FHLBank to provide the critical first layer of support upon which many layers of private and public support are built to bring about new affordable housing and/or community growth.

Community Bank has partnered with a number of nonprofit Community Development Corporations to support affordable housing and infrastructure development projects through programs offered by the Federal Home Loan Bank of Atlanta. These include the Affordable Housing Program (AHP) and the Economic Development and Growth Enhancement (EDGE) Program. By using AHP, EDGE, and other similar programs, community banks like mine can make affordable housing and community development projects economically feasible.

A good example of this is the Yardley Hills project in Calvert County, Maryland. That project utilized over $2.7 million in complex layered funding made available by participation in the Federal Home Loan Bank of Atlanta's Affordable Housing Program. In another project, we used the EDGE loan program to provide the Jarboe Family Head Start Center in St. Mary's County, Maryland with permanent funding when other traditional banking sources of large regional banks became unavailable. Federal Home Loan Bank Community Investment Programs have allowed us to partner with the USDA to provide single-family homeownership to very low-income families with structured funding and first time homebuyer funds.

Finally, for one of our community's volunteer fire/rescue needs, we obtained a $2,000,000 Economic Development Program advance to provide permanent financing for a new firehouse located in a low-income community in La Plata, Maryland.

Senators, these projects and hundreds of others like them would not have been economically feasible without the programs of the Federal Home Loan Bank. They enable community banks to meet those credit needs that often would go unmet by larger nonlocal banks. It is also important to point out that the Federal Home Loan Banks provide the training and technical assistance that teach smaller institutions to use these programs—training that would otherwise be too expensive for or unavailable to community banks.

The examples I have given with respect to my bank describe in part the distinctive role played by the Federal Home Loan Banks in housing finance. They make loans, called advances, to their members on the security of mortgages and other eligible collateral. Federal Home Loan Bank advances directly support our housing markets, including those focused on low- and moderate-income households, as well as all aspects of community development critical to the creation of jobs.

Federal Home Loan Banks also help their members provide other needed forms of community development credit. Since the passage of the Gramm-Leach-Bliley Act, Federal Home Loan Banks may now allow "community financial institutions" to pledge as collateral for advances small business, small farm, and small agribusiness loans. Expanding the types of eligible collateral that smaller financial institutions may pledge serves a number of purposes. Many smaller institutions, particularly in rural areas, have faced funding needs but have not had sufficient residential mortgage collateral to secure FHLBank advances. Expanding the eligible forms of collateral for these institutions will help them meet these funding needs. With the help of the Federal Home Loan Banks, small local financial institutions may now better serve the community development credit needs of their areas.

As I indicated earlier in my testimony, the Federal Home Loan Banks also help members meet their Community Reinvestment Act (CRA) responsibilities. They do this through programs such as the Affordable Housing Program (AHP), the Community Investment Program (CIP), EDGE, and others. These programs give members access to subsidized and other low-cost funding for affordable housing and community development projects that benefit low- and moderate-income neighborhoods.

By supporting their member institutions, the Federal Home Loan Banks also strengthen their communities. Each Federal Home Loan Bank is required, by law, to allocate 10 percent of its net income to affordable housing programs. The funds provided under this program are grants and loans. Last year, the Federal Home Loan Banks contributed $199 million to the AHP. Since the program's beginning in 1990, the Federal Home Loan Banks have set aside approximately $1.7 billion in AHP subsidies, helping to create 360,000 units for low-income families. The Federal Home Loan Banks collectively are the largest source in the Nation of private funding for affordable housing.

The Federal Home Loan Banks also have established a number of other housing and economic development initiatives for their members. These programs are funded voluntarily by the Federal Home Loan Banks separate from AHP. The Federal Home Loan Bank of Atlanta has established a predevelopment fund that offers recoverable grants to help finance predevelopment expenses associated with affordable housing and economic development projects. The Atlanta Bank also offers a training and technical assistance initiative for community development corporations serving

urrounding Historically Black Colleges and Universities, as well program called EDGE, mentioned earlier in this testimony, to mmunity economic development projects. In addition, FHLBank both an at-cost advance program to help members finance loans pment activity, and a fund to provide matching equity investinvesting in New Market Tax Credits.

mples cited earlier involving my bank, EDGE loans have helped center serving low-income families in Tuscaloosa, Alabama. cal assistance supported by the Federal Home Loan Bank of Atrolina enabled Elizabeth City State University, a Historically o obtain financing through the Bank's Affordable Housing Proilitation of owner-occupied units damaged by Hurricane Floyd. e Loan Banks have customized programs as well-programs like tial minority-homebuyers; first-time low-income homebuyer prodevelopment and affordable housing capacity initiatives; flood ograms; and rural technical assistance programs to help commuet affordable housing needs by establishing rural housing parte that the Federal Home Loan Bank System is able to provide fits it does because of its dynamic membership of large and small s regional, decentralized, cooperative structure. And, I can say without the Federal Home Loan Banks and the programs they e far more difficult for my bank, and the thousands of other commain independent, competitive, and capable of extending imporommunity development credit.

rector Responsibility

the role of the Federal Home Loan Banks in meeting their misompetitive funding to their member financial institutions to inlity of funds for residential and community development lending, xamples of why the Federal Home Loan Bank System is so vital ks like mine. As I stated earlier, I am also an elected Member rectors of the Federal Home Loan Bank of Atlanta, and that role important responsibilities.

now that the Federal Home Loan Banks have obligations in addiof being a creative funding source for the extension of residential velopment credit. The Federal Home Loan Banks, although being ral, State, and local taxation, are required to make payments to nding Corporation (REFCORP) and the Affordable Housing proe mandatory contributions are equivalent to a 26.5 percent effec

e.

me Loan Bank of Atlanta and its board of directors support the position that the housing GSE's should provide complete and cial disclosures that constitute "best of class." That is why we, her FHLBanks, have been working on these issues with all relesolve the specific issues presented by the FHLBanks' statutory ve structure, and joint and several liability.

want the Atlanta Bank to meet the highest standards of disclotime, as a director, I have an obligation to all the other member/ ain that such disclosures are not administered in a manner that mission, operations, or increase the cost of funds of the Bank. If, gree to voluntarily register the Bank's equity with the SEC, not additional personal civil and criminal liabilities under the relevant o assume liability for my decision to voluntarily register. In conry duty as a corporate director consistent with the Business Judgt believe that all critical issues have been satisfactorily resolved greements reached before I, as a director representing the sharek, am permitted to agree to such action.

le of the outstanding issues is how joint and several liability will Federal Home Loan Banks have always been jointly and severally er's debt. Under SEC registration, it is possible that each Federal could have to create an additional on balance sheet liability revalue" of such liability for the combined debt of all the FHLBanks. g issues like this and others must be effectively resolved in a manFederal Home Loan Banks can rely on going forward without the to-quarter or year-to-year reconsideration upon each SEC filing. pular misconceptions, the Federal Home Loan Banks are privately ir members and do not receive any taxpayer assistance to operate.

The Federal Home Loan Bank System debt is not guaranteed by the Federal Government, and does not constitute an obligation of the United States. The Federal Home Loan Banks have operated since 1932 to help bring needed credit to the members and communities they serve. And they have done so in a safe and sound manner. The Federal Home Loan Banks are required by statute to obtain sufficient collateral on advances to protect against losses, and to accept only certain collateral on their advances. Consequently, no Federal Home Loan Bank has ever experienced a credit loss on an advance. At the end of 2002, for example, the Federal Home Loan Banks had rights to collateral, either loans or securities, on a member-by-member basis, with an estimated fair market value in excess of outstanding advances.

The resources and services provided by the Federal Home Loan Banks to their member institutions play a key role in the continued success of our Nation's housing market. They play a key role in serving the financial needs of our local communities. Without the Federal Home Loan Banks, it would be far more difficult for our Nation to achieve these objectives.

Thank you for the opportunity to appear before you this afternoon. I would be pleased to answer any questions that you may have.

PREPARED STATEMENT OF SHEILA C. BAIR

DEAN'S PROFESSOR OF FINANCIAL REGULATORY POLICY

ISENBERG SCHOOL OF MANAGEMENT, UNIVERSITY OF MASSACHUSETTS

SEPTEMBER 9, 2003

Chairman Bennett, Senator Johnson, Members of the Subcommittee, it is a pleasure to appear before you today to assist you in your oversight of the Federal Home Loan Bank System. A strong housing market is among the Nation's top economic priorities, and the Federal Home Loan Bank System is an indispensable component of that market. When the Hoover_Administration developed the blueprint for the System in the throes of the Great Depression, it was based on the premise that this cooperative was needed to assure a constant flow of funding when deposits proved inadequate due to national or regional economic conditions. Seventy years later, with over $500 billion in FHLB advances outstanding, the underlying premise for the System remains valid. The Federal Home Loan Banks play a vital role in mortgage finance and deserve to be continued and strengthened.

Challenges Confronting the System

It is in the spirit of System supporter that I come to you this morning to raise three issues that I believe warrant your attention: Multidistrict membership, expansion of the System's mortgage acquisition programs, and lack of SEC registration of FHLB securities. These issues are important because their resolution will help determine the future of the system and its long-term stability. They were examined in detail in a paper I recently completed that was funded by a grant to the School of Management from the Fannie Mae Corporation, which I would like to submit for the record. The conclusions reached in the paper are my own, and do not reflect the views of the research sponsor. After discussing my paper, I will make some general observations about the FHLB System's regulatory structure in relation to efforts underway to improve safety and soundness regulation of Fannie Mae and Freddie Mac. Multidistrict Membership

Recent industry consolidations have prompted some to call for allowing members to belong to more than one district FHLBank. Throughout the System's history, no single institution has ever been a member of more than one district bank and the System's authorizing statute leaves little doubt that this is what Congress intended. The Federal Housing Finance Board's (FHFB) efforts to allow multidistrict membership by regulation have been highly controversial, supported by only 5 of the System's 12 district banks. Four of the FHLBanks are strongly opposed, with the remaining three undecided and expressing serious reservations.

My primary objection to multidistrict membership is that Congress not the FHFB should decide whether such a fundamental change should be made to the System's historic regional and cooperative structure. I am also concerned that multidistrict membership could have a destabilizing influence on the System. Multidistrict membership would allow large institutions to "shop" their advance activity among multiple FHLBanks, but because all the FHLBanks raise funds in the same way, their ability to compete based on price will be limited. As a consequence, they will likely compete on collateral and credit standards. In addition to diminution of credit quality, allowing one member to have multiple relationships with FHLBanks

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ational risk since the System lacks safeguards to obviate the collateral or the prospect of competing blanket liens. Moreover, emberships could increase large borrower activity in the System acerbating large borrower concentrations. Nearly 24 percent of is already concentrated in the System's 10 top borrowers. bership would, by definition, help only institutions large enough f it, and fundamentally alter the basic concept of the System— ional banks existing to serve the funding needs of institutions heir districts. Moreover, given the seismic consolidation activity e 1980's-which the System weathered quite well-it is difficult consolidation activity should provide the impetus for such a draUnder a holding company structure, separately chartered subable to hold memberships in different banks-the same arrangeanks have with the Federal Reserve Banks-which maintains e Federal Home Loan Bank Act and the regional character of the

quisition Programs

I examined-expansion of the System's mortgage acquisition prorily benefits the System's largest members. Begun in 1997 as a at $750 million, these programs have grown exponentially. The $90 billion worth of mortgages in portfolio, representing over 10 s. One FHLBank now has half its assets invested in mortgages of its assets in advances, the business activity that Congress as

in the System's legislative history or authorizing statute that or direct mortgage purchases, and the other two major housing nnie Mae and Freddie Mac were established and chartered by for that purpose. Congress, not the individual FHLBanks or the de whether it wants the System to be a major player in the secmarket, and if so, the terms and limitations that should apply.1 ted with mortgage acquisition are distinctly different from those System's traditional role of making fully collateralized advances. payment penalties and call features that allow the FHLBanks to their interest rate risks. Different, more complex tools are needrate/prepayment risk presented by mortgages held in portfolio. s also significant-there is a serious question as to whether the ent numbers of qualified staff or infrastructure needed to manage y risk associated with secondary mortgage market participation. FHLBank and the Office of Finance are relatively small, and they traditional business of advances, not mortgage acquisition and ent. Regarding credit risk, the mortgage acquisition programs' that the originators-not the FHLBanks-retain the credit risk. nators provide credit enhancements that are only as good as the them to be based on their own interpretation of historical default is outside their traditional mission and expertise. It is also tellFHFB proposed rulemaking-now withdrawn-would have elimise programs most important tools in managing credit risk-the pools of purchased mortgage assets achieve an investment grade ependent ratings agency.

blic policy basis has been advanced for the System's foray into this of business. Though promotional materials for the programs claim gned to help smaller institutions, available data suggests that they whelmingly for the benefit of large originators. According to trade he top five mortgage originators sold $42.7 billion in mortgages to 2002.2 Assuming the accuracy of this report, these five institunt for almost all of the $45.7 billion dollars in FHLBank mortgage 002. If Congress wishes to authorize yet another GSE entry into rtgage market, it should assure itself there is a valid public policy eeting legitimate market needs of smaller, community-based instione justification. Enriching large mortgage originators is not.

specific limitations on Fannie Mae and Freddie Mac regarding capital, safeand mission requirements. However, since Congress never authorized the ter the secondary mortgage market, it did not specify the limitations that (April 2, 2003), at p.6; 2002 FHLBank System Annual Report at p.22.

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SEC Registration

In my paper, I also concluded that voluntary SEC registration would be in the best interests of the System and its debtholders. I will not belabor the arguments, because Assistant Secretary Abernathy has already eloquently stated them in his testimony. Suffice it to say, voluntary SEC registration would enhance the image of the System and demonstrate that the FHLBanks are committed to a policy of full disclosure.

Thoughts on Regulatory Structure

Questions about the capability of the System to manage new risks associated with multidistrict membership and mortgage acquisition programs are heightened by longstanding weaknesses in the FHFB examination process, identified by the Government Accounting Office (GAO) in 1998 and again in 2002. Though the FHFB has taken a number of steps to address these weaknesses, including increasing the number of examiners and putting greater focus on major risks and the quality of controls at FHLBanks, the GAO found in a report released last February that it is still too soon to evaluate the effectiveness of these measures. As of February 2003, the FHFB had only 14 examiners, with plans to increase the total number of examiners to 24 by the end of 2004. According to its fiscal year 2003 budget, only $9.7 million of its $27 million budget was allocated for the Office of Supervision. By way of comparison, Treasury's two bank regulatory bureaus-the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) will typically assign teams of 20-30 examiners to each of its largest institutions, and will spend 70-80 percent of their budgets in direct support of supervision.

More fundamentally, the structure of the FHFB suffers from many of the same defects now being scrutinized at the Office of Federal Housing Enterprise Oversight. It is a small, low-profile agency that simply cannot attract and retain the quality of staff that it needs. It exists outside the financial regulatory mainstream, and thus does not benefit from the, routine day-to-day interaction that occurs among the major bank regulatory agencies. It is responsible for only 12 Banks, plus the Office of Finance-a narrow constituent base that creates the perception of "captive regulator." Other major financial regulators have a much broader regulatory base, and their actions are generally reflective of the views and interests of diverse and competing constituencies. For instance, bank regulators are constantly mediating differences between large and small banks, those with different business lines, geographic concentrations, or customer bases. This in turn enhances the credibility and quality of regulatory decisionmaking. When a regulator's jurisdiction is confined to a small group of closely aligned institutions, the pressure and input it receives can become narrowly focused and one-sided. It becomes difficult for the regulator to stay objective and "above the fray."

Should a new agency be created at the Treasury Department for oversight of Fannie Mae and Freddie Mac, I believe it would be a stronger agency if it also included oversight of the FHLB System. The new regulator would have a bigger, better view of the housing finance market and would be in a better position to evaluate the advantages—and dangers—of the major housing GSE's competing directly with each other in the same lines of business. From the standpoint of systemic risk and taxpayer exposure, it is just as important to the Government for the FHLB System to have quality safety and soundness oversight as it is for Fannie and Freddie. At year-end 2002, the System had $668 billion in outstanding debt, compared to Fannie's $884 billion and Freddie's $644 billion. It enjoys the same implied government guarantee, with an even more generous line of credit from the U.S. Treasury. Though unlikely, a widespread failure in the System could have staggering ramifications for U.S. taxpayers and the housing market.

Some have argued that the FHLBanks would be overwhelmed by the other two politically powerful GSE's if their oversight were to be housed in the same agency. I do not believe it. With their longstanding community bank ties, and extensive grass roots, I have no doubt the FHLBanks can hold their own. I have also heard it argued that the Treasury Department would be hostile to the System, which I can say from first hand experience is not the case. On the contrary, I believe the Treasury respects the role of the System in the housing finance market and would not do anything to disrupt it.

The competitive impact on FHLB funding costs should also be weighed in the balance when considering whether to merge the FHFB into the new agency. The creation of a credible, high quality GSE regulator within the Treasury will likely receive a positive reaction in the capital markets, which could reduce Fannie and Freddie's funding costs. If the FHLB System is left out, that could widen spreads between FHLBank securities and those issued by the Enterprises. Wider spreads

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