This page lists the most recent publications related to problems in the financial markets and housing. It also includes key publications issued since October 1997. http://www.gao.gov/docsearch/featured/financialmarketsandhousing.html Sun, 22 Nov 2009 23:41:34 -0500 GAO http://www.gao.gov/images/title_object.jpg http://www.gao.gov/ Feed provided by GAO. Click to visit. http://www.gao.gov/new.items/d10218.pdf The Housing and Economic Recovery Act of 2008 (HERA) created the Federal Housing Finance Agency (FHFA) and gave it responsibility for, among other things, the supervision and oversight of Fannie Mae, Freddie Mac, and the 12 federal home loan banks. Specifically, FHFA was assigned responsibility for ensuring that each of the regulated entities operates in a fiscally safe and sound manner, including maintenance of adequate capital and internal controls, and carries out its housing and community development finance mission. HERA also requires FHFA to annually prepare financial statements, and further requires the Government Accountability Office (GAO) to audit these statements. Pursuant to HERA's requirement, GAO audited FHFA's fiscal year 2009 financial statements to determine whether (1) the financial statements were fairly stated and (2) FHFA management maintained effective internal control over financial reporting. GAO also tested FHFA's compliance with selected laws and regulations. GAO is not making any recommendations in this report. In commenting on a draft of this report, FHFA noted the challenges it faced in establishing the new agency while working to stabilize the housing market. It noted that it would continue to work to enhance its internal controls and ensure the reliability of its financial reporting, its operational soundness, and public confidence in its mission. In GAO's opinion, FHFA's fiscal year 2009 financial statements are fairly presented in all material respects. GAO also concluded that FHFA had effective internal control over financial reporting as of September 30, 2009. GAO found no reportable instances of noncompliance with the laws and regulations it tested. HERA established FHFA as an independent agency on July 30, 2008, and abolished, effective within 1 year of enactment, the Office of Federal Housing Enterprise Oversight (OFHEO) and the Federal Housing Finance Board (FHFB) - which, together with a mission group within the Department of Housing and Urban Development (HUD), had previous supervisory and oversight responsibilities for Fannie Mae, Freddie Mac, and the 12 federal home loan banks. During fiscal year 2009, OFHEO's and FHFB's personnel, property, and program activities, and certain employees and activities of HUD, were transferred to FHFA, and the assets, liabilities, and financial transactions of OFHEO and FHFB were consolidated into FHFA. While FHFA was in existence prior to the start of fiscal year 2009, this was its first full year of operations and the first year for which it prepared financial statements. Consequently, FHFA's financial statements do not present comparative information for the prior year. In early September 2008, Fannie Mae and Freddie Mac were placed into conservatorship by the Director of FHFA, with the stated intent to stabilize these entities. The assets, liabilities, and activities of the two entities, Fannie Mae and Freddie Mac, are not reflected in FHFA's fiscal year 2009 financial statements, based on determinations by the Office of Management and Budget (OMB) and the Department of the Treasury (Treasury) that they did not meet the criteria for inclusion in the financial statements of the U.S. government or the Treasury under federal accounting concepts. Specifically, OMB and Treasury concluded this because the entities are not currently reflected in the federal government's budget and because the conservatorship arrangement is considered to be temporary. FHFA management concurred with this conclusion. Should circumstances change, this decision would need to be revisited. Over the longer term, Congress and the executive branch face difficult decisions on how to restructure the entities and promote housing opportunities while limiting the risks to taxpayers and the financial markets. GAO issued a report containing a framework for evaluating various options available. GAO noted other less significant matters involving FHFA's internal controls and will be reporting separately to FHFA management on these matters. Mon, 16 Nov 2009 00:00:00 -0500 http://www.gao.gov/new.items/d10151.pdf The Department of the Treasury (Treasury) provided $81.1 billion in Troubled Asset Relief Program (TARP) aid to the U.S. auto industry, including $62 billion in restructuring loans to Chrysler Group LLC (Chrysler) and General Motors Company (GM). In return, Treasury received 9.85 percent equity in Chrysler, 60.8 percent equity and $2.1 billion in preferred stock in GM, and $13.8 billion in debt obligations between the two companies. As part of Government Accountability Office's (GAO) statutory responsibilities for providing oversight of TARP, this report addresses (1) steps Chrysler and GM have taken since December 2008 to reorganize, (2) Treasury's oversight of its financial interest in the companies, and (3) considerations for Treasury in monitoring and selling its equity in the companies. GAO reviewed documents on the auto companies' restructuring and spoke with officials at Treasury, Chrysler, and GM, and individuals with expertise in finance and the auto industry. Chrysler and GM have made changes since December 2008 to address key challenges to achieving viability, but the ultimate effect of these changes remains to be seen. The companies have eliminated a substantial amount of their long-term debt, reduced the number of brands and models of vehicles they sell, rationalized their dealership networks, and lowered production costs and capacities by reducing the number of factories and employees. It is difficult to fully assess the impact of these changes because of the short amount of time that has passed since reorganization and the low level of new vehicle sales. Moreover, Chrysler and GM are revaluing their assets and liabilities based on their reorganizations in 2009 and expect to prepare financial statements based on this effort in the coming months. Treasury does not plan to be involved in the day-to-day management of Chrysler and GM, but it plans to monitor the companies' performance. Treasury developed several principles to guide its role as a shareholder, including the commitment that although Treasury reserves the right to set up-front conditions to protect taxpayers and promote financial stability, Treasury will oversee its financial interests in a hands-off, commercial manner. The conditions that Treasury set for the companies include requiring that a portion of their vehicles be manufactured in the United States and that they report to Treasury on the use of the TARP funding provided. Treasury officials told us that they are also requiring that Chrysler and GM submit financial information on a regular basis and that they plan to meet with the companies' top management on a regular basis to discuss the companies' financial condition. Treasury should make certain that its current approach for monitoring and selling its equity in Chrysler and GM fully addresses all important considerations financial and industry experts identified. For example, Treasury initially hired or consulted with a number of individuals with experience in investment banking or equity analysis to help assess Chrysler's and GM's financial condition and develop financing packages for the companies. Many of these individuals have recently left as the restructuring phase of Treasury's work has been completed. Treasury will need to ensure these staff and any staff that depart in the future are replaced as needed with similarly qualified personnel. Also, Treasury does not currently contract with or employ outside firms with specialty expertise for its work with the auto industry but may need to do so in the future, to make sure sufficient expertise is available to oversee the government's significant financial interests in Chrysler and GM. In addition, although Treasury officials told us they are considering all options for divesting the government's ownership interests, including an initial public offering or private sale, they have focused primarily on a series of public offerings for GM and have not identified criteria for determining the optimal time and method to sell. Regardless of the option pursued, however, Treasury is unlikely to recover the entirety of its investment in Chrysler or GM, given that the companies' values would have to grow substantially above what they have been in the past. Mon, 02 Nov 2009 00:00:00 -0500 http://www.gao.gov/new.items/d1016.pdf GAO's eighth report assesses the Troubled Asset Relief Program's (TARP) impact over the last year. Specifically, it addresses (1) the evolution of TARP's strategy and the status of TARP programs as of September 25, 2009; (2) the Department of the Treasury's (Treasury) progress in creating an effective management structure, including hiring for the Office of Financial Stability (OFS), overseeing contractors, and establishing a comprehensive system of internal control; and (3) indicators of TARP's performance that could help Treasury decide whether to extend the program. GAO reviewed relevant documentation and met with officials from OFS, contractors, and financial regulators. Over the last year, TARP in general, and the Capital Purchase Program (CPP) in particular, along with other efforts by the Board of Governors of the Federal Reserve System (Federal Reserve) and Federal Deposit Insurance Corporation (FDIC), have made important contributions to helping stabilize credit markets. TARP is still a work in progress, and many uncertainties and challenges remain. For example, while some CPP participants had repurchased over $70 billion in preferred shares and warrants as of September 25, 2009, whether Treasury will fully recoup TARP assistance to the automobile industry and American International Group Inc., among others, remains uncertain. Moreover, other programs, such as the Public-Private Investment Program and the Home Affordable Modification Program (HAMP) are still in varying stages of implementation. As of September 25, 2009, Treasury had disbursed almost $364 billion in TARP funds; however, Treasury has yet to update its projected use of funds for most programs in light of current market conditions, program participation rates, and repurchases. Without more current estimates about expected uses of the remaining funds, Treasury's ability to plan for and effectively execute the next steps of the program will be limited. Amid concerns about the direction and transparency of TARP, the new administration has attempted to provide a more strategic direction for using the remaining funds. TARP has moved from investment-based initiatives to programs aimed at stabilizing the securitization markets and preserving homeownership, and most recently at providing assistance to community banks and small businesses. While some programs, such as the Term Asset-Backed Securities Loan Facility, appear to have generated market interest, others, such as HAMP, face ongoing implementation and operational challenges. Related to transparency, Treasury has taken a number of steps to improve communication with the public and Congress, including launching a Web site and preparing to hire a communications director for OFS to support these efforts. Treasury has also made significant progress in establishing and staffing OFS; however, it must continue to focus on filling critical leadership positions, including the Chief Homeownership Preservation Officer and Chief Investment Officer, with permanent staff. Treasury's network of contractors and financial agents that support TARP administration and operations has grown from 11 to 52. While Treasury has an appropriate infrastructure in place, it must remain vigilant in managing and monitoring conflicts of interests that may arise with the use of private sector sources. Thu, 08 Oct 2009 00:00:00 -0400 http://www.gao.gov/new.items/d091049t.pdf This testimony discusses issues relating to efforts to reform the regulatory structure of the financial system. In the midst of the worst economic crisis affecting financial markets globally in more than 75 years, federal officials have taken unprecedented steps to stem the unraveling of the financial services sector. While these actions aimed to provide relief in the short term, the severity of the crisis has shown clearly that in the long term, the current U.S. financial regulatory system was in need of significant reform. Our January 2009 report presented a framework for evaluating proposals to modernize the U.S. financial regulatory system, and work we have conducted since that report further underscores the urgent need for changes in the system. Given the importance of the U.S. financial sector to the domestic and international economies, in January 2009, we also added modernization of its outdated regulatory system as a new area to our list of high-risk areas of government operations because of the fragmented and outdated regulatory structure. We noted that modernizing the U.S. financial regulatory system will be a critical step to ensuring that the challenges of the 21st century can be met. This testimony discusses (1) how regulation has evolved and recent work that further illustrates the significant limitations and gaps in the existing regulatory system, (2) the experiences of countries with other types of varying regulatory structures during the financial crisis, and (3) how certain aspects of proposals would reform the U.S. regulatory system. The current U.S. financial regulatory system is fragmented due to complex arrangements of federal and state regulation put into place over the past 150 years. It has not kept pace with major developments in financial markets and products in recent decades. Today, almost a dozen federal regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies share responsibility for overseeing the financial services industry. Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing U.S. regulatory system. For example, regulators have struggled, and often failed, both to identify the systemic risks posed by large and interconnected financial conglomerates and to ensure these entities adequately manage their risks. In addition, regulators have had to address problems in financial markets resulting from the activities of sometimes less-regulated and large market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Further, the increasing prevalence of new and more complex financial products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Our recent work has also highlighted significant gaps in the regulatory system and the need for an entity responsible for identifying existing and emerging systemic risks. Various countries have implemented changes in their regulatory systems in recent years, but the current crisis affected most countries regardless of their structure. All of the countries we reviewed have more concentrated regulatory structures than that of the United States. Some countries, such as the United Kingdom, have chosen an integrated approach to regulation that unites safety and soundness and business conduct issues under a single regulator. Others, such as Australia, have chosen a "twin peaks" approach, in which separate agencies are responsible for safety and soundness and business conduct regulation. However, regardless of regulatory structure, each country we reviewed was affected to some extent by the recent financial crisis. One regulatory approach was not necessarily more effective than another in preventing or mitigating a financial crisis. However, regulators in some countries had already taken some actions that may have reduced the impact on their institutions. These and other countries also have taken or are currently contemplating additional changes to their regulatory systems to address weaknesses identified during this crisis. The Department of the Treasury's recent proposal to reform the U.S. financial regulatory system includes some elements that would likely improve oversight of the financial markets and make the financial system more sound, stable, and safer for consumers and investors. For example, under this proposal a new governmental body would have responsibility for assessing threats that could pose systemic risk. This proposal would also create an entity responsible for business conduct, that is, ensuring that consumers of financial services were adequately protected. However, our analysis indicated that additional opportunities exist beyond the Treasury's proposal for additional regulatory consolidation that could further decrease fragmentation in the regulatory system, reduce the potential for differing regulatory treatment, and improve regulatory independence. Tue, 29 Sep 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09932.pdf The 2008 financial market crisis and the economic recession led to a rapid and substantial increase in federal debt. This report, part of a line of work on debt management, was conducted under the Comptroller General's authority. It describes current debt management challenges and examines the role of a program that could benefit Treasury--Treasury Inflation Protected Securities (TIPS). GAO analyzed market data and interviewed experts as well as the two largest holders of Treasury securities in each of six sectors. In January 1997, Treasury introduced an inflation-indexed security--TIPS. Treasury's stated objectives were to both raise the national savings rate and to reduce the federal government's cost of borrowing. TIPS offer inflation protection to investors who are willing to pay a premium for this protection in the form of a lower interest rate. In a functioning TIPS market, the difference between the interest rate on nominal Treasury securities and the interest rate on TIPS is expected to be approximately equal to the expected inflation rate. Federal government actions in response to both the financial market crisis and the economic recession have added significantly to Treasury's borrowing needs. Since the onset of the recession in December 2007, Treasury has borrowed more than $2.3 trillion, largely by issuing short-term nominal debt, which significantly changed the composition of Treasury's debt portfolio. The challenges presented by increasing debt and the change in its composition take place in the context of the medium and longer term fiscal outlook and will not recede with the return of financial market stability and economic growth. The Congressional Budget Office (CBO) projects that, absent changes in current policy, debt held by the public will double in 5 years (from 2008 to 2013) and almost triple in 11 years (from 2008 to 2019)--reaching 82 percent of GDP. In order to meet these challenges Treasury needs to diversify its funding sources and lengthen the term-to-maturity of its debt portfolio. TIPS can contribute to this effort. Treasury's TIPS program has had varying degrees of liquidity (the ease with which investors can trade the security) since its inception. The major institutional investors that GAO interviewed perceived Treasury's commitment to the TIPS program as having wavered in recent years, decreasing the liquidity of TIPS in the market. Investors demand a premium for holding less-liquid TIPS, which increases Treasury's borrowing costs. TIPS offer benefits to Treasury and measuring the cost against which to weigh these benefits requires both forward-looking and after-the-fact analysis. A more robust TIPS program could benefit Treasury by diversifying and expanding its funding sources and reducing the cost of nominal securities. Governments are well suited to bear inflation risk because periods of inflation are often associated with increased revenues. TIPS auctions also help provide a measure of market inflation expectations. On July 1, 2009, GAO briefed Treasury's Office of Debt Management on the findings from our analysis and interviews with major institutional investors. Treasury later posed questions about ways to improve the TIPS program to the Primary Dealers and the Treasury Borrowing Advisory Committee (TBAC). At the August 2009 TBAC meeting, members discussed TIPS. Following the meeting, Treasury's Deputy Assistant Secretary for Federal Finance reaffirmed Treasury's commitment to TIPS and announced plans to gradually increase issuance of TIPS. Tue, 29 Sep 2009 00:00:00 -0400 http://www.gao.gov/new.items/d091048t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury), through the Office of Financial Stability (OFS), has the authority to purchase or insure almost $700 billion in troubled assets held by financial institutions. It focuses on (1) the nature and purpose of activities that have been initiated under TARP over the past year and ongoing challenges; (2) Treasury's efforts to establish a management infrastructure for TARP; and (3) outcomes measured by indicators of TARP's performance. TARP is one of many programs and activities the federal government has put in place over the past year to respond to the financial crisis. It represents a significant government commitment to stabilizing the financial system. For example, as of September 11, 2009, it had disbursed $363 billion to participating institutions. At the same time, TARP's Capital Purchase Program (CPP) has shown evidence of some success in returning funds to the federal government. Treasury has received almost $7 billion in dividend payments, about $2.9 billion in warrant liquidations, and over $70 billion in repurchases from institutions participating in CPP, as of August 31, 2009. But TARP still faces a variety of challenges. For example, CPP, the largest of the TARP programs, has hundreds of participating institutions. Because of its size, this program requires ongoing strong oversight to ensure that participants comply with the program's requirements as we have recommended in prior reports. In addition, most of the other investment-based TARP programs that have provided assistance to a few large individual institutions present Treasury with the challenge of determining when assistance is no longer needed. Further, amid concerns about the strategic direction of the program and lack of transparency, the new administration has attempted to provide a more strategic plan for using the remaining funds and has created a number of programs aimed at stabilizing the securitization markets and preserving homeownership. While some programs, such as the Term Asset-backed Securities Loan Facility (TALF), are fully operational, others including the Home Affordable Modification Program (HAMP) and the Public-Private Investment Program (PPIP), are still new and face ongoing implementation and operational challenges. Finally, even though substantial investments have been made to avert the collapse of American International Group, Inc. (AIG), General Motors Corporation (GM), and Chrysler LLC (Chrysler), the ultimate outcomes of these investments are unclear and will be influenced by the long-term viability of these entities. Certain of these TARP investments were made with Treasury's expectation that the disbursements would be returned to the federal government. HAMP funds, however, are direct expenditures which are not expected to be repaid. But given the many challenges and uncertainties facing TARP programs, the total cost to the government of these programs remains unclear at this time. Thu, 24 Sep 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09975.pdf GAO's seventh report on the Troubled Asset Relief Program (TARP) focuses on the initial assistance the government provided to American International Group, Inc. (AIG)--an organization with over 200 companies operating in over 130 countries and jurisdictions and $830 billion in assets--in September 2008 and the restructuring of that assistance in November 2008 and March 2009. The unfolding crisis threatened the stability of the U.S. banking system and the solvency of a number of financial institutions, including AIG. In September 2008, downgrades of AIG's credit rating prompted collateral calls by counterparties and raised concerns that a rapid and disorderly failure of AIG would further destabilize the markets. As a result, the Board of Governors of the Federal Reserve System (Federal Reserve) authorized the Federal Reserve Bank of New York (FRBNY), in consultation with the Department of the Treasury (Treasury), to provide assistance to AIG. This report describes (1) the basis for the federal assistance, (2) the nature and type of assistance and steps intended to protect the government's interest, and (3) selected GAO-developed indicators of the status of federal assistance and AIG's financial condition. To do this, GAO reviewed signed agreements and other relevant documentation from the Federal Reserve, FRBNY, Treasury, and AIG and interviewed their officials, among others. To develop the indicators, GAO reviewed rating agencies' reports, identified critical activities, and discussed them with the above named agencies and AIG. Treasury had no substantive comments on the report. It provided technical comments along with the Federal Reserve, FRBNY, and AIG. The Federal Reserve and Treasury provided assistance to AIG to limit further disruption to financial markets. These agencies determined that market events could have caused AIG to fail, which would have posed systemic risk to the financial system. According to the Federal Reserve, a disorderly failure of AIG would have contributed to higher borrowing costs and additional failures, further destabilizing fragile financial markets. The Federal Reserve and Treasury determined that an AIG default would place considerable pressure on AIG's counterparties and trigger serious disruptions to an already distressed commercial paper market. They concluded that because AIG was a large seller of credit default swaps--protection against losses from defaults--on collateralized debt obligations (CDO), had AIG failed, its counterparties would have been exposed to large losses if the values of the CDOs had continued to decline and AIG defaulted on its contracts. The Federal Reserve intended the initial September 2008 assistance to enable AIG to meet these added obligations with its counterparties and begin the process of selling business lines to raise monies to repay the government and resolve other liabilities. Subsequent assistance in November 2008 and March 2009 was intended to augment these goals, support liquidity needs, and repay FRBNY while mitigating disruptions in the broader financial markets. To address systemic risk that could result if AIG were to fail, the Federal Reserve and Treasury made over $182 billion available to assist AIG between September 2008 and April 2009. As of September 2, 2009, AIG's outstanding balance of assistance was $120.7 billion. Some federal assistance was designated for specific purposes, such as a special purpose vehicle to provide liquidity for purchasing assets such as CDOs. Other assistance, such as that available through the Treasury's Equity Facility, is available to meet the general financial needs of the parent company and its subsidiaries. Repayment of the $120.7 billion outstanding government exposure is expected to come from various sources. As of September 2, 2009, $6.8 billion was paid toward principal on the Maiden Lane facilities created by FRBNY to purchase certain AIG assets and provide AIG with liquidity. In providing the assistance, the Federal Reserve and Treasury have taken several steps intended to protect the government's interest. These include making loans that are secured with collateral, instituting certain controls over management, and obtaining compensation for risks such as charging interest, requiring dividend payments, and obtaining warrants. Moreover, Federal Reserve and Treasury staff routinely monitor AIG's operations and receive reports on AIG's condition and restructuring. While these efforts are being made, the government remains exposed to risks, including credit risk and investment risk, which could result in the Federal Reserve and Treasury not being repaid in full. While federal assistance has helped stabilize AIG's financial condition, GAO-developed indicators suggest that AIG's ability to restructure its business and repay the government is unclear at this time. Indicators of AIG's financial risk suggest that since AIG reported significant losses in late 2008, AIG's operations, with federal assistance, have begun to show signs of stabilizing in mid 2009. Similarly, after a declining trend through 2008 and early 2009, indicators of AIG insurance companies' financial risk suggest improved financial conditions that were largely results of federal assistance. Indicators of AIG's repayment of federal assistance show some progress in AIG's ability to repay the federal assistance; however, improvement in the stability of AIG's business depends on the long-term health of the company, market conditions, and continued government support. Therefore, the ultimate success of AIG's restructuring and repayment efforts remains uncertain. Mon, 21 Sep 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09922t.pdf This testimony discusses the performance of the nonprime mortgage market as of March 31, 2009, which includes subprime and Alt-A loans. Nonprime loans accounted for an increasing share of the overall mortgage market from 2000 through 2006, rising from 12 percent to 34 percent. Over this period, the dollar volume of nonprime mortgages originated annually climbed from $100 billion to $600 billion in the subprime market and from $25 billion to $400 billion in the Alt-A market. However, in the summer of 2007, the subprime and Alt-A market segments contracted sharply, partly in response to a dramatic increase in default and foreclosure rates for these mortgages. As of the first quarter of 2009, approximately 1 in 8 nonprime mortgages were in the foreclosure process. These developments have prompted greater scrutiny of lending practices in the nonprime market, a number of government efforts to modify troubled loans, and proposals to strengthen federal regulation of the mortgage industry. statement discusses (1) trends in the loan and borrower characteristics of nonprime mortgages originated from 2000 through 2007; (2) the performance of these mortgages by market segment, product type, and geographic location as of March 31, 2009; and (3) the performance of recent nonprime loan cohorts as of that date. This statement is based on a report being released at this hearing, titled Characteristics and Performance of Nonprime Mortgages. Approximately 1.6 million of the 14.4 million nonprime loans originated from 2000 through 2007 had completed the foreclosure process as of March 31, 2009. Of the 5.2 million loans that were still active at the end of March--that is, that had not been prepaid or completed the foreclosure process--almost one-quarter were seriously delinquent, meaning they were either 90 or more days behind in payments or already in the foreclosure process. As a result, hundreds of thousands of additional nonprime borrowers are at risk of losing their homes in the near future. Within the subprime market segment, about 28 percent of active loans were seriously delinquent, and within the active Alt-A segment, the serious delinquency rate was about 17 percent. Within both segments, serious delinquency rates were even higher for certain adjustable-rate mortgages (ARM). The rates varied widely by location. At the state level, California, Florida, Illinois, Massachusetts, Nevada, and New Jersey had the highest rates as of March 31, 2009. Among active Alt-A loans, almost all (98 percent) of the loans that were seriously delinquent as of March 31, 2009, were from the 2004 through 2007 cohorts. Likewise, 93 percent of the loans that had completed the foreclosure process as of that date were from those cohorts. Tue, 28 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09848r.pdf During the first part of this decade, the number of mortgage originations grew rapidly, particularly in the nonprime segment of the mortgage market, which includes subprime and Alt-A loans. In dollar terms, nonprime loans accounted for an increasing share of the overall mortgage market, rising from 12 percent in 2000 to 34 percent in 2006. Over this period, the dollar volume of nonprime mortgages originated annually climbed from $100 billion to $600 billion in the subprime market and from $25 billion to $400 billion in the Alt-A market. However, these market segments contracted sharply in the summer of 2007, partly in response to a dramatic increase in default and foreclosure rates for these mortgages. As we reported in 2007, a loosening of underwriting standards for subprime and Alt-A loans contributed to this increase. As of the first quarter of 2009, approximately 1 in 8 nonprime mortgages were in the foreclosure process. The negative repercussions from nonprime lending practices has prompted greater scrutiny of this market segment, a number of government efforts to modify troubled loans, and proposals to strengthen federal regulation of the mortgage industry. To inform congressional oversight and decision making about efforts to address current problems in the mortgage market, Congress requested that we examine the evolution and condition of the nonprime market segment. Accordingly, this report discusses (1) trends in the loan and borrower characteristics of nonprime mortgages originated from 2000 through 2007 and (2) the performance of these mortgages as of March 31, 2009. Nonprime lending increased rapidly earlier in the decade before abruptly declining in 2007 as the nation entered a financial crisis. In the data we analyzed, about two-thirds of the nonprime mortgages originated from 2000 through 2007 were subprime loans. The number of subprime originations increased more than five-fold from 2000 through 2005--rising from approximately 457,000 to about 2.3 million--before declining somewhat in 2006 and falling off sharply in 2007. Despite this generally rising trend, subprime loans accounted for a declining share of the nonprime market over this period because the volume of Alt-A originations increased at an even faster rate. Specifically, Alt-A originations grew 18-fold from 2000 through 2005--rising from approximately 78,000 to about 1.4 million--before declining in 2006 and declining further in 2007. As a result, the Alt-A share of the nonprime market increased from about 15 percent in 2000 to 43 percent in 2006, and continued to increase to 57 percent in 2007. The majority of nonprime loans originated from 2000 through 2007 were used to refinance an existing loan rather than to purchase a home. As of March 31, 2009, approximately 1.6 million of the 14.4 million nonprime loans (11 percent) originated from 2000 through 2007 had completed the foreclosure process. Subprime mortgages accounted for about 80 percent of these loans and Alt-A mortgages accounted for the remaining 20 percent. Additionally, about 7.6 million of the 14.4 million loans (53 percent) originated had prepaid as of March 31, 2009. Because many of these prepaid loans were due to borrowers refinancing into new nonprime mortgages, the total number of originations over the period we examined far exceeds the number of individual borrowers. For the majority of the 5.2 million nonprime loans that were still active as of March 31, 2009, the borrowers were current on their payments. However, about 1.2 million, or 23 percent, of these active loans were seriously delinquent (either in default or in the foreclosure process), indicating that hundreds of thousands of additional nonprime borrowers are at risk of losing their homes in the near future. Specifically, about 594,000 (11 percent) of active nonprime loans were in default and about 613,000 (12 percent) were in the foreclosure process. Within the subprime market segment, about 775,000 loans (28 percent) were seriously delinquent. Among active Alt-A mortgages, approximately 433,000 (17 percent) were seriously delinquent. Tue, 28 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09837.pdf GAO's sixth report on the Troubled Asset Relief Program (TARP) focuses on the Department of the Treasury's (Treasury) efforts to establish its Home Affordable Modification Program (HAMP). This 60-day report examines (1) the design of HAMP's program features with respect to maximizing assistance to struggling homeowners, (2) the analytical basis for Treasury's estimate of the number of loans that are likely to be successfully modified using TARP funds under HAMP, and (3) the status of Treasury's efforts to implement operational procedures and internal controls for HAMP. For this work, GAO reviewed documentation from Treasury and its financial agents and met with officials from Treasury, its financial agents, and other organizations. Under HAMP, Treasury will use up to $50 billion in TARP funds to (1) modify the first-lien mortgages of homeowners in danger of foreclosure, (2) encourage the modification of mortgages in areas experiencing serious declines in property values, (3) reduce or pay off second-lien mortgages for homeowners with loans modified under HAMP, (4) arrange deeds-in-lieu or short sales as alternatives to foreclosure; and (5) provide incentive payments to encourage refinancing under the HOPE for Homeowners program. The first-lien mortgage modification effort is the largest and most developed part of HAMP, and Treasury and its financial agents are establishing the operational infrastructure for this effort. However, one of the requirements under the first-lien program--that borrowers with high levels of household debt agree to obtain counseling--may not fully meet Treasury's goals. Treasury's estimate of the number of borrowers who would likely be helped under its HAMP loan modification program reflects uncertainty created by data gaps and the need to make numerous assumptions, and this projection may be overstated. In addition, Treasury has not specified its plans for systematically updating key assumptions and calculations. Treasury announced that up to 3 to 4 million borrowers who were at risk of default and foreclosure could be offered a loan modification under HAMP. Treasury has taken a number of important steps toward implementing operational procedures and internal controls for HAMP but has not finalized all of the associated processes and is not systematically evaluating servicers' capacity during program admission. Treasury officials have developed and continue to refine key operational procedures and internal controls, including establishing an organizational structure for overseeing HAMP, delegating implementation authorities and responsibilities to its financial agents, and drafting work flows for processes such as those associated with the payment of incentives. As of July 20, 2009, about 180,000 borrowers have entered into trial modifications but HAMP incentive payments will not be made until July 27 at the earliest--pending successful completion of the 90-day trial periods. Yet concerns have been raised by Treasury, the Congressional Oversight Panel, and federal banking regulators about servicers' capacity to fulfill program requirements and implement HAMP. Because servicers are not fully evaluated during the admittance process, Treasury is unable to adequately identify, assess, and address any potential risks that may prevent them from fulfilling program requirements. Thu, 23 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09739.pdf The Emergency Economic Stabilization Act directed GAO to study the role of leverage in the current financial crisis and federal oversight of leverage. GAO's objectives were to review (1) how leveraging and deleveraging by financial institutions may have contributed to the crisis, (2) regulations adopted by federal financial regulators to limit leverage and how regulators oversee compliance with the regulations, and (3) any limitations the current crisis has revealed in regulatory approaches used to restrict leverage and regulatory proposals to address them. To meet these objectives, GAO built on its existing body of work, reviewed relevant laws and regulations and academic and other studies, and interviewed regulators and market participants. Some studies suggested that leverage steadily increased in the financial sector before the crisis, and deleveraging by financial institutions may have contributed to the crisis. First, the studies suggested that deleveraging by selling financial assets could cause prices to spiral downward during times of market stress. Second, the studies suggested that deleveraging by restricting new lending could slow economic growth. However, other theories also provide possible explanations for the sharp price declines observed in certain assets. As the crisis is complex, no single theory is likely to fully explain what occurred or rule out other explanations. Regulators and market participants we interviewed had mixed views about the effects of deleveraging. Some officials told us that they generally have not seen asset sales leading to downward price spirals, but others said that asset sales have led to such spirals. Federal regulators impose capital and other requirements on their regulated institutions to limit leverage and ensure financial stability. Federal bank regulators impose minimum risk-based capital and leverage ratios on banks and thrifts and supervise the capital adequacy of such firms through on-site examinations and off-site monitoring. Bank holding companies are subject to similar capital requirements as banks, but thrift holding companies are not. The Securities and Exchange Commission uses its net capital rule to limit broker-dealer leverage and used to require certain broker-dealer holding companies to report risk-based capital ratios and meet certain liquidity requirements. Other important market participants, such as hedge funds, use leverage. Hedge funds typically are not subject to regulatory capital requirements, but market discipline, supplemented by regulatory oversight of institutions that transact with them, can serve to constrain their leverage. The crisis has revealed limitations in regulatory approaches used to restrict leverage. First, regulatory capital measures did not always fully capture certain risks. For example, many financial institutions applied risk models in ways that significantly underestimated certain risk exposures. As a result, these institutions did not hold capital commensurate with their risks and some faced capital shortfalls when the crisis began. Federal regulators have called for reforms, including through international efforts to revise the Basel II capital framework. The planned U.S. implementation of Basel II would increase reliance on risk models for determining capital needs for certain large institutions. Although the crisis underscored concerns about the use of such models for determining capital adequacy, regulators have not assessed whether proposed Basel II reforms will address these concerns. However, such an assessment is critical to ensure that changes to the regulatory framework address the limitations revealed by the crisis. Second, regulators face challenges in counteracting cyclical leverage trends and are working on reform proposals. Finally, the crisis has reinforced the need to focus greater attention on systemic risk. With multiple regulators responsible for individual markets or institutions, none has clear responsibility to assess the potential effects of the buildup of systemwide leverage or the collective activities of institutions to deleverage. Wed, 22 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09920t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury), through the Office of Financial Stability (OFS), has the authority to purchase and insure almost $700 billion in troubled assets held by financial institutions. Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the status of actions taken under the program. This statement today is based on our fifth mandated report, issued on June 17, 2009, which follows up on the previous recommendations and covers the actions taken as part of TARP through June 12, 2009. Our oversight work under the act is ongoing, and our next report will be issued later this month, and will focus on TARP's loan modification program. Specifically, this statement focuses on (1) the nature and purpose of activities that have been initiated under TARP, including repurchases of preferred shares and warrants; (2) Treasury's efforts to establish a management structure for TARP; and (3) outcomes measured by indicators of TARP's performance. As of July 10, 2009, Treasury had disbursed about $361 billion of the roughly $700 billion in TARP funds. Most of the funds (about $204 billion) went to purchase preferred shares and subordinated debentures of 651 financial institutions under the Capital Purchase Program (CPP), which continues to be OFS's primary vehicle for stabilizing financial markets. At the same time that Treasury continues to purchase preferred shares in institutions, other institutions have paid over $70 billion to repurchase shares. As of July 10, 2009, 12 of the 33 financial institutions that repurchased their preferred shares from Treasury had repurchased their warrants and 3 others had repurchased their warrant preferred stock from Treasury at an aggregate cost of about $80.3 million. As permitted by the act--as amended by the American Recovery and Reinvestment Act of 2009 (ARRA)--participants may repurchase or buy back their preferred stock and warrants issued to Treasury under CPP at any time, subject to consultation with the primary federal banking regulator. While, OFS has made progress in establishing its management infrastructure, continued attention to hiring remains important, however, because some offices within OFS, including the Office of the Chief Risk and Compliance Officer, still have a number of vacancies that will need to be filled as TARP programs are fully implemented. Treasury has continued to make progress in establishing its management infrastructure and internal controls and has responded to our two most recent contracting recommendations and continued to respond to the others. In the hiring area, Treasury has continued to establish its management infrastructure, including hiring more staff. In the internal controls area, consistent with our previous report recommendation that Treasury update the guidance that is available to the public on determining warrant exercise prices so that it is consistent with OFS's actual practices, Treasury updated its frequently asked questions on its Web site to clarify the process it follows for determining the prices. Treasury has continued to build a network of contractors and financial agents to support TARP administration and operations and has an opportunity to enhance transparency through its existing reporting mechanisms. Treasury issues a number of reports and uses other mechanisms, such as public announcements and its Web site, to provide information to the public. GAO again notes the difficulty of measuring the effect of TARP's activities. While isolating and estimating the effect of TARP programs continues to present a number of challenges, indicators of the cost of credit and perceptions of risk in credit markets suggest broad improvement since the announcement of CPP in October 2008. Nevertheless, credit market indicators we have been monitoring suggest there has been broad improvement in interbank, mortgage, and corporate debt markets in terms of the cost of credit and perceptions of risk (as measured by premiums over Treasury securities). Wed, 22 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09889t.pdf This testimony is based primarily on certain information in our June 17, 2009, report--our fifth report under the act's mandate--which covers TARP activities as of June 12, 2009. Specifically, this statement includes information on (1) terms and rates for dividend payments from participants, (2) the dividend payments received through June 30, 2009, from participants, and (3) repurchases of preferred stock and warrants4 by participants. To do this work, we reviewed documents provided by OFS and conducted interviews with officials from OFS. According to Treasury, as of June 30, 2009, Treasury had disbursed about $339 billion in TARP funds. Although most of the disbursements have been for the Capital Purchase Program (CPP), Treasury has utilized other programs as well. The agreements entered into under the various programs for the purchase of preferred stock entitled Treasury to receive dividends on varying terms and at varying rates. For example, according to the CPP terms for publicly held institutions, participating institutions pay Treasury quarterly dividends at a rate of 5 percent per year for the first 5 years on the preferred stock acquired by Treasury. According to Treasury, from TARP's inception through June 30, 2009, Treasury received approximately $6.7 billion in dividend payments on preferred stock acquired through the CPP, Targeted Investment Program (TIP), Automotive Industry Financing Program (AIFP), and Asset Guarantee Program (AGP). The dividend payments received are generally deposited into the General Fund of the U.S. Treasury and are not to be used to reduce the outstanding balance under the almost $700 billion TARP limit. According to Treasury records, as of June 30, 2009, 32 institutions, including 10 of the largest bank holding companies participating in TARP, had repurchased their preferred stock from Treasury for a total of about $70.1 billion. Also, as of June 30, 2009, 11 financial institutions had repurchased their warrants and 3 institutions had repurchased their warrant preferred stock from Treasury at an aggregate cost of about $20.3 million. Funds received from the repurchases of initial preferred stock are deposited into the General Fund of the U.S. Treasury and reduce the outstanding balance under the almost $700 billion TARP limit. Treasury may then issue new debt to purchase new financial instruments if it so chooses until December 31, 2009, or a later date determined by the Secretary of the Treasury under the sunset provision of the act. However, like the dividend payments, any amounts received from the repurchases of warrants and warrant preferred stock are deposited in the General Fund of the U.S. Treasury and are not to be used to reduce the outstanding balance under the almost $700 billion TARP limit. As of June 30, 2009, Treasury had disbursed approximately $339 billion in TARP funds, had approximately $102 billion outstanding in additional obligations to purchase or insure troubled assets, and had received approximately $70 billion from preferred stock repurchased by CPP participants.8 As a result, Treasury has approximately $328 billion remaining under the almost $700 billion limit on the amount of purchased or insured troubled assets that Treasury may have outstanding at any time (the almost $700 billion TARP limit reduced for $339 billion in disbursements and $102 billion in obligations, and increased by $70 billion in preferred stock repurchases). Thu, 09 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09805t.pdf GAO annually audits the consolidated financial statements of the U.S. government (CFS). The Congress and the President need reliable, useful, and timely financial and performance information to make sound decisions and conduct effective oversight of federal government programs and policies. Except for the 2008 and 2007 Statements of Social Insurance, GAO has been unable to provide assurance on the reliability of the CFS due primarily to inadequate systems and lack of sufficient, reliable evidence to support certain material information in the CFS. Unless these weaknesses are adequately addressed, they will, among other things, (1) hamper the federal government's ability to reliably report a significant portion of its assets, liabilities, costs, and other related information; and (2) affect the federal government's ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs and activities. This testimony presents the results of GAO's audit of the CFS for fiscal year 2008 and discusses federal financial management challenges and the long-term fiscal outloo For the second consecutive year, GAO rendered an unqualified opinion on the Statement of Social Insurance; however, three major impediments continued to prevent GAO from rendering an opinion on the federal government's accrual basis consolidated financial statements: (1) serious financial management problems at the Department of Defense, (2) the federal government's inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies, and (3) the federal government's ineffective process for preparing the consolidated financial statements. In addition, as of September 30, 2008, the federal government did not maintain effective internal controls over financial reporting and compliance with significant laws and regulations due to numerous material weaknesses. Moreover, financial management system problems continue to hinder federal agency accountability. The federal government still has a long way to go, but over the years, progress has been made in improving federal financial management. For example, audit results for many federal agencies have improved; federal financial system requirements have been developed; and accounting and reporting standards have continued to evolve to provide greater transparency and accountability over the federal government's operations, financial condition, and fiscal outlook. In addition, the federal government issued a summary financial report which is intended to make the information in the Financial Report of the U.S. Government more understandable and accessible to a broader audience. The federal government's response to the financial markets crisis and economic downturn has created new federal accountability, financial reporting, and debt management challenges. Such challenges will require utmost attention to ensure (1) that sufficient internal controls and transparency are established and maintained for all market stabilization and economic recovery initiatives; (2) that all related financial transactions are reported on time, accurately, and completely; and (3) these initiatives are effectively and efficiently financed. Moreover, while policymakers are currently understandably focused on efforts directed toward market stabilization and economic growth, once stability in financial markets and the economic downturn are addressed, attention will have to be turned with the same level of intensity to the serious longer-term challenges of addressing the federal government's large and growing structural deficits and debt. Finally, the federal government should consider the need for further revisions to the current federal financial reporting model to recognize its unique needs. A broad reconsideration of issues, such as the kind of information that may be relevant and useful for a sovereign nation, could lead to reporting enhancements that might help provide the Congress and the President with more useful financial information to deliberate and monitor strategies to address the nation's long-term fiscal challenges. Wed, 08 Jul 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09658.pdf GAO's fifth report on the Troubled Asset Relief Program (TARP) follows up on prior recommendations. It also reviews (1) activities that had been initiated or completed under TARP as of June 12, 2009; (2) the Department of the Treasury's Office of Financial Stability's (OFS) hiring efforts and use of contractors; and (3) TARP performance indicators. To do this, GAO reviewed signed agreements and other relevant documentation and met with officials from OFS, contractors, and financial regulators. Treasury continued to operationalize its more recent programs, including the Capital Assistance Program (CAP). As part of this program, the Federal Reserve led the stress tests of the largest 19 U.S. bank holding companies, which revealed that about half needed to raise additional capital to keep them strongly capitalized and lending even if economic conditions worsen. Whether any of the institutions will have to participate in CAP has yet to be determined. While the Federal Reserve disclosed the stress test results, it has no plans to disclose information about the 19 institutions going forward. What information, if any, is disclosed will be left to the discretion of the affected institutions raising a number of concerns including potentially inconsistent or only selected information being disclosed. Moreover, the Federal Reserve had not developed a mechanism to share information with OFS about the ongoing condition of the 19 bank holding companies that continue to participate in TARP programs. According to Treasury, its Financial Stability Plan has provided a basis for its communication strategy. Treasury plans to more regularly communicate with congressional committees of jurisdiction about TARP. However, until this strategy is fully implemented, all congressional stakeholders will not be receiving information in a consistent or timely manner. A key component of the communication strategy is the new www.financialstability.gov Web site. While a goal of the new site is to provide the public with a more user friendly format, Treasury has not yet measured the public's satisfaction with the site. OFS has made progress in establishing its management infrastructure. Continued attention to hiring remains important because some offices within OFS, including the Office of the Chief Risk and Compliance Officer, continue to have a number of vacancies that will need to be filled as TARP programs are fully implemented. Treasury has also continued to build a network of contractors and financial agents to support TARP administration and operations. These contracts and agreements are key tools OFS has used to help develop and administer its TARP programs. Treasury has provided information to the public on procurement contracts and financial agency agreements, but has not included a breakdown of cost data by each entity. As a result, Treasury is missing an opportunity to provide additional transparency about TARP operations. Wed, 17 Jun 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09699t.pdf In fiscal year 2008, GAO delivered advice and analyses to the Congress in response to requests from all of the standing committees of the House and the Senate, as well as over 80 percent of their subcommittees. The hard work of our staff yielded significant results across the government, including expert testimony at over 300 congressional hearings, hundreds of improvements in government operations, and billions in financial benefits. GAO submits for congressional consideration a request for a fiscal year 2010 appropriation of $567.5 million to support 3,250 full-time equivalent (FTE) staff. This request represents an increase of $36.5 million, or 6.9 percent, over our fiscal year 2009 funding level, which would support a 3.5 percent increase over our 2009 FTE level. Importantly, almost 70 percent of our requested increase is needed for mandatory pay and uncontrollable cost increases. While our fiscal year 2009 funding level allows us to make progress in responding to new congressional requests sooner, our fiscal year 2010 request would enable GAO to make greater progress in addressing the issues of greatest interest to the Congress and the American public during these challenging times, which is our highest priority. GAO is also requesting authority to use $15.2 million in offsetting collections, as detailed in our budget submission. GAO is an invaluable resource for helping the Congress provide oversight, accountability, and transparency in government. The demand for GAO services continues to remain high as a direct result of the high quality of our work, and this high demand is an indication of the Congress's desire for timely and objective analyses and professional advice. In each of fiscal years 2007 and 2008, GAO received over 1,200 requests and mandates. The number of congressional mandates, our highest-priority work, more than doubled from fiscal year 2007 to 2008. In addition, as evidenced above, our work covers more and more complex issues across a broad range of federal programs, requiring more in-depth analysis to complete. High Congressional Demand for GAO Services This congressional demand for GAO studies also has affected our ability to respond promptly to congressional requests. For instance, in fiscal year 2008, GAO delayed starting work on 21 percent of our accepted requests due to staff unavailability. The average time we took to initiate congressionally requested engagements was almost 5 months in the first half of 2009, compared with less than 3 months in fiscal year 2005. In addition, GAO is providing testimony at an increased number of congressional hearings. We testified at 304 hearings in fiscal year 2008. This was the second highest number for GAO in the last 25 years. We expect to continue receiving a high volume of requests related to either the nation's new challenges, such as the recent developments in the financial markets and economy, or to the many emerging initiatives of the Congress and the administration. Moreover, all Senate committees are required to review programs within their jurisdiction to root out fraud, waste, and abuse in program spending--giving particular scrutiny to issues raised in GAO reports--and develop recommendations for improved government performance. Also, recent changes to House rules require each standing committee or subcommittee to hold at least one hearing on any issue raised by GAO that indicates that federal programs or operations authorized by that committee or subcommittee are at high risk for fraud, waste, abuse, or mismanagement. Our January 2009 issuance of the biennial, High-Risk Series: An Update, which identifies federal areas and programs at risk of fraud, waste, abuse, and mismanagement, as well as those in need of broad-based transformations, identified 30 at-risk federal programs. Issued to coincide with the start of each new Congress, our high-risk updates have continued to help to focus and sustain attention to these programs so that executive branch officials who are accountable for each program's performance, as well as members of the Congress, have the information needed to complete their oversight responsibilities. The high-risk update report is available on our Web site at http://www.gao.gov. Thu, 21 May 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09677t.pdf In 2008, GAO issued two reports on hedge funds--pooled investment vehicles that are privately managed and often engage in active trading of various types of securities and commodity futures and options contracts--highlighting the need for continued regulatory attention and for guidance to better inform pension plans on the risks and challenges of hedge fund investments. Hedge funds generally qualified for exemption from certain securities laws and regulations, including the requirement to register as an investment company. Hedge funds have been deeply affected by the recent financial turmoil. But an industry survey of institutional investors suggests that these investors are still committed to investing in hedge funds in the long term. For the first time hedge funds are allowed to borrow from the Federal Reserve under the Term-Asset Backed Loan Facility. As such, the regulatory oversight issues and investment challenges raised by the 2008 reports still remain relevant. This testimony discusses: (1) federal regulators' oversight of hedge fund-related activities; (2) potential benefits, risks, and challenges pension plans face in investing in hedge funds; (3) the measures investors, creditors, and counterparties have taken to impose market discipline on hedge funds; and (4) the potential for systemic risk from hedge fund-related activities. To do this work we relied upon our issued reports and updated data where possible Under the existing regulatory structure, the Securities and Exchange Commission and Commodity Futures Trading Commission can provide direct oversight of registered hedge fund advisers, and along with federal bank regulators, they monitor hedge fund-related activities conducted at their regulated entities. Although some examinations found that banks generally have strengthened practices for managing risk exposures to hedge funds, regulators recommended that they enhance firmwide risk management systems and practices, including expanded stress testing. The federal government does not specifically limit or monitor private sector plan investment in hedge funds. Under federal law, fiduciaries must comply with a standard of prudence, but no explicit restrictions on hedge funds exist. Pension plans invest in hedge funds to obtain a number of potential benefits, such as returns greater than the stock market and stable returns on investment. However, hedge funds also pose challenges and risks beyond those posed by traditional investments. For example, some investors may have little information on funds' underlying assets and their values, which limits the opportunity for oversight. Plan representatives said they take steps to mitigate these and other challenges, but doing so requires resources beyond the means of some plans. According to market participants, hedge fund advisers have improved disclosures and transparency about their operations as a result of industry guidance issued and pressure from investors and creditors and counterparties. Regulators and market participants said that creditors and counterparties have generally conducted more due diligence and tightened their credit standards for hedge funds. However, several factors may limit the effectiveness of market discipline or illustrate failures to properly exercise it. Further, if the risk controls of creditors and counterparties are inadequate, their actions may not prevent hedge funds from taking excessive risk and can contribute to conditions that create systemic risk if breakdowns in market discipline and risk controls are sufficiently severe that losses by hedge funds in turn cause significant losses at key intermediaries or in financial markets. Financial regulators and industry observers remain concerned about the adequacy of counterparty credit risk management at major financial institutions because it is a key factor in controlling the potential for hedge funds to become a source of systemic risk. Although hedge funds generally add liquidity to many markets, including distressed asset markets, in some circumstances hedge funds' activities can strain liquidity and contribute to financial distress. In response to their concerns regarding the adequacy of counterparty credit risk, a group of regulators had collaborated to examine particular hedge fund-related activities across entities they regulate, and the President's Working Group on Financial Markets (PWG). The PWG also established two private sector committees that recently released guidelines to address systemic risk and investor protection. Thu, 07 May 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09553.pdf The turmoil in financial markets and the economic downturn has brought significant financial stress to the auto manufacturing industry. The economic reach of the auto industry in the United States is broad, affecting autoworkers, auto suppliers, stock and bondholders, dealers, and certain states. To help stabilize the U.S. auto industry and avoid disruptions that could pose systemic risk to the nation's economy, in December 2008 the Department of the Treasury established the Automotive Industry Financing Program (AIFP) under the Troubled Asset Relief Program (TARP). From December 2008 through March 2009, Treasury has allocated about $36 billion to this program, including loans to Chrysler Holding LLC (Chrysler) and General Motors (GM). GAO has previously identified three principles to guide federal assistance to large firms: define the problem, determine the national interests and set goals and objectives, and protect the government's interests. As part of GAO's statutorily mandated responsibilities to provide timely oversight of TARP activities, this report discusses the (1) nature and purpose of assistance to the auto industry, (2) how the assistance addresses the three principles, and (3) important factors for Chrysler and GM to address in achieving long-term viability and the challenges that they face to become viable. To address these objectives, GAO reviewed Chrysler's and GM's restructuring plans and financial statements, as well as Treasury documents related to AIFP. GAO also reviewed the terms and conditions of the federal loans to identify risks to the government and compared these loan provisions to GAO's principles for providing federal financial assistance to large firms. In addition, GAO interviewed representatives of Chrysler, GM, Ford Motor Company (Ford) and the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America (UAW), and officials from the Departments of the Treasury, Transportation, and Energy. GAO also conducted semistructured interviews with a panel of individuals identified by the National Academy of Sciences for their expertise in the fields of auto industry trends and data, labor relations, vehicle manufacturing, and corporate restructuring. GAO provided a draft of this report to the Departments of the Treasury, Transportation, and Energy for their review and comment. These agencies provided technical clarifications, which GAO incorporated as appropriate. GAO also made a draft of this report available to Chrysler and GM officials for their review and comment. Chrysler and GM officials provided technical corrections and clarifications, which GAO incorporated as appropriate. GAO is not making recommendations in this report. From December 2008 through March 2009, the Treasury Department established a series of programs to help bring relief to the U.S. auto industry and prevent the economic disruptions that a sudden collapse of Chrysler and GM could create. In December 2008, Treasury provided bridge loans of $4 billion to Chrysler and $13.4 billion to GM and required both automakers to submit restructuring plans in February 2009. In March, Treasury determined that the automakers' restructuring plans were not sufficient to achieve long-term viability and required that they take more aggressive action as a condition of receiving additional federal assistance. At the same time, Treasury also established programs to ensure payments to suppliers of parts and components needed to manufacture cars and to guarantee warranties of cars Chrysler and GM sell during the restructuring period. In addition to these programs, the President announced a new White House initiative to help communities and workers affected by the downturn in the industry. In the coming weeks, Treasury will determine whether the additional steps Chrysler and GM have taken or plan to take are sufficient to warrant further assistance. If the companies are successful in implementing the additional steps toward restructuring, then Treasury may provide additional assistance. In providing assistance to the auto industry, Treasury identified goals and objectives and took steps to protect the government's interest. Provisions to protect the government's interest include requiring automakers to submit periodic financial reports and to gain concessions from stakeholders such as the UAW, creditors, and bondholders. To date, however, Chrysler and GM have not reached agreements with these stakeholders. In addition, Treasury included provisions to secure collateral from the automakers. However, because many of Chrysler's and GM's assets were already encumbered by other creditors, the amount of assets on which Treasury could secure senior liens was limited. An additional area of risk is the financial health of the automakers' pension plans. In the event that Chrysler or GM cannot continue to maintain its pension plans--such as in the case of liquidation--the Pension Benefit Guaranty Corporation, a government corporation, may be required to take responsibility for paying the benefits for the plans, which are not fully funded. GAO's panel of individuals with auto industry expertise identified a number of factors for achieving viability, including reducing the number of brands, reassessing the scope and size of dealership networks, reducing production capacity and costs, and obtaining labor concessions. However, Chrysler's and GM's restructuring plans submitted in February do not fully address these factors, according to GAO's panelists. In its assessment of the plans, Treasury identified concerns similar to those identified by the panelists, and concluded that Chrysler and GM need to establish a new strategy for long-term viability in order to justify a substantial additional investment of federal funds. Achieving viability is made more difficult because of many additional challenges facing the automakers, some of which are outside their control--such as the weak economy and the limited availability of credit. The condition of the U.S. economy will likely continue to affect the financial health of Chrysler and GM, as historically automobile sales almost always decrease during periods of economic recession. Given these challenges, Treasury, Chrysler, and GM are considering a range of options available for the automakers to achieve viability, including restructuring under the bankruptcy code. Thu, 23 Apr 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09507r.pdf Under the American Recovery and Reinvestment Act of 2009 (ARRA), Congress required the Small Business Administration (SBA) to implement a total of eight administrative provisions to help facilitate small business lending and enhance liquidity in the secondary markets. These administrative provisions include (1) temporarily requiring SBA to reduce or eliminate certain fees on 7(a) and 504 loans; (2) temporarily increasing the maximum 7(a) guarantee from 85 percent to 90 percent; and (3) implementing provisions designed specifically to facilitate secondary markets, such as extending existing guarantees in the 504 program and making loans to systemically important brokerdealers that operate in the 7(a) secondary market. Further, ARRA established deadlines for SBA to issue regulations that implement certain administrative provisions, such as those pertaining to facilitating secondary market activities. Specifically, ARRA required SBA to issue regulations extending the guarantee related to the 504 program within 15 days after enactment (March 4, 2009) and for making loans to systemically important broker-dealers within 30 days after enactment (March 19, 2009). ARRA also mandates that we report within 60 days after the date of enactment, April 17, 2009, on SBA's initial efforts to comply with these provisions. In response, this report (1) summarizes key activities undertaken by the Administrator of SBA to implement the administrative provisions including establishment of project plans with timelines for fulfilling responsibilities, and (2) analyze whether the Administrator is accomplishing the purpose of increasing liquidity in the secondary markets for SBA loans. Because SBA's efforts are still in their early stages, we agreed with the staffs of the House and Senate Committees on Small Business to focus our work on four key administrative provisions for the purposes of this report. These four provisions are eliminating or reducing fees on 7(a) and 504 loans, extending the existing guarantee on 7(a) loans, and taking two specific steps to facilitate activities in the secondary markets: extending the guarantee on 504 financing and making loans to systemically important broker-dealers. However, consistent with ARRA's requirements, we are also providing information on the status of SBA's implementation of the other four administrative provisions. SBA has implemented two of the four key administrative ARRA provisions as defined for purposes of this report, and plans to have the two secondary market provisions finalized by June 2009. On March 16, 2009, SBA issued policy notices to eliminate certain fees on 7(a) and 504 loans and to extend the maximum guarantee on 7(a) loans from 85 percent to 90 percent. According to SBA officials, eliminating fees and extending lender protections on certain 7(a) loans should provide incentives for small businesses to apply for additional loans and lenders to originate them. However, SBA has not met its statutory requirement to issue regulations associated with extending existing guarantees on 504 projects (which were due by March 4, 2009) and making loans to systemically important broker-dealers that participate in the secondary market for 7(a) loans (which were due by March 19, 2009). According to SBA officials, issuing the regulations for these ARRA provisions is complicated and time consuming because it involves establishing new programs and related infrastructure, such as establishing policies and procedures, hiring and training staff, developing information systems, and establishing risk mitigation strategies as well as resolving critical policy issues. For example, an SBA official said that the agency must determine the extent to which broker-dealers and perhaps small business lenders would be required to share in the potential losses associated with extending the guarantee in the 504 program. While requiring broker-dealers and lenders to share in potential losses could help ensure sound loan underwriting and thereby limit SBA's potential exposure, it could also lessen their willingness to participate and thereby fail to facilitate secondary market activity as ARRA intended. SBA officials and trade groups we contacted also said that ARRA's array of requirements may also place strains on the agency's staff resources, and our previous work has also concluded that limited resources and pending retirements could affect its capacity to implement programs such as those specified in ARRA. To address these and other challenges, SBA has established an intra-agency process to implement ARRA's provisions, including the appointment of relevant project teams, and indicated it has consulted with Treasury and Federal Reserve officials on its responsibilities. According to SBA, the draft rules for the secondary market provisions are now undergoing internal SBA review, and those rules are expected to be sent to the Office of Management and Budget (OMB) for its review and finalized by June 2009. Thu, 16 Apr 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09539t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury) has the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through its Office of Financial Stability (OFS). As Congress may know, Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on the findings resulting from our oversight of the actions taken under the program. We are also responsible for auditing TARP's annual financial statements and for producing special reports on any issues that emerge from our oversight. To carry out these oversight responsibilities, we have assembled interdisciplinary teams with a wide range of technical skills, including financial market and public policy analysts, accountants, lawyers, and economists who represent combined resources from across GAO. This testimon is based primarily on our March 31, 2009 report that we are issuing today--the third under the act's mandate, which covers the actions taken as part of TARP through March 27, 2009, and follows up on the recommendations we made in our previous reports. As of March 27, 2009, Treasury had disbursed $303.4 billion of the $700 billion in TARP funds. Most of the funds (about $199 billion) went to purchase preferred shares of 532 financial institutions under the Capital Purchase Program (CPP)--Treasury's primary vehicle under TARP for stabilizing financial markets. Treasury has continued to take significant steps to address all of the recommendations from our December 2008 and January 2009 reports. In particular, Treasury has recently expanded the scope of the monthly CPP surveys of the largest institutions to include all institutions participating in the program, which is intended to provide Treasury with information necessary to begin to track the effectiveness of the program. Treasury also continued to make progress in several other areas, including requiring firms participating in certain new programs to show how assistance will expand lending. These requirements will better enable Treasury to determine what institutions plan to do with any capital infusions and to track the resulting lending activity of participating institutions on a regular basis. In addition, we specifically found that though Treasury is now receiving dividends from the investments it has made in CPP and certain other programs, it has not publicly reported these receipts, which totaled almost $2.9 billion through March 20, 2009. In February 2009, Treasury announced its broad strategy for using the remaining TARP funds and provided the details for its major components in the following weeks. Specifically, Treasury announced the Financial Stability Plan, which outlined a comprehensive set of measures to help address the financial crisis and restore confidence in our financial markets, and a Homeowner Affordability and Stability Plan to mitigate foreclosures and preserve homeownership. While articulating its plan was an important first step, Treasury continues to struggle with developing an effective overall communication strategy that is integrated into TARP operations. Without such a strategy, Treasury may face challenges, should it need additional funding for the program. Also, while Treasury has announced up to $70 billion dollars in assistance to AIG--more assistance than has been announced for any other single institution to date--it has yet to disperse the up to $30 billion of additional assistance or finalize the agreement. We continue to note the difficulty of measuring the effect of TARP's activities. Developments in the credit markets have generally been mixed since our January 2009 report. Some indicators revealed that the cost of credit has increased in interbank and corporate bond markets and decreased in mortgage markets, while perceptions of risk (as measured by premiums over Treasury securities) have declined in interbank and mortgage markets and risen in corporate debt markets. Tue, 31 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09504.pdf GAO's third report on the Troubled Asset Relief Program (TARP) follows up on recommendations from the January 28, 2009, report (GAO-09-296). It also reviews (1) the nature and purpose of activities that had been initiated under TARP as of March 27, 2009; (2) the Department of Treasury's Office of Financial Stability's (OFS) hiring efforts, use of contractors, and progress in developing an internal control system; and (3) TARP performance indicators. For this work, GAO reviewed signed agreements and other relevant documentation and met with officials from OFS, contractors, and federal agencies. As of March 27, 2009, Treasury had disbursed $303.4 billion of the $700 billion in TARP funds. Most of the funds (almost $199 billion) went to purchase preferred shares of 532 financial institutions under the Capital Purchase Program (CPP), Treasury's primary vehicle under TARP for stabilizing financial markets. Treasury has continued to improve the integrity, accountability and transparency of TARP. For example, it recently expanded monthly surveys of the largest institutions' lending activity to cover all CPP participants, as GAO recommended. These surveys should provide additional important information about how the capital investments are impacting participants' lending activities and capital levels. Treasury also continues to develop a process to monitor compliance with the terms of the agreements but has not yet hired asset managers. Treasury officials told GAO that these managers will have a role in helping ensure that institutions were honoring dividend and stock repurchase requirements. In February 2009, Treasury announced its broad strategy for using the remaining TARP funds and in the following weeks provided details for its major components. While articulating its plan was an important step, Treasury continues to struggle with developing an effective overall communication strategy that is integrated into TARP operations. Without such a strategy, Treasury may face challenges should it need additional funding for the program. Finally, as Treasury finalizes the terms of the agreement with American International Group, Inc. (AIG) for $30 billion in additional assistance, it should require that AIG seek additional concessions from employees and existing derivatives counterparties, as appropriate. GAO's January 2009 report also included recommendations about OFS's management infrastructure, including hiring, contract oversight, and internal controls. Treasury has continued to take steps to address GAO's recommendations. First, it has continued to hire additional permanent staff to address OFS's long-term organizational needs. Second, Treasury has enhanced its capacity to manage vendors by using trained oversight personnel and looking for opportunities to use fixed-price arrangements. Further actions are needed to complete its review of existing vendor conflict-of-interest mitigation plans and to improve documentation of decisions relating to potential conflicts. Third, OFS continued to refine, develop, and document its internal control framework over financial reporting and compliance, including its risk assessment activities. However, GAO noted that certain internal control procedures and the guidance pertaining to determining warrant exercise prices had not been updated to be consistent with actual practice. GAO also noted that Treasury had not publicly reported that through March 20, 2009, it had received dividends totaling almost $2.9 billion from TARP participants. Further steps in these areas are needed to improve the program's transparency and integrity. GAO again notes the difficulty of measuring the effect of TARP's activities. Developments in the credit markets have generally been mixed since the January 2009 report. Some indicators revealed that the cost of credit has increased in interbank and corporate bond markets and decreased in mortgage markets, while perceptions of risk have declined in interbank and mortgage markets and risen in corporate debt markets. In addition, although Federal Reserve survey data suggest that lending standards remained tight, the largest CPP recipients extended roughly $245 billion in new loans to consumers and businesses in both December 2008 and January 2009, according to the Treasury's new loan survey. However, attributing any of these changes directly to TARP continues to be problematic because of the range of actions that have been and are being taken to address the current crisis. While these indicators may be suggestive of TARP's ongoing impact, no single indicator or set of indicators can provide a definitive determination of the program's impact. Tue, 31 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09524t.pdf This testimony discusses H.R. 885, Improved Financial and Commodity Markets Oversight and Accountability Act. This proposed legislation recently referred to Congress is intended to enhance the independence of inspectors general (IG) in key financial regulatory agencies including the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the National Credit Union Administration, the Pension Benefit Guaranty Corporation, and the Securities and Exchange Commission. In numerous reports and testimonies over the last several years, we have discussed the key role that IGs play in federal agency oversight. The Inspector General Act of 1978, created offices of inspector general at major departments and agencies with IGs who are appointed by the President, confirmed by the Senate, and may be removed only by the President with notice to the Congress stating the reasons. The IGs are to prevent and detect fraud and abuse in their agencies' programs and operations; conduct audits and investigations; and recommend policies to promote economy, efficiency, and effectiveness. In 1988, the 1978 IG Act was amended to establish additional IG offices in designated federal entities (DFE) defined by the act. Generally, the DFE IGs have the same authorities and responsibilities as those originally established by the IG Act but there is a clear distinction--they are appointed and may be removed by their agency heads rather than by the President and are not subject to Senate confirmation. In the now more than three decades since passage of the IG Act, the IGs have been instrumental in enhancing government accountability. This testimony discusses (1) the legislative proposals in H.R. 885, (2) the key principles and importance of auditor and IG independence, and (3) current coordination mechanisms in place for IG offices. Currently, both the administration and the Congress are considering many options aimed at strengthening the financial regulatory system. H.R. 885 would provide for the inspectors general for selected financial regulatory agencies to be appointed by the President with Senate confirmation. Those IGs currently are appointed by their agency heads and may be removed by their agency heads. H.R. 885, Improved Financial and Commodity Markets Oversight and Accountability Act, would provide for the conversion of these IGs from appointment by their respective agency heads to appointment by the President with confirmation by the Senate. Likewise, after this conversion, these IGs may be removed only by the President with advance notification to the Congress of the reasons. We believe that the differences in the appointment and removal processes between presidentially appointed IGs and those appointed by their agency heads result in a clear difference in the level of independence of the IGs. A general tenet to keep in mind is that the further removed the appointment source is from the entity to be audited, the greater the level of independence. In the past, the Congress has taken actions to convert IGs from appointment by their agency heads to appointment by the President with Senate confirmation as a way to enhance IG independence. For example, on the heels of the savings and loan and banking crisis, over two decades ago, the role of the Federal Deposit Insurance Corporation's (FDIC) IG became increasingly important in providing oversight. Due to the perceived limitation of the FDIC IG's independence resulting from agency appointment, the Congress converted the IG from agency appointment to appointment by the President with Senate confirmation. In another example, the Congress took action to convert the Tennessee Valley Authority (TVA) IG to appointment by the President with Senate confirmation because of concerns about interference by TVA management. In both cases, Congress recognized that the IG's independence would be enhanced by the presidential appointment. The change from agency appointment to appointment by the President has been recognized by Congress since the advent of the IG concept as strengthening the critical element of IG independence. As we have noted in prior reports and testimony, we believe independence is one of the most important elements of an effective IG function. Wed, 25 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09484t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury) has the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through its Office of Financial Stability (OFS). As Congress may know, Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the actions taken under the program. We are also responsible for auditing OFS's annual financial statements and for producing special reports on any issues that emerge from our oversight. To carry out these oversight responsibilities, we have assembled interdisciplinary teams with a wide range of technical skills, including financial market and public policy analysts, accountants, lawyers, and economists who represent combined resources from across GAO. In addition, we are building on our in-house technical expertise with targeted new hires and experts. The act also created additional oversight entities--the Congressional Oversight Panel (COP) and the Special Inspector General for TARP (SIGTARP)--that also have reporting responsibilities. We are coordinating our work with COP and SIGTARP and are meeting with officials from both entities to share information and coordinate our oversight efforts. These meetings help to ensure that we are collaborating as appropriate and not duplicating efforts. This testimony is based primarily on our January 30, 2009 report, the second under the act's mandate, which covers the actions taken as part of TARP through January 23, 2009, and follows up on the nine recommendations we made in our December 2, 2008 report.3 This statement also provides additional information on some recent program developments, including Treasury's new financial stability plan and, as you requested, provides some insights on our ongoing work on the implications of actions related to the financial crisis on federal debt management. Our oversight work under the act is ongoing, and our next report is due to be issued by March 31, 2009, as required. Specifically, this statement focuses on (1) the nature and purpose of activities that have been initiated under TARP; (2) the status of OFS's hiring efforts, use of contractors, and development of a system of internal control; (3) implications of TARP and other events on federal debt management, and (4) preliminary indicators of TARP's performance. To do this work, we reviewed documents related to TARP, including contracts, agreements, guidance, and rules. We also met with OFS, contractors, federal agencies, and officials from all eight of the first large institutions to receive disbursements. We plan to continue to monitor the issues highlighted in our prior reports, as well as future and ongoing capital purchases, other more recent transactions undertaken as part of TARP (for example, guarantees on assets of Citigroup and Bank of America), and the status of other aspects of TARP. Thu, 19 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09499t.pdf Financial regulators have an important role in assessing risk management systems at financial institutions. Analyses have identified inadequate risk management at large, complex financial institutions as one of the causes of the current financial crisis. The failure of the institutions to appropriately identify, measure, and manage their risks has raised questions not only about corporate governance but also about the adequacy of regulatory oversight of risk management systems. GAO's objectives were to review (1) how regulators oversee risk management at these institutions, (2) the extent to which regulators identified shortcomings in risk management at certain institutions prior to the summer of 2007, and (3) how some aspects of the regulatory system may have contributed to or hindered the oversight of risk management. GAO built upon its existing body of work, evaluated the examination guidance used by examiners at U.S. banking and securities regulators, and reviewed examination reports and work papers from 2006-2008 for a selected sample of large institutions, and horizontal exams that included additional institutions. In January 2009, GAO designated the need to modernize the financial regulatory system as a high risk area needing congressional attention. Regulatory oversight of risk management at large, financial institutions, particularly at the holding company level, should be considered part of that effort. The banking and securities regulators use a variety of tools to identify areas of risk and assess how large, complex financial institutions manage their risks. The banking regulators--Federal Reserve, Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS)--and securities regulators--Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA)--use somewhat different approaches to oversee risk management practices. Banking examiners are assigned to continuously monitor a single institution, where they engage in targeted and horizontal examinations and assess risks and the quality of institutions' risk management systems. SEC and FINRA identify areas of high risk by aggregating information from examiners and officials on areas of concern across broker-dealers and by monitoring institutions. SEC and FINRA conduct discrete targeted and horizontal examinations. The banking regulators focused on safety and soundness, while SEC and FINRA tended to focus on compliance with securities rules and laws. All regulators have specific tools for effecting change when they identify weaknesses in risk management at institutions they oversee. In the examination materials GAO reviewed for a limited number of institutions, GAO found that regulators had identified numerous weaknesses in the institutions' risk management systems before the financial crisis began. For example, regulators identified inadequate oversight of institutions' risks by senior management. However, the regulators said that they did not take forceful actions to address these weaknesses, such as changing their assessments, until the crisis occurred because the institutions had strong financial positions and senior management had presented the regulators with plans for change. Regulators also identified weaknesses in models used to measure and manage risk but may not have taken action to resolve these weaknesses. Finally, regulators identified numerous stress testing weaknesses at several large institutions, but GAO's limited review did not identify any instances in which weaknesses prompted regulators to take aggressive steps to push institutions to better understand and manage risks. Some aspects of the regulatory system may have hindered regulators' oversight of risk management. First, no regulator systematically looks across institutions to identify factors that could affect the overall financial system. While regulators periodically conducted horizontal examinations on stress testing, credit risk practices, and risk management for securitized mortgage products, they did not consistently use the results to identify potential systemic risks. Second, primary bank and functional regulators' oversee risk management at the level of the legal entity within a holding company while large entities manage risk on an enterprisewide basis or by business lines that cut across legal entities. As a result, these regulators may have only a limited view of institutions' risk management or their responsibilities and activities may overlap with those of holding company regulators. Thu, 19 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09490t.pdf The Board of Governors of the Federal Reserve System (Federal Reserve) and the Department of the Treasury (Treasury) have made available over $182 billion in assistance to American International Group (AIG) to prevent its failure. However, questions have been raised about the goals of the assistance and how it is being monitored. Also, because AIG is generally known for its insurance operations, questions exist about the effect of the assistance on certain insurance markets. This statement provides preliminary findings on (1) the goals and monitoring of federal assistance to AIG and challenges to AIG's repayment of the assistance; and (2) the potential effects of the federal assistance on the U.S. commercial property/casualty insurance market. GAO's work on these issues is ongoing. To date, we have reviewed relevant documents on the assistance and ongoing operations of AIG, as well as documents issued by the Federal Reserve and Treasury. We also interviewed officials from these organizations as well as industry participants (competitors, brokers, and customers) and insurance regulators, among others. Federal financial assistance to AIG, both from the Federal Reserve and Federal Reserve Bank of New York through their authority to lend funds to critical nonbank institutions and from Treasury's Troubled Asset Relief Program (TARP), has focused on preventing systemic risk that could result from a rating downgrade or failure of AIG. The goal of the assistance and subsequent restructurings was to prevent systemic risk from the failure of AIG by allowing AIG to sell assets and restructure its operations in an orderly manner. The Federal Reserve has been monitoring AIG's operations since September, and Treasury has begun to more actively monitor AIG's operations as well. Although the ongoing federal assistance has prevented further downgrades in AIG's credit rating, AIG has had mixed success in fulfilling its other restructuring plans, such as terminating its securities lending program, selling assets, and unwinding its AIG Financial Products portfolio. For example, AIG has made efforts at selling certain business units and has begun an overall restructuring, but market and other conditions have prevented significant asset sales, and most restructuring efforts are still under way. AIG faces ongoing challenges from the continued overall economic deterioration and tight credit markets. AIG's ability to repay its obligations to the federal government has also been impaired by its deteriorating operations, inability to sell its assets and further declines in its assets. All of these issues will continue to adversely impact AIG's ability to repay its government assistance. As part of GAO's ongoing work related to the federal assistance provided to AIG, GAO is reviewing the potential impact of the assistance on the commercial property/casualty insurance market. Specifically, GAO is reviewing potential effects of the assistance on AIG's pricing practices. According to some of AIG's competitors, federal assistance to AIG has allowed AIG's commercial property/casualty insurance companies to offer coverage at prices that are inadequate for the risk involved. Conversely, state insurance regulators, insurance brokers, and insurance buyers said that while AIG may be pricing somewhat more aggressively than in the past in order to retain business in light of damage to the parent company's reputation, they did not see indications that this pricing was inadequate or out of line with previous AIG pricing practices. Moreover, some have noted that AIG has lost business because of the problems encountered by its parent company. As GAO evaluates these issues, it faces a number of challenges associated with determining the adequacy of commercial property/casualty premium rates, especially in the short term. These challenges include the unique, negotiated nature of many commercial insurance policies, the subjective assumptions involved in determining premiums, and the fact that for some lines of commercial insurance it can take several years to determine if premiums charged were adequate for the related losses. Wed, 18 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09474t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury) has the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through its Office of Financial Stability (OFS). As Congress may know, Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the actions taken under TARP. This testimony is based primarily on our January 30, 2009 report, the second under the act's mandate, which covers the actions taken as part of TARP through January 23, 2009, and follows up on the nine recommendations we made in our December 2, 2008 report. This testomony also provides additional information on some recent developments related to TARP, including Treasury's new financial stability plan. Treasury has made progress in establishing a management structure for TARP, including adopting a framework for developing and implementing its system of internal control for TARP activities that is consistent with our recommendation. However, as of our January report, OFS had yet to implement a disciplined risk-assessment process. Treasury has taken steps to help ensure a smooth transition to a new administration by keeping positions filled and using an expedited hiring process. However, it continues to face difficulty providing competitive salaries to attract skilled employees. Also, given the TARP's evolving nature and the changes under the new administration, Treasury needs to identify OFS's long-term organizational needs. Additionally, consistent with our recommendation on contracting oversight, Treasury has enhanced such oversight by tracking costs, schedules, and performance and addressing the training requirements of personnel who oversee the contracts. However, as we previously recommended, Treasury needs to continue to identify and mitigate conflicts of interest in contracting. Wed, 11 Mar 2009 00:00:00 -0400 http://www.gao.gov/new.items/d09397t.pdf The U.S. financial system is more prone to systemic risk today because (1) the current U.S. financial regulatory system is not designed to adequately oversee today's large and interconnected financial institutions, (2) not all financial activities and institutions fall under the direct purview of financial regulators, and (3) market innovations have led to the creation of new and sometimes complex products that were not envisioned as the current regulatory system developed. Credit default swaps (CDS) are one of the products that have assumed a key role in financial markets. My statement will discuss (1) the extent to which U.S. financial regulators and the UK regulator oversee CDS, (2) risks and challenges that CDS present to the stability of financial markets and institutions and similar concerns that other products may pose, and (3) the recent steps that financial regulators and the industry have taken to address risks pose by CDS and similar efforts that may be warranted for other financial products. GAO reviewed research studies and congressional testimonies. We interviewed financial regulators and a variety of financial market participants. In January 2009, GAO designated the financial regulatory system as a high-risk area in need of congressional attention. Issues involving systemic risk regulation in general and CDS in particular should be considered as part of that effort. The current regulatory structure for CDS does not provide any one regulator with authority over all participants in the CDS market, making it difficult to monitor and manage potential systemic risk. Federal oversight of CDS trading and monitoring of the CDS market are largely conducted through the banking regulators' safety and soundness oversight of supervised banks that act as CDS dealers. The Securities and Exchange Commission and the Commodity Futures Trading Commission lack the authority to regulate CDS broadly as financial products. Regulators have sought to address potential systemic risks arising from CDS activities mainly through collaborative efforts with other supervisors and key market participants. However, the extent to which regulators routinely monitor the CDS activity of unregulated market participants is unclear. The Financial Services Authority in the United Kingdom has authority over most CDS products and can collect information about the CDS market, but it has pursued most of its regulatory efforts in collaboration with U.S. regulators. CDS pose a number of risks to institutions and markets, many of which are not unique. These include counterparty credit, operational, concentration, and jump-to-default risks. Market participants and observers noted that CDS referencing asset-backed securities (ABS) and collateralized debt obligations (CDOs), particularly those related to mortgages, currently pose greater risks to institutions and markets than other types of CDS. Other risks and challenges from CDS relate to the lack of transparency in CDS markets, the potential for manipulation related to the use of CDS as a price discovery mechanism, and the use of CDS for speculative purposes. Regulators and market participants noted that over-the-counter (OTC) derivatives, to varying degrees, may pose some similar risks and a few identified equity derivatives as the OTC derivatives that were most similar to CDS. Financial regulators and market participants have initiated several efforts to mitigate these risks. These efforts target primarily operational and counterparty credit risks and include improving the operational infrastructure of CDS markets, creating a clearinghouse or central counterparty process to clear CDS trades, and establishing a central trade registry for CDS. If effectively implemented and sustained, these initiatives couldbegin to address some of the risks noted. But the effectiveness of these recent initiatives could be limited because participation is voluntary and regulators lack the authority to require all market participants to report their trades to a repository. Moreover, customized and highly structured CDS, which can include CDS with complex reference entities that may present additional risks, generally lack the standardization necessary for centralized clearing. Other ideas to reform CDS markets, such as mandatory clearing or limiting some types of trades, have important limitations that would need to be addressed. Finally, many participants and observers agreed that OTC derivatives other than CDS generally share some of the same risks and could benefit from similar efforts to mitigate their impact. Thu, 05 Mar 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09417t.pdf This testimony discusses our work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury) has the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through the Office of Financial Stability (OFS). As you know, Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the status of actions taken under the program. We are also responsible for auditing OFS's annual financial statements and for issuing special reports on any issues that emerge from our oversight. To carry out these oversight responsibilities, we have assembled interdisciplinary teams with a wide range of technical skills, including financial market and public policy analysts, accountants, lawyers, and economists who represent combined resources from across GAO. In addition, we are building on our in-house technical expertise with targeted new hires, re-employed annuitants with related expertise, and outside experts. The act also created additional oversight entities--the Congressional Oversight Panel (COP) and the Special Inspector General for TARP (SIGTARP)--that also have reporting responsibilities. We are coordinating our work with COP and SIGTARP and are meeting with officials from both entities to share information and coordinate our oversight efforts. These meetings help to ensure that we are collaborating as appropriate and not duplicating efforts. Treasury has announced a number of new programs to try to stabilize financial markets, but most of its activity during this period has continued to be through its Capital Purchase Program (CPP). As of February 19, Treasury had disbursed about $300 billion in TARP funds, about $196 billion of which was for CPP. Treasury has recently announced the Financial Stability Plan, which outlines a set of measures to address the financial crisis and restore confidence in the U.S. financial and housing markets, and a Homeowner Affordability and Stability Plan to mitigate foreclosures and preserve homeownership. Treasury also has taken important steps since our first report to implement all nine of our recommendations. However, due in part to the short time frame since our first report, we continued to identify a number of areas that warrant Treasury's ongoing attention concerning TARP. Tue, 24 Feb 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09359t.pdf This testimony discusses GAO's work on the Troubled Asset Relief Program (TARP), under which the Department of the Treasury (Treasury) has the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through the Office of Financial Stability (OFS). As you know, Treasury was granted this authority in response to the financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. The Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the status of actions taken under the program. This testimony is based on our January 30, 2009, report, which is the second under the act's mandate, covers the actions taken as part of TARP through January 23, 2009, and follows up on the nine recommendations we made in our December 2008 report. Our oversight work under the act is ongoing, and our next report will be issued by March 31, 2009. Like the report, this testimony focuses on (1) the nature and purpose of activities that have been initiated under TARP as of January 23, 2009; (2) the status of the transition to the new administration at OFS and its hiring efforts, use of contractors, and development of a system of internal control; and (3) preliminary indicators of TARP's performance. Thu, 05 Feb 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09349t.pdf This testimony discusses our January 8, 2009, report that provides a framework for modernizing the outdated U.S. financial regulatory system. We prepared this work under the authority of the Comptroller General to help policymakers weigh various regulatory reform proposals and consider ways in which the current regulatory system could be made more effective and efficient. This testimony is based on our report, which (1) describes how regulation has evolved in banking, securities, thrifts, credit unions, futures, insurance, secondary mortgage markets and other important areas; (2) describes several key changes in financial markets and products in recent decades that have highlighted significant limitations and gaps in the existing regulatory system; and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts. On January 22, we released an update to our biennial High-Risk Series, which described high-risk areas in federal programs, including by focusing on the need for broad-based transformations to address major economy, efficiency, or effectiveness challenges. Based on recent economic events and our past work on financial regulatory reform, we added the need to modernize the outdated U.S. financial regulatory system as a new high-risk area this year. The current U.S. financial regulatory system has relied on a fragmented and complex arrangement of federal and state regulators--put into place over the past 150 years--that has not kept pace with major developments in financial markets and products in recent decades. Today, almost a dozen federal regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies share responsibility for overseeing the financial services industry. As the nation finds itself in the midst of one of the worst financial crises ever, it has become apparent that the regulatory system is ill-suited to meet the nation's needs in the 21st century. Summary Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing regulatory system. First, regulators have struggled, and often failed, to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks. Second, regulators have had to address problems in financial markets resulting from the activities of large and sometimes less-regulated market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Fourth, standard setters for accounting and financial regulators have faced growing challenges in ensuring that accounting and audit standards appropriately respond to financial market developments, and in addressing challenges arising from the global convergence of accounting and auditing standards. Finally, as financial markets have become increasingly global, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators. These significant developments have outpaced a fragmented and outdated regulatory structure, and, as a result, significant reforms to the U.S. regulatory system are critically and urgently needed. The current system has significant weaknesses that, if not addressed, will continue to expose the nation's financial system to serious risks. Wed, 04 Feb 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09296.pdf This is the second GAO report on the Troubled Asset Relief Program (TARP). It follows up on the nine recommendations from the December 2, 2008, report (GAO-09-161). It also reviews (1) the nature and purpose of activities that had been initiated under TARP as of January 23, 2009; (2) Treasury's Office of Financial Stability (OFS) hiring and transition efforts, use of contractors, and progress in developing a system of internal control; and (3) preliminary indicators of TARP's performance. To do this work, GAO reviewed signed agreements and other relevant documentation and met with officials from OFS, contractors, federal agencies, and some participating institutions. As of January 23, 2009, Treasury had disbursed about $293.7 billion of the $700 billion in program funds. Most of the funds (about $194.2 billion) went to purchase preferred shares of 317 financial institutions under the Capital Purchase Program--Treasury's primary vehicle under TARP for stabilizing financial markets. GAO's previous report emphasized the lack of monitoring and reporting for CPP investments and recommended stronger measures for ensuring that participating institutions use the funds to meet the program's purpose and comply with CPP requirements on, for example, executive compensation and dividend payments. In response to our recommendation, Treasury developed plans to survey the largest twenty institutions monthly to monitor lending and other activities and analyze quarterly monitoring data for all institutions. While the monthly survey is a step toward greater transparency and accountability for the largest institutions, we continue to believe that additional action is needed to better ensure that all participating institutions are accountable for their use of program funds. Treasury has continued to develop a system for detecting noncompliance with key requirements of the program but has not yet finalized its plans. Further, Treasury has made limited progress in formatting articulating and communicating an overall strategy for TARP, continuing to respond to institution- and industry-specific needs by, for example, making further capital purchases and offering loans to the automobile industry. GAO's previous report also included recommendations about OFS's management infrastructure, including hiring, contract oversight, and internal controls. Treasury has taken steps to address our recommendations, but still faces several challenges. First, it took proactive steps to help ensure a smooth transition to the new administration by keeping positions filled and using an expedited hiring process, including direct hire authority. Moreover, after losing some potential candidates because of conflicts of interest, Treasury is asking candidates to address potential conflicts earlier in the recruitment process to avoid unnecessary delays in finalizing employment offers. However, it continues to face difficulty providing competitive salaries to attract skilled employees. OFS continues to rely on detailees and contractors to carry out program functions. Second, consistent with our recommendation about contracting oversight, Treasury has enhanced such oversight by tracking costs, schedules, and performance and addressing the training requirements of personnel who oversee the contracts. As we previously recommended, Treasury needs to continue to identify and mitigate conflicts of interest in contracting. Similarly, OFS has adopted a framework for organizing the development and implementation of its system of internal control for TARP activities, which is consistent with our recommendation. However, it has yet to implement a disciplined risk-assessment process.Given the recency of program actions and time lags in the reporting of available data, GAO continues to believe that it is too early in the program's implementation to see measurable results in many areas. However, while perceptions of risk have declined in interbank markets, they changed very little in corporate bond and mortgage markets. Finally, as GAO also noted in December, these indicators may be suggestive of TARP's ongoing impact, but no single indicator or set of indicators can provide a definitive determination of the program's effects because of the range of actions that have been and are being taken to address the current crisis. GAO will continue to refine and monitor the indicators going forward. Fri, 30 Jan 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09314t.pdf This testimony discusses GAO's January 8, 2009, report that provides a framework for modernizing the outdated U.S. financial regulatory system. GAO prepared this work under the authority of the Comptroller General to help policymakers weigh various regulatory reform proposals and consider ways in which the current regulatory system could be made more effective and efficient. This testimony (1) describes how regulation has evolved in banking, securities, thrifts, credit unions, futures, insurance, secondary mortgage markets and other important areas; (2) describes several key changes in financial markets and products in recent decades that have highlighted significant limitations and gaps in the existing regulatory system; and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts. The current U.S. financial regulatory system has relied on a fragmented and complex arrangement of federal and state regulators--put into place over the past 150 years--that has not kept pace with major developments in financial markets and products in recent decades. Today, almost a dozen federal regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies share responsibility for overseeing the financial services industry. As the nation finds itself in the midst of one of the worst financial crises ever, it has become apparent that the regulatory system is ill-suited to meet the nation's needs in the 21st century. Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing regulatory system. First, regulators have struggled, and often failed, to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks. Second, regulators have had to address problems in financial markets resulting from the activities of large and sometimes less-regulated market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Fourth, standard setters for accounting and financial regulators have faced growing challenges in ensuring that accounting and audit standards appropriately respond to financial market developments, and in addressing challenges arising from the global convergence of accounting and auditing standards. Finally, as financial markets have become increasingly global, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators. These significant developments have outpaced a fragmented and outdated regulatory structure, and, as a result, significant reforms to the U.S. regulatory system are critically and urgently needed. The current system has significant weaknesses that, if not addressed, will continue to expose the nation's financial system to serious risks. Our report offers a framework for crafting and evaluating regulatory reform proposals consisting of nine characteristics that should be reflected in any new regulatory system. By applying the elements of the framework, the relative strengths and weaknesses of any reform proposal should be better revealed, and policymakers should be able to focus on identifying trade-offs and balancing competing goals. Similarly, the framework could be used to craft proposals, or to identify aspects to be added to existing proposals to make them more effective and appropriate for addressing the limitations of the current system. Wed, 21 Jan 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09310t.pdf This testimony discusses GAO's January 8, 2009, report that provides a framework for modernizing the outdated U.S. financial regulatory system. GAO prepared this work under the authority of the Comptroller General to help policymakers weigh various regulatory reform proposals and consider ways in which the current regulatory system could be made more effective and efficient. This testimony (1) describes how regulation has evolved in banking, securities, thrifts, credit unions, futures, insurance, secondary mortgage markets and other important areas; (2) describes several key changes in financial markets and products in recent decades that have highlighted significant limitations and gaps in the existing regulatory system; and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts. The current U.S. financial regulatory system has relied on a fragmented and complex arrangement of federal and state regulators--put into place over the past 150 years--that has not kept pace with major developments in financial markets and products in recent decades. Today, almost a dozen federal regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies share responsibility for overseeing the financial services industry. As the nation finds itself in the midst of one of the worst financial crises ever, it has become apparent that the regulatory system is ill-suited to meet the nation's needs in the 21st century. Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing regulatory system. First, regulators have struggled, and often failed, to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks. Second, regulators have had to address problems in financial markets resulting from the activities of large and sometimes less-regulated market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Fourth, standard setters for accounting and financial regulators have faced growing challenges in ensuring that accounting and audit standards appropriately respond to financial market developments, and in addressing challenges arising from the global convergence of accounting and auditing standards. Finally, as financial markets have become increasingly global, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators. These significant developments have outpaced a fragmented and outdated regulatory structure, and, as a result, significant reforms to the U.S. regulatory system are critically and urgently needed. The current system has significant weaknesses that, if not addressed, will continue to expose the nation's financial system to serious risks. Our report offers a framework for crafting and evaluating regulatory reform proposals consisting of nine characteristics that should be reflected in any new regulatory system. By applying the elements of the framework, the relative strengths and weaknesses of any reform proposal should be better revealed, and policymakers should be able to focus on identifying trade-offs and balancing competing goals. Similarly, the framework could be used to craft proposals, or to identify aspects to be added to existing proposals to make them more effective and appropriate for addressing the limitations of the current system. Wed, 14 Jan 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09216.pdf The United States and other countries are in the midst of the worst financial crisis in more than 75 years. While much of the attention of policymakers understandably has been focused on taking short-term steps to address the immediate nature of the crisis, these events have served to strikingly demonstrate that the current U.S. financial regulatory system is in need of significant reform. To help policymakers better understand existing problems with the financial regulatory system and craft and evaluate reform proposals, this report (1) describes the origins of the current financial regulatory system, (2) describes various market developments and changes that have created challenges for the current system, and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts. To do this work, GAO synthesized existing GAO work and other studies and met with dozens of representatives of financial regulatory agencies, industry associations, consumer advocacy organizations, and others. Twenty-nine regulators, industry associations, and consumer groups also reviewed a draft of this report and provided valuable input that was incorporated as appropriate. In general, reviewers commented that the report represented an important and thorough review of the issues related to regulatory reform. The current U.S. financial regulatory system has relied on a fragmented and complex arrangement of federal and state regulators--put into place over the past 150 years--that has not kept pace with major developments in financial markets and products in recent decades. As the nation finds itself in the midst of one of the worst financial crises ever, the regulatory system increasingly appears to be ill-suited to meet the nation's needs in the 21st century. Today, responsibilities for overseeing the financial services industry are shared among almost a dozen federal banking, securities, futures, and other regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies. Much of this structure has developed as the result of statutory and regulatory changes that were often implemented in response to financial crises or significant developments in the financial services sector. For example, the Federal Reserve System was created in 1913 in response to financial panics and instability around the turn of the century, and much of the remaining structure for bank and securities regulation was created as the result of the Great Depression turmoil of the 1920s and 1930s. Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing regulatory system. First, regulators have struggled, and often failed, to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks. The portion of firms operating as conglomerates that cross financial sectors of banking, securities, and insurance increased significantly in recent years, but none of the regulators is tasked with assessing the risks posed across the entire financial system. Second, regulators have had to address problems in financial markets resulting from the activities of large and sometimes less-regulated market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Regulators failed to adequately oversee the sale of mortgage products that posed risks to consumers and the stability of the financial system. Fourth, standard setters for accounting and financial regulators have faced growing challenges in ensuring that accounting and audit standards appropriately respond to financial market developments, and in addressing challenges arising from the global convergence of accounting and auditing standards. ? Finally, despite the increasingly global aspects of financial markets, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators. Thu, 08 Jan 2009 00:00:00 -0500 http://www.gao.gov/new.items/d09266t.pdf This testimony discusses our first report on the newly created Troubled Asset Relief Program (TARP), which gave the Department of Treasury the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through the Office of Financial Stability (OFS). Treasury was granted this authority in response to the recent financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. Among other things, the Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the status of actions taken under the program. This testimony is based on our December 2, 2008, report. This report is the first under the act's mandate and covers the actions taken as part of TARP through November 25, 2008.3 Our oversight work under the act is ongoing, and our next report will be issued by January 31, 2009. Treasury has taken a number of steps to try to stabilize the U.S. financial markets and banking system, including injecting billions of dollars into financial institutions. Although Treasury initially planned to buy mortgages and mortgage-related assets through TARP, Treasury shifted its focus to a preferred stock and warrant purchase program, known as the Capital Purchase Program (CPP). Treasury has provided more than $155 billion in capital to 87 institutions through CPP as of December 5, 2008. It has also established a Systemically Significant Failing Institution (SSFI) program, through which Treasury may invest in any financial instrument, including debt, equity, or warrants determined to be a troubled asset, and continues to explore other programs, including those focused on insurance, foreclosure mitigation, and consumer lending. As of December 5, 2008, Treasury had allocated a total of $335 billion of TARP funds and disbursed $195 billion to institutions under the various programs. While we recognize that TARP has existed for a short time and that a new program of such magnitude faces many challenges, especially in this current uncertain economic climate, we found that Treasury has yet to address a number of critical issues. These include determining how it will ensure that CPP is achieving its intended goals and monitoring compliance with limitations on executive compensation, dividend payments, and stock repurchases. Moreover, it has yet to formalize transition planning efforts given the upcoming shift to a new administration or to establish an effective management structure and an essential system of internal controls. Wed, 10 Dec 2008 00:00:00 -0500 http://www.gao.gov/new.items/d09231t.pdf A dramatic increase in mortgage loan defaults and foreclosures is one of the key contributing factors to the current downturn in the U.S. financial markets and economy. In response, Congress passed and the President signed in July the Housing and Economic Recovery Act of 2008 and in October the Emergency Economic Stabilization Act of 2008 (EESA), which established the Office of Financial Stability (OFS) within the Department of the Treasury and authorized the Troubled Asset Relief Program (TARP). Both acts establish new authorities to preserve homeownership. In addition, the administration, independent financial regulators, and others have undertaken a number of recent efforts to preserve homeownership. GAO was asked to update its 2007 report on default and foreclosure trends for home mortgages, and describe the OFS's efforts to preserve homeownership. GAO analyzed quarterly default and foreclosure data from the Mortgage Bankers Association for the period 1979 through the second quarter of 2008 (the most recent quarter for which data were available). GAO also relied on work performed as part of its mandated review of Treasury's implementation of TARP, which included obtaining and reviewing information from Treasury, federal agencies, and other organizations (including selected banks) on home ownership preservation efforts. To access GAO's first oversight report on Treasury's implementation of TARP, see GAO-09-161. Default and foreclosure rates for home mortgages rose sharply from the second quarter of 2005 through the second quarter of 2008, reaching a point at which more than 4 in every 100 mortgages were in the foreclosure process or were 90 or more days past due. These levels are the highest reported in the 29 years since the Mortgage Bankers Association began keeping complete records and are based on its latest available data. The subprime market, which consists of loans to borrowers who generally have blemished credit and that feature higher interest rates and fees, experienced substantially steeper increases in default and foreclosure rates than the prime or government-insured markets, accounting for over half of the overall increase. In the prime and subprime market segments, adjustable-rate mortgages experienced steeper growth in default and foreclosure rates than fixed-rate mortgages. Every state in the nation experienced growth in the rate at which loans entered the foreclosure process from the second quarter of 2005 through the second quarter of 2008. The rate rose at least 10 percent in every state over the 3-year period, but 23 states experienced an increase of 100 percent or more. Several states in the "Sun Belt" region, including Arizona, California, Florida, and Nevada, had among the highest percentage increases. OFS initially intended to purchase troubled mortgages and mortgage-related assets and use its ownership position to influence loan servicers and to achieve more aggressive mortgage modification standards. However, within two weeks of EESA's passage, Treasury determined it needed to move more quickly to stabilize financial markets and announced it would use $250 billion of TARP funds to inject capital directly into qualified financial institutions by purchasing equity. In recitals to the standard agreement with Treasury, institutions receiving capital injections state that they will work diligently under existing programs to modify the terms of residential mortgages. It remains unclear, however, how OFS and the banking regulators will monitor how these institutions are using the capital injections to advance the purposes of the act, including preserving homeownership. As part of its first TARP oversight report, GAO recommended that Treasury, among other things, work with the bank regulators to establish a systematic means for determining and reporting on whether financial institutions' activities are generally consistent with program goals. Treasury also established an Office of Homeownership Preservation within OFS that is reviewing various options for helping homeowners, such as insuring troubled mortgage-related assets or adopting programs based on the loan modification efforts of FDIC and others, but it is still working on its strategy for preserving homeownership. While Treasury and others will face a number of challenges in undertaking loan modifications, including making transparent to investors the analysis supporting the value of modification versus foreclosure, rising defaults and foreclosures on home mortgages underscore the importance of ongoing and future efforts to preserve homeownership. GAO will continue to monitor Treasury's efforts as part of its mandated TARP oversight responsibilities. Thu, 04 Dec 2008 00:00:00 -0500 http://www.gao.gov/new.items/d09161.pdf On October 3, 2008, the Emergency Economic Stabilization Act was signed into law. The act established the Office of Financial Stability (OFS) within the Department of the Treasury (Treasury) and authorized the Troubled Asset Relief Program (TARP). Every 60 days, the U.S. Comptroller General is required to report on a variety of areas associated with oversight of TARP. This report reviews (1) the activities that have been undertaken through TARP as of November 25, 2008; (2) the structure of OFS, its use of contractors, and its system of internal controls; and (3) preliminary indicators of TARP's performance. GAO reviewed documents related to TARP, including contracts, agreements, guidance, and rules. GAO also met with OFS, contractors, federal agencies, and officials from some participating institutions. GAO plans to continue to monitor these and other issues including future and ongoing capital purchases, other transactions undertaken as part of TARP (e.g., capital purchases in Citigroup and American International Group), and the status of other aspects of TARP. Treasury has taken a number of steps to stabilize U.S. financial markets and the banking system, including injecting billions of dollars in financial institutions. Through the capital purchase program (CPP)--a preferred stock and warrant purchase program--Treasury provided more than $150 billion in capital to 52 institutions as of November 25, 2008. GAO recognizes that TARP has existed for less than 60 days and that a new program of such magnitude faces many challenges, especially in this current uncertain economic climate. However, Treasury has yet to address a number of critical issues, including determining how it will ensure that CPP is achieving its intended goals and monitoring compliance with limitations on executive compensation and dividend payments. Moreover, further actions are needed to formalize transition planning efforts and establish an effective management structure and an essential system of internal control. To help ensure the program's integrity, accountability, and transparency, GAO recommends that Treasury (1) work with the bank regulators to establish a systematic means of determining and reporting in a timely manner whether financial institutions' activities are generally consistent with the purposes of CPP and help ensure an appropriate level of accountability and transparency; (2) develop a means to ensure that institutions participating in CPP comply with key program requirements (e.g., executive compensation, dividend payments, and the repurchase of stock); (3) formalize the existing communication strategy to ensure that external stakeholders, including Congress, are informed about the program's current strategy and activities and understand the rationale for changes in this strategy to avoid information gaps and surprises; (4) facilitate a smooth transition to the new administration by building on and formalizing ongoing activities, including ensuring that key OFS leadership positions are filled during and after the transition; (5) expedite OFS's hiring efforts to ensure that Treasury has the personnel needed to carry out and oversee TARP; (6) ensure that sufficient personnel are assigned and properly trained to oversee the performance of all contractors, especially for Contracts priced on a time and materials basis, and move toward fixed-price arrangements whenever possible; (7) continue to develop a comprehensive system of internal control over TARP, including policies, procedures, and guidance that are robust enough to protect taxpayers interests and ensure that the program objectives are being met; (8) issue final regulations on conflicts of interest quickly and review and renegotiate mitigation plans to enhance specificity and compliance; and (9) institute a system to effectively manage and monitor the mitigation of conflicts of interest. Tue, 02 Dec 2008 00:00:00 -0500 http://www.gao.gov/new.items/d08885.pdf The increase in leveraged buyouts (LBO) of U.S. companies by private equity funds prior to the slowdown in mid-2007 has raised questions about the potential impact of these deals. Some praise LBOs for creating new governance structures for companies and providing longer term investment opportunities for investors. Others criticize LBOs for causing job losses and burdening companies with too much debt. This report addresses the (1) effect of recent private equity LBOs on acquired companies and employment, (2) impact of LBOs jointly undertaken by two or more private equity funds on competition, (3) Securities and Exchange Commission's (SEC) oversight of private equity funds and their advisers, and (4) regulatory oversight of commercial and investment banks that have financed recent LBOs. GAO reviewed academic research, analyzed recent LBO data, conducted case studies, reviewed regulators' policy documents and examinations, and interviewed regulatory and industry officials, and academics. Academic research that GAO reviewed generally suggests that recent private equity LBOs have had a positive impact on the financial performance of the acquired companies, but determining whether the impact resulted from the actions taken by the private equity firms versus other factors is difficult. The research also indicates that private equity LBOs are associated with lower employment growth than comparable companies. However, uncertainty remains about the employment effect--in part because, as one study found, target companies had lower employment growth before being acquired. Further research may shed light on the causal relationship between private equity and employment growth, if any. Private equity firms have increasingly joined together to acquire target companies (called "club deals"). In 2007, there were 28 club deals, totaling about $217 billion in value. Club deals could reduce or increase the number of firms bidding on a target company and, thus, affect competition. In analyzing 325 public-to-private LBOs done from 1998 through 2007, GAO generally found no statistical indication that club deals, in aggregate, were associated with lower or higher prices paid for the target companies, after controlling for differences in the targets. However, our results do not rule out the possibility of parties engaging in illegal behavior in any particular LBO. Indeed, according to securities filings and media reports, some large club deals have led to lawsuits and an inquiry into the practice by the Department of Justice. Because private equity funds and their advisers typically claim an exemption from registration as an investment company or investment adviser, respectively, SEC exercises limited oversight of these entities. However, in examining some registered advisers to private equity funds, SEC has found some control weaknesses but generally has not found such funds to pose significant concerns for fund investors. The growth in LBOs has led to greater regulatory scrutiny. SEC, along with other regulators, has identified conflicts of interest arising in LBOs as a potential concern and is analyzing the issue. Before 2007, federal financial regulators generally found that the major institutions that financed LBOs were managing the associated risks. However, after problems with subprime mortgages spilled over to other markets in mid-2007, the institutions were being exposed to greater-than-expected risk. As a result, the regulators reassessed the institutions' risk-management practices and identified some weaknesses. The regulators are monitoring efforts being taken to address weaknesses and considering the need to issue related guidance. While the institutions have taken steps to decrease their risk exposures, the spillover effects from the subprime mortgage problems to leveraged loans illustrate the importance of understanding and monitoring conditions in the broader markets, including connections between them. Failure to do so could limit the effectiveness and ability of regulators to address issues when they occur. Tue, 09 Sep 2008 00:00:00 -0400 http://www.gao.gov/new.items/d08692.pdf Millions of retired Americans rely on defined benefit pension plans for their financial well-being. Recent reports have noted that some plans are investing in 'alternative' investments such as hedge funds and private equity funds. This has raised concerns, given that these two types of investments have qualified for exemptions from federal regulations, and could present more risk to retirement assets than traditional investments. To better understand this trend and its implications, GAO was asked to examine (1) the extent to which plans invest in hedge funds and private equity; (2) the potential benefits and challenges of hedge fund investments; (3) the potential benefits and challenges of private equity investments; and (4) what mechanisms regulate and monitor pension plan investments in hedge funds and private equity. To answer these questions GAO interviewed relevant federal agencies, public and private pension plans, industry groups and investment professionals, and analyzed available survey data. According to several recent surveys of private and public sector plans, investments in hedge funds and private equity generally comprise a small share of total plan assets, but a considerable and growing number of plans have such investments. Available survey data of mid to large-size plans indicate that between 21 and 27 percent invest in hedge funds while over 40 percent invest in private equity; such investments are more prevalent among larger plans, as shown below. The extent of investment in hedge funds and private equity by plans with less than $200 million in total assets is unknown. Pension plans invest in hedge funds to obtain a number of potential benefits, such as returns greater than the stock market and stable returns on investment. However, hedge funds also pose challenges and risks beyond those posed by traditional investments. For example, some investors may have little information on funds' underlying assets and their values, which limits the opportunity for oversight. Plan representatives said they take steps to mitigate these and other challenges, but doing so requires resourcesbeyond the means of some plans. Pension plans primarily invest in private equity funds to attain returns superior to the stock market. Pension plan officials GAO spoke with generally had a long history of investing in private equity and said such investments have met expectations for returns. However, these investments present several challenges, such as wide variation in performance among funds, and the resources required to mitigate these challenges may be too substantial for some plans. The federal government does not specifically limit or monitor private sector plan investment in hedge funds or private equity, and state approaches to public plans vary. Under federal law, fiduciaries must comply with a standard of prudence, but no explicit restrictions on hedge funds or private equity exist. Although a federal advisory council recommended that the Department of Labor (Labor) develop guidance for plans to use in investing in hedge funds, Labor has not yet done so. While most states also rely on a standard of investor prudence, some also have legislation that restricts or prohibits plan investment in hedge funds or private equity. For example, one state prohibits plans below a certain size from investing directly in hedge funds. Thu, 14 Aug 2008 00:00:00 -0400 http://www.gao.gov/new.items/d08563t.pdf The housing government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System (FHLBank System), play a critical role in the nation's housing finance system. However, concerns exist that the fragmented federal oversight structure for the GSEs is not well positioned to help ensure that they operate in a safe and sound manner and fulfill their housing missions. This testimony provides information on the GSEs' missions and risks, the current regulatory structure, and proposed regulatory reforms. To prepare this testimony, GAO relied on a substantial body of previous work and updated its analysis in light of recent events. While the GSEs provide certain public benefits, they also pose potential risks. Fannie Mae and Freddie Mac's primary activity involves purchasing mortgages from lenders and issuing mortgage-backed securities that are either sold to investors or held in the GSEs' retained portfolio. The 12 FHLBanks traditionally made loans to their members and more recently instituted programs to purchase mortgages from their members and hold such mortgages in their portfolios. While not obligated to do so, the federal government could provide financial assistance to the GSEs, if one or more experienced financial difficulties, that could result in significant costs to taxpayers. Due to the GSEs' large size, the potential also exists that financial problems at one or more of the GSEs could have destabilizing effects on financial markets. The current housing GSE regulatory structure is fragmented and not well equipped to oversee their financial soundness or housing mission achievement. The Office of Federal Housing Enterprise Oversight (OFHEO) is responsible for safety and soundness oversight of Fannie Mae and Freddie Mac while the Federal Housing Finance Board (FHFB) is responsible for safety and soundness and mission oversight of the FHLBank System. Both regulators lack key statutory authorities to fulfill their safety and soundness responsibilities as compared to the authorities available to federal bank regulators. For example, OFHEO and FHFB are not authorized to limit the asset growth of housing GSEs if capital falls below predetermined levels. Moreover, the Department of Housing and Urban Development (HUD), which has housing mission oversight responsibility for Fannie Mae and Freddie Mac, faces a number of challenges in carrying out its responsibilities. In particular, HUD may not have sufficient resources and technical expertise to review sophisticated financial products and issues. Creating a single housing GSE regulator could better ensure consistency of regulation among the GSEs. With safety and soundness and mission oversight combined, a single regulator would be better positioned to consider potential trade-offs between these sometimes competing objectives. To be effective, the single regulator must have all the regulatory oversight and enforcement powers necessary to address unsafe and unsound practices, respond to financial emergencies, assess the extent to which the GSEs' activities benefit home buyers and mortgage markets, and otherwise ensure that the GSEs comply with their public missions. To ensure the independence and prominence of the regulator and allow it to act independently of the influence of the housing GSEs, this new GSE regulator should be governed by a board or hybrid board structure. Thu, 06 Mar 2008 00:00:00 -0500 http://www.gao.gov/new.items/d08200.pdf Since the 1998 near collapse of Long-Term Capital Management (LTCM), a large hedge fund--a pooled investment vehicle that is privately managed and often engages in active trading of various types of securities and commodity futures and options--the number of hedge funds has grown, and they have attracted investments from institutional investors such as pension plans. Hedge funds generally are recognized as important sources of liquidity and as holders and managers of risks in the capital markets. Although the market impacts of recent hedge fund near collapses were less severe than that of LTCM, they recalled concerns about risks associated with hedge funds and they highlighted the continuing relevance of questions raised over LTCM. This report (1) describes how federal financial regulators oversee hedge fund-related activities under their existing authorities; (2) examines what measures investors, creditors, and counterparties have taken to impose market discipline on hedge funds; and (3) explores the potential for systemic risk from hedge fund-related activities and describes actions regulators have taken to address this risk. In conducting this study, GAO reviewed regulators' policy documents and examinations and industry reports and interviewed regulatory and industry officials, and academics. Regulators only provided technical comments on a draft of this report, which GAO has incorporated into the report as appropriate. Under the existing regulatory structure, the Securities and Exchange Commission and Commodity Futures Trading Commission can provide direct oversight of registered hedge fund advisers, and along with federal bank regulators, they monitor hedge fund-related activities conducted at their regulated entities. Since LTCM's near collapse, regulators generally have increased reviews--by such means as targeted examinations--of systems and policies of their regulated entities to mitigate counterparty credit risks, including those involving hedge funds. Although some examinations found that banks generally have strengthened practices for managing risk exposures to hedge funds, regulators recommended that they enhance firmwide risk management systems and practices, including expanded stress testing. Regulated entities have the responsibility to practice prudent risk management standards, but prudent standards do not guarantee prudent practices. As such, it will be important for regulators to show continued vigilance in overseeing hedge fund-related activities. According to market participants, hedge fund advisers have improved disclosures and transparency about their operations since LTCM as a result of industry guidance issued and pressure from investors and creditors and counterparties (such as prime brokers). But market participants also suggested that not all investors have the capacity to analyze the information they receive from hedge funds. Regulators and market participants said that creditors and counterparties have generally conducted more due diligence and tightened their credit standards for hedge funds. However, several factors may limit the effectiveness of market discipline or illustrate failures to properly exercise it. For example, because most large hedge funds use multiple prime brokers as service providers, no one broker may have all the data necessary to assess the total leverage of a hedge fund client. Further, if the risk controls of creditors and counterparties are inadequate, their actions may not prevent hedge funds from taking excessive risk. These factors can contribute to conditions that create systemic risk if breakdowns in market discipline and risk controls are sufficiently severe that losses by hedge funds in turn cause significant losses at key intermediaries or in financial markets. Financial regulators and industry participants remain concerned about the adequacy of counterparty credit risk management at major financial institutions because it is a key factor in controlling the potential for hedge funds to become a source of systemic risk. Regulators have used risk-focused and principles-based approaches to better understand the potential for systemic risk and respond more effectively to financial shocks that threaten to affect the financial system. For instance, regulators have collaborated to examine some hedge fund activities across regulated entities. The President's Working Group has taken steps such as issuing guidance and forming two private sector groups to develop best practices to enhance market discipline. GAO views these as positive steps, but it is too soon to evaluate their effectiveness. Thu, 24 Jan 2008 00:00:00 -0500 http://www.gao.gov/new.items/d0878r.pdf Substantial growth in the mortgage market in recent years has helped many Americans become homeowners. However, as of the latest quarterly data available, June 2007, more than 1 million mortgages were in default or foreclosure, an increase of 50 percent compared with June 2005. Defaults and foreclosures on home mortgages can impose significant costs on borrowers, lenders, mortgage investors, and neighborhoods. Additionally, recent increases in defaults and foreclosures have contributed to concern and increased volatility in certain U.S. and global financial markets. These developments have raised questions about the extent and causes of problems in the mortgage market. To provide some insights on these issues, Congress asked GAO to analyze (1) the scope and magnitude of recent default and foreclosure trends, and how these trends compare with historical values, and (2) developments in economic conditions and the primary and secondary mortgage markets associated with these trends. Overall, the number and percentage of mortgages in default or foreclosure rose sharply from the second quarter of 2005 through the second quarter of 2007 to levels at or near historical highs, but there was significant variation among market segments, loan types, and states. The overall default rate grew by 29 percent, reaching a point at which just over 1 in every 100 mortgages was in default, almost a 28-year high. The foreclosure start rate did reach a 28-year high, rising by 55 percent. The subprime market experienced substantially steeper increases in default and foreclosure start rates than the prime or government-insured markets, accounting for two-thirds or more of the overall increase in the number of loans in default or foreclosure during this time frame. Among types of loans, ARMs experienced relatively steeper growth in default and foreclosure rates, compared with FRMs which experienced no or modest increases. According to mortgage industry researchers and participants, the number and percentage of loans in default and foreclosure are likely to worsen through the end of 2007 and into 2008, due partly to scheduled payment increases for many ARMs. A number of studies and industry data indicate that a combination of economic and market developments contributed to recent increases in default and foreclosure rates. First, the rapid decline in the rate of home price appreciation throughout much of the nation beginning in 2005 may have reduced incentives for borrowers to keep current on their mortgages and made it more difficult for borrowers to refinance or sell their homes to avoid default or foreclosure. Second, in some states with foreclosure rates that were already relatively high in 2005, weak labor market conditions likely contributed to mortgage problems. Third, more aggressive lending practices--an easing of underwriting standards and wider use of certain loan features associated with poorer loan performance--reduced the likelihood that some borrowers would be able to meet their mortgage obligations, particularly in times of economic hardship or limited house price appreciation. Fourth, growth in the market for private label RMBS beginning in 2003 provided liquidity to some brokers and lenders to support these more aggressive lending practices. Investors were attracted to these securities because of their seemingly high risk-adjusted returns. A number of other factors--including incentives that potentially emphasized loan volume over loan quality and growth in the incidence of mortgage fraud--may have contributed to recent default and foreclosure trends, but additional information would be needed to fully assess their impact. Tue, 16 Oct 2007 00:00:00 -0400 http://www.gao.gov/new.items/d0832.pdf As the financial services industry has become increasingly concentrated in a number of large, internationally active firms offering an array of products and services, the adequacy of the U.S. financial regulatory system has been questioned. GAO has identified the need to modernize the financial regulatory system as a challenge to be addressed in the 21st century. This report, mandated by the Financial Services Regulatory Relief Act of 2006, discusses (1) measurements of regulatory costs and benefits and efforts to avoid excessive regulatory burden, (2) the challenges posed to financial regulators by trends in the industry, and (3) options to enhance the efficiency and effectiveness of the federal financial regulatory structure. GAO convened a Comptroller General's Forum (Forum) with supervisors and leading industry experts, reviewed regulatory agency policies, and summarized prior reports to meet these objectives. The inherent problems of measuring the costs and benefits of regulation make it difficult to assess the extent to which regulations may be unduly burdensome to U.S. financial services firms, particularly in comparison to firms in other countries. Additionally, it is difficult to separate the costs of complying with regulation from other costs and thus determine regulatory burden. Regulatory agencies, however, have undertaken several initiatives to reduce regulatory burden; these efforts contributed to the Financial Services Regulatory Relief Act of 2006. While noting that regulation contributes to confidence in financial institutions and markets, participants in the Forum agreed regulators have opportunities to further reduce regulatory burden and suggested regulators better measure the results of implemented regulations. GAO also recently recommended regulatory agencies consider whether and how to measure the performance of regulation during the process of promulgating the regulation and improving the communication of regulatory reviews to the public. The current regulatory structure, with multiple agencies that oversee segments of the financial services industry, is challenged by a number of industry trends. The development of large, complex, internationally active firms whose product offerings span the jurisdiction of several agencies creates the potential for inconsistent regulatory treatment of similar products, gaps in consumer and investor protection, or duplication among regulators. Regulatory agencies have made efforts to collaborate in responding to these trends and avoid inconsistencies, gaps, and duplication. However, challenges remain; until recently, the Office of Thrift Supervision and the Securities and Exchange Commission, for instance, had not sought to resolve potentially duplicative and inconsistent regulation of several financial services conglomerates for which both agencies have jurisdiction. Finally, despite the challenges posed by the industry's dynamic environment, accountability for addressing issues that span agencies' jurisdiction is not clearly assigned. These issues have led GAO to suggest in prior work that the federal regulatory structure should be modernized. GAO and others have recommended several options to accomplish modernization of the federal financial regulatory structure; these include consolidating certain regulatory functions as well as having a single regulator for large, complex firms. There also are potential lessons that can be learned from the experience of other nations that have restructured their financial regulators. Several Forum participants, for instance, suggested that one important lesson the United States could learn from the United Kingdom's Financial Services Authority was the value of setting principles or goals for regulators. The Department of the Treasury's recently announced plan to propose a restructured regulatory system provides an opportunity to take the first step toward modernization by providing clear and consistent goals for the regulatory agencies. Fri, 12 Oct 2007 00:00:00 -0400 http://www.gao.gov/new.items/d07879.pdf Pending legislation to the Federal Housing Administration's (FHA) Title I Manufactured Home Loan program would increase loan limits, insure each loan, incorporate stricter underwriting requirements, and set up-front premiums. GAO was asked to review (1) selected characteristics of manufactured housing and the demographics of the owners; (2) federal and state consumer protections for owners of manufactured homes; and (3) the potential benefits and costs of the proposed changes for borrowers and the federal government. In addressing these objectives, GAO analyzed select Census data; researched federal laws and laws in eight states; interviewed local, state, and federal officials; and analyzed various scenarios that might affect Title I program costs. According to 2005 American Housing Survey data, most manufactured homes (factory-built housing designed to meet the national building code) were located in rural areas in southern states, and most were occupied by lower-income owners rather than renters. Although the market for new manufactured homes declined substantially from 1996 to 2005, buyers increasingly bought larger homes and placed them on private property rather than in manufactured home parks. In addition, some states are experiencing park closures, with the properties being converted to other uses. Overall, manufactured homes can be an affordable housing option, with monthly housing costs lower than for other housing types. Owners of manufactured homes generally have more consumer protections if their homes are considered real rather than personal property, but protections provided by laws in the states GAO examined vary. Consumer protections extending to lending and settlement processes for personal property loans are not as broad as those for real property loans (mortgages). Also, delinquent Title I borrowers can be subject to repossession or foreclosure, but the consumer protections for repossession are often less extensive than those for foreclosure. State laws give owners of manufactured homes on leased land varying levels of notice, protection, and compensation related to length of leases, rent increases, evictions, and park closures. According to some FHA and lending officials, potential benefits of the proposed changes for borrowers include loans big enough to buy larger homes and more financing as more lenders participate in the program. The program insured about 24,000 loans in 1990 but only about 1,400 loans representing $54 million in mortgage insurance in 2006. While the changes could benefit borrowers, according to FHA and the Congressional Budget Office, the potential costs could expand the government's liability. To gain an understanding of the effects of the proposed changes, GAO presented various scenarios. Although risk factors unique to manufactured home lending (such as placement on leased land) as well as commonly used predictors of loan performance (such as credit scores) are associated with default risk, these data were not available. Instead, GAO modeled different variations of borrower default risk and other factors (such as premiums and lender recovery) that were based on the experience of FHA loans to illustrate how variations in these key factors could affect potential gains and losses to FHA's General Insurance Fund. The analysis suggests that in all instances where borrowers had medium or high default risk, the fund would experience a loss. However FHA has not articulated which borrowers would be served, how the loans would be underwritten and priced under a risk-based structure, or collected data on credit scores and land ownership type. FHA explained that among other reasons, it had not done so because the Title I program was currently a low-volume program. As a result, the effects of the proposed changes are unclear. Fri, 24 Aug 2007 00:00:00 -0400 http://www.gao.gov/new.items/d071053.pdf After widespread unlawful trading practices surfaced in the mutual fund industry in late 2003, the Securities and Exchange Commission (SEC), through its Office of Compliance Inspections and Examinations (OCIE), took steps intended to revise its examination process to better identify and focus its resources on those activities representing the highest risk to investors. More recently, some registrants raised concerns about the lack of communication from SEC examiners about the status of and results of examinations. This report (1) describes OCIE's revisions after 2003 to the examination approach for investment companies and investment advisers; (2) discusses OCIE's compliance with its examination exit procedures; and (3) describes reforms OCIE implemented since January 2006 to enhance, among other things, communication with registrants. To address these objectives, GAO analyzed OCIE examination data; planning documents and guidance; interviewed OCIE officials; and gathered views of registrants. Since the detection of mutual fund trading abuses in late 2003, OCIE has shifted its approach to examinations of investment companies and investment advisers from one that focused on routinely examining all registered firms, regardless of risk, to one that focuses on more frequently examining those firms and industry practices at higher-risk for compliance issues. The effectiveness of OCIE's revised approach largely depends on OCIE's accurately assessing the risk level of investment advisers. The method that OCIE employs to predict the level of risk for the majority of investment advisers has some limitations, particularly in that this method relies on proxy indicators of compliance risks without incorporating information about the relative strength of a firm's compliance controls. OCIE has taken steps to assess the effectiveness of this method for predicting risk-levels and to seek additional indicators of compliance risks. GAO continues to believe that implementing GAO's prior recommendation to obtain and use compliance reports from firms--a source of information on the effectiveness of their compliance controls--could potentially help OCIE better identify higher-risk firms. GAO's review of investment company, investment adviser, and broker-dealer examinations conducted from fiscal years 2003 through 2006 found that examiners generally follow OCIE's exit procedures for communicating deficiencies to registrants and providing written notice of the examination's outcome, except in an estimated 9 percent of investment company and investment adviser examinations where OCIE directed examiners to forgo these procedures. These examinations were part of a series of OCIE examinations that probed specific activities across a number of firms and were initiated in response to the widespread unlawful trading practices which had surfaced at that time. In addition, GAO estimated that in 7 percent of broker-dealer examinations, either examiners did not follow exit procedures or OCIE officials were not able to provide evidence that they did. OCIE has implemented several initiatives since January 2006 intended to improve communication with registrants and other aspects of the examination program. For instance, OCIE established a hotline for registrants to receive comments or complaints, began requiring examiners to contact registrants when examinations extend past 120 days, and implemented tools and protocols designed to reduce duplicating examinations. GAO's review indicated that examiners generally complied with the new requirement to notify registrants when an examination extends past 120 days. Comments from industry representatives on OCIE's initiatives suggested some concerns about the hotline. Specifically, several registrants questioned the independence of the hotline, as it is located within OCIE, and said that as a result they would hesitate to use it. Tue, 14 Aug 2007 00:00:00 -0400 http://www.gao.gov/new.items/d071109t.pdf Fewer borrowers are using the Federal Housing Administration's (FHA) single-family and manufactured housing insurance programs. To help counter this trend, proposed changes to the single-family program would raise loan limits, allow risk-based pricing of premiums, and reduce down payments. Changes such as higher loan limits also were proposed for the manufactured housing program. To assist Congress in considering the impact of these changes, this testimony provides information from recently issued GAO reports and preliminary views from ongoing work. Specifically, GAO discusses (1) trends in FHA's share of the mortgage market, (2) likely impacts of proposed changes to the single-family program, (3) practices important to implementing the changes to the single-family program, if passed, and (4) preliminary observations from our work on the manufactured housing program. To conduct this work, GAO analyzed agency, Home Mortgage Disclosure Act, and Census data and interviewed agency and lending industry officials and other stakeholders. FHA's share of the single-family mortgage market declined 13 percentage points from 1996 through 2005, with conventional lenders gaining notably increased percentages of lower-income and minority borrowers. This decline in market share was associated with a number of factors, including FHA's product restrictions and product innovations in the conventional market. The proposed changes to the single-family program could affect borrowers as well as program costs. For example, GAO estimated that in 2005 FHA could have insured 9 to 10 percent more loans if proposed mortgage limits were in effect. But, if the risk-based pricing proposal had been in effect in 2005, 20 percent of borrowers would not have qualified for FHA insurance. FHA determined that the expected claim rates of these borrowers were higher than it found tolerable for either the borrower or the Mutual Mortgage Insurance Fund. Absent any program changes, FHA estimates that the fund would require an appropriation of approximately $143 million in fiscal year 2008. If proposed changes were passed, FHA estimates that the fund would generate $342 million in negative subsidies (i.e., net cash inflows). Although FHA is taking steps to enhance tools important to implementing the proposed changes to its single-family program, it does not plan to use a common industry practice, piloting, to mitigate the risks of any zero-downpayment product. In response to prior GAO recommendations, FHA improved its loan performance models and is refining its mortgage scorecard (which evaluates the default risk of borrowers). However, the proposals would introduce new risks and challenges. The proposal to lower down payments is of particular concern given the greater default risk of these loans and the difficulty of setting prices for new products whose risks may not be well understood. One of the ways FHA plans to mitigate new or increased risks is through stricter underwriting standards, but it does not plan to pilot any zero-down-payment product. Other mortgage institutions use pilots to manage risks associated with changing or expanding product lines. Proposals for the manufactured home loan program would increase loan limits, insure each loan made, incorporate stricter underwriting requirements, and set premium rates. While the changes could benefit borrowers, according to FHA and the Congressional Budget Office, the potential costs could expand the government's liability. However, FHA has not articulated which borrowers would be targeted if the program were expanded, specified changes in its underwriting requirements, developed a risk-based pricing structure for the proposed legislation, or estimated costs to the General Insurance Fund. As a result, the potential effects of the changes on the program and the insurance fund are unclear. Wed, 18 Jul 2007 00:00:00 -0400 http://www.gao.gov/new.items/d07708.pdf In recent years, the Federal Housing Administration (FHA) has experienced a sharp decline in market share. Also, the agency has estimated that, absent program changes, its Mutual Mortgage Insurance Fund (Fund) would require appropriations in 2008. To adapt to market changes, FHA has implemented new procedures and proposed the following major legislative changes: raising FHA's loan limits, allowing risk-based pricing, and lowering down-payment requirements. GAO was asked to report on (1) the likely program and budget impacts of FHA's modernization efforts; (2) the tools, resources, and risk management practices important to FHA's implementation of the legislative proposals, if passed; and (3) other options that FHA and Congress could consider to help FHA adapt to market changes. To address these objectives, GAO analyzed FHA and Home Mortgage Disclosure Act (HMDA) data and interviewed officials from FHA and other mortgage institutions. FHA's recent changes to insurance approval and appraisal requirements have streamlined its insurance process, and FHA's major legislative proposals could affect the demand for FHA's loans, the cost and availability of insurance to borrowers, and the insurance program's budgetary costs. Based on GAO's analysis of HMDA data, the number of FHA-insured loans could have been from 9 to 10 percent greater in 2005 had the higher, proposed mortgage limits been in effect. GAO's analysis of data on 2005 FHA home purchase borrowers shows that 43 percent would have paid the same or less under the risk-based pricing proposal than they actually paid, 37 percent would have paid more, and 20 percent (those with the highest expected claim rates) would not have qualified for FHA insurance. While to be viewed with caution, FHA has made estimates indicating that the loans it expects to insure in 2008 would result in negative subsidies (i.e., net cash inflows) of $342 million if the major legislative changes were enacted, rather than requiring an appropriation of $143 million absent any program changes. FHA has taken or planned steps to enhance tools and resources and adopt risk-management practices important to implementing the legislative proposals, but does not intend to use a common industry practice, piloting, to mitigate the risks of any zero-down-payment product it is authorized to offer. In response to prior GAO recommendations, FHA has taken steps to improve the loan performance and scoring models it would use in risk-based pricing. It also has identified minor changes to its information systems and staff increases needed to implement the proposals but faces long-term challenges in these areas. Additionally, the legislative proposals would introduce new risks. The proposal to lower down-payment requirements is of particular concern given the higher default rates on these loans and the difficulty of setting prices for new products whose risks may not be well known. GAO has previously indicated that Congress may want to consider requiring FHA to limit the initial availability of any new products and also recommended that FHA itself consider piloting. However, FHA has indicated that it does not plan to pilot any no-down-payment product it might offer. Mortgage industry participants and researchers have suggested more options that Congress and FHA could consider to help FHA adapt to changes in the mortgage market, but some changes could have budget impacts and complicate oversight efforts. Some administrative changes--such as implementing a more limited form of risk-based pricing--are within FHA's existing authority. Congress also could grant FHA additional authority that would allow it to invest the Fund's current resources in information technology and human capital, but this would increase the federal government's budget deficit. Finally, Congress could contemplate other approaches to the provision of federal mortgage insurance, such as creating a government corporation. However, any fundamental changes to how the federal government provides mortgage insurance could require new oversight mechanisms and would require careful deliberation. Fri, 29 Jun 2007 00:00:00 -0400 http://www.gao.gov/new.items/d07645.pdf The Federal Housing Administration (FHA) historically has been an important participant in the mortgage market, which includes loans that carry government insurance or guarantees (such as FHA-insured mortgages) and those that do not (conventional mortgages). The conventional market comprises prime loans for the most creditworthy borrowers and subprime loans for borrowers with impaired credit. Reduced demand for FHA-insured mortgages--which are used primarily by borrowers who would have difficulty obtaining conventional prime loans--has raised questions about the agency's role in and ability to adapt to the mortgage market. This report discusses (1) trends in FHA's share of the market for home purchase mortgages from 1996 through 2005, and how they compared with the trends for other market segments; and (2) factors associated with the trends in FHA's market share and the implications of these trends for homebuyers and FHA. To address these objectives, GAO analyzed FHA and Home Mortgage Disclosure Act (HMDA) data and interviewed officials from FHA and other mortgage institutions. From 1996 through 2005, FHA's share of the market for home purchase mortgages in terms of numbers of loans declined 13 percentage points (from 19 to 6 percent), while the prime and subprime shares grew 3 and 13 percentage points, respectively. The agency experienced a sharp decrease among populations where it traditionally has had a strong presence. For example, FHA's market share dropped 25 percentage points (from 32 to 7 percent) among minority borrowers and 16 percentage points (from 26 to 10 percent) among low- and moderate-income borrowers. At the same time, subprime market share among these groups rose dramatically. The decline in FHA's market share was associated with a number of factors and has been accompanied by higher ultimate costs for certain conventional borrowers and a worsening in indicators of credit risk among FHA borrowers. More specifically, (1) FHA's product restrictions and lack of process improvements relative to the conventional market and (2) product innovations and expanded loan origination and funding channels in the conventional market--coupled with interest rate and house price changes--provided conditions that favored conventional over FHA-insured mortgages. In contrast to FHA-insured loans, the majority of conventional subprime loans had higher ultimate costs to borrowers, partly because their initial low interest rates could increase substantially in a short period of time. Relatively high default and foreclosure rates for subprime mortgages and a contraction of this market segment could shift market share to FHA. The extent to which this occurs will depend partly on the ability of FHA and other market participants to offer mortgage alternatives to borrowers considering or struggling to maintain higher-priced subprime loans. Fri, 29 Jun 2007 00:00:00 -0400 http://www.gao.gov/new.items/d071033t.pdf The Federal Housing Administration (FHA) differs from other key mortgage industry participants in that it allows borrowers to obtain down-payment assistance from nonprofit organizations (nonprofits) that operate programs supported partly by property sellers. Research has raised concerns about how this type of assistance affects home purchase transactions. To assist Congress in considering issues related to down-payment assistance, this testimony provides information from GAO's November 2005 report, Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance (GAO-06-24). Specifically, this testimony discusses (1) trends in the use of down-payment assistance with FHA-insured loans, (2) the impact that the presence of such assistance has on purchase transactions and house prices, and (3) the influence of such assistance on loan performance. The proportion of FHA-insured purchase loans that were financed in part by down-payment assistance increased from 35 percent to nearly 50 percent from 2000 through 2004. Assistance from nonprofit organizations that received at least part of their funding from property sellers accounted for much of this increase, growing from about 6 percent of FHA-insured purchase loans in 2000 to approximately 30 percent in 2004. More recent data indicate that in 2005 and 2006, the percentages of FHA-insured loans with down-payment assistance from all sources and from seller-funded nonprofits were roughly equivalent to 2004 levels. Assistance from seller-funded nonprofits alters the structure of the purchase transaction in important ways. First, because many seller-funded nonprofits require property sellers to make a payment to their organization, assistance from these nonprofits creates an indirect funding stream from property sellers to homebuyers. Second, GAO analysis indicated that FHA-insured homes bought with seller-funded nonprofit assistance were appraised at and sold for about 2 to 3 percent more than comparable homes bought without such assistance. Regardless of the source of assistance and holding other variables constant, GAO analysis indicated that FHA-insured loans with down-payment assistance have higher delinquency and insurance claim rates than do similar loans without such assistance. Furthermore, loans with assistance from seller-funded nonprofits do not perform as well as loans with assistance from other sources. This difference may be explained, in part, by the higher sales prices of comparable homes bought with seller-funded assistance and the homebuyers having less equity in the transaction. Fri, 22 Jun 2007 00:00:00 -0400 http://www.gao.gov/new.items/d07615t.pdf The Federal Housing Administration (FHA) has seen increased competition from conventional mortgage and insurance providers. Additionally, because of the worsening performance of the mortgages it insures, FHA has estimated that its single-family insurance program would require a subsidy--that is, appropriations--in fiscal year 2008 in the absence of program changes. To help FHA adapt to the evolving market, proposed changes to the National Housing Act would allow greater flexibility in setting insurance premiums and reduce down-payment requirements. To assist Congress in considering the financial challenges facing FHA, this testimony provides information from recent reports GAO has issued and ongoing work concerning the proposed legislation that address different aspects of FHA's risk management. Specifically, this testimony looks at (1) FHA's management of risk related to loans with down-payment assistance, (2) instructive practices for managing risks of new products, (3) FHA's development and use of its mortgage scorecard, and (4) FHA's estimation of program costs. Recent trends in mortgage lending have significantly affected FHA, including growth in the proportion of FHA-insured loans with down-payment assistance, wider availability of low- and no-down-payment products, and increased use of automated tools (e.g., mortgage scoring) to underwrite loans. Although FHA has taken steps to improve its risk management, in a series of recent reports, GAO identified a number of weaknesses in FHA's ability to estimate and manage risk that may affect its financial performance. For example, FHA has not developed sufficient standards and controls to manage risks associated with the substantial proportion of loans with down-payment assistance, including assistance from nonprofit organizations funded by home sellers. According to FHA, high claim and loss rates for loans with such assistance were major reasons for the estimated positive subsidy cost (meaning that the present value of estimated cash inflows would be less than the present value of estimated cash outflows) for fiscal year 2008, absent any program changes. FHA has not consistently implemented practices--such as stricter underwriting or piloting--used by other mortgage institutions to help manage the risks associated with new product offerings. Although FHA has indicated that it would impose stricter underwriting standards for a no-down-payment mortgage if the legislative changes were enacted, it does not plan to pilot the product. The way that FHA developed its mortgage scorecard, while generally reasonable, limits how effectively it assesses the default risk of borrowers. With increased competition from conventional mortgage providers, limitations in its scorecard could cause FHA to insure mortgages that are relatively more risky. FHA's reestimates of the costs of its single-family mortgage program have generally been less favorable than originally estimated. Increases in the expected level of claims were a major cause of a particularly large reestimate that FHA submitted as of the end of fiscal year 2003. GAO made several recommendations in its recent reports, including that FHA (1) incorporate the risks posed by down-payment assistance into its scorecard, (2) study and report on the impact of variables not in its loan performance models that have been found to influence credit risk, and (3) consider piloting new products. FHA has taken actions in response to GAO's recommendations, but continued focus on risk management will be necessary for FHA to operate in a financially sound manner in the face of market and program changes. Thu, 15 Mar 2007 00:00:00 -0400 http://www.gao.gov/new.items/d07154.pdf As financial institutions increasingly operate globally and diversify their businesses, entities with an interest in financial stability cite the need for supervisors to oversee the safety and soundness of these institutions on a consolidated basis. Under the Comptroller General's Authority, GAO reviewed the consolidated supervision programs at the Federal Reserve System (Federal Reserve), Office of Thrift Supervision (OTS), and Securities and Exchange Commission (SEC) to (1) describe policies and approaches that U.S. consolidated supervisors use to oversee large and small holding companies; (2) review the management of the consolidated supervision programs, including use of program objectives and performance measures; and (3) evaluate how well consolidated supervisors are collaborating with other supervisors and each other in their activities. In conducting this study, GAO reviewed agency policy documents and supervisory reports and interviewed agency and financial institution officials. The Federal Reserve, OTS, and SEC have responded to the dramatic changes in the financial services industry and for many of the largest financial services firms the agencies focus on the firms' consolidated risks, controls, and capital. Reflecting in part differences in structure, traditional roles and responsibilities, and the length of time they have had to develop and refine their programs, the agencies employ somewhat differing policies and approaches for their consolidated supervision programs. Consolidated supervision becomes more important in the face of changes in the financial services industry, particularly with respect to the increased importance of enterprise risk management by large, complex financial services firms. Consolidated supervision provides a basis for the supervisors to oversee the risks of financial services firms on the same level that the firms manage those risks. GAO found that while all of these agencies were meeting international standards for effective oversight of large, internationally active conglomerates and have broad goals for supervision, they could more clearly articulate the specific objectives and performance measures for their evolving consolidated supervision programs. Both Federal Reserve and OTS, for example, focus on the safety and soundness of the depository institution but could take steps to better measure how consolidated supervision contributes to this in ways that differ from primary supervision of the depository institution. Such objectives and measures would help the agencies ensure consistent treatment of the firms that are subject to consolidated supervision. More effective collaboration can occur if agencies take a more systematic approach to agreeing on roles and responsibilities and establishing compatible goals, policies, and procedures on how to use available resources as efficiently as possible. While the three agencies coordinate and exchange information, they could take a more systematic approach to collaboration with respect to their consolidated supervision programs. For instance, SEC and OTS have authority for some of the same firms with no effective mechanism to prevent duplication, assign accountability, or resolve potential conflicts. Similarly, while the Federal Reserve and other federal bank supervisory agencies have taken steps to share information and examination activities when the Federal Reserve is not the primary supervisor of the lead bank in a bank holding company, some duplication and lack of accountability remain. As a result, consolidated supervision of U.S. financial institutions is not as efficient and effective as it could be if agencies collaborated more systematically. GAO has noted in the past that it is difficult to collaborate within the fragmented U.S. regulatory system and has recommended that Congress modernize or consolidate the regulatory system. However, if the current system is maintained, it is increasingly important for agencies to collaborate to ensure effective and efficient consolidated supervision, consistent treatment of financial services firms, and clear accountability of the agencies for their supervisory activities. Thu, 15 Mar 2007 00:00:00 -0400 http://www.gao.gov/new.items/d061112t.pdf Alternative mortgage products (AMPs) can make homes more affordable by allowing borrowers to defer repayment of principal or part of the interest for the first few years of the mortgage. Recent growth in AMP lending has heightened the importance of borrowers' understanding and lenders' management of AMP risks. GAO's report discusses the (1) recent trends in the AMP market, (2) potential AMP risks for borrowers and lenders, (3) extent to which mortgage disclosures discuss AMP risks, and (4) federal and selected state regulatory response to AMP risks. GAO used regulatory and industry data to analyze changes in AMP monthly payments under various scenarios; reviewed available studies; and interviewed relevant federal and state regulators and mortgage industry groups, and consumer groups. From 2003 through 2005, AMP originations, comprising mostly interest-only and payment-option adjustable-rate mortgages, grew from less than 10 percent of residential mortgage originations to about 30 percent. They were highly concentrated on the East and West Coasts, especially in California. Federally and state-regulated banks and independent mortgage lenders and brokers market AMPs, which have been used for years as a financial management tool by wealthy and financially sophisticated borrowers. In recent years, however, AMPs have been marketed as an "affordability" product to allow borrowers to purchase homes they otherwise might not be able to afford with a conventional fixed-rate mortgage. Because AMP borrowers can defer repayment of principal, and sometimes part of the interest, for several years, some may eventually face payment increases large enough to be described as "payment shock." Mortgage statistics show that lenders offered AMPs to less creditworthy and less wealthy borrowers than in the past. Some of these recent borrowers may have more difficulty refinancing or selling their homes to avoid higher monthly payments, particularly in an interest-rate environment where interest rates have risen or if the equity in their homes fell because they were making only minimum monthly payments or home values did not increase. As a result, delinquencies and defaults could rise. Federal banking regulators stated that most banks appeared to be managing their credit risk well by diversifying their portfolios or through loan sales or securitizations. However, because the monthly payments for most AMPs originated between 2003 and 2005 have not reset to cover both interest and principal, it is too soon to tell to what extent payment shocks would result in increased delinquencies or foreclosures for borrowers and in losses for banks. Regulators and others are concerned that borrowers may not be well-informed about the risks of AMPs, due to their complexity and because promotional materials by some lenders and brokers do not provide balanced information on AMPs benefits and risks. Although lenders and certain brokers are required to provide borrowers with written disclosures at loan application and closing, federal standards on these disclosures do not currently require specific information on AMPs that could better help borrowers understand key terms and risks. In December 2005, federal banking regulators issued draft interagency guidance on AMP lending that discussed prudent underwriting, portfolio and risk management, and consumer disclosure practices. Some lenders commented that the recommendations were too prescriptive and could limit consumer choices of mortgages. Consumer advocates expressed concerns about the enforceability of these recommendations because they are presented in guidance and not in regulation. State regulators GAO contacted generally relied on existing regulatory structure of licensing and examining independent mortgage lenders and brokers to oversee AMP lending. Wed, 20 Sep 2006 00:00:00 -0400 http://www.gao.gov/new.items/d061021.pdf Alternative mortgage products (AMPs) can make homes more affordable by allowing borrowers to defer repayment of principal or part of the interest for the first few years of the mortgage. Recent growth in AMP lending has heightened the importance of borrowers' understanding and lenders' management of AMP risks. This report discusses the (1) recent trends in the AMP market, (2) potential AMP risks for borrowers and lenders, (3) extent to which mortgage disclosures discuss AMP risks, and (4) federal and selected state regulatory response to AMP risks. To address these objectives, GAO used regulatory and industry data to analyze changes in AMP monthly payments; reviewed available studies; and interviewed relevant federal and state regulators and mortgage industry groups, and consumer groups. From 2003 through 2005, AMP originations, comprising mostly interest-only and payment-option adjustable-rate mortgages, grew from less than 10 percent of residential mortgage originations to about 30 percent. They were highly concentrated on the East and West Coasts, especially in California. Federally and state-regulated banks and independent mortgage lenders and brokers market AMPs, which have been used for years as a financial management tool by wealthy and financially sophisticated borrowers. In recent years, however, AMPs have been marketed as an "affordability" product to allow borrowers to purchase homes they otherwise might not be able to afford with a conventional fixed-rate mortgage. Because AMP borrowers can defer repayment of principal, and sometimes part of the interest, for several years, they may eventually face payment increases large enough to be described as "payment shock." Mortgage statistics show that lenders offered AMPs to less creditworthy and less wealthy borrowers than in the past. Some of these recent borrowers may have more difficulty refinancing or selling their homes to avoid higher monthly payments, particularly if interest rates have risen or if the equity in their homes fell because they were making only minimum monthly payments or home values did not increase. As a result, delinquencies and defaults could rise. Officials from the federal banking regulators stated that most banks appeared to be managing their credit risk by diversifying their portfolios or through loan sales or securitizations. However, because the monthly payments for most AMPs originated between 2003 and 2005 have not reset to cover both interest and principal, it is too soon to tell to what extent payment shocks would result in increased delinquencies or foreclosures for borrowers and in losses for banks and other lenders. Regulators and others are concerned that borrowers may not be well-informed about the risks of AMPs, due to their complexity and because promotional materials by some lenders and brokers do not provide balanced information on AMPs benefits and risks. Although lenders and certain brokers are required to provide borrowers with written disclosures at loan application and closing, federal standards on these disclosures do not currently require specific information on AMPs that could better help borrowers understand key terms and risks. In December 2005, federal banking regulators issued draft interagency guidance on AMP lending that discussed prudent underwriting, portfolio and risk management, and consumer disclosure practices. Some lenders commented that the recommendations were too prescriptive and could limit consumer choices of mortgages. Consumer advocates expressed concerns about the enforceability of these recommendations because they are presented in guidance and not in regulation. State regulators GAO contacted generally relied on existing regulatory structure of licensing and examining independent mortgage lenders and brokers to oversee AMP lending. Tue, 19 Sep 2006 00:00:00 -0400 http://www.gao.gov/new.items/d06868t.pdf The Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) has faced several challenges in recent years, including rising default rates, higher-than-expected program costs, and a sharp decline in program participation. To help FHA adapt to market changes, HUD has proposed a number of changes to the National Housing Act that would raise FHA's mortgage limits, allow greater flexibility in setting insurance premiums, and reduce down-payment requirements. Implementing the proposed reforms would require FHA to manage new risks and estimate the costs of program changes. To assist Congress in considering issues faced by FHA, this testimony provides information from recent reports GAO has issued that address FHA's risk management and cost estimates. Specifically, this testimony looks at (1) FHA's development and use of its mortgage scorecard, (2) FHA's consistent underestimation of program costs, (3) instructive practices for managing risks of new mortgage products, and (4) weaknesses in FHA's management of risks related to loans with down-payment assistance. Recent trends in mortgage lending have significantly affected FHA, including increased use of automated tools (e.g., mortgage scoring) to underwrite loans, increased competition from lenders offering low-and no-down-payment products, and a growing proportion of FHA-insured loans with down-payment assistance. Although FHA has taken steps to improve its risk management, in a series of recent reports, GAO identified a number of weaknesses in FHA's ability to manage risk and estimate program costs during this period of change. The way that FHA developed and uses its mortgage scorecard, while generally reasonable, limits how effectively it assesses the default risk of borrowers. With one exception, FHA's reestimates of program costs have been less favorable than originally estimated, including a $7 billion reestimate for fiscal year 2003. FHA has not consistently implemented practices used by other mortgage institutions to help manage the risks associated with new mortgage products. FHA has not developed sufficient standards and controls to manage risks associated with insuring a growing proportion of loans with down-payment assistance. GAO made several recommendations in its recent reports, including that FHA (1) incorporate the risks posed by down-payment assistance into its mortgage scorecard, (2) study and report on the impact of variables not in its loan performance models that have been found to influence credit risk, and (3) consider piloting new mortgage products. FHA has taken actions in response to GAO's recommendations, but additional improvements in managing risk and estimating program costs will be important if FHA is to successfully implement its proposed program changes. Tue, 20 Jun 2006 00:00:00 -0400 http://www.gao.gov/new.items/d06435.pdf Along with private mortgage providers, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) has been impacted by technological advances that began in the mid-1990s and that have significantly affected the way the mortgage industry works. As a result, in 2004, FHA implemented Technology Open to Approved Lenders (TOTAL) Scorecard--an automated tool that evaluates the majority of new loans insured by FHA. However, questions have emerged about the effectiveness of TOTAL. Given these concerns, you asked GAO to evaluate the way the agency developed and uses this new tool. This report looks at (1) the reasonableness of FHA's approach to developing TOTAL and (2) the potential benefits to HUD of expanding its use of TOTAL. Some of the choices that FHA made during the development process could limit TOTAL's effectiveness, although overall the process was reasonable. Like the private sector, FHA and its contractor used many of the same variables, as well as an accepted modeling process, to develop TOTAL. However, the data that FHA and its contractors used to develop TOTAL were 12 years old by the time FHA implemented the scorecard, and the market has changed significantly since then. Also, FHA, among other things, (1) did not develop a formal plan for updating TOTAL on a regular basis; (2) did not include all the important variables that could help explain expected loan performance; and (3) selected a type of model that limits how the scorecard can be used. Despite potential problems with TOTAL, HUD could still see added benefits from it. As a result of TOTAL, FHA lenders and borrowers have seen two new benefits--less paperwork and more consistent underwriting decisions. However, FHA could gain additional benefits if, like private lenders and mortgage insurers, it put TOTAL to other uses. These uses include relying on TOTAL to help inform general management decision making, price products based on risk, and launch new products. Adopting these scorecard uses from the private sector could potentially generate three other benefits for FHA, including the ability to react to changes in the market, more control over its financial condition, and a broader customer base. Additionally, HUD's Government National Mortgage Association, a government corporation that guarantees securities of federally insured or guaranteed mortgage loans, could use credit scores that are used by TOTAL to help improve the transparency of the secondary mortgage market. Thu, 13 Apr 2006 00:00:00 -0400 http://www.gao.gov/new.items/d0624.pdf The Federal Housing Administration (FHA) permits borrowers to obtain down payment assistance from third parties; but, research has raised concerns about the performance of loans with such assistance. Due to these concerns, GAO examined the (1) trends in the use of down payment assistance with FHA-insured loans, (2) the impact that the presence of such assistance has on purchase transactions and house prices, (3) how such assistance influences the performance of these loans, and (4) FHA's standards and controls for these loans. Almost half of all single-family home purchase mortgages that FHA insured in fiscal year 2004 had down payment assistance. Nonprofit organizations that received at least part of their funding from sellers provided assistance for about 30 percent of these loans and represent a growing source of down payment assistance. However, assistance from seller-funded nonprofits alters the structure of the purchase transaction. First, because many seller-funded nonprofits require property sellers to make a payment to their organization; assistance from these nonprofits creates an indirect funding stream from property sellers to homebuyers. Second, GAO analysis indicated that FHA-insured homes bought with seller-funded nonprofit assistance were appraised at and sold for about 2 to 3 percent more than comparable homes bought without such assistance. Regardless of the source of assistance and holding other variables constant, GAO analysis indicated that FHA-insured loans with down payment assistance have higher delinquency and claim rates than do similar loans without such assistance. Furthermore, loans with assistance from seller-funded nonprofits do not perform as well as loans with assistance from other sources. This difference may be explained, in part, by the higher sales prices of comparable homes bought with seller-funded assistance. Although FHA has implemented some standards and controls on loans with down payment assistance, stricter standards and additional controls could help in managing the risks these loans pose. FHA standards permit assistance from seller-funded nonprofits; in contrast, mortgage industry participants restrict such assistance. Further, government guidelines call for routine identification of risks that could impede meeting program objectives; however, FHA has not conducted routine analysis of the performance of loans with down payment assistance. Wed, 09 Nov 2005 00:00:00 -0500 http://www.gao.gov/new.items/d069.pdf The Government National Mortgage Association, commonly known as Ginnie Mae, is a wholly owned government corporation that guarantees mortgage-backed securities (MBS) backed by pools of federally insured or guaranteed mortgage loans. The agency supports federal housing programs by facilitating the securitization of loans backed by the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), Rural Housing Service, and the Office of Public and Indian Housing within the Department of Housing and Urban Development (HUD). Concerned that Ginnie Mae's share of the overall MBS market has declined significantly, Congress asked us to address (1) the state of Ginnie Mae's market share and guarantee volume, (2) the potential implications of changes in its share and volume, and (3) the challenges Ginnie Mae faces and steps it is taking and could take to address these challenges. Despite its declining share of the overall MBS market, Ginnie Mae continues to serve its key public policy goal of providing a strong secondary market outlet for federally insured and guaranteed housing loans. Ginnie Mae MBS financed more than 90 percent of new FHA-insured and VA-guaranteed loans in fiscal year 2004, and the agency appears to face relatively little competition in this market. Ginnie Mae's total volume has declined in recent years, however, and its share of the overall MBS market has fallen from 42 percent of new securities in 1985 to 7 percent in 2004. This drop is largely the result of the decline in the market share of the FHA and VA loan programs and the concurrent rise in the securitization of non-government-backed mortgages. Further declines in Ginnie Mae's volume could potentially have implications for borrowers, the liquidity of its securities, and federal revenues. For example, Ginnie Mae's securities could become less liquid, although it is unclear at what levels of volume this would occur. In addition, Ginnie Mae's program revenues could decline if its volume decreased. In fiscal year 2004, program revenues exceeded expenses by $295 million, which helped reduce the federal budget deficit. Ginnie Mae faces a number of challenges in responding to changes in the marketplace, meeting stakeholders' needs, and managing its operations, and the agency has been taking steps to address these challenges. For example, it has expanded its product mix to reach more borrowers and has begun disclosing more information on loans underlying its securities to help investors better predict risk. GAO and others have identified opportunities for improvement in Ginnie Mae's data integrity and internal controls. The agency has begun addressing these issues, but it contracts out most of its operations, so ensuring that it has sufficient staff capabilities to plan, monitor, and manage its contracts is essential. Mon, 31 Oct 2005 00:00:00 -0500 http://www.gao.gov/new.items/d05875.pdf The U.S. Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), provides insurance for private lenders against losses on home mortgages. FHA's largest insurance program is the Mutual Mortgage Insurance Fund (Fund), which currently is self-financed and operates at a profit. FHA submitted a "reestimate" of $7 billion for the credit subsidy and interest for the Fund as of the end of fiscal year 2003, reflecting a reduction in estimated profits. Given this substantial reestimate, Congress asked GAO, among other things, to determine what factors contributed to the $7 billion reestimate and the underlying loan performance variables influencing these factors and to assess how the loan performance variables underlying the reestimate could impact future estimates of new loans. The $7 billion reestimate was due primarily to an increase in estimated and actual claims over what FHA previously estimated. For example, actual claim activity in fiscal year 2003 exceeded estimated claim activity for 2003--by twice as much in some cases--for the majority of loan cohorts. Prepayments also played a role in the reestimate as they were higher than previous estimates. In fact, actual prepayment activity during 2003 exceeded estimated prepayment activity for all cohorts. Because of the additional claims it paid, upfront premiums it refunded, and the annual premiums it lost, FHA's net cash outflows for the year increased, contributing to the $7 billion adjustment of the Fund's credit subsidy. Several recent events may help explain this increase, including changes to underwriting guidelines, competition from the private sector, and an increase in the use of down payment assistance. FHA has taken some steps to tighten underwriting guidelines and better estimate loan performance, though it is not clear that these steps are sufficient to reverse recent increases in actual and estimated claims and prepayments or help FHA to more reliably predict future claim and prepayment activity. Increases in claim and prepayment activity are likely to continue to add risk to FHA's portfolio. Fri, 02 Sep 2005 00:00:00 -0400 http://www.gao.gov/new.items/d05857t.pdf To assist Congress in considering legislation to authorize the Secretary of the Department of Housing and Urban Development (HUD) to carry out a pilot program to insure zero down payment mortgages, this testimony provides information about practices mortgage institutions use in designing and implementing low and no down payment products. It also contains information about how these practices could be instructive for FHA in managing risks associated with a zero down payment product--a product for which the risks are not well understood. This testimony is primarily based on GAO's February 2005 report, Mortgage Financing: Actions Needed to Help FHA Manage Risks from New Mortgage Loan Products, (GAO-05-194). In recent years, many mortgage institutions have become increasingly active in supporting low and even no down payment mortgage products. In considering the risks of these new products, a substantial amount of research GAO reviewed indicates that loan-to-value (LTV) ratio and credit score are among the most important factors when estimating the risk level associated with individual mortgages. GAO's analysis of the performance of low and no down payment mortgages supported by FHA and others corroborates key findings in the literature. Generally, mortgages with higher LTV ratios (smaller down payments) and lower credit scores are riskier than mortgages with lower LTV ratios and higher credit scores. Some practices of other mortgage institutions offer a framework that could help FHA manage the risks associated with introducing new products or making significant changes to existing products. Mortgage institutions sometimes require additional credit enhancements, such as higher insurance coverage, and stricter underwriting, such as credit score thresholds, when introducing a new low or no down payment product. FHA is authorized to require an additional credit enhancement, but does not currently use this authority. FHA has used stricter underwriting criteria, but told us it is unlikely they would use a credit score threshold for a new zero down payment product. Mortgage institutions may also impose limits on the volume of the new products they will permit and on who can sell and service these products. FHA officials question the circumstances in which they can limit volumes for their products and believe they do not have sufficient resources to manage a product with limited volumes, but the potential costs of making widely available a product with risk that is not well understood could exceed the cost of initially implementing such a product on a limited basis. Thu, 30 Jun 2005 00:00:00 -0400 http://www.gao.gov/new.items/d05576t.pdf Serious concerns exist regarding the risk management practices and the federal oversight of the housing government-sponsored enterprises (GSE)--Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System (FHLBank System), which had combined obligations of $4.6 trillion as of year-end 2003. In 2003, Freddie Mac disclosed significant accounting irregularities. In 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) cited Fannie Mae for accounting irregularities and earnings manipulation. Fannie Mae has to restate its financial statements for 2001-2004 and OFHEO has required the GSE to develop a capital restoration plan. Also in 2004, the FHLBanks of Chicago and Seattle entered into written agreements with their regulator, the Federal Housing Finance Board (FHFB), to implement changes to enhance their risk management. To assist Congress in its housing GSE oversight, this testimony provides information on GSEs' missions and risks, the current regulatory structure, and proposed regulatory reforms. While the GSEs provide certain public benefits, they also pose potential risks. Fannie Mae and Freddie Mac's primary activity involves purchasing mortgages from lenders and issuing mortgage-backed securities that are either sold to investors or held in the GSEs' retained portfolio. The 12 FHLBanks traditionally made loans to their members and more recently instituted programs to purchase mortgages from their members and hold such mortgages in their portfolios. While not obligated to do so, the federal government could provide financial assistance to the GSEs if one or more experienced financial difficulties that could result in significant costs to taxpayers. Due to the GSEs' large size, the potential also exists that financial problems at one or more of the GSEs could have destabilizing effects on financial markets. The current housing GSE regulatory structure is fragmented and not well-equipped to oversee their financial soundness or mission achievement. For example, although all the GSEs face increasingly similar risks (particularly potential losses in their mortgage portfolios resulting from fluctuations in interest rates), OFHEO is responsible for Fannie Mae and Freddie Mac's safety and soundness oversight while FHFB is responsible for the safety and soundness and mission oversight of the FHLBanks. OFHEO also lacks key regulatory authorities necessary to fulfill its oversight responsibilities. Moreover, the Department of Housing and Urban Development (HUD), which has housing mission oversight responsibility for Fannie Mae and Freddie Mac, faces a number of challenges in carrying out its responsibilities. In particular, HUD may not have sufficient resources and technical expertise to review sophisticated financial products and issues. Creating a single housing GSE regulator could better ensure consistency of regulation among the GSEs. With safety and soundness and mission oversight combined, a single regulator would be better positioned to consider potential trade-offs between these sometimes competing objectives. To ensure the independence and prominence of the regulator and allow it to act independently of the influence of the housing GSEs, this new GSE regulator should have a structure that consists of a board or a hybrid board and director model. To be effective, the single regulator must also have all the regulatory oversight and enforcement powers necessary to address unsafe and unsound practices, respond to financial emergencies, monitor corporate governance and compensation practices, assess the extent to which the GSEs' activities benefit home buyers and mortgage markets, and otherwise ensure that the GSEs comply with their public missions. Thu, 21 Apr 2005 00:00:00 -0400 http://www.gao.gov/new.items/d05489t.pdf The FHLBank System (FHLBank System or System) is a government-sponsored enterprise (GSE) that consists of 12 Federal Home Loan Banks (FHLBanks) and is cooperatively owned by member financial institutions, typically commercial banks and thrifts. The primary mission of the FHLBank System is to promote housing and community development generally by making loans, also known as advances, to member financial institutions. To minimize the potential for significant financial problems, the Federal Housing Finance Board (FHFB) regulates the FHLBank System's safety and soundness. Over time, a number of developments have affected the System's safety and soundness and have created pressures on its traditional cooperative structure. To assist the committee in understanding the important issues surrounding the FHLBank System and its regulation, this testimony provides information on the development of the System; two legislative changes and FHFB rulemaking that led to changes in membership, asset composition, and capital structure; and important challenges and questions the FHLBank System currently faces. Established in 1932 to facilitate the extension of mortgage credit, the FHLBank System has undergone significant statutory changes in the last 15 years. Between the 1930s and the 1980s, the System consisted primarily of thrift members that accepted advances from the FHLBanks. However, during the 1980s, hundreds of FHLBank member thrifts failed forcing Congress to fundamentally reform the System through the Financial Institutions Recovery, Reform, and Enforcement Act of 1989 (FIRREA). For example, FIRREA permitted commercial banks to join the System. Although FIRREA is credited with strengthening the thrift industry and the System, concerns were raised during the 1990s about the System's capital structure. In particular, commercial bank members could remove stock from their FHLBank on 6-months notice, which raised concerns about the System's financial stability. Among other provisions, the Gramm-Leach-Bilely Act (GLBA) of 1999 created a more permanent and risk-based capital structure for the System. Due to these statutes and FHFB rulemaking, the FHLBank System has evolved substantially since 1990. For example, commercial banks now account for more than 70 percent of all System members. The composition of FHLBank System assets has also fluctuated considerably over the years. For example, FHFB authorized the FHLBanks to purchase mortgages directly from their members in the 1990s. The System's mortgage assets grew to about $113 billion at yearend 2003 representing about 14 percent of total assets. However, the rapid growth in System mortgage assets leveled off in 2004 as two FHLBanks experienced problems managing the interest-rate risks associated with holding mortgages on their books. As provided by GLBA, System capital is now more permanent as members generally must invest capital for a period of 5 years and the FHLBanks are subject to new leverage and risk-based capital requirements. The FHLBank System faces important challenges and questions going forward. For example, FHFB has called the FHLBanks' risk-management practices into question, particularly those related to mortgage purchase programs. Further, proposals to permit the FHLBanks to issue mortgage-backed securities (securitization) could help ensure the growth of the mortgage purchase business and improve risk management, however these proposals raise questions regarding the FHLBanks' capacity to manage the related risks. Additionally, there is limited empirical information available regarding the extent to which the System is fulfilling its housing and community mission. Finally, questions have been raised regarding the potential negative affects that large financial institutions may have on the traditional cooperative structure of the FHLBank System and its programs designed to benefit targeted groups. Wed, 13 Apr 2005 00:00:00 -0400 http://www.gao.gov/new.items/d05194.pdf The U.S. Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), insures billions of dollars in home mortgage loans made by private lenders. FHA insures low down payment loans and a number of parties have made proposals to either eliminate or otherwise change FHA's borrower contribution requirements. GAO was asked to (1) identify the key characteristics of existing low and no down payment products, (2) review relevant literature on the importance of loan-to-value (LTV) ratios and credit scores to loan performance, (3) report on the performance of low and no down payment mortgages supported by FHA and others, and (4) identify lessons for FHA from others in terms of designing and implementing low and no down payment products. FHA and many other mortgage institutions provide many low and no down payment products with requirements that vary in terms of eligibility, borrower investment, underwriting, and risk mitigation. While these products are similar, there are some important differences, including that FHA has lower loan limits, allows closing costs and the up-front insurance premium to be financed in the mortgage, and permits the down payment funds to come from nonprofits that receive funds from sellers. FHA also differs in that it does not require prepurchase counseling. A substantial amount of research GAO reviewed indicates that LTV ratio and credit score are among the most important factors when estimating the risk level associated with individual mortgages. GAO's analysis of the performance of low and no down payment mortgages supported by FHA and others corroborates key findings in the literature. Generally, mortgages with higher LTV ratios (smaller down payments) and lower credit scores are riskier than mortgages with lower LTV ratios and higher credit scores. Some practices of other mortgage institutions offer a framework that could help FHA manage the risks associated with introducing new products or making significant changes to existing products. Mortgage institutions may impose limits on the volume of the new products they will permit and on who can sell and service these products. FHA officials question the circumstances in which they can limit volumes for their products and believe they do not have sufficient resources to manage a product with limited volumes. Mortgage institutions sometimes require additional credit enhancements, such as higher insurance coverage; and sometimes require stricter underwriting, such as credit score thresholds, when introducing a new low or no down payment product. FHA is authorized to require an additional credit enhancement by sharing risk through co-insurance but does not currently use this authority. FHA has used stricter underwriting criteria but this has not included credit score thresholds. Fri, 11 Feb 2005 00:00:00 -0500 http://www.gao.gov/new.items/d0561.pdf In light of the passage of the 1999 Gramm-Leach-Bliley Act and increased competition within the financial services industry at home and abroad, GAO was asked to report on the current state of the U.S. financial services regulatory structure. This report describes the changes to the financial services industry, focusing on banking, securities, futures, and insurance; the structure of the U.S. and other regulatory systems; changes in regulatory and supervisory approaches; efforts to foster communication and cooperation among U.S. and other regulators; and the strengths and weaknesses of the current regulatory structure. The financial services industry has changed significantly over the last several decades. Firms are now generally fewer and larger, provide more and varied services, offer similar products, and operate in increasingly global markets. These developments have both benefits and risks, both for individual institutions and for the regulatory system as a whole. Actions that are being taken to harmonize regulations across countries, especially the Basel Accords and European Union Financial Services Action Plan, are also affecting U.S. firms and regulators. While the financial services industry and the international regulatory framework have changed, the regulatory structure for overseeing the U.S. financial services industry has not. Specialized regulators still oversee separate functions--banking, securities, futures, and insurance--and while some regulators do oversee complex institutions at the holding company level, they generally rely on functional regulators for information about the activities of subsidiaries. In addition, no one agency or mechanism looks at risks that cross markets or industry segments or at the system and its risks as a whole. Although a number of proposals for changing the U.S. regulatory system have been put forth, the United States has chosen not to consolidate its regulatory structure. At the same time, some industrial countries--notably the United Kingdom--have consolidated their financial regulatory structures, partly in response to industry changes. Absent fundamental change in the overall regulatory structure, U.S. regulators have initiated some changes in their regulatory approaches. For example, starting with large, complex institutions, bank regulators, in the 1990s, sought to make their supervision more efficient and effective by focusing on the areas of highest risk. And partly in response to changes in European Union requirements, SEC has issued rules to provide consolidated supervision of certain internationally active securities firms on a voluntary basis. Regulators are also making efforts to communicate in national and multinational forums, but efforts to cooperate have not fully addressed the need to monitor risks across markets, industry segments, and national borders. And from time to time regulators engage in jurisdictional disputes that can distract them from focusing on their primary missions. GAO found that the U.S. regulatory structure worked well on some levels but not on others. The strength and vitality of the U.S. financial services industry demonstrate that the regulatory structure has not failed. But some have questioned whether a fragmented regulatory system is appropriate in today's environment, particularly with large, complex firms managing their risks on a consolidated basis. While the structure of the agencies alone cannot ensure that regulators achieve their goals--agencies also need the right people, tools, and policies and procedures--it can hinder or facilitate their efforts to provide consistent, comprehensive regulation that protects consumers and enhances the delivery of financial services. Wed, 06 Oct 2004 00:00:00 -0400 http://www.gao.gov/new.items/d04269t.pdf Congress established government sponsored enterprises (GSE)-- such as Fannie Mae, Freddie Mac, the FHLBank System, and the Farm Credit System--to facilitate the development of mortgage and agricultural lending in the United States. Although the federal government does not explicitly guarantee the GSEs' approximately $4.4 trillion in financial obligations, the potential exists that the government would provide financial assistance in an emergency as it has done in the past. Recent financial reporting problems at Freddie Mac have raised concerns about the quality of the GSEs' corporate governance and regulatory oversight. To assist Congress in reviewing the adequacy of GSE oversight, this testimony provides information on GSE corporate governance, regulatory oversight, and mission compliance measures. GSEs should lead by example in connection with governance, accountability, integrity, and public trust issues. GSEs should strive to achieve model corporate governance structure, provide reasonable transparency of financial and performance activities, and adopt compensation arrangements that focus on both long-term and short-term results. However, GSE corporate governance has not always reflected best practices. For example, currently, the Chief Executive Officers (CEO) of Freddie Mac and Fannie Mae also serve as the chairmen of their respective GSE boards, which is not consistent with model governance standards that call for officers to work for an independent board. GAO notes that as part of its regulatory agreement, Freddie Mac has agreed to separate the position of CEO and the position of chairman within a reasonable period of time. However, Fannie Mae has yet to take this step. With respect to compensation arrangements, Freddie Mac's focus on short-term financial results as performance targets appears to have contributed to the GSE's recent financial reporting problems. GSE regulators must be capable, credible, strong, and independent. However, the regulatory structure for the housing GSEs--Fannie Mae, Freddie Mac, and the FHLBank System--is fragmented with safety and soundness and mission oversight responsibilities divided among three regulators. A single housing GSE regulator offers many advantages over this fragmented structure including prominence in government, the sharing of technical expertise, and the ability to assess trade-offs between safety and soundness considerations and certain mission compliance activities, such as affordable housing initiatives. Although there are advantages of a single director model for the new housing GSE regulator, GAO believes on balance that a board or a hybrid board and director might make the most sense to oversee the GSEs' safety and soundness and mission oversight. To be effective, the single GSE regulator must also have all the regulatory oversight and enforcement powers necessary to carry out its critical responsibilities. Because of a lack of clear measures, it is difficult for Congress, accountability organizations, and the public to determine whether the benefits provided by the GSEs' activities are in the public interest and outweigh their financial risks. Available evidence and data indicate that the housing GSEs have made, in some cases, progress in benefiting homebuyers. For example, it is generally agreed that Fannie Mae and Freddie Mac's activities have lowered mortgage interest rates, although there is debate over the degree of these benefits. However, it is not clear that the housing GSEs' large holdings of mortgage-backed securities benefit borrowers. There is also limited information as to the extent to which the FHLBank System's more than $500 billion in outstanding loans to financial institutions have facilitated mortgage lending. Tue, 10 Feb 2004 00:00:00 -0500 http://www.gao.gov/new.items/d04208.pdf In 2001, the Department of Housing and Urban Development's (HUD) Inspector General reported on serious problems in HUD's Discount Sales Program, under which nonprofit organizations purchase HUD-owned properties at a discount, rehabilitate them, and resell them to low- and moderate-income homebuyers. The objectives of the program are to expand affordable housing opportunities, help revitalize neighborhoods, and reduce HUD's property inventory in a timely, efficient, and cost-effective manner. Although the Inspector General recommended that the agency suspend the program and evaluate its viability, HUD did neither. GAO was asked to assess (1) the costs of the program to HUD, (2) the benefits of the program to homebuyers, and (3) HUD's efforts to monitor participating nonprofits and enforce program requirements. GAO found that the Discount Sales Program poses significant costs to HUD, is of questionable benefit to homebuyers, and has serious monitoring and compliance problems. GAO estimates that the program cost HUD between $18.8 and $23.9 million in calendar year 2002. Between $15.1 and $20.2 million was a reduction in net revenue resulting from HUD's selling approximately 1,200 properties through the program instead of through its regular sales process. Personnel expenses for administering the program accounted for the remaining $3.7 million. GAO's analysis of 238 properties sold under the program in 2002 suggests that most of the homebuyers did not benefit financially. Assuming that nonprofits and homebuyers would incur the same rehabilitation costs, GAO estimates that 76 percent of the homebuyers would have spent less purchasing the properties through HUD's regular process and paying for the rehabilitation work themselves. And while the program can help homebuyers access a range of homeownership services, these services are also available from other sources. GAO did not evaluate the extent to which the program generated other benefits, such as neighborhood revitalization. While uncovering numerous program violations, HUD's monitoring efforts have faced challenges. For example, HUD monitors nonprofits through desk reviews of the annual reports it requires nonprofits to submit each February. However, as of July 2003, HUD's four homeownership centers, which administer the program, had not received reports for more than half of the properties the agency estimates were purchased and resold under the program in 2002. Even with this problem, the desk reviews found that 28 of the 44 nonprofits that submitted reports violated resale limits, earning an estimated total of $704,720 in excess profits. HUD requires that nonprofits use their excess profits to pay down the mortgages of the homebuyers they overcharged, but the agency's ability to enforce this requirement is extremely limited. As of July 2003, nonprofits had made only $62,000 in payments on mortgages. Fri, 30 Jan 2004 00:00:00 -0500 http://www.gao.gov/new.items/d03364.pdf The Federal Home Loan Bank System (System) faces additional risks due to the development of new products such as direct mortgage purchase programs. Responding to concern about the methods used for administrative decisionmaking, and the ability of the Federal Housing Finance Board (FHFB) to fulfill its critical mission to regulate the safety and soundness of the System, GAO was asked to (1) compare the FHFB chair's administrative authorities with those of other financial regulators and discuss the basis for that authority, (2) assess FHFB's compliance with selected statutes and regulations in connection with an August 2002 reduction-in-force (RIF) carried out as part of an agency reorganization, and (3) assess FHFB's progress in enhancing its FHLBank safety and soundness examination program. FHFB's chair has greater authority to make key administrative decisions than the chairs at five of the six other financial regulators GAO reviewed. FHFB's chair has the authority to appoint and remove officials and reorganize the agency without a vote by the board. In contrast, statutes, regulations, and practices limit the chairs' authorities at most other regulators. In particular, the boards or commissions at these agencies approve most senior-level appointments and several boards approve major reorganizations. The basis for the FHFB chair's comparatively broad administrative authority is a delegation of authority, which the board passed in 1990 and 1993. The delegation allows the chair to make and implement key decisions without obtaining or benefiting from the views of all board members and has contributed to sometimes bitter conflicts among board members over the past 8 years. Although FHFB provided significant financial compensation to staff subject to the RIF, its procedures were not fully consistent with all applicable federal age discrimination statutes and regulations. For example, FHFB presented a settlement agreement to separated staff that offered 3 to 6 months salary in exchange for, among other things, the employees agreeing to waive their rights to file charges, complaints, or appeals with the Equal Employment Opportunity Commission (EEOC). EEOC regulations implementing the Age Discrimination in Employment Act do not permit waivers of employees' rights to file charges or complaints with EEOC. In addition, FHFB did not advise the affected employees in writing to consult an attorney prior to signing the agreements as is required. Although for several years FHFB did not take steps to correct weaknesses in its FHLBank examination program that GAO identified in a 1998 report, FHFB's current Chair has recently undertaken several steps to improve its examinations. In 1998, and again in 2002, GAO found that FHFB performed limited reviews of FHLBank functions that are critical in managing the banks' financial and operational risks. Among other changes announced in 2002, FHFB plans to increase the number of examiners from 10 to 24 and revise its examination approach to focus on the major risks and quality of controls at each FHLBank. Although these changes have the potential to improve FHFB's examination program, it is too soon to assess their effectiveness. Fri, 28 Feb 2003 00:00:00 -0500 http://www.gao.gov/new.items/d02773.pdf Federal Housing Administration (FHA) loans made in recent years have experienced somewhat higher foreclosure rates than loans made in earlier years. However, recent loans are performing much better than loans made in the 1980s. Although economic factors such as house price appreciation are key determinants of mortgage foreclosure, changes in underwriting requirements, as well as changes in the conventional mortgage market, may partly explain the higher foreclosure rates experienced in the 1990s. Factors not fully captured in the model GAO used may be affecting the performance of recent FHA loans and causing the overall risks of FHA's portfolio to be somewhat greater than previously estimated. Thus, the Mutual Mortgage Insurance Fund may be somewhat less able to withstand worse-than-expected loan performance resulting from adverse economic conditions. Wed, 10 Jul 2002 00:00:00 -0400 http://www.gao.gov/new.items/d02671t.pdf The Housing Affordability for America Act of 2002 establishes risk-based capital requirements for the Mutual Mortgage Insurance Fund of the Federal Housing Administration (FHA). Through the fund, FHA operates a single-family insurance program that helps millions of Americans buy homes. The Fund's estimated value rose dramatically in 1999, prompting proposals to spend current resources or reduce net cash flows into the Fund. The value of the Fund at the end of fiscal year 1999 was $15.8 billion. This capital ratio of 3.20 percent of the unamortized insurance-in-force exceeded the minimum required capital ratio of two percent. A two-percent capital ratio appears sufficient to withstand moderately severe economic downturns that could lead to worse-than-expected loan performance. Determining an appropriate capital ratio depends on the level of risk Congress wishes the Fund to withstand. FHA faces the failure of borrowers to perform, or credit risk, and the risk of managerial shortcomings, or operational risk. By defining the risk that the Fund must withstand, the act will define actuarial soundness and help FHA manage the Fund. Wed, 24 Apr 2002 00:00:00 -0400 http://www.gao.gov/new.items/d01460.pdf The Mutual Mortgage Insurance Fund has maintained an economic value of at least two percent of the Fund's insurance-in-force, as required by law. GAO's and the Department of Housing and Urban Development's (HUD) analysis show that the Fund had an economic value of $15.8 billion (3.20 percent) and $16.6 billion (3.66 percent), respectively. Given the economic value of the Fund and the state of the economy at the end of fiscal year 1999, a two-percent capital ratio appears sufficient to withstand moderately severe economic downturns that could lead to worse-than-expected loan performance. However, under more severe economic conditions, the economic value of two percent of insurance-in-force would not be adequate. Because of the uncertainty and professional judgment associated with this type of economic analysis, GAO cautions against relying on one estimate or even a group of estimates to determine the adequacy of the Fund's reserves over the longer term. HUD could exercise several options under current legislative authority to reduce the capital ratio for the Fund. It is difficult, however, to reliably measure the impact of policy changes on the Fund's capital ratio and Federal Housing Administration borrowers without using tools designed to estimate the multiple impacts that policy changes often have. Nonetheless, any option that reduces the Fund's reserve, if not accompanied by a similar reduction in other government spending, would result in a budget surplus reduction or a deficit increase. Wed, 28 Feb 2001 00:00:00 -0500 http://www.gao.gov/archive/2000/gg00003.pdf In 1998, Long-Term Capital Management (LTCM)--one of the largest U.S. hedge funds--lost more than 90 percent of its capital. The Federal Reserve concluded that rapid liquidation of LTCM's trading positions and related positions of other market participants might pose a significant threat to already unsettled global financial markets. As a result, the Fed arranged a private sector recapitalization to prevent LTCM's collapse. The circumstances surrounding LTCM's near collapse and recapitalization raised questions that go beyond the activities of LTCM and hedge funds to how federal financial regulators fulfill their supervisory responsibilities and whether all regulators have the necessary tools to identify and address potential threats to the financial system. This report discusses (1) how LTCM's positions became large and leveraged enough to be deemed a potential systemic threat, (2) what federal regulators know about LTCM and when they found out about its problems, (3) what the extent of coordination among regulators was, and (4) whether regulatory authority limits regulators' ability to identify and mitigate potential systemic risk. Fri, 29 Oct 1999 00:00:00 -0400 http://www.gao.gov/archive/1998/gg98005.pdf The extent to which federal sales practice requirements would protect over-the-counter purchasers of complex financial instruments known as derivatives depends in part on whether these products are considered securities, futures, or neither. This report examines the use of these instruments and suggests steps to determine whether federal sales practice requirements should be implemented. GAO discusses the (1) federal sales practice requirements applicable to these products and the dealers marketing them; (2) extent of end-user satisfaction with sales practices, product use, and related disputes and the costs of these disputes; (3) views of end-users and dealers on the nature of their relationship and responsibilities; (4) steps that dealers and end-users have taken to reduce the potential for sales practice disputes; and (5) steps that regulators have taken to address sales practice issues. Thu, 02 Oct 1997 00:00:00 -0400