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servatorship and maintaining the ongoing business value may not be the appropriate course of action. The broad goals of financial regulation in this regard should be to promote a resilient housing finance system. Maintaining the operations of an entity that is no longer viable is inconsistent with that goal. We look forward to working with the Committee in developing specific receivership authorities for the new regulatory agency. RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM JOHN W. SNOW Q.1. It is my understanding that if a new GSE regulating entity is created as an office within the Department of the Treasury, you would approve such a proposal only if Treasury had the power to approve its testimony, clear all of its proposed regulation, and maintain full control of its budget.
If we are to establish a world-class regulator for the GSE's, isn't it important that such a regulator be an independent entity, like the Office of the Comptroller of the Currency (OCC), rather than an office within the Treasury Department, in order to ensure that its decisions are insulated from partisan politics and have greater credibility in the investor community? Furthermore, you stated that you believed that it was necessary for Treasury to have these powers over the new regulator in order to disabuse the investor community of any perceived Government backing. Wouldn't placing the regulator within Treasury with these powers increase that perception? A.1. The degree of independence for a new GSE regulatory agency is vitally important with regard to specific matters of supervision, enforcement, and access to the Federal courts. The ability of the new regulatory agency to take actions regarding supervision and enforcement outside of the political process is important for ensuring that the new agency can properly oversee the operations of its regulated entities. Without such independence, a regulator may be prevented from taking the appropriate regulatory actions if such actions have unpopular political consequences. Likewise, providing the new regulatory agency with access to the Federal courts provides it with a necessary tool to perform its duties, and such access is consistent with the powers of our Nation's other financial regulators. Permanent budget authority is also an important component of independence for the new GSE regulatory agency.
While political independence for the new regulatory agency is important, the structure and location of the new regulatory agency deserves special consideration. Drawing upon the statements of those who have recommended placing the new regulatory agency within Treasury, it seems that it is believed that the Treasury would lend stature, authority, depth of experience, and a broader perspective to the new agency. None of those things would be available if Treasury is walled off from the policymaking processes (approving testimony, clearing proposed regulations, and having review authority over the budget) of the new agency.
Establishing a new regulatory agency for the housing GSE's within the Treasury Department does create the potential for reinforcing any market misperception of an implied guarantee of GSE obligations. That is why it is vitally important that the Treasury Department be able to monitor the new regulator's policies to ensure that such policies are not reinforcing any market misperception of an implied guarantee and that such policies encourage greater market discipline of the GSE's. In that regard, Treasury approval of the new agency's policies will ensure that there is no confusion between Treasury debt, which is backed by the full faith and credit of the U.S. Government, and GSE debt, which does not have such backing. Q.2. Do you believe that the current GSE minimum capital standard of 2.5 percent is too low or too high? Please explain in detail.
Has Treasury performed an analysis of the impact a change in the GSE minimum capital standard might have both on the housing and the investor markets? If so, please submit this analysis for the record. On what basis do you believe the decision to increase or decrease the minimum capital requirement should be made? Please describe how you envision the process to work. Do you believe that the Director of the proposed financial regulating entity should have the sole discretion to set both the risk-based and minimum capital standards? Why would allowing the regulator to have discretion over risk-based capital be insufficient to maintain safety and soundness for the GSE's? A.2. The current minimum capital standards for Fannie Mae and Freddie Mac are set in statute at 2.5 percent of on-balance-sheet obligations and 0.45 percent for certain off-balance-sheet obligations. We believe that the new regulatory agency should have broad authority with regard to setting the capital requirements of the Enterprises, both with respect to risk-based capital and minimum capital. It is not a question of whether the current standard is too high or too low, but rather that the authority for setting capital standards needs to be flexible enough to employ the best regulatory thinking, conscious of the Enterprises' own measures of risk, so that the regulator can require that its regulated entities maintain capital and reserves sufficient to support the risks that arise or exist in its business.
In regard to the impact a change in the GSE minimum capital standard might have both on the housing and the investor markets, we would not expect the new regulatory agency to initiate such a change unless the risks undertaken by the GSE's warranted such a change. In that regard, changes in capital standards should go toward strengthening the financial position of the GSE's and further promoting our goal of a strong and resilient housing finance system that serves the needs of our Nation's homeowners. In addition, we would expect that any such changes to capital standards would go through the standard notice and comment rulemaking process that all financial regulatory agencies employ.
Similar to the authority of our Nation's other financial institution regulators, the new regulatory agency for the housing GSE's should also have the authority to adjust the GSEs minimum capital standards. Minimum capital standards provide protection against the general, indefinable, perhaps unforeseen risks that are present with any financial enterprise. Financial institution regulators rely on both minimum and risk-based capital standards in evaluating the financial health of their regulated entities. While risk-based capital standards are more finely tuned to the particular risks of a financial institution, the methodology for determining such standards is subject to its own unique set of risks. One such risk is model risk—the risk that the financial models underlying the risk-based capital standard turn out to be incorrect. Model risk is a key indefinable or unforeseen risk that risk-based capital standards will not adequately capture. Thus, not providing the new regulatory agency with the ability to adjust minimum capital standards would limit new agency's effectiveness as a financial regulator. Q.3. Current law provides that if one or both of the GSE's were in serious financial trouble, they would be placed in conservatorship, meaning that the Office of Federal Housing Enterprise Oversight (OFHEO) would attempt to financially restructure the GSE's to maintain their assets. In your testimony, you recommended changing this authority to "enhanced receivership,” directing the new regulator to liquidate the assets of the GSE's with “appropriate wind down authority.” Why do you believe that the current conservatorship authority should not be kept? Why is it not in the public interest to maintain the assets of the GSE's, instead of liquidating them to private entities? A.3. The Administration's proposal regarding receivership does not envision eliminating the new regulatory agency's authority to place an entity into conservatorship, but rather it provides the new regulatory agency with the receivership authority necessary to direct the orderly liquidation of assets and otherwise to direct an orderly wind down of an enterprise, in full recognition that Congress has retained to itself, in the case of Fannie Mae and Freddie Mac, the power to revoke a charter. Such receivership authority is necessary because if financial circumstances were sufficiently troubling, placing an entity in conservatorship and maintaining the ongoing business value may not be the appropriate course of action. The broad goals of financial regulation in this regard should be to promote a resilient housing finance system. Maintaining the operations of an entity that is no longer viable is inconsistent with that goal. Q.4. How does Treasury plan to regulate the process for new program and activity approval of the GSE's? In your testimony, you asserted that you believed Treasury did not recommend prior approval of new products and activity, but you did recommend giving Treasury the ability to withhold prior approval of new programs. Please elaborate on this. What criteria would Treasury propose for approval of new programs and activity? Please describe them in detail. How would this process differ from the current process administered by HUD? How would Treasury propose defining the difference between new programs and new activity? Many policy experts believe there is an unavoidable tension between maintaining safety and soundness and aggressively pursuing affordable housing goals. In reviewing new GSE programs and activity, how would Treasury balance safety and soundness of the GSE's with their housing mission objectives? What expertise in housing finance does Treasury have, that HUD does not, to justify Treasury becoming the new program and activity regulator?
A.4. The Administration has proposed that the authority for approving new activities of the housing enterprises be transferred from the Department of Housing and Urban Development (HUD) to the new regulatory agency. This proposal is consistent with availability of one of the central tools that every effective financial regulator has—the ability to say “no” to new activities that are inconsistent with the charter of the regulated institutions, inconsistent with their prudential operation, or inconsistent with the public interest. The current financial regulator for Fannie Mae and Freddie Mac lacks that authority, one of its most serious weaknesses, and if we are serious about creating an effective, credible financial regulator, it must have the authority to approve new activities.
As long as we are going to maintain a bifurcated regulatory structure for Fannie Mae and Freddie Mac, there may be some tension between mission regulation and safety and soundness regulation. As it relates to new activities approval, the Administration's proposal addresses this tension by providing the Secretary of HUD with a consultative role in reviewing new activities. Through this consultative process, HUD would continue to have an important role to play in providing its expertise on new activities that have a direct impact on the housing and mortgage markets.
The Administration's proposal for regulatory reform of the housing GSE's also strengthens the authority of HUD to promote the housing goals of Fannie Mae and Freddie Mac. In particular, HUD would continue to have responsibilities for setting the affordable goals for Fannie Mae and Freddie Mac and enforcing the Fair Housing Act. Under our proposal, HUD would also be provided explicit enforcement authority over the housing goals to ensure that Fannie Mae and Freddie Mac are meeting their housing promotion requirements.
In terms of the process for new activities, it is important to understand that Treasury's formal role in approval of new activities would only arise in those few cases when a new activity was such a departure from existing norms as to require formal promulgation of a new regulation. That is to say that variations within the GSEs’ current secondary market activities that clearly are authorized by statute may not require any Treasury review of proposed regulatory changes by the new agency. In fact, we would not expect approval of new activities to require new regulations in most cases. Q.5. In your testimony, you argued that including the Federal Home Loan Bank (FHLB) System in GSE regulatory reform would be better than keeping them out. However, you mentioned that there were significant differences between the FHLBanks and the other housing GSE's. What differences between the FHLBanks and the other housing GSE's do you believe are significant with respect to their regulation and would you specifically address such differences in legislation reforming their oversight? Please explain in detail. A.5. The importance of our housing finance markets requires that all of the housing GSE's be included in a single program of worldclass supervision. We see the need for this for the Federal Home Loan Bank System just as we see it for Fannie Mae and Freddie
Mac. There are some differences between the FHLBanks and the other housing GSE's that require special consideration as changes to their regulation are considered. Some of these include: Debt issuance of FHLBanks by the Office of Finance; how the differing capital structures of the housing GSE's are addressed; and how the cooperative ownership structure of the FHLBanks would be addressed. While some of these issues may need to be addressed specifically with legislation, another useful way to account for the unique characteristics of housing GSE's is to create two divisions within the new regulatory agency-one division specializing in Fannie Mae and Freddie Mac and one in the FHLBanks. We look forward to working with the Committee on these issues. RESPONSE TO A WRITTEN QUESTION OF SENATOR SUNUNU
FROM JOHN W. SNOW Q.1. Secretary Snow, if you are calling for the GSE's to comply with bank-like capital standards, are you suggesting the elimination of the .45 percent capital charge that Fannie Mae and Freddie Mac currently hold for off-balance-sheet assets, such as mortgage-backed securities that they guarantee? Are you calling for a new capital requirement to be imposed on the off-balance-sheet assets of banks? A.1. We are not suggesting the elimination of any particular capital requirement nor are we suggesting new capital requirements for banks. The key aspect of our housing GSE regulatory reform proposal with respect to capital requirements is that we believe that the regulator should have broad authority with regard to setting the capital requirements of the Enterprises, both with respect to risk-based capital and minimum capital. Given the unique nature of mortgage guarantee business of Fannie Mae and Freddie Mac such authority could be used to set minimum capital standards for those obligations even though they are off-balance-sheet obligations. The new regulatory agency's authority for setting capital standards needs to be flexible enough to employ the best regulatory thinking, conscious of the Enterprises' own measures of risk, so that the regulator can direct its regulated entities each to maintain capital and reserves sufficient to support the risks that arise or exist in its business. One such risk is clearly the credit risk associated with the GSEs' guarantees of mortgage-backed securities, and the new agency should have authority to require capital for that risk. RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM JOHN W. SNOW Q.1. As I said in my opening statement, I am very concerned about the unintended consequences this legislation may have on small banks. I am especially concerned that they may find themselves limited in products they can use to make loans to underserved populations and for CRA compliance. Do I have your commitment today to do what we can to ensure small banks are not adversely affect by this legislation? A.1. In developing our approach to regulatory reform for the housing GSE's we have been focused on two core objectives: Promoting a sound and resilient financial system, and increased homeowner