk. Because banks do not get any credit if they use callable debt, they do not use callable debt. They take all of the interest rate risk. Their capital is fixed, essentially, regardless of their posture from a risk standpoint, and this distinguishes American banks from European banks, for example, and Canadian banks, where American banks on a dollar-for-dollar basis have more risk than European banks and Canadian banks because only in the United States do we have a fixed leverage requirement and because it is fixed, banks want to have the risk that would give them the return on that capital. Our risk-based capital standard, on the other hand, rewards us if we get rid of risk. So if we use mortgage insurance, our capital requirement goes down. If we use more callable debt, our capital requirement goes down. So we had a very strong incentive to disperse risk.

I do not view Fannie Mae and Freddie Mac as being repositories of risk. I view us as being intermediaries, where we take risk from the consumer, and we transform that risk into forms that the capital markets are most likely to want to value highly. They will not

value that loan. But if we can take that loan, put it into a mortgage-backed security and have that mortgage-backed security sold, or we can take that loan, issue our debt, and own it on our balance sheet, the market values that consumer risk more highly. And so our goal is not to stock up on risk. Our goal is to be a risk dispersal mechanism and to get a reasonable return for our shareholders, but not by increasing our risk profile.

Indeed, last July, we completed a year-long study in which we set a mandatory parameter of our risk appetite, and we set a very high standard. We wanted to be, on a stand-alone basis, without any GSE trappings, a AA, AA-minus company. We wanted to have, from both interest rate risk and credit risk, a lower volatility of earnings than your typical AA company.

As you know, we do not have a lot of AA-rated financial institutions. That is a very high standard to aspire to. We did not say, "Well, we are a GSE we get away with being an A, and could not we rock-and-roll then if we took on more risk." We instead said we think it is better for us to have a low tolerance for risk because that will facilitate our long-term access to the market through all conditions and maximize our mission and our shareholder value. Senator CORZINE. How about the concept of operational risk? Mr. RAINES. Operational risk is I think a vital piece of it. Unlike other capital standards

Senator CORZINE. Do you think the capital standards that OFHEO now has in place actually take that into consideration?

Mr. SYRON. Excuse me. There is a 30-percent weight in our capital standards for operational risk, and it is appropriately so because I think the issue that you raised, as you become larger, I am not convinced that your operational risk on a proportional basis does diminish. So that is a reasonable question, but we do have a 30-percent, if you will, surcharge for operational risk in our capital ratios.

Mr. RAINES. Which is being debated in the bank context, as you know, and the banks have fiercely resisted having any capital set aside for operational risk. We are big operations.

Senator CORZINE. But should that be tied to the size of the balance sheet, ultimately, the size of the book of risk that you have played into the market?

Mr. RAINES. It probably does not correlate very well with the size of the balance sheet. It may well correlate better with the capital requirement or it may correlate better with number of loans or number of debt issuances because our operational risk comes in moving $12 trillion through the company every year, and that is more a function of the number of loans than it is of the size of the balance sheet because if the 18 million loans I think that we have are pooled into 1 million mortgage-backed securities, you do not have 18 million transactions, instead you have 1 million transactions that you are paying out on.

Senator CORZINE. As you also well know, that the hedging risk that you speak about, it is not just callable securities. There is a whole book of derivatives and other kinds of elements that are extraordinarily volatile in and of their own context, and so I think that we all need to do a lot of scrubbing on that operational risk.

And the bigger the book, the greater the danger. I am not sure it is a straight-lined element that needs to be examined.

Mr. RAINES. As well, our regulator's version of our risk-based capital standard has in it a counterparty risk element, and so it matters as to who your counterparties are, and it matters as to what your exposure is to them. So we have a big incentive, for example, to have collateral behind these obligations. So if they do not perform, we do not absorb all of the risk. There is still some residual risk, but it is mitigated by having cash collateral available.

Senator CORZINE. Those two issues are the ones that I am most interested in. I would like to see a real scrubbing. I hear a lot of complaints about the Federal Reserve study, that it is assertive, not empirical. We need to have open debate about where the subsidy or the amount of benefit that exists in the marketplace, and I think we all would be debating from a much clearer view if we actually had objective evidence about how we worked on this. I think it would be worthwhile. I would suggest that it would be worthwhile for all of us to see that all at one time, with different people having different points of view, to bring challenge to that. But it is really a remarkable thing that I have heard many of my colleagues say about where our marketplace is, and by the way we do have adjustable rates, even in the fixed rate. I guess that is called the refinancing market people.

[Laughter.]

Chairman SHELBY. What is the market capitalization? What is the value today roughly of Fannie Mae?

Mr. RAINES. You want to.know what the stock price is?

Chairman SHELBY. The market.

Mr. RAINES. I can tell you when I left the office, it was about $75 billion, but I am not so sure where it is now.

[Laughter.]

Chairman SHELBY. Mr. Syron, what was Freddie Mac's capitalization?

Mr. SYRON. Forty-two billion dollars, sir.

Chairman SHELBY. Twenty-two billion dollars.

Mr. SYRON. Forty-two.

Chairman SHELBY. What?

Mr. SYRON. Forty-two.

Chairman SHELBY. Oh, so over $100 billion, $120 billion.

What role would Congress play if we had a conservatorship? Would Congress be deciding whether to provide financial assistance once the GSE was in a conservatorship? In other words, taxpayers' money would be needed to keep it going possibly?

Mr. SYRON. Excuse me, Senator, may I try answering that? Because I think the point is absolutely correct about the difference between receivership and conservatorship between the GSE's and an ordinary depository institution, where you have the deposit insurance funds.

I mean, actually, if we think that there is this implied guarantee, leaving that aside, but if we were to assume arguendo, as they say, and we thought that there was this implied guarantee

Chairman SHELBY. Do you think there is? I mean, do you think there is a benefit of subsidy that comes to Freddie Mac because people think there is an implied guarantee?

Senator SARBANES. I believe that the marketplace, to some degree not 100-percent-but to some degree thinks that these institutions are so large, just as they would think with Citicorp, just as they would with JP Morgan, just as they would with a variety of other investment banks in the United States, thinks that special steps would be taken if they were to get into difficulty, to answer your question directly.

Chairman SHELBY. You think that is factored in, in the marketplace, don't you.

Mr. SYRON. I do, sir. But having said that, it comes back to this issue of conservatorship versus receivership. Because if that was the case, and the Congress at some point-and I am not saying it would. It might well decide not to-if the Congress were to decide in this one, and actually it is a Nobel Laureate that estimated that the chance of a cataclysmic meltdown in these institutions was less than 1 in 500,000. I can get you the exact citation, but it was about the same as an asteroid hitting the United States.

Chairman SHELBY. I hope they do not hit at the same time. [Laughter.]

Mr. SYRON. Well, I do not know. It might not be all bad if you

Owe us.

[Laughter.]

Chairman SHELBY. You might not distinguish one from the other. Mr. SYRON. Yes, that is right.

If you were to think in that 1 in 500,000 case or whatever probability you were to assign on it, that the Congress would have to do something, then, in that regard, it would be, you know it really would not make a difference if you were in receivership. There would be no advantage to being in receivership because the assets of the Enterprises would have to go to the debtholders. There would be no insurance fund or anything else. The question would be then, after the assets of the Enterprise were fully liquidated were they sufficient to address all of the claims of the debtholders. Chairman SHELBY. Would there be anything left?

Mr. SYRON. Exactly.

Mr. RAINES. Senator, I think, with regard to the conservator, what would happen is that what a conservator would do is we would all be fired. A conservator would be running the company, and the goal of the conservator would be to pay off the liabilities of the company, and the conservator would wind down the company and pay off as many of the liabilities as the conservator could. At the end of the day if there were fewer assets than there were liabilities, he would announce simply that there was not enough money to pay everybody and that the company is no longer functioning. Undoubtedly, our regulator would report to the Congress that the Enterprise had failed or was in the course of having failed. Now, would Congress at that point say this is so important that we need to do something? I have no idea. I think it depends entirely on what the circumstances are.

Chairman SHELBY. Senator Sarbanes and I sat on this Committee during the thrift debacle. We understand.

Mr. RAINES. There has been the thrift debacle, there has been the airline debacle, there has been Chrysler. There have been many occasions where the Congress, no one had ever uttered the

word that there might be some implied guarantee, where Congress, for public policy reasons, decided it wanted to intervene but there is no obligation on the Congress of the United States to appropriate any funds to any conservator. The conservator only has the assets of the company to work with.

Chairman SHELBY. But if you had a receivership, and if you had language in there to what the receiver could do or not do or the steps within certain things, wouldn't that work? Because all receiverships, they do not go straight to liquidation in all receiverships, do they?

Mr. RAINES. No, but if the receiver has the authority to displace the senior debtholders, then that will be a huge problem because our debtholders would wonder for what reason do they have their authority?

In the bank's situation, it has been made clear that the receivers there cannot avoid certain contracts in order to protect those obligations. But in the discussions that I have heard, I have seen no such protection being suggested for the debtholders of Fannie Mae, and I think it just adds an element of confusion, particularly since it is not clear to me that you could apply a new receiver provision to the outstanding debt because those debtholders put their money forward under an entirely different regime. They have a contract, and it is not clear to me that that contract can be abrogated after the fact without having given them notice before they bought the securities.

Chairman SHELBY. I know in a private company, if a company goes bankrupt, the bondholders stand in a high-priority relationship. Stockholders' equity

Mr. RAINES. Right, gone.

Chairman SHELBY. —they are really at risk.

Mr. SYRON. Senator, I think the question is what is the advantage of receivership versus conservatorship, and as far as I can see, from the public FISC point of view, there is no advantage of receivership over conservatorship, but it comes with this cost of casting a shadow, particularly in international capital markets, over the claims about debtholders. So that is the way I would be inclined to look at it.

Senator SARBANES. When you say your "debtholders," who are you referring to?

Mr. SYRON. I am referring, sir, to the debtholders not of mortgage I am not referring to the holders of mortgage-backed securities. I am referring to the people that hold the debentures of the corporation, both domestically and overseas.

Senator SARBANES. Well, what would happen to the holders of the mortgage-backed securities?

Mr. SYRON. The holders of the mortgage-backed securities would have, I mean, we are responsible for the payment of the faith and credit, but the holders of the mortgage-backed securities would have ultimately to fall back on the assets, the mortgages that secure them and ultimately, if necessary, on the properties that were held. And given the history of these things, they would be in a quite favorable position.

Senator SARBANES. Who would get paid first?