that the Bank hold retained earnings against risks greater than those of an asset holding the second highest credit rating from an NSRO (e.g., AA from Standard & Poor's). The proposed rule eliminates this requirement. We suspect, given the inadequacy of the notice, that the effective capital requirement for junk AMA under the proposed rule is a fraction of what it is under the current rule.

If the Finance Board decides to republish the rule, we strongly urge it to give commenters adequate notice of the precise capital impact of FHLBanks holding noninvestment grade securities or loans.

Credit Enhancement Requirements -- Proposed § 955.5(b)

The preamble states that the proposal "would retain the requirement in.....the current rule that the credit enhancement must be provided by a member or housing associate of the Bank," and would "allow a Bank greater freedom to design specific AMA Products." 68 Fed. Reg. At 39,029. In fact, however, the proposed rule would do the opposite: allow the member to shed all but minor credit risk by transferring that risk either to the FHLBank or a mortgage insurer.

Economic cost; third party credit enhancement. The current rule requires that the member retain the first loss position, and that any insurance cover losses only after the member has taken losses on a credit enhancement that was sufficient to achieve an investment grade rating. This requirement was absolutely central to the Finance Board's legal justification and policy rationale for adopting the final rule in 2000:

The Finance Board believes that the recourse model, under which the seller of a mortgage retains all or part of the credit risk, is a more economically efficient system for bringing the benefits of the capital markets to the mortgage industry. Under the recourse model, entities that underwrite the loans benefit from good underwriting and therefore are economically disciplined to reduce credit risk. In contrast to the insurance-based secondary market model, under which Fannie Mae and Freddie Mac are paid a premium to insure against credit losses, the recourse model allows an originator to take on more credit risk (so long as that risk is adequately capitalized) and to profit from successful management of that credit risk. Thus, credit risk is dispersed among the many potential originators in the Bank System, and even further dispersed through the permitted insurance and credit derivative structures.

In general, [the AMA rule] enables the Bank and the member to take best advantage of their core competencies by: (1) requiring the member to bear most of the economic cost and the management burden associated with lowering the credit risk of AMA assets to levels comparable with investment grade rates securities; thus (2) leaving the Bank with AMA assets that have a risk profile similar to the securities that have historically been a normal part of Bank operations.

65 Fed. Reg. at 43975

it, the proposed rule would allow a FHLBank to hold substantial
Originating member practically none. The proposed rule would
at requirement that a third party cover only those losses that remain
as borne expected losses. For a FHLBank to purchase an AMA asset,
receive an assurance from the member/originator that the asset is
the time of sale. For its part, the member may transfer any or all of its
nsurer, and limited risk to a pool insurer. This arrangement shares no
with a traditional advance the statutorily authorized activity of the
member holds credit risk funded by its FHLBank. It also represents an
of the Finance Board's original adoption of a “recourse model" in
sly disparaged "insured-based" model.

-

g strange that Finance Board has proposed to eliminate such a critical hout any meaningful notice or discussion. To the extent that the egally valid, it must have been based on a theory that the retention of member made AMA the functional equivalent of an advance, and lental" activity. The proposed changes destroy that notion.

oly, the section of the preamble discussing these changes concludes, not intended to alter the economics of the current risk-sharing simply cannot understand the factual basis for such a statement.

nce Board should decide to republish the rule, we urge it to explain the asis for this sea change in its approach.

igations of members. Under the proposed rule, members must continue
to support any credit obligation they make to a FHLBank, using

to secure advances. The Finance Board seeks comment on whether to
o use any type of collateral to secure its credit enhancement obligations.
O proffer any justification for such a step.

matter, Congress was quite strict in specifying the types of collateral
to secure advances. Congress wished to be sure that the Banks had high
when they exposed themselves to credit risk from their members. Now,
AMA purchases, and the associated credit risk, as the functional
incidental to, an advance, the Finance Board implicitly asserts the
e these credit exposures collateralized in any way it sees fit or,
olly uncollateralized. It is an odd reading of the FHLBank Act to contend
it risk it specifically authorizes (advances) is subject to strict statutory
that no such requirements apply to unauthorized, "incidental" activities.

lity of this step aside, it is also poor policy and will inevitably lead to HLBanks.

Transactions

8

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RA

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Section 955.5(c) provides:

“Grandfathered transactions. Assets acquired in transactions otherwise
authorized by resolution of the Finance Board and that are within any total
dollar cap established by the Finance Board at the time of such

authorization, shall not be subject to the requirements of this section.”

This provision is described in the preamble as “minor technical revisions" to the existing grandfather rule, relating to “AMA-type assets acquired by a Bank in accordance with prior resolutions of the Finance Board." 68 Fed. Reg. at 39,030 (emphasis added).

Grandfather provisions are commonly understood to allow existing activities to continue, even when a change in applicable law would have ended or amended them. If “prior” in the preamble is meant to convey "prior to adoption of the rule,” and bind the Finance Board's interpretation of the rule, then § 955.5(c) would be a grandfather provision. As drafted, however, section 955.5(c) does not contain any “prior” reference and thus is not a grandfather provision in any sense of the term, but rather is a grant of authority to the Finance Board allowing it to exempt any Bank from any provision of the rule without notice and comment. (Under this reading, the reference to "prior" in the preamble presumably would mean "prior to acquisition of the asset.”) We urge the Finance Board to clarify the matter in the event this section of the proposed rule is republished.

AMA-Qualified Interests in Whole Loans

As noted above, we oppose expanding permissible AMA assets to include interests in whole loans in addition to whole loans.

The proposed rule codifies the recent practice of allowing a FHLBank to deal with members of other banks, using that member's own Bank as a conduit. The FHLBank Act nowhere authorizes a Bank to deal with banks or thrifts that are not its own members and shareholders. This practice is a clear evasion of the Act, which we oppose.

$955.8-- Administrative and Investment Transactions Between Banks

The Finance Board's current AMA rule allows one Bank (hereafter, "passive Bank") to effectively outsource its administration of an AMA program to another bank (hereafter, “dominant Bank"). The pricing function can be included in this delegation, subject only to the caveat that the passive Bank must retain a right to refuse to acquire AMA at prices it does not consider appropriate. The Finance Board seeks comment on whether to eliminate this one caveat.

Allowing a FHLBank to effectively outsource the pricing of its assets to another institution presents a serious safety and soundness risk under the current rule. Removing the one line of defense for the passive Bank effectively places it at the mercy of another

competitor at that. This step would raise innumerable potential safety
moral hazard issues, none of which are discussed in the proposal. For
dominant Bank have an incentive to price the passive bank's AMA
gh or artificially low? We also question whether the officers of the
■ be violating fiduciary duties owed to their Bank by ceding
otentially significant part of the institution to a competitor. We urge
to seek comment on these questions in the event it republishes this

hese issues would be less serious if, according to the FHLBank Act,
alt only with its own members, in its own district. But the proposal
ank (perhaps the dominant Bank, above) soliciting loans from members
rhaps the passive Bank, above).

ed capital requirements for AMA

the proposal envisions the FHLBanks taking on considerably more risk
n their history, capital concerns obviously arise. The proposed rule,
-ly repeals all special capital requirements for AMA. Each FHLBank
nplement its own capital structure plan, governed by Part 932 of the
ules.

sed rule contains no explanation of the effective capital charges that
MA assets under Part 932. We strongly urge the Finance Board to
1 opportunity for comment on how much capital would be held against
r Part 932 in any new proposed AMA rule.

ad the Finance Board for its announced decision to withdraw the
ule. As our letter makes clear, we believe that the best course would be
-issuing the proposal.

I am writing to reaffirm and underscore Freddie Mac's commitment to completing the
process of voluntarily registering our common stock with the Securities and Exchange
Commission (SEC) under the Securities Exchange Act of 1934 so that we become a reporting
company under that Act. We are enthusiastically and irrevocably committed to the voluntary
agreement we announced last summer to submit to the full panoply of the periodic financial
disclosure reporting requirements that apply to registrants. As we have previously stated, we
expect to complete the restatement and re-audit of our prior year financial statements in the
third quarter of this year. Following completion of this process, we will proceed
expeditiously to resume our Form 10 registration process with the SEC.