Enforcement Powers of the Regulator To insure the regulator's effectiveness, these tripwires should be tied to certain remedies. For example, if the GSE falls below a certain capital level, the regulator could be given authority to require submission of a written explanation and a business plan for amelioration. Triggering another "tripwire" might empower the regulator to halt any further erosion of capital, through a limitation on dividend distributions, or restraints on executive compensation. Principle Three: Lines of Defense - Audits. Reports, and Examinations Any new regulatory structure should give the regulator authority to require regular reports, annual audits, and periodic examinations. Competent and professional regulators should be required to monitor the financial condition of the GSE's operations. To insure the highest level of sophistication and expertise by this system, the costs of the process could be borne by the GSEs through clearly established assessments. We currently publish a great deal of information on our operations and financial performance that could aid a regulator. There are only two secondary mortgage market entities. We have to compete with each other daily, for lenders to sell us loans and investors to purchase our securities, our stock and our debt. Both of us have been leaders in providing financial and operations information to the marketplace. There is a lot of data about us out there already including timely reporting from GAO reports and audits, and from other sources, such as stock analysts. - Moreover, Freddie Mac already has many lines of defense which the Congress and a regulator can rely on. For example, we have a Board of Directors that reviews all major policy decisions of the Corporation. They have a fiduciary responsibility to insure that Freddie Mac continues to meet its mission and investor needs. These are all talented, successful individuals in their own right, including five members appointed by the President. Mark-to-Market Accounting - Another state-of-the-art technique that should be used in measuring capital is mark-to-market accounting. Using mark-to-market accounting addresses the concern that, by the time a decline in GAAP capital becomes sufficiently severe, a great deal of damage to the company's safety and soundness may have already been done. Thus, minimum capital should be based not only on a GAAP method, but also using the marked-to-market net worth - that is, the current market value of their assets less the current market value of their liabilities. The market value of the companies will be sensitive to changes in the financial position of the companies, providing early warning to the regulator of emerging problems. Mark-to-market accounting represents a better measure of how much real value there is in a firm. Here is an example of this. If you bought a house in the early 1960s, the price would have changed. Most likely it would have increased. In calculating your personal net worth, you would obviously determine its value in today's market. It would not make sense to value it at the price you paid for it in 1960. The same is true for how much Freddie Mac is worth and its capital needs. Mark-to-market accounting is a more appropriate, state-of-the-art, measure for GSEs. For this reason, Freddie Mac has disclosed the market value of all its assets and obligations for the past several years. We were one of the first in the country to do this. We did it in part because we believe it helps investors and regulators better understand the company's financial condition. It is an excellent management and regulatory tool, responding to market changes very fast, telling management or a regulator sooner than GAAP, if a firm is in trouble. After years of debate, the Financial Accounting Standards Board has begun to move on proposals to require market value disclosures on financial instruments for financial institutions. Additionally, the Treasury has recently recommended that financial institutions release more information about market values. Principle Four: An Independent. Professional Regulator Capable of I agree with Treasury's recommendation for a separate "arms-length" Bureau in HUD to oversee Freddie Mac and Fannie Mae. While HUD has at times come under criticism in carrying out its regulatory responsibilities, there remain strong reasons for retaining HUD as the center of responsibility for secondary mortgage market regulation. The regulation of the safety and soundness of the housing GSES is best conducted in an environment of expertise in and support for the fulfillment of their housing mission. As the federal government's lead agency on housing issues, HUD is the best equipped entity to strike the proper balance between mission fulfillment and safety and soundness. It needs only the capacity and sophistication to follow through effectively. A strengthened HUD would be more effective and efficient. For instance, creating a single, independent regulator for all GSES could foster the growth of a large new regulatory bureaucracy that would be expensive to operate and take years to get up and running. In addition, GSES are a sufficiently diverse group of enterprises that expertise in the activities of one would not necessarily translate into expertise in the activities of another. Thus, separate specialized divisions within any independent regulator would probably have to be created, creating de facto separate regulators within the new entity. An "OCC-type" regulator in HUD would address any lack of confidence in its regulatory record. The OCC is considered effective, while managing to maintain a substantial degree of independence within Treasury. The director of this new office would be a presidential appointee, subject to Senate confirmation, for five-year term. Το prevent any political conflict of interest, the Congress may consider prohibiting any HUD, Freddie Mac or Fannie Mae employee from being employed with the new regulator for two years after leaving any of the above entities. Avoid Unnecessary Regulatory Intrusion and Micromanagement Freddie Mac is a sophisticated institution. It engages in issuing complex financial products traded routinely in both domestic and foreign markets. Our management is accountable to boards of directors and shareholders for our performance. We are subject to congressional oversight. If we are well capitalized and are also subject to the discipline of public ownership, we should be free to operate within the mandate of their charter. One objective in regulating GSEs must be to assure continued reliability of the secondary market. In the case of secondary mortgage entities, capital standards must insure that would allow them to continue assisting housing while at the same time achieving the aims of safety and soundness. Any requirements that would impose excessive capital standards ΟΙ bureaucratic regulations could, in my opinion, seriously undermine the confidence of investors. This, in turn, would adversely affect private sector investment in housing. I urge you to avoid a regulatory bureaucracy that stifles flexibility and innovation or attempts to micromanage an entity's operations. Legislation should prevent regulatory oversight from intruding into the operations of the company or reducing its flexibility to respond to changing market conditions. I want to emphasize this point because I see it as an area that could become very troublesome in an era of regulatory zeal. My view is this: If a company is well capitalized for the risks it takes, the authority of regulators to dictate operating decisions should be severely limited. That means that the enforcement powers available to the regulator, and the circumstances in which it may be involved, must be clearly spelled out in the law. This reduces potentially dangerous regulatory intrusion. CONCLUSION I believe this is an exciting time for Freddie Mac as it moves toward both it 21st birthday and the 21st century. It would be a fitting commemoration, as it "comes of age", to have a bold, innovative, state-of-the-art regulatory structure in place to guide it into the 21st century. This will insure a continuation of the great congressional housing success story that Freddie Mac represents. To that end, Mr. Chairman, the above recommendations are a sincere effort to unite or balance safety and soundness with mission. I hope my testimony reflects this. I would welcome an opportunity to discuss it with you in more detail. /1501 |