Mr. SYRON. Yes, sir. Mr. RICE. I just wanted to make a clarification, Mr. Chairman. I really believe the new regulator, when I was speaking about OFHEO's oversight, the bank still would be responsible for issuing the debt, but the oversight would still go with the new regulatory body. Chairman SHELBY. Mr. Syron, you mentioned options in the times a few years back. A lot of people believe it was not the issuance of options, it is the way the options were treated, and that is of course still subject to debate, on the balance sheets, because options do have a place, I believe, in corporate America. Mr. SYRON. Senator, I totally agree with you. My concern was that the way they were treated, from a tax perspective as compared to the way that Chairman SHELBY. That is right. Mr. SYRON. —and restricted stock was treated created unfortunate incentives. Chairman SHELBY. Absolutely. I totally agree. Gentlemen, thank you for your insights today. We appreciate it. The hearing is adjourned. [Whereupon, at 5:08 p.m., the hearing was adjourned.] [Prepared statements, response to written questions, and additional material supplied for the record follow:] Statement of Franklin D. Raines Chairman and CEO, Fannie Mae Before the Senate Committee on Banking, Housing, and Urban Affairs February 25, 2004 Chairman Shelby, Senator Sarbanes, members of the committee, thank you for inviting me today to testify on GSE regulatory reform. The last time I came before you to discuss this subject was last October. Since that time, this committee has worked diligently to give shape to a new GSE regulatory regime that ensures strong oversight of Fannie Mae and Freddie Mac. On behalf of Fannie Mae, let me express how much I appreciate the hard work and scrious thought the Committee has invested in this issue over many years and in particular over the past several months. I believe at the end of the day we share the same goals. We all want to protect, advance and strengthen the best housing finance system in the world. We all want to ensure that the government-sponsored housing enterprises, which fuel this remarkable system, continue to achieve their mission to expand homeownership in America. And we want to strengthen GSE oversight because effective oversight is in the best interest of the company, our mission, and the U.S. housing finance system. Let me repeat something I said last October: Fannie Mae supports a strong, credible safety and soundness regulator. In fact, strong, effective oversight is the backbone of our unique GSE status. Congress created Fannie Mae in 1938 as an instrument of national policy -- a policy to expand homeownership because it is good for families, communities, the economy, and the country. In 1968, Congress privatized Fannie Mae, but imposed a restrictive charter to ensure we continued to be an instrument of national policy promoting homeownership. And in 1992, Congress further focused us as an instrument of national policy, creating explicit affordable housing goals for the company and establishing a safety and soundness regulator to ensure the company's ongoing financial viability so that it could continue to serve homeowners. Strong oversight is the means by which the federal government displays its commitment to a national policy favoring homeownership. That national policy is working. Fannie Mae and Freddie Mac have helped to create a market-based, consumer-focused housing finance system that draws capital from all over the world, making long-term, fixed-rate, refinanceable mortgages more widely available at lower costs. All of this is accomplished at no cost to the government. The highly efficient mortgage market touches millions of homeowners, as well as an entire housing industry. Last year, over $3.7 trillion of single-family mortgages were originated, as an estimated 22 million households either financed a new home purchase or refinanced an existing mortgage. In each of the last two years homeowners were able to take advantage of strong home price appreciation and low interest rates by taking out over $125 billion of home equity through "cash-out" refinancing, using the proceeds both to retire other, more expensive debt and to finance home improvement or other consumer expenditures. Other homeowners who refinanced were able to lower dramatically their mortgage payments, increasing their purchasing power. For example, a homeowner with a $150,000 mortgage was able to lower his monthly payment from $948 to $852 as mortgage rates dropped from 6.5 to 5.5 percent. And low interest rates and strong demographic demand led to record home sales and a record high homeownership rate of 68.6 percent last year. We have consistently said that there should be a straightforward test for examining policy proposals that will affect our housing finance system: • Does it improve the safety and soundness of the housing finance system? · Does it expand opportunities for homeownership? · Does it support innovation necessary to better serve consumers and address the nation's toughest housing problems? There are three issues that I would like to examine in the context of these four questions today: the GSE capital regime, conservatorship versus receivership and the necessary balance between private management and public oversight. CAPITAL There has been much discussion of capital in the debate over reform of our regulatory structure. It is critical that our capital regime be considered as one integrated whole, and that when it is compared to bank capital regimes, the comparison be made on the basis of relative risk. The structure of our capital regime is different from the bank capital regime because it applies to only two companies and we essentially invest in only one asset, residential mortgages. As a result, our risks are more easily specified by a regulator and are lower than those of other financial institutions that invest in higher-risk assets such as commercial loans, credit card debt and foreign debt. Development of Our Capital Regulation In the early 1980s, faced with declining capital levels among banks, deregulation of the industry and problems caused by stagflation and crises with less-developed-country debt, U.S. bank regulators instituted numerical capital standards for the first time in the form of a leverage requirement. It was recognized that such a requirement was blunt in that it did not tie capital to risk and, in 1988, U.S. regulators joined their colleagues from other industrialized countries in instituting a risk-based capital standard in what was known as the Basel Accord. The new bank risk-based standard only covered credit risk. It divided a bank's assets into four "buckets," depending on the obligor. Government securities required no capital support. The capital requirement for agency securities was 1.6 percent, for prime residential mortgages 4 percent and for assets such as commercial and consumer loans 8 percent. Regardless of whether a commercial loan was to a blue-chip or startup company, the capital requirement was the same 8%. The rules also required that banks hold capital against off-balance-sheet exposures. Because the Basel Accord did not cover interest rate risk but, instead, was narrowly tailored to credit risk, U.S. regulators, unlike their foreign counterparts, uniquely continued to impose a leverage requirement as well as the new risk-based requirement on banks. However, they intended that this dual set of capital requirements would only be temporary until an interest-rate risk component could be developed for the risk-based standard. As Federal Reserve Chairman, Alan Greenspan, testified before this committee in 1992: "We are looking very closely at the leverage ratio which was "But now that we are in the process of getting interest-rate risk The following day he elaborated before a House committee: “And, as I've indicated elsewhere, one of the things that we are At the time Chairman Greenspan made these statements, the financial regulatory community anticipated that an interest-rate risk component of the risk-based capital requirements would be in place by early 1993.3 It is still not in place. The U.S. federal banking regulators put a lot of effort into developing an interest-rate risk capital requirement. The Federal Reserve, OCC and FDIC issued joint proposals for an interest-rate risk component in 1992, 1993 and 1995.4 Testimony of Alan Greenspan, Senate Banking Committee, July 21, 1992 2 Testimony of Alan Greenspan, House Subcommittee on Domestic Policy, July 22, 1992. 3 "The agencies are expected to adopt final rules on interest rate risk by early next year," Boston Chief Slams Regulators, Claudia Cummins, American Banker, July 6, 1992 at 2. Their efforts foundered. In June 1996, they finally abandoned attempts to promulgate an explicit interest-rate risk standard," in part because of the great difficulty in fashioning an interest-rate risk requirement for an industry comprised, at the time, of 9,500 heterogeneous banks. Where bank regulators failed, OFHEO succeeded. Based on legislation adopted by Congress in 1992, OFHEO, over a 10-year period, developed a comprehensive set of capital requirements that covered all of the risks faced by the two companies it regulates: credit risk, interest-rate risk and operations and management risk. For OFHEO the task was made easier by the fact that the new standard was designed to cover just two relatively homogeneous companies that invest in assets with broad and deeply liquid markets and finance these assets with wholesale funds." 6 That is the crux of the difference between developing capital standards for GSEs and banks. Because there are just two low-risk, transparent enterprises supervised by a focused regulator, it is possible to develop capital standards tailored to the risks they face. In contrast, bank regulators must rely on the leverage requirement to compensate for the fact that the risk-based capital standards at their disposal are not sophisticated enough to capture all the risks a bank faces and not flexible enough to adequately cover the varied circumstances that the thousands of banks encounter. Faced with these conditions, bank regulators must have the flexibility to adjust the leverage ratio when they see a bank taking on increased risk. OFHEO's Risk-Based Capital Rule Fannie Mae's exposure to a severe economic scenario is more than adequately captured by the risk-based capital test that is now in force. The risk-based capital rule is rigorous and closely aligns required capital with the risks that the company takes. Under our riskbased capital standard, we must hold enough capital to survive a ten-year period of severe economic and financial stress characterized by simultaneous movements in interest rates of up to 600 basis points and nationwide mortgage defaults equal to those experienced in the oil patch region during the early 1980s. Risk-based capital is defined as the amount necessary to maintain positive capital over this 10-year period plus an additional 30 percent surcharge to cover unspecified management and operations risk. A recent study by Joseph Stiglitz, winner of the 2001 Nobel Prize in economics, confirms the rigorous nature of this test, and the comfort policymakers should take regarding the inherent financial strength of any institution that can pass such a test. The paper 4 See 57 FR 35507 (August 10, 1992), 58 FR 48206 (September 14, 1993) and 60 FR 39495 (August 2, 1995). 3 See 61 FR 33166 (June 26, 1996). 6 One of the difficulties faced by bank regulators in developing an interest-rate risk capital requirement was determining the duration of bank core deposits such as checking and savings accounts. Although these are nominally short-term, or even overnight, funds, they are often left on deposit for extended periods of time even in the face of rising interest rates. In contrast, the duration of wholesale funds is more explicit. |