We also urge the Committee to maintain a new program standard, not a new activity standard. In saying that, based on earlier discussion, I note that there seems to be a little confusion about the definition of those terms, but I think there is some precedent to indicate what programs HUD dealt with in the past. Requiring the regulator to provide advance approval of each and every new activity significantly exceeds the standard required of banks and could chill innovation and mortgage lending.

Freddie Mac supports parity of supervisory and enforcement powers among financial institutions. Although an array of powers currently exist, we would support providing the new regulator additional authority, such as new removal and suspension authority and new authority to assist civil money and criminal penalties.

Now, let me say a few words about mission oversight. In 1992, Congress established three GSE affordable housing goals: An income goal, a geographic goal, and a special goal for unmet needs as determined by HUD.

HUD has significant discretion to establish and adjust these goals and has raised them markedly over the years. Today, 50 percent of our mortgage purchases must be dedicated to meeting these needs. The GSE affordable housing goals are the toughest of any financial institution. Additional statutory goals could simply balkanize the mortgage market.

And I may say, departing slightly from my written and oral comments, that within Freddie Mac, at least, our Economic Department would disagree with Secretary Martinez' conclusion that we are lagging the market. If you compare apples-to-apples and oranges-to-oranges, we do not believe we are. FHA has a different mission. Therefore, its percentage would obviously be different from ours, and we are limited statutorily, and by safety and soundness standards, to certain parts of the market which, when you put it all together, makes us look like we are lagging, but within our universe, we do not feel we are.

HUD also has significant enforcement powers. Not only can HUD require the submission of a housing plan should we ever fail to meet one of our goals, but it can also require a housing plan if it determines there is a good chance that we might miss a goal. By contrast, bank regulators cannot bring enforcement proceedings against an institution failing to meet its CRA obligations.

Considering that we consistently have met the goals since they have become permanent, and that existing powers already are the industry's toughest, we respectfully suggest no additional powers are needed.

In summary, Freddie Mac is prepared to embrace significant enhancements which will make our regulatory structure stronger. Building these enhancements into existing law would give the new regulator supervisory and enforcement powers comparable to those of bank regulators. The new structure would also maintain the tougher GSE regulatory requirements, including program approval standards and a risk-based capital stress test.

Our mission regulator would continue to oversee the most challenging, quantitatively affordable housing goals in the industry, with more than adequate powers to enforce them. Taken together, this enhanced GSE regulatory structure would be strong, solid, and

credible. It is essential to maintaining the confidence of the Congress and the public.

I would look forward to working with Chairman Shelby, Ranking Member Sarbanes, and other Members of this Committee as you move forward to address these issues, and I will be obviously happy to answer any questions the Committee may have. Chairman SHELBY. Thank you.

Mr. Rice.

STATEMENT OF NORMAN B. RICE

PRESIDENT AND CHIEF EXECUTIVE OFFICER
FEDERAL HOME LOAN BANK OF SEATTLE

Mr. RICE. Thank you. Good afternoon, Chairman Shelby, and Ranking Member Sarbanes, and Members of the Committee. I am Norman Rice, President and Chief Executive Officer of the Federal Home Loan Bank of Seattle, and I would like to thank you for the opportunity to speak today on behalf of the Council of Federal Home Loan Banks.

I will just start this afternoon by commending Congress for the process now underway regarding regulatory restructuring of the housing GSE's. It is also important to note that the Bank System continues to work toward voluntary SEC registration, pending resolution of some critical accounting and reporting accommodations. For example, the Seattle Bank's Board of Directors, at our September 2003 meeting, adopted a resolution calling for SEC registration, and we are now moving to make that happen. The bottom-line goal for our 12 banks is to provide complete and transparent financial disclosures that are considered no less than best in class.

While there remain differences of opinion within our system on the matter of regulatory reform, we have reached consensus on four principles that we believe must serve as a framework for specific action and represent our bottom-line concerns as Congress moves forward on legislation.

Principle No. 1: Preserve and reaffirm our mission. We strongly believe any legislation should accomplish the following regarding the mission of the Bank System: Provide cost-effective funding to members for use in housing finance and community development; preserve our regional affordable housing programs; support housing finance through advances and mortgage programs; and allow for innovative new business activities that advance our mission.

Principle No. 2: Create a strong and independent regulator. Safety and soundness of the Bank System is our number one concern. This is neither a partisan nor an ideologically driven endeavor. It is for this reason we ask that Congress protect the Bank System through the creation of a strong and independent regulator. This is absolutely consistent with the role of other bank regulatory agencies in which the regulator responsible for safety and soundness has free and unfettered authority to determine policy, rulemaking, adjudicative, and budget matters.

We strongly believe that a regulator lacking true independence may eventually find itself pursuing other agendas, not the will of Congress, nor what is demanded to ensure safety and soundness. Principle No. 3: Preserve the Bank System funding. It is critical that we ensure that nothing is done to any of the housing GSE's that would increase their cost of funds and, correspondingly, in

crease costs for financial institutions and consumers. Therefore, any legislation must: Preserve the role and function of the Office of Finance, which issues our system's debt; It must ensure that neither the U.S. Treasury, nor the independent GSE regulatory unit, has the ability to impede or limit our access to the capital markets without cause; And it must not limit the financial management tools available to the GSE's to prudently manage risk.

Principle No. 4: Recognize and reaffirm the unique nature of the Bank System. We believe any legislation must preserve the cooperative ownership of the Bank System, joint and several liability, and the regional structure that assures we are locally controlled and responsive to the needs of our communities.

Regardless of the regulatory structure established by Congress, we believe these principles must be considered as you move forward in your policymaking. So, in closing, I would like to put forward some ideas that reflect my own thinking on these matters.

I believe there are two threshold issues that could help Congress attain its goal of protecting the public interest in the housing GSE's.

First, there is much that separates the Federal Home Loan Banks from the two other housing GSE's: Our mission is broader, incorporating economic and community development. We have different capital requirements; The Bank System is cooperatively owned and capitalized by our members, while the other housing GSE's must meet the earnings expectations of Wall Street; The other two housing GSE's pay Federal income tax, but the Federal Home Loan Banks pay special taxes, equivalent to a Federal corporate income tax rate of 26 percent.

These are not inconsequential differences. Yet, despite these differences, we increasingly have more in common. All three housing GSE's are managing increasingly complex sets of financial, operating, and accounting risks. And in my view, all three would benefit from more rigorous oversight of these activities.

Second, the choices you make on regulatory reform must be based on the underlying philosophy about the housing GSE's. In your judgment, is the public interest best advanced by encouraging competition or encouraging market domination? In the end, I believe the Nation's home lenders will better serve the Nation's homebuyers if there are choices and competition in the secondary mortgage market. Full-fledged competition among GSE's is a way to more prudently manage growth and disburse risk among more investors.

As one of 12 Federal Home Loan Bank presidents, my responsibility is to protect and enhance this cooperative and the overall public interests invested in our Bank System-the same process that each of you bring to this process.

I would like to thank you for your time this afternoon, and I would be also happy to answer any of your questions you may have regarding my testimony.

Chairman SHELBY. Thank you very much.

Mr. Raines, the minimum capital threshold of 2.5 percent that Fannie Mae and Freddie Mac are subject to is often compared, as we know, to the 4-percent-minimum capital standard the banks and thrifts must meet. Do you believe that is a fair comparison?

Mr. RAINES. I do not believe it is a fair comparison, for several

reasons.

First, the minimum capital requirement that we have applies not just the 2.5-percent on-balance sheet, but also there is a 45 basis for off-balance sheet items, which banks do no count off-balance sheet items in the calculation of their so-called minimum capital. But more importantly, banks are in a far more risky business than we are.

Chairman SHELBY. Elaborate on that for the record. We basically know that a first mortgage on a home is probably one of the safe investments. I mean, it is not perfect, but it is pretty safe. Would you compare it to some of the other risks that banks take.

Mr. RAINES. Yes, sir. I think the simple comparison is to compare capital to losses. If you compare our capital to our losses on an annual basis, we have 450 times more in minimum capital than in our annual losses. A typical bank has 15 times.

Chairman SHELBY. Four hundred fifty times?

Mr. RAINES. Four hundred and fifty times as much minimum capital as our losses, a typical bank 15 times, a typical large bank, 12 times.

Chairman SHELBY. And how long is this 450? Is this this year or what about the last

Mr. RAINES. It has been maintained for many, many years.
Chairman SHELBY. It remains constant.

Mr. RAINES. And, indeed, even if you just look at banks' residential mortgages, banks lose 30 times as much on their residential mortgages as we do. So, even if we do not count their investments overseas, their investments in leases, their investments in a wide range of riskier things, if we just look at residential mortgages, they have 30 times the losses that Fannie Mae has.

Chairman SHELBY. You do not make credit card loans, do you? Mr. RAINES. We do not do that. Indeed, if we were to turn the equation around and say maybe banks should have the same level of capital that we have compared to losses, it gives you an idea of how high bank capital would have to go, even on their mortgages, if they had to have 30 times the capital that they have today.

So that is why it is very important to relate capital to risk. The most dangerous thing I think you can do in the financial system is require excess capital for the risk that is being taken because what that does is it diminishes the flow of capital into the marketplace. And so what you need to do, I believe, is to match capital with risk, and Fannie Mae and Freddie Mac, throughout our entire history, have had far lower risk profiles than comparable banks.

Chairman SHELBY. Both you and Mr. Gould have expressed your opposition clearly to a change in statutory minimum capital guidelines, but at the same time, you have generally expressed support for strengthening the authority of the new regulator using bank regulators as a model.

Why would it not make sense to allow the new regulator, if we create one, to have more discretion over the minimum capital standard?

Mr. RAINES. The major reason, I believe, is that the minimum capital standard is this capital standard relates to our mission, and it is saying how much it is that you think Fannie Mae should do.

If you double the minimum capital standard, without any change in risk, you are saying Fannie Mae can do half as much, and I believe that should stay with Congress.

But where it comes to risk, we believe that a regulator should have extensive ability to change the capital standard. Indeed, I have to say to you, and I am a very trusting person, but I have to say to you I wonder what would be the reason to raise our minimum capital standard if our risk has not gone up? What would be the reason? And the only reason I can think of is that the regulator will just have a different view of how active we should be in the housing market.

Chairman SHELBY. But, on the contrary, if the risk were not there, could a regulator not lower the risk capital?

Mr. RAINES. In theory, the regulator could lower it. We are not asking for it to be increased, and we are not asking for it to decrease. We are asking for our capital to be related to risk.

Chairman SHELBY. And if you could quantify your capital, just Fannie Mae, and I will ask Mr. Gould, what is this 2.5 percent? How many billions of dollars are you talking about?

Mr. RAINES. It is about $30 billion currently.

Chairman SHELBY. This is Fannie Mae.

Mr. RAINES. This is Fannie Mae. But on top of that, we have also pledged to issue another 1.5 percent against our assets in subordinated debt. So, if you calculate all of the capital, all of the riskbearing capital that we have, we have 4 percent capital-2.5 percent that is equity and another 1.5 percent which is subordinated debt, which if we were a bank would be counted as part of the overall capital calculation.

We have 4-percent capital if you are talking about risk bearing. Chairman SHELBY. For a lot less risk, you are saying.

Mr. RAINES. For a lot less risk, and it is important to remember that, when everyone talks about the risk to others, remember the first people who lose their money are the Fannie Mae shareholders. They have $30 billion as the first line

Chairman SHELBY. Well, that is the way it should be, is it not? Mr. RAINES. Exactly. That is why they keep me on my toes.

Chairman SHELBY. Mr. Rice, uniform capital standards for housing GSE's. You state that it is your view the capital requirements be standardized for all three housing GSE's. Are you proposing a 4-percent minimum, a 2.5-percent or regulatory discretion? What are you really saying?

Mr. RICE. I believe in regulatory discretion, but I do want to state that the Federal Home Loan Banks have had zero credit losses-zero-ever, and we are required to hold 4 percent minimum capital.

So, I would hope, with the discretion of an independent regulator, they would understand that there is some imbalance in the minimum capital standards, and maybe they would lower it to a level closer to the other housing GSE's.

Chairman SHELBY. On the other hand, the Federal Home Loan Banks can make advances based on collateral beyond mortgage-related assets; is that correct?

Mr. RICE. That is correct.