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Before the Committee on Banking, Housing, and Urban Affairs, U.S. 

United States Government Accountability Office: 


For Release on Delivery Expected at 10:00 a.m. EDT: 

Thursday, April 21, 2005: 

Housing Government-Sponsored Enterprises: 

A New Oversight Structure Is Needed: 

Statement of David M. Walker, Comptroller General of the United States: 


GAO Highlights: 

Highlights of GAO-05-576T, a testimony before the Committee on Banking, 
Housing, and Urban Affairs, U.S. Senate:

Why GAO Did This Study: 

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.

What GAO Found: 

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. 

What GAO Recommends: 

GAO recommends that Congress establish a single regulator with a board 
or hybrid board and director governance model. This single regulator 
should be equipped with adequate authorities to oversee all housing GSE 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Thomas J. McCool at (202) 
512-8678 or

[End of section]

Mr. Chairman, Mr. Ranking Minority Member, and Members of the 

I appreciate the opportunity to participate in today's hearing to 
discuss federal oversight of the housing government-sponsored 
enterprises (GSE), namely Fannie Mae, Freddie Mac, and the Federal Home 
Loan Bank System (FHLBank System). When I testified before this 
committee in February 2004 on this same topic, it was shortly after 
Freddie Mac had disclosed significant financial problems associated 
with its accounting practices.[Footnote 1] Freddie Mac's regulator--the 
Office of Federal Housing Enterprise Oversight (OFHEO)--did not detect 
the GSE's accounting irregularities at an early stage. At that hearing, 
I discussed the need for the establishment of a capable, credible, 
strong, and independent regulatory structure to help ensure that the 
housing GSEs operate safely and soundly. To accomplish this goal, GAO-
-and others---proposed that Congress replace the current fragmented 
regulatory structure for housing GSE oversight with a single regulator 
that would be responsible for safety and soundness and mission 
activities. Subsequently, this committee took the lead in approving a 
strong bill to create a single GSE regulator. 

Over the past year, the need for fundamental regulatory reform of the 
housing GSEs has become even more clear and compelling. As you well 
know, Fannie Mae has been found to have engaged in the misapplication 
of accounting standards and earnings manipulation, and company staff 
even allegedly falsified signatures on documents. Fannie Mae will have 
to restate its financial statements for the past several years and 
OFHEO has required the GSE to develop a capital restoration plan. I am 
encouraged that OFHEO identified these deficiencies at Fannie Mae and 
has moved aggressively to correct them. I also note that the FHLBank 
System's regulator--the Federal Housing Finance Board (FHFB)--has 
identified risk management deficiencies at the Chicago and Seattle 
FHLBanks and entered into written agreements with these institutions to 
correct identified deficiencies. Nevertheless, I believe the evidence 
clearly shows that the current regulatory structure is not well-
equipped to oversee the operations and effectively monitor the risks of 
the large and complex housing GSEs, which had combined financial 
obligations of about $4.6 trillion at year-end 2003.[Footnote 2]

To assist the committee in its oversight of the housing GSEs and their 
regulation, my testimony today is divided into two sections. First, I 
will provide an overview of the GSEs and their missions, identify the 
risks they pose to taxpayers and the financial system, and describe the 
current regulatory structure, which is divided among OFHEO, the 
Department of Housing and Urban Development (HUD), and FHFB. Second, I 
will identify deficiencies in the current regulatory structure and 
discuss how a single regulator that is governed by a board and endowed 
with adequate legal authorities is, in our view, the best potential 
means to help ensure that the GSEs meet their housing-related missions 
while doing so in a safe and sound manner. 

To prepare for this testimony, we relied heavily on a substantial 
amount of work that we had done on the housing GSEs and their 
regulatory oversight in the past (see Related GAO Products), but we 
also reviewed our historical positions in light of recent events. We 
conducted our work in Washington, D.C., in April 2005 in accordance 
with generally accepted government auditing standards. 

Overview of the Housing GSEs, Their Risks, and Regulatory Structure: 

I would like to begin my testimony by briefly describing the missions 
and activities of each of the GSEs, and the risks they pose to 
taxpayers. Then I will describe the current GSE regulatory structure. 

The Housing GSEs Share Similar Missions: 

Fannie Mae and Freddie Mac's mission is to enhance the availability of 
mortgage credit across the nation during both good and bad economic 
times by purchasing mortgages from lenders (banks, thrifts, and 
mortgage lenders), which then use the proceeds to make additional 
mortgages available to home buyers. Most mortgages purchased by Fannie 
Mae and Freddie Mac are conventional mortgages, which have no federal 
insurance or guarantee. The companies' mortgage purchases are subject 
to a conforming loan limit that currently stands at $359,650 for a 
single-family home in most states. Although Fannie Mae and Freddie Mac 
hold some mortgages in their portfolios that they purchased, most 
mortgages are placed in mortgage pools to support mortgage-backed 
securities (MBS). MBS issued by Fannie Mae or Freddie Mac are either 
sold to investors (off-balance sheet obligations) or held in their 
retained portfolios (on-balance sheet obligations). Fannie Mae and 
Freddie Mac guarantee the timely payment of principal and interest on 
MBS that they issue. 

The 12 FHLBanks that constitute the FHLBank System traditionally made 
loans--also known as advances--to their members (typically banks or 
thrifts) to facilitate housing finance and community and economic 
development. FHLBank members are required to collateralize advances 
with high-quality assets such as single-family mortgages. More 
recently, the FHLBanks initiated programs to purchase mortgages 
directly from their members and hold them in their retained portfolios. 
This process is similar to Fannie Mae and Freddie Mac's traditional 
business activities, although the FHLBanks do not currently have the 
authority to securitize mortgages.[Footnote 3]

The housing GSEs' activities have generally been credited with 
enhancing the development of the U.S. housing finance market. For 
example, when Fannie Mae and the FHLBank System were created during the 
1930s, the housing finance market was fragmented and characterized by 
regional shortages of mortgage credit.[Footnote 4] It is widely 
accepted that the housing GSEs' activities helped develop a unified and 
liquid mortgage finance market in this country. 

Housing GSE Activities Involve Significant Risks: 

While the housing GSEs have generated public benefits, their large size 
and activities pose potentially significant risks to taxpayers. As a 
result of their activities, the GSEs' outstanding debt and off-balance 
sheet financial obligations were about $4.6 trillion as of year-end 
2003. The GSEs face the risk of losses primarily from credit risk, 
interest rate risk, and operational risks.[Footnote 5] Although the 
federal government explicitly does not guarantee the obligations of 
GSEs, it is generally assumed on Wall Street that assistance would be 
provided in a financial emergency. In fact, during the 1980s, the 
federal government provided financial assistance to both Fannie Mae and 
the Farm Credit System (another GSE) when they experienced difficulties 
due to sharply rising interest rates and declining agricultural land 
values, respectively. The potential exists that Congress and the 
executive branch would determine that such assistance was again 
necessary in the event that one or more of the GSEs experienced severe 
financial difficulties. Because the markets perceive that there is an 
implied federal guarantee on the GSEs' obligations, the GSEs are able 
to borrow at interest rates below that of private corporations. 

The GSEs also pose potential risks to the stability of the U.S. 
financial system. In particular, if Fannie Mae, Freddie Mac, or the 
FHLBank System were unable to meet their financial obligations, other 
financial market participants depending on payments from these GSEs may 
in turn become unable to meet their financial obligations. To the 
extent that this risk, called systemic risk, is associated with the 
housing GSEs, it is primarily based on the sheer size of their 
financial obligations. For example, as discussed in OFHEO's 2003 report 
on systemic risk, if either Fannie Mae or Freddie Mac were to become 
insolvent, financial institutions holding the enterprise's MBS could be 
put into a situation where they could no longer rely on those 
securities as a ready source of liquidity.[Footnote 6] Depending on the 
response of the federal government, the financial health of the banking 
segment of the financial services industry could decline rapidly, 
possibly leading to a decline in economic activity. As another example, 
derivatives counterparties holding contracts with a financially 
troubled GSE could realize large losses if the GSE were no longer able 
to meet its obligations. If such an event were to occur, widespread 
defaults could occur in derivatives markets. 

Housing GSE Regulatory Structure Is Divided among OFHEO, HUD, and FHFB: 

The current regulatory structure for the housing GSEs is divided among 
OFHEO, HUD, and FHFB, as described below: 

* OFHEO is an independent office within HUD and is responsible for 
regulating Fannie Mae and Freddie Mac's safety and soundness. OFHEO 
oversees the two GSEs through its authority to examine their 
operations, determine capital adequacy, adopt rules, and take 
enforcement actions. Although OFHEO's financial plans and forecasts are 
included in the President's budget and are subject to the 
appropriations process, the agency is not funded with tax dollars. 
Rather, Fannie Mae and Freddie Mac pay annual assessments to cover 
OFHEO's costs. 

* HUD is responsible for ensuring that Fannie Mae and Freddie Mac are 
accomplishing their housing missions. HUD is to accomplish this 
responsibility through its authority to set housing goals, and to 
review and approve new programs, and through its general regulatory 
authority. HUD is funded through appropriations. 

* FHFB is responsible for regulating the FHLBank System's safety and 
soundness as well as its mission activities. The agency has a five-
member board, with the President of the United States appointing four 
members--each of whom serves a 7-year term--subject to Senate approval. 
The fifth member is the Secretary of HUD. The President also appoints 
FHFB's chair subject to Senate approval. Like OFHEO, FHFB carries out 
its oversight authorities through examinations, establishing capital 
standards, rule making, and taking enforcement actions. FHFB is funded 
through assessments of the 12 Federal Home Loan Banks and is not 
subject to the appropriations process. 

Housing GSE Regulatory Reform Is Necessary to Better Ensure Safety and 
Soundness and Mission Achievement: 

As I stated previously, OFHEO has moved aggressively over the past year 
to identify and address risk management and accounting deficiencies at 
Fannie Mae and Freddie Mac, and FHFB has entered into written 
agreements with two FHLBanks to correct interest rate risk management 
deficiencies. Nevertheless, we continue to believe that the current 
fragmented regulatory structure for the housing GSEs is inadequate to 
monitor these large and complex financial institutions and their 
mission activities. Establishing a single housing GSE regulator with a 
board structure and equipping the agency with adequate authorities 
would better ensure that the GSEs operate in a safe and sound manner 
and fulfill their housing missions. 

Current GSE Regulatory Structure Is Fragmented, OFHEO Lacks Key 
Authorities, and HUD's Mission Oversight Capacity Is Questionable: 

The current fragmented structure of federal housing GSE regulation does 
not provide for a comprehensive and effective approach to safety and 
soundness regulation. Although the housing GSEs operate differently, 
their business activities and risks are becoming increasingly similar. 
As I described previously, the FHLBank System has established mortgage 
purchase programs over the past several years and FHLBank System 
mortgage holdings were $113 billion at year-end 2003. While still small 
compared with Fannie Mae and Freddie Mac's combined retained mortgage 
portfolios of $1.3 trillion for the same time period, the FHLBank 
System now operates more like Fannie Mae and Freddie Mac and is 
increasingly incurring interest rate risks. Management of interest rate 
risk for mortgage holdings involves the application of sophisticated 
risk-management techniques, including the use of financial derivatives. 
Although such strategies are appropriate for risk management, they 
require specialized expertise, sophisticated information systems, and 
an understanding and application of sometimes complex accounting rules. 
In my view, it simply does not make sense for the federal government to 
entrust regulation of large and complex GSEs that are incurring similar 
risks to two different regulators, which have different approaches to 
examinations and setting capital standards. 

Moreover, OFHEO, and FHFB to a lesser degree, lack key authorities to 
fulfill their safety and soundness responsibilities, as described 

* Unlike with bank regulators and FHFB, (1) OFHEO's authority to issue 
cease and desist orders does not specifically list an unsafe and 
unsound practice as grounds for issuance and (2) OFHEO's powers do not 
include the same direct removal and prohibition authorities applicable 
to officers and directors. 

* Bank regulators have prompt corrective action authorities that are 
arguably more robust and proactive than those of OFHEO and FHFB. These 
authorities require that bank regulators take specific supervisory 
actions when bank capital levels fall to specific levels or provide the 
regulators with the option of taking other actions when other specified 
unsafe and unsound actions occur.[Footnote 7] Although OFHEO has 
statutory authority to take certain actions when Fannie Mae or Freddie 
Mac capital falls to predetermined levels, the authorities are not as 
proactive or broad as those of the bank regulators.[Footnote 8] OFHEO 
has also established regulations requiring specified supervisory 
actions when unsafe conditions are identified that do not include 
capital, but OFHEO's statute does not specifically mention these 
authorities. FHFB's statute does not establish a prompt corrective 
action scheme that requires specified actions when unsafe conditions 
are identified. Although FHFB officials believe they have all the 
authority necessary to carry out their safety and soundness 
responsibilities, the agency has significant discretion in resolving 
troubled FHLBanks. Consequently, there is limited assurance that FHFB 
would act decisively to correct identified problems. 

* Unlike bank regulators---which can place insolvent banks into 
receivership--and FHFB, which can take actions to liquidate an FHLBank, 
OFHEO is limited to placing Fannie Mae or Freddie Mac into a 
conservatorship.[Footnote 9] Thus, it is not clear that OFHEO has 
sufficient authority to fully resolve a situation in which Fannie Mae 
or Freddie Mac is unable to meet its financial obligations. 

Finally, we have significant concerns about HUD's capacity as the 
mission regulator for Fannie Mae and Freddie Mac. As I stated in my 
testimony last year, HUD officials we contacted said the department 
lacked sufficient staff and resources necessary to carry out its GSE 
mission oversight responsibilities. HUD officials said that although 
the GSEs' assets had increased nearly sixfold since 1992, HUD's 
staffing had declined by 4,200 positions and GSE oversight--which 
consisted of about 13 full-time positions--must compete with other 
department priorities for the limited resources available. While HUD's 
ability to ensure adequate resources for its GSE oversight 
responsibilities is limited, its mission oversight responsibilities are 
increasingly complex. For example, as we have noted in the past, it is 
not clear that HUD has the expertise necessary to review sophisticated 
financial products and issues, which may be associated with the 
department's program review and approval and general regulatory 
authorities.[Footnote 10] In addition, without the authority to impose 
assessments on Fannie Mae and Freddie Mac to cover the costs associated 
with their mission oversight, it would appear that HUD will always be 
challenged to fulfill its GSE mission oversight responsibilities. 

A Single Housing GSE Regulator with a Board or Hybrid Board/Director 
Governance Model and Equipped with Sufficient Authorities Is Critical: 

To address the deficiencies in the current GSE regulatory structure 
that I have just described, we have consistently supported and continue 
to believe in the need for the creation of a single regulator to 
oversee both safety and soundness and mission of the housing 
GSEs.[Footnote 11] A single housing GSE regulator could be more 
independent, objective, efficient, and effective than separate 
regulatory bodies and could be more prominent than either one alone. We 
believe that valuable synergies could be achieved, and expertise in 
evaluating GSE risk management could be shared more easily, within one 
agency. In addition, we believe that a single regulator would be better 
positioned to oversee the GSEs' compliance with mission activities, 
such as special housing goals and any new programs or initiatives any 
of the GSEs might undertake. This single regulator should be better 
able to assess these activities' competitive effects on all three 
housing GSEs and better able to ensure consistency of regulation for 
GSEs that operate in similar markets. 

Further, a single regulator would be better positioned to consider 
potential trade-offs between mission requirements and safety and 
soundness considerations, because such a regulator would develop a 
fuller understanding of the operations of these large and complex 
financial institutions. Some critics of combining safety and soundness 
and mission have voiced concerns that doing so could create regulatory 
conflict for the regulator. However, we believe that a healthy tension 
would be created that could lead to improved oversight. The trade-offs 
between safety and soundness and compliance with mission requirements 
could be best understood and accounted for by having a single regulator 
that has complete knowledge of the GSEs' financial condition, regulates 
the mission goals Congress sets, and assesses efforts to fulfill them. 

New GSE Regulator Should Have a Board or Hybrid Board/Director 
Governance Structure: 

In determining the appropriate structure for a new GSE regulator, I 
note that Congress has authorized two different structures for 
governing financial regulatory agencies: a single director and board. 
Among financial regulators, single directors head the Office of the 
Comptroller of the Currency, the Office of Thrift Supervision and 
OFHEO, while boards or commissions run FHFB, the Securities and 
Exchange Commission, and the Board of Governors of the Federal Reserve, 
among others. The single director model has advantages over a board or 
commission; for example, the director can make decisions without the 
potential hindrance of having to consult with or obtain the approval of 
other board members. 

In our previous work, however, we have stated that a "stand-alone" 
agency with a board of directors would better ensure the independence 
and prominence of the regulator and allow it to act independently of 
the influence of the housing GSEs, which are large and politically 
influential. A governing board may offer the advantage of allowing 
different perspectives, providing stability, and bringing prestige to 
the regulator. Moreover, including the secretaries of Treasury and HUD 
or their designees on the board would help ensure that GSE safety and 
soundness and housing mission compliance issues are considered. 

I would note that in other regulatory sectors---besides financial 
regulation---Congress has established alternative board structures that 
could be considered as potential models for the new GSE regulator. One 
such alternative structure would be the hybrid board/director 
governance model. Under such an approach, there would be a 
presidentially appointed and Senate-confirmed agency head who would 
report to a board of directors composed of secretaries from key 
executive branch agencies, such as Treasury and HUD. Having board 
members from the same political party could lessen some of the tensions 
and conflicts observed at boards purposefully structured to have a 
split in membership along party lines. A board composed of members from 
the same political party, however, may not benefit from different 
perspectives to the same extent as a board with members from different 
political parties. Therefore, an advisory committee to the regulator 
could be formed to include representatives of financial markets, 
housing, and the general public. This advisory committee could be 
required to have some reasonable representation from different 
political parties. 

Adequate Regulatory Authorities Are Essential: 

It is also essential that the new GSE regulator have adequate powers 
and authorities to address unsafe and unsound practices, respond to 
financial emergencies, and ensure that the GSEs comply with their 
public missions. These authorities include (1) cease and desist 
authority related to unsound practices, (2) removal and prohibition 
authority related to officers and directors, (3) prompt corrective 
action authority, and (4) authority to resolve a critically 
undercapitalized GSE, which may include placing it into receivership. 
Additionally, the new housing GSE regulator should have the authority 
to adjust as necessary the housing enterprises' minimum and risk-based 
capital requirements to help ensure their continued safety and 

I would also like to comment on an area of recent debate concerning 
discussions of GSE regulatory reform, i.e., restrictions on Fannie 
Mae's and Freddie Mac's retained mortgage portfolios, which were 
approximately $1.3 trillion as of year-end 2003. In testimony before 
this committee on April 6, 2005, Federal Reserve Chairman Greenspan 
stated that the GSEs' large retained mortgage portfolios do not 
necessarily benefit housing finance, are primarily intended to increase 
the GSEs' profitability, and increase the potential for systemic 
financial risks. To address these concerns, Chairman Greenspan called 
for limits on the GSEs' mortgage portfolios to be phased in over time. 
Moreover, Treasury Secretary Snow also expressed concern about the 
GSEs' mortgage portfolios and called for limits on their size. We also 
have commented that the GSEs' housing portfolios raise potential risks, 
and their benefits to housing finance markets are not clear. In my 
view, providing the new regulator with strong criteria to evaluate the 
costs and benefits of the GSEs' mortgage portfolios and the authority 
to limit them, if necessary, is essential. The criteria could include 
the extent to which the mortgage portfolios enhance the GSEs' housing 
mission, increase financial risks, and raise financial stability 

Further, the new housing GSE regulatory agency should be provided with 
explicit authority to oversee the GSEs' corporate governance and 
management compensation practices. As I stated in my previous 
testimony, while the GSEs should have been leaders with respect to 
corporate governance, in many respects they were not. For example, 
unlike leading organizations, the chairman of Fannie Mae's board also 
served as the GSE's chief executive officer (CEO). I note that both 
Fannie Mae and Freddie Mac have formally agreed with OFHEO to separate 
the positions of chairperson of the board and CEO, thereby helping to 
ensure that the GSE boards independently establish company policies 
that their CEOs are responsible for carrying out. OFHEO also found that 
Fannie Mae's compensation system provided managers with financial 
incentives to take actions--such as accounting irregularities--that 
increased the GSE's reported short-term profitability. Without the 
authority to police such practices, the new regulator would not be able 
to fully carry out its oversight responsibilities. 

I also believe that the new GSE regulator should be tasked with the 
responsibility to conduct research on the extent to which the housing 
GSEs are fulfilling their housing and community development missions. 
As I described earlier, there are already questions about the extent to 
which the housing GSEs' mortgage holdings benefit housing finance 
markets. Moreover, federal agencies, academics, and the GSEs have 
initiated studies that have estimated the extent to which Fannie Mae's 
and Freddie Mac's activities generate savings to home buyers, which 
have reached differing conclusions. Additional studies may be needed to 
more precisely estimate the extent to which the GSEs' activities 
benefit home buyers. Further, there is virtually no empirical 
information on the extent to which FHLBank advances lower mortgage 
costs for home buyers or encourage lenders to expand their commitment 
to housing finance. Without better information, Congress and the public 
cannot judge the effectiveness of the GSEs in meeting their missions or 
whether the benefits provided by the GSEs' various activities are in 
the public interest and outweigh their financial and systemic risks. 

Regulatory Funding Structure: 

Finally, I would now like to comment on issues surrounding the 
potential funding arrangements for a new housing GSE regulator. 
Exempting the new GSE regulator from the appropriations process would 
provide the agency with the financial independence necessary to carry 
out its responsibilities. More importantly, without the timing 
constraints of the appropriations process, the regulator could more 
quickly respond to budgetary needs created by any crisis at the GSEs. 
However, being outside the appropriations process can create trade-
offs. First, while the regulator will have more control over its own 
budget and funding level, it will lose the checks and balances provided 
by the federal budget and appropriations processes or the potential 
reliance on increased appropriations during revenue shortfalls. As a 
result, the regulator would need to establish a system of budgetary 
controls to ensure fiscal restraint. Second, removing the regulator 
from the appropriations process could diminish congressional oversight 
of the agency's operations. This trade-off could be mitigated through 
increased oversight by the regulator's congressional authorizing 
committees, such as a process of regular congressional hearings on the 
new GSE regulator's operations and activities. 

Mr. Chairman, this completes my prepared statement. I would be happy to 
respond to any questions that you or other Members of the Committee may 

GAO Contacts and Staff Acknowledgments: 

For further information regarding this testimony, please contact Thomas 
J. McCool, Managing Director, at (202) 512-8678 or; or 
William B. Shear, Director, at (202) 512-4325 or 
Individuals making contributions to this testimony include Allison M. 
Abrams, Marianne E. Anderson, Wesley M. Phillips, and Karen C. Tremba. 

[End of section]

Related GAO Products: 

Federal Home Loan Bank System: An Overview of Changes and Current 
Issues Affecting the System. GAO-05-489T. Washington, D.C.: April 13, 

Government-Sponsored Enterprises: A Framework for Strengthening GSE 
Governance and Oversight. GAO-04-269T. Washington, D.C.: February 10, 

Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ 
Significantly. GAO-03-973. Washington, D.C.: September 8, 2003. 

Financial Regulation: Review of Selected Operations of the Federal 
Housing Finance Board. GAO-03-364. Washington, D.C.: February 28, 2003. 

OFHEO's Risk Based Capital Stress Test: Incorporating New Business Is 
Not Advisable. GAO-02-521. Washington, D.C.: June 28, 2002. 

Federal Home Loan Bank System: Establishment of a New Capital 
Structure. GAO-01-873. Washington, D.C.: July 20, 2001. 

Comparison of Financial Institution Regulators' Enforcement and Prompt 
Corrective Action Authorities. GAO-01-322R. Washington, D.C.: January 
31, 2001. 

Capital Structure of the Federal Home Loan Bank System. GAO/GGD-99-
177R. Washington, D.C.: August 31, 1999. 

Federal Housing Finance Board: Actions Needed to Improve Regulatory 
Oversight. GAO/GGD-98-203. Washington, D.C.: September 18, 1998. 

Federal Housing Enterprises: HUD's Mission Oversight Needs to Be 
Strengthened. GAO/GGD-98-173. Washington, D.C.: July 28, 1998. 

Risk-Based Capital: Regulatory and Industry Approaches to Capital and 
Risk. GAO/GGD-98-153. Washington, D.C.: July 20, 1998. 

Government-Sponsored Enterprises: Federal Oversight Needed for 
Nonmortgage Investments. GAO/GGD-98-48. Washington, D.C.: March 11, 

Federal Housing Enterprises: OFHEO Faces Challenges in Implementing a 
Comprehensive Oversight Program. GAO/GGD-98-6. Washington, D.C.: 
October 22, 1997. 

Government-Sponsored Enterprises: Advantages and Disadvantages of 
Creating a Single Housing GSE Regulator. GAO/GGD-97-139. Washington, 
D.C.: July 9, 1997. 

Housing Enterprises: Investment, Authority, Policies, and Practices. 
GAO/GGD-91-137R. Washington, D.C.: June 27, 1997. 

Comments on "The Enterprise Resource Bank Act of 1996." GAO/GGD-96-
140R. Washington, D.C.: June 27, 1996. 

Housing Enterprises: Potential Impacts of Severing Government 
Sponsorship. GAO/GGD-96-120. Washington, D.C.: May 13, 1996. 

Letter from James L. Bothwell, Director, Financial Institutions and 
Markets Issues, GAO, to the Honorable James A. Leach, Chairman, 
Committee on Banking and Financial Services, U.S. House of 
Representatives, Re: GAO's views on the "Federal Home Loan Bank System 
Modernization Act of 1995." B-260498. Washington, D.C.: October 11, 

FHLBank System: Reforms Needed to Promote Its Safety, Soundness, and 
Effectiveness. GAO/T-GGD-95-244. Washington, D.C.: September 27, 1995. 

Housing Finance: Improving the Federal Home Loan Bank System's 
Affordable Housing Program. GAO/RCED-95-82. Washington, D.C.: June 9, 

Government-Sponsored Enterprises: Development of the Federal Housing 
Enterprise Financial Regulator. GAO/GGD-95-123. Washington, D.C.: May 
30, 1995. 

Federal Home Loan Bank System: Reforms Needed to Promote Its Safety, 
Soundness, and Effectiveness. GAO/GGD-94-38. Washington, D.C.: December 
8, 1993. 

Improved Regulatory Structure and Minimum Capital Standards Are Needed 
for Government-Sponsored Enterprises. GAO/T-GGD-91-41. Washington, 
D.C.: June 11, 1991. 

Government-Sponsored Enterprises: A Framework for Limiting the 
Government's Exposure to Risks. GAO/GGD-91-90. Washington, D.C.: May 
22, 1991. 

Government-Sponsored Enterprises: The Government's Exposure to Risks. 
GAO/GGD-90-97. Washington, D.C.: August 15, 1990. 


[1] See GAO, Government Sponsored Enterprises: A Framework for 
Strengthening GSE Governance and Oversight, GAO-04-269T (Washington, 
D.C.: Feb. 10, 2004). 

[2] The reported housing GSEs' financial data for financial obligations 
and retained mortgage portfolios identified in this testimony are 
subject to change. Both Fannie Mae and the FHLBank System are currently 
revising previous financial statements. 

[3] Securitization is the process of aggregating similar financial 
instruments, such as loans or mortgages, into pools and selling 
investors securities that are backed by cash flows from these pools. 

[4] Freddie Mac was established in 1970. 

[5] Credit risk is the possibility of financial loss resulting from 
default by homeowners on housing assets that have lost value; interest 
rate risk is the risk of loss due to fluctuations in interest rates; 
and operational risk includes the possibility of financial loss 
resulting from inadequate or failed internal processes, people, and 
systems or from external events. 

[6] Office of Federal Housing Enterprises Oversight, Systemic Risk: 
Fannie Mae, Freddie Mac, and the Role of OFHEO (Washington, D.C; Feb. 
4, 2003). 

[7] Capital can be a lagging indicator of unsafe and unsound conditions 
at financial institutions. Declining asset quality is an unsafe and 
unsound condition that may be identified months or years before capital 

[8] For example, bank regulators are generally required to take 
specified regulatory actions at earlier stages of capital depletion 
than is OFHEO. Bank regulators are also required to initiate four 
supervisory actions against an undercapitalized institution--including 
restricting asset growth--while OFHEO is mandated to take only two 
actions (not including restricting asset growth). 

[9] According to OFHEO officials, a receivership is empowered to take 
over the assets and operate an entity, assuming all of its powers and 
conducting all of its business as well as removing officers and 
directors. A receiver may place the failed institution into liquidation 
and sell its assets. While a conservator may also remove officers and 
directors of an entity, a conservator is typically appointed to 
conserve rather than dispose of assets. 

[10] See GAO, Government Sponsored Enterprises: Federal Oversight 
Needed for Nonmortgage Investments, GAO/GGD-98-48 (Washington, D.C.: 
Mar. 11, 1998). HUD's general regulatory authority can be used to limit 
or disallow activities that are determined not to support the mission 
of Fannie Mae or Freddie Mac. 

[11] See GAO, Government-Sponsored Enterprises: Advantages and 
Disadvantages of Creating a Single Housing GSE Regulator, GAO/GGD-97-
139 (Washington, D.C.: July 9, 1997).