provide unfettered regulator discretion on minimum capital. Changing capital standards unnecessarily, capriciously or frequently will reduce the amount of mortgage business the GSE's can do, resulting in higher costs for homeowners and renters. Supervisory and Enforcement Parity The current legislative structure provides our safety and soundness regulator an array of supervisory and enforcement authorities to ensure that Freddie Mac is adequately capitalized and operating safely.15 If Congress were to deem it appropriate, we would support providing the GSE safety and soundness regulator authorities similar to those accorded to the Federal banking agencies. These enhanced powers would include broadening the individuals against whom the regulator could initiate cease-and-desist proceedings, new authority to initiate administrative enforcement proceedings for engaging in unsafe and unsound practices, new removal and suspension authority and authority to impose industry-wide prohibitions, and new authority to assess civil money and criminal penalties. Conservatorship v. Receivership While it may be appropriate to draw on certain banking provisions to improve the GSE regulatory oversight structure, we strongly believe the mechanism for dealing with extreme financial distress is not one of them. Receivership is an efficient disposition mechanism for thousands of Federally insured depository institutions, whose failure would not threaten the stability of and public confidence in the financial system, particularly in the Federal deposit insurance system. However, it is not a credible option for dealing with two GSE's. In contrast to the situation for most insured institutions, the decision to liquidate a GSE would have substantial economic, market, and public policy consequences. It would threaten the public policy mission of the GSE's and could potentially disrupt the legal obligations and expectations of market participants. Recognizing the unique role of the GSE's, and our mission to expand homeownership, Congress chose a different disposition mechanism when it established the current GSE regulatory oversight structure. To address the unlikely event of extreme financial distress, Congress gave the safety and soundness regulator the right to appoint a conservator, which would rehabilitate an ailing GSE. However, Congress reserved to itself the right to appoint a receiver. Although Freddie Mac believes that current law provides ample convervatorship powers, we would be willing to consider whether additional authorities could enhance Congress' and the public's confidence in our safe and sound operation. Such enhancements to existing GSE conservatorship powers would achieve the important policy objective of strengthening the GSE regulatory oversight structure without the potential unintended consequences that could result from receivership. Many market participants might view a change to receivership as a first step to privatization of the GSE's. This could have significant implications on our ability to support the market for 30-year, fixed-rate mortgages. Mission Oversight and New Program Approval We believe that the HUD Secretary should retain all existing GSE mission-related authority consistent with HUD's mission to expand homeownership and increase access to affordable housing. Specifically, HUD should retain authority to ensure that the purposes of the GSEs' charters are accomplished and continue to have regulatory, reporting, and enforcement responsibility for the affordable housing goals, just as under current law. Additionally, HUD should retain existing fair housing authority. We also believe that, in keeping with its housing mission, HUD should retain its authority to approve any new programs of Freddie Mac and Fannie Mac. HUD alone has the expertise to determine whether new mortgage programs are in keeping with our charter and statutory purposes. In this vein, we also urge the Committee to maintain a new program standard-not a new activity standard. Requiring the regulator to provide advance approval of each and every new activity significantly exceeds the standard required of banks and would chill innovation in mortgage lending. Our ability to lower housing costs for homeowners and renters is directly linked to our expertise in managing mortgage credit risk and our distinguished record of bringing innovative products and services to market. Affordable Housing Goals Meeting the annual affordable housing goals is a key aspect of our meeting our mission. Established in 1993 and increased in 1995 and 2000, the affordable housing 15 "Comparison of Financial Institution Regulators' Enforcement and Prompt Corrective Action Authorities," GAO-01-322R, January 31, 2001. goals specify that significant shares of Freddie Mac's business finance homes for low- and moderate-income families and families living in underserved areas. In 2000, HUD specified that 50 percent of Freddie Mac's mortgage purchases must qualify for the low- and moderate-income goal,16 31 percent must be of mortgages to borrowers in underserved areas, 17 and 20 percent must be of mortgages to verylow income borrowers or low-income borrowers living in low-income areas. 18 Freddie Mac has successfully met all the permanent housing goals, which are the highest and toughest of any financial institution. The existing statutory and regulatory structure provides great discretion to our mission regulator to determine the goals-and creates strong incentives for us to achieve them. The HUD Secretary currently has the regulatory authority to establish and adjust the housing goals. In the event a GSE fails to meet one or more of the goals or there is a substantial probability that a GSE will fail one or more of the goals-the Secretary is authorized to require the submission of a housing plan. Further, the Secretary may initiate a cease-and-desist proceeding and impose civil money penalties for failing to fulfill the housing plan. By contrast, bank regulators do not have authority to bring enforcement proceedings against an institution that is not meeting its CRA obligations. These are strong incentives for the GSE's to strive to meet the goals year after year-to say nothing of the reputational "penalty" for failing to meet a goal. Considering that we have consistently met the permanent affordable housing goals, and that existing powers already are the industry's toughest, additional enforcement authority seems completely unnecessary. Additional enforcement authority would add little to the legislative and regulatory incentives that Congress and HUD have put in place. Therefore, we respectfully suggest that no additional authority is needed. Market Discipline Commitments In October 2000, Freddie Mac and Fannie Mae announced a set of six public commitments to ensure the GSE's adhere to a high standard of financial risk management. These commitments continue to represent a very high "bar" among financial institutions. Excluding the commitment to adhere to an interim risk-based capital standard (which was rendered obsolete with the completion of the current risk-based capital stress test) the commitments are as follows: • Periodic issuance of publicly traded and externally rated subordinated debt on a semiannual basis and in an amount such that the sum of core capital and outstanding subordinated debt will equal or exceed approximately 4 percent of onbalance-sheet assets. Because subordinated debt is unsecured and paid to the holders only after all other debt instruments are paid, the yield at which our subordinated debt trades provides a direct and quantitative market-based indication of our financial strength. • Maintenance of at least 5 percent of on-balance sheet assets in liquid, marketable, nonmortgage securities and compliance with the Basel Committee on Banking Supervision Principles of Sound Liquidity Management, which requires at least 3 months' worth of liquidity, assuming no access to new issue public debt markets. • Public disclosure of interest-rate risk sensitivity results on a monthly basis. The test assumes both a 50 basis-point shift in interest rates and a 25 basis-point shift in the slope of the yield curve-representing an abrupt change in our exposure to interest-rate risk. • Public disclosure of credit risk sensitivity results on a quarterly basis. The disclosure shows the expected loss in the net fair value of Freddie Mac's assets and liabilities from an immediate nationwide decline in property values of 5 percent. • Public disclosure of an annual independent rating from a nationally recognized statistical rating organization. 16 Low- and moderate-income families have incomes at or below 100 percent of the area median income. 17 Underserved areas are defined as (1) for OMB-defined metropolitan areas, census tracts having a median income at or below 120 percent of the median income of the metropolitan areas and a minority population of 30 percent or greater; or a median income at or below 90 percent of median income of the metropolitan area; and (2) for nonmetropolitan areas, counties having a median income at or below 120 percent of the state nonmetropolitan median income and minority population of 30 percent or greater; or a median income at or below 95 percent of the greater of the state nonmetropolitan median income or the nationwide nonmetropolitan median income. 18 Low-income areas refer to census tracts in which the median income is at or below 80 percent of the area median income. Low-income families have incomes at or below 80 percent of area median income, while very-low income families have incomes at or below 60 percent of the area median income. In July 2002, the GSE's made an additional commitment to voluntarily register their common stock with the Securities and Exchange Commission under the Securities Exchange Act of 1934 so that both companies will become reporting companies under that law. Freddie Mac remains irrevocably committed to completing this process as soon as possible after the company's return to timely reporting. Freddie Mac would support giving the regulator authority to ensure we carry out these important public commitments. Taken together, they significantly enhance the degree of market discipline under which the GSE's operate. Robust and frequent credit and interest-rate risk disclosures, combined with the release of annual independent ratings and the issuance of subordinated debt, constitute an important "early warning system" for investors. Top Priorities for Freddie Mac Finally, I would like to say a few words about Freddie Mac-and my top priorities for strengthening this vital company and restoring the trust of the Congress, the public, and investors. Commitment to Exemplary Accounting Clearly, my most pressing priority is to get Freddie Mac's financials done and done right. On November 21, 2003, the Freddie Mac Board of Directors and our management team announced the release of the company's restated and revised financial results for the years 2000 through 2002. The restatement was a significant step in Freddie Mac's progress toward achieving accurate and timely financial reporting. The company will issue its annual report for 2002 on Friday, February 27, 2004 and hold the related annual stockholders' meeting on March 31, 2004. As for 2003 and beyond, we are currently working around the clock with the objective of releasing quarterly and full-year 2003 results by June 30, 2004 and to provide the 2003 annual report and hold the related stockholders' meeting as soon as possible thereafter. I am also focused on ensuring that these problems do not happen again. I am pleased to report that, under the guidance of our Board of Directors, Freddie Mac is building an environment that will allow us to provide comprehensive and understandable information about our company, incorporating the highest level of financial transparency, accounting controls, compliance, and professional standards. Our aim is not simply to meet what is required but to become a model of financial excellence. We have added over 100 professionals in the accounting, reporting, and control areas, including a significant number of new officers and senior managers. We have also retained leading experts in the areas of public disclosures and corporate governance to assist the company in designing and implementing processes and practices in these areas. In October 2003, we hired a Senior Vice President-Chief Compliance Officer who is responsible for overseeing Freddie Mac's compliance with policies, procedures and practices, including compliance with laws and regulations. Additionally, in October 2003, we created the position of Chief Enterprise Risk Officer. Both of these positions currently report directly to me. We are also working to create and implement new infrastructure and systems to ensure the quality, integrity, transparency, and timeliness of our financial reporting. Finally, we have taken steps to ensure that Freddie Mac's corporate culture promotes integrity, high ethical standards, and the importance of compliance. Virtually all of our employees have completed a corporate-wide training program on the company's Code of Conduct and the provisions of the Act sponsored by Senator Sarbanes and Chairman Oxley. The scope of these activities is wide and deep. I was deeply involved in the transformation of a Fortune 500 company before, and I am committed to doing it again. Freddie Mac is on the path to becoming a new and better company. Enhanced Commitment to Mission My second priority is to renew and expand the company's commitment to mission. It is a great honor to be the leader of a company that has an explicit mission to do good things for society. There are very few publicly owned companies that have such a "higher calling"-and, as a Nation, we should work to make them better, as is the Committee's intent. The special privileges that flow from the GSE charter entail special responsibility. While the annual affordable housing goals are an important component of our mission to expand mortgage market accessibility, I view the goals more as a threshold than a ceiling. I am particularly focused on the housing finance needs of minority consumers. The homeownership rate for African-Americans is 48 percent and 47 percent for Hispanics. We must do better-and we will. When I was at the Federal Reserve Bank of Boston, I oversaw one of the first major research projects looking at discrimination in mortgage lending. That research led to calls for greater objectivity in mortgage underwriting and eventually to the birth of automated underwriting. Automated underwriting systems, such as Freddie Mac's Loan Prospector®, have played a critical role in expanding minority borrower access to mortgage markets. Now Freddie Mac is looking at ways to integrate nontraditional credit variables into automated underwriting. It won't be easy-but neither was creating the first mortgage-backed security, which is now widely traded around the world. We are also studying the best way to extend the efficiencies of the conforming mortgage market to the subprime market. This market serves a needed function, but many borrowers particularly minority borrowers-could qualify for lower-cost conforming mortgages if they had the chance. Further, abusive lending practices make this market ripe for the standardization and accountability that the GSE's provide. It is time to transform that market so that is serves borrowers better. These and other initiatives to enhance Freddie Mac's commitment to mission are currently under active consideration. I would be happy to return to the Committee at some future point to describe specific new commitments Freddie Mac will make to further expand access to low-cost mortgage money for more families. Maintaining Safety and Soundness A final priority is to maintain Freddie Mac's rock-solid commitment to safety and soundness. Despite last year's accounting travails, Freddie Mac's franchise was safe and strong. Our safety and soundness regulator, the Office of Housing Enterprises Oversight (OFHEO), continually assessed us as "adequately capitalized," the highest rating. And we are in full agreement with OFHEO's directive of [date] to hold excess capital until our financials are complete. I have been particularly impressed by the company's assiduous management of interest-rate risk. Each day at 5 p.m., I receive a set of measures of Freddie Mac's exposure to interest-rate risk for that day. And each month, investors around the world see what I see when the company discloses our average monthly duration gap and other statistics. Only the housing GSE's provide such frequent and transparent measures of risk exposure. Freddie Mac is clearly a company that is serious about managing risk-and good at it, too. This will not change. If anything, I will see that our risk management practices and disclosures are strengthened. Conclusion Freddie Mac strongly supports the enactment of legislation that provides strong, credible regulatory oversight. These enhancements are needed even overdue. They are critical to the achievement of our mission and to maintaining the confidence of the Congress and the public. As a former regulator, I strongly support significant enhancements that will make our regulatory structure stronger, in many cases, than the bank regulatory_model. Building these new enhancements into existing law would give the new GSE regulator comparable supervisory and enforcement powers as bank regulators. In addition, these enhancements would impose tougher regulatory requirements in many areas. Our mission regulator would continue to oversee the most challenging, quantitative affordable housing goals in the industry-with tremendous powers to enforce them. These enhancements will ensure that we improve on the greatest housing finance system in the world-without damaging it. A measured approach to reform is critical to keeping the door of homeownership to a new generation of homebuyers. Thank you for the opportunity to appear today. I look forward to working with Chairman Shelby, Ranking Member Sarbanes, and the Members of this Committee to secure the future of our housing finance system and, with it, the dreams of millions of families. PREPARED STATEMENT OF NORMAN B. RICE FEBRUARY 25, 2004 Good afternoon Chairman Shelby, Ranking Member Sarbanes, and Members of the committee. I am Norman B. Rice, President and Chief Executive Officer of the Federal Home Loan Bank of Seattle. I would like to start today by underscoring the critical importance of this Committee's work-and that of Congress and the Administration-in supporting a worldclass regulatory structure that ensures and enhances the safety, soundness and economic viability of the housing Government Sponsored Enterprises (GSE's). In my role representing the Council of Federal Home Loan Banks before this Committee, I wanted to very clearly state our support of this effort. The Bank System should-and must-at all times lead by example in terms of pursuing the highest levels of oversight and public accountability. This Committee is to be commended for the thoroughness of the process and efforts regarding the creation of a new regulatory structure for the housing GSE's. We believe the strong, independent structure being discussed can serve the Bank System-and the more than 8,000 community financial institutions we serve-appropriately, and we stand committed to working with you in this effort. The Federal Home Loan Banks are also acutely aware of how much is at stake in this process for those who struggle to make ends meet and find safe, affordable housing in communities across our country every day, for American residents and taxpayers, and for our member shareholders. We understand that this Committee is considering the creation of a new agency. If so, it is imperative that the agency you create improves the oversight, the mission delivery, and the effectiveness of the business activities of the housing GSE's-not hinder them. outlined a set of four When I testified before this Committee in October 2003, principles that framed the Bank System's bottom-line needs regarding a new regulatory structure for the housing GSE's. These continue to be the key elements we believe must be included in legislation in order to create a world-class regulator. What I put forth, in essence, were the pillars on which the Bank System cooperative rests the elements that allow our 12 Banks to provide more than a half trillion dollars each year in advances to our member shareholders; that allow us to issue more than $150 million in Affordable Housing Program grants to communities across America; that allow us to provide more than $9 billion annually in reducedrate loans for the purpose of community and economic development that benefit lowto moderate-income families and neighborhoods. Critical to what must be contained in a regulatory structure? Yes. Critical to the economic health of the communities our member shareholders serve? Yes. Those Bank System principles include the following: Preserve and Reaffirm the Bank System's Mission Mission is everything to us. We strongly believe that any legislation should accomplish the following: • Provide cost-effective funding to members for use in housing finance and community development. • Preserve our regional affordable housing programs, which create housing opportunities for low- and moderate-income families. Since the inception of our Affordable Housing Programs in 1991, the Bank System has contributed more than $1.7 billion in grants to communities across America. • Support housing finance through advances and mortgage programs. • Preserve the Bank System's ability to bring to market innovative new business activities that advance our mission without creating a cumbersome process that prevents us from responding in a timely way to the needs of our member financial institutions. A Strong and Independent Regulator Safety and soundness of the Bank System is our No. 1 concern. 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, application, adjudicative, and budget matters. It is essential that this regulator have the independent authority to promulgate rules and perform its safety and soundness role without undue outside agency interference. Preserve Bank System Funding It is critical that we ensure that nothing is done that increases the Bank System's cost of funds and, correspondingly, increases costs for consumers and financial institutions. Therefore, any legislation must: • Preserve the role and function of the Office of Finance and clearly establish it as an entity of the Federal Home Loan Bank System, regulated and examined by the System's regulator. |