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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. aken 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 environme 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 mis. sion 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
PRESIDENT AND CHIEF EXECUTIVE OFFICER
FEBRUARY 25, 2004
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.
When I testified before this Committee in October 2003, I outlined a set of four principles that framed the Bank System's bottom-line needs regarding a new reguIatory 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 commu
nity development. • Preserve our regional affordable housing programs, which create housing opportu
nities 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 bil
lion 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.
• 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. • Not limit the financial management tools available to prudently manage the fi
nancial risks inherent in our funding and business activities. Preserve the Unique Nature of the Bank System
While all three GSE's have much in common, we believe it is important to both recognize and preserve the unique nature of the FHLBanks.
Therefore, any legislation must: • Preserve the cooperative ownership of the Bank System and the joint and several
liability that is the underpinning of the Bank System. • Preserve the unique regional structure of the 12 Banks that assures we are locally
controlled and responsive to the financial and economic development needs of our communities.
I also would like to speak more specifically to the regulatory structure we understand is under discussion—that of an independent agency that operates outside of a cabinet-level department.
I will present to you this afternoon the Bank System's view on the following aspects of this proposed structure: • Ensuring regulatory independence. • Agency oversight responsibilities. • Creating separate divisions for the Federal Home Loan Banks and the publicly
traded housing GSE's. Ensuring Regulatory Independence
A regulator lacking true independence is often subject to a wide range of demands and influences that we believe would be detrimental to the supervision, business activities, and mission fulfillment of the housing GSE's. The regulator of this new, proposed agency must have a laser focus on following the will of Congress in assuring fulfillment of the mission and the safety and soundness of the housing GSE's, not the agendas of outside agencies and other political influences.
We know that some have discussed the possibility of an advisory body in addition to or as a part of this regulator. The Bank System understands the potential value of a board or advisory committee, and the regulatory role other cabinet-level departments have played in the past. However, it is important that the new “world class” regulator not be hamstrung by a cumbersome board structure, and not be dominated or controlled by any single agency represented on the board. This new regulatory body must have the authority to govern-promulgate rules and perform its safety and soundness role. Agency Oversight Responsibilities
The Bank System believes this independent regulator should have the following authorities: • Ensuring the safety and soundness of the housing GSE's. • Overseeing all mission-based goals and programs.
There are obvious differences in the mission-based goals and programs for the two housing GSE's and the Federal Home Loan Banks. We are required to annually contribute 10 percent of our net income for affordable housing grants, while Fannie Mae and Freddie Mac have affordable housing goals. However, we believe a proposed new regulator should have the authority to review, approve, and monitor all mission-based goals and programs. Though we appreciate the goals the other housing GŜE's maintain, we believe that in addition to greater consumer access to credit, one of the best ways of passing along our subsidy is through our Affordable Housing Program and the direct 10 percent contribution made by each of the 12 Federal Home Loan Banks annually. In addition, our current regulator has that mission-oversight authority, and we believe it has served the Bank System, its members and their communities very
well. • Setting capital standards.
Along with independence, any world-class regulator must have the authority to set both leverage- and risk-based capital standards. As you know, Congress conducted an extensive review and revision of our capital structure in the GrammLeach-Bliley legislation, and the Federal Housing Finance Board was given this broad authority in the Act. We believe any new regulatory agency should have the authority to raise and lower capital requirements as deemed appropriate and necessary. Anything less, in our opinion, would be a significant step backward.
Approving new business activities and programs. Having the capacity to innovate and keep pace with an evolving financial services industry is critical to all 12 Federal Home Loan Banks. We believe a world-class regulator should preserve the Bank System's ability to innovate around existing products and services. In turn, the regulator should be diligent in examining and approving these innovations and exploring areas that represent new risk to the GSE. Speaking on behalf of the Seattle Bank, I believe our Mortgage Purchase Program (MPP) is a good example of where a regulator insisted on close oversight and then approved a new business line. This new activity was and remains fully consistent with our mission and the statutory authority Congress conferred, but prior review was appropriate because it entailed substantial new risks. Likewise, going forward, the new regulator should enjoy and exercise the same authority to approve innovation. In turn, a Federal Home Loan Bank should be expected to demonstrate, first, that it has the capacity to manage the business before it is allowed to incur substantial new risk. Since nothing is static in financial services generally—and housing finance in particular—it is incumbent upon the regulator and regulated alike to remain vigilant. To that end, we continue to strengthen our internal infrastructure in an effort to better manage the risks of this new business, which has proven to drive significant value back to our mem
ber shareholders and lower housing costs for consumers. Creating Separate Divisions for the Bank System and the Publicly Traded Housing GSE's
While Fannie Mae, Freddie Mac, and the Federal Home Loan Banks all share GSE status, we are, fundamentally, very different entities.
The Federal Home Loan Banks are cooperatively owned and capitalized by our members, most of whom are community banks occupying and delivering benefits to Main Streets across the country, while the other two housing GSE's must meet the quarterly earnings expectations of Wall Street investors.
To that end, the Bank System believes that creating separate divisions within a regulatory structure would add efficiencies in the provision of appropriate oversight and supervision. Our assumption is that staffing from previous regulatory agencies—such as the Finance Board and OFHEO—could be retained to provide a baseline of expertise for the two divisions.
In concluding this afternoon, I want to emphasize to the Committee that the onus for strengthening our system lies not only with Congress and regulators, but also with the housing GSE's themselves.
We must be willing to take the steps necessary to efficiently manage our financial institutions in a safe and sound manner, and provide world-class financial transparency and disclosure regarding our business operations. The Federal Home Loan Banks unanimously support providing enhanced, comprehensive, and fully transparent securities disclosure. On that point, there is no debate.
Where there is a difference of opinion among the Banks—and where there has been much discussion with our regulator, the Federal Housing Finance Board, and others—is concerning who should have authority over financial disclosures and transparency: The Securities Exchange Commission (SEC) or the housing GSE regulator. From the Bank System's perspective, we believe that a world-class regulator with the experience and expertise to oversee the housing GSE's would, potentially, be better able to set the framework and supervision for the level of financial disclosure now being demanded of our system.
If Congress' intent is to create a new, independent regulatory structure for the housing GSE's, why not invest the agency with the authority to oversee financial disclosure? Why not accommodate in this new framework the resources and expertise to supervise financial disclosure that conforms to SEC standards, yet fits appropriately within the Congressionally mandated scope of the housing GSE charter and mission?
We would respectfully request that this Committee consider this as an option as you continue your regulatory restructuring discussions for the housing GSE's.
However, if Congress were to choose the SEC to regulate these financial disclosures, the Bank System believes some very specific accommodations would be necessary.
The Banks have identified financial, operational, and legal considerations that could lead to uncertainties and risks to the system and adversely affect their ability to carry out their Congressionally mandated housing finance mission.
As just one example-issuer stock-repurchase requirements.