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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 financial 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.

are

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 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 dis

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

perse risk.

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.

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