oversight

Housing Enterprises: Advantages and Disadvantages of Creating a Single Housing GSE Regulator

Published by the Government Accountability Office on 1997-07-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on Capital Markets, Securities
                          and Government-Sponsored Enterprises, Committee on
                          Banking and Financial Services
                          House of Representatives

For Release on Delivery
Expected at
10:00 a.m., EDT
                          HOUSING ENTERPRISES
on Thursday
July 24, 1997

                          Advantages and
                          Disadvantages of Creating a
                          Single Housing GSE
                          Regulator
                          Statement of Jean Gleason Stromberg
                          Director, Financial Institutions and Markets Issues
                          General Government Division




GAO/T-GGD-97-160
Summary

Housing Enterprises: Advantages of
Creating a Single Housing GSE Regulator

              GAO’s testimony, based on its recent report,1 discusses the advantages and
              disadvantages of creating a single regulator for the housing
              government-sponsored enterprises (GSE)—the Federal National Mortgage
              Association (Fannie Mae), the Federal Home Loan Mortgage Corporation
              (Freddie Mac), and the Federal Home Loan Bank System (FHLBank
              System). Currently, the Federal Housing Finance Board (FHFB) oversees
              the safety and soundness and the mission compliance of the FHLBank
              System. The Office of Federal Housing Enterprise Oversight (OFHEO), an
              independent office within the Department of Housing and Urban
              Development (HUD), oversees the safety and soundness of Fannie Mae and
              Freddie Mac. The Secretary of HUD has general regulatory power over
              Fannie Mae and Freddie Mac.

              GAO  reviewed its past and ongoing work related to these GSEs and their
              regulators, and solicited the views of housing, GSE, and regulatory officials.
              In GAO’s 1991 and 1993 reports on GSEs, it identified five criteria that a GSE
              regulatory agency structure should meet to facilitate effective oversight.2
              The criteria specify that a GSE regulatory agency’s structure should provide
              for (1) objectivity and independence from the GSE, (2) prominence in
              government, (3) economy and efficiency, (4) consistency in regulation of
              similar markets, and (5) separation of primary and secondary market
              regulation.

              GAO  determined that the housing GSE regulators would be more effective if
              the regulatory function was combined and one regulator was authorized to
              oversee both safety and soundness and mission compliance. GAO’s analysis
              of different regulatory structures indicated that an independent,
              arm’s-length, stand-alone regulatory body headed by a board would best fit
              its criteria for an effective regulatory agency structure. Although there
              have been changes in the structure of regulatory oversight for the housing
              GSEs since GAO first established its criteria, neither OFHEO, HUD, nor FHFB
              meets all five criteria. A single housing GSE regulatory agency could be
              more independent and objective than separate regulatory bodies and could
              be more prominent than any one alone. Although the GSEs operate
              differently, the risks they manage and their missions are similar. A single
              regulator should be better able to assess the competitive effect of specific
              mission requirements, such as special housing goals, and new programs or


              1
              Government-Sponsored Enterprises: Advantages and Disadvantages of Creating a Single Housing GSE
              Regulator (GAO/GGD-97-139, July 9, 1997).
              2
               Government-Sponsored Enterprises: A Framework for Limiting the Government’s Exposure to Risks
              (GAO/GGD-91-90, May 22, 1991); and Federal Home Loan Bank System: Reforms Needed to Promote
              Its Safety, Soundness, and Effectiveness (GAO/GGD-94-38, Dec. 8, 1993).



              Page 1                                                                     GAO/T-GGD-97-160
Summary
Housing Enterprises: Advantages of
Creating a Single Housing GSE Regulator




initiatives on all three housing GSEs and better ensure consistency of
regulation for GSEs that operate in similar markets.




Page 2                                                      GAO/T-GGD-97-160
Statement

Housing Enterprises: Advantages of
Creating a Single Housing GSE Regulator

              Mr. Chairman and Members of the Subcommittee:

              We are pleased to appear here today to discuss our recently issued report
              on creating a single regulator for the three housing government-sponsored
              enterprises (GSE) — the Federal National Mortgage Association (Fannie
              Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and
              the Federal Home Loan Bank System (FHLBank System).3 First, I will
              discuss the advantages and disadvantages of creating a single housing GSE
              regulator. Second, I will discuss the question whether both safety and
              soundness and mission oversight should be vested in that regulator. Third,
              I will discuss several possible regulatory structures. Finally, I will briefly
              mention one other issue that is important in considering how best to
              regulate the housing GSEs.

              As you know, the current regulatory arrangement for the housing GSEs
              involves three regulators. The Office of Federal Housing Enterprise
              Oversight (OFHEO) regulates the safety and soundness of Fannie Mae and
              Freddie Mac. HUD regulates Fannie Mae’s and Freddie Mac’s mission
              compliance and has general regulatory authority over matters not made
              exclusive to OFHEO by statute. The Federal Housing Finance Board (FHFB)
              regulates both the safety and soundness and mission compliance of the
              (FHLBank System).

              In our 1991 and 1993 reports on GSEs, we identified criteria that a GSE
              regulatory agency structure should meet in our view to facilitate effective
              oversight.4 These criteria were: (1) objectivity and independence,
              (2) prominence in government, (3) ability to achieve economy and
              efficiency, (4) ability to provide consistency in regulation, and (5) ability to
              separate primary and secondary market regulation. On the basis of work
              we have done subsequently, we believe those criteria remain sound. In
              addition to reviewing our past work in light of the current regulatory
              structure and GSE activities, as well as ongoing work related to these GSEs




              3
              Government-Sponsored Enterprises: Advantages and Disadvantages of Creating a Single Housing GSE
              Regulator (GAO/GGD-97-139, July 9, 1997).
              4
               Government-Sponsored Enterprises: A Framework for Limiting the Government’s Exposure to Risks
              (GAO/GGD-91-90, May 22, 1991); and Federal Home Loan Bank System: Reforms Needed to Promote
              Its Safety, Soundness, and Effectiveness (GAO/GGD-94-38, Dec. 8, 1993).



              Page 3                                                                     GAO/T-GGD-97-160
                   Statement
                   Housing Enterprises: Advantages of
                   Creating a Single Housing GSE Regulator




                   and their regulators,5 we solicited views of housing, GSE, and regulatory
                   officials.

                   Our ongoing work has strengthened our belief that the housing GSE
                   regulators would be more effective if combined and authorized to oversee
                   both safety and soundness and mission compliance. Although there have
                   been changes in the regulatory oversight of the housing GSEs since we first
                   established our criteria, neither OFHEO, HUD, nor FHFB meet all of the
                   criteria. In particular, we note that FHFB is not completely an arm’s-length
                   regulator, as it is still involved in governance of the FHLBank System. In
                   addition, regulation of Fannie Mae’s and Freddie Mac’s mission
                   compliance is the responsibility of HUD, while their safety and soundness is
                   the responsibility of OFHEO. Our analysis of different regulatory structures
                   indicates that an independent, arm’s-length, stand-alone regulatory body
                   headed by a board would best fit our criteria for an effective regulatory
                   agency structure for the housing GSEs.


                   We continue to support the creation of a single housing GSE regulator as
We Continue to     recommended in our 1993 report. Although we recognize that the housing
Support a Single   GSEs operate and are structured differently, the risks they manage are

Housing GSE        similar. We believe valuable synergies could be achieved and expertise
                   could be shared. Both OFHEO and FHFB evaluate how the enterprises
Regulator          manage credit, interest rate, and other risks. In addition, OFHEO’s current
                   work in setting capital standards and developing a stress test for its GSEs
                   could be useful in evaluating the risks to the FHLBank System and the
                   adequacy of its capital.

                   We also believe that a single housing GSE regulator could foster
                   competition among the three GSEs while providing consistent rules and
                   interpretations. FHFB recently approved three FHLBank pilot programs that
                   involve services Fannie Mae or Freddie Mac could have or already does
                   provide. OFHEO officials told us they independently assessed the
                   competitive impact of these programs on Fannie Mae and Freddie Mac.
                   However, had a single regulator been responsible for all three GSEs, a
                   single assessment could have combined consideration of all competitive
                   effects and better ensured consistency of regulatory oversight. We
                   recognize that because of possible conflicting interests of the housing GSEs

                   5
                    See Government-Sponsored Enterprises: Development of the Federal Housing Enterprise Financial
                   Regulator (GAO/GGD-95-123, May 30, 1995); a study required by the Federal Housing Enterprises
                   Financial Safety and Soundness Act of 1992. In addition, Section 430 of the Department of Veterans
                   Affairs/Department of Housing and Urban Development Appropriations Act of 1997 required us to
                   assess OFHEO’s operations and determine whether its resources are adequate and being used
                   appropriately to fulfill its critical safety and soundness mission. This work is ongoing.



                   Page 4                                                                          GAO/T-GGD-97-160
                        Statement
                        Housing Enterprises: Advantages of
                        Creating a Single Housing GSE Regulator




                        in pursuing their lines of business and missions, such an assessment could
                        be difficult. However, we believe the process could be handled more
                        effectively and efficiently within one regulatory body.

                        The most often identified disadvantage of creating a single housing GSE
                        regulator is the potential disruption in operations of the existing
                        regulatory agencies, especially for a relatively new agency like OFHEO. On
                        the other hand, these effects should be short term and the outcome should
                        result in more effective regulation in the long run.


                        In our May 1991 report on GSEs, we stated that regulation of a GSE’s mission
Regulation of Mission   cannot be effectively separated from safety and soundness, and we still
and Safety and          support this position.6 A regulator that performs both roles must, however,
Soundness Would Be      be fully independent and at arm’s length from the GSEs it regulates. We
                        strongly believe that the independence this would provide is imperative to
More Effective If       ensure objectivity. As we noted in 1991, there is a distinction between a
Combined                safety and soundness regulator that confirms a GSE’s compliance with its
                        statutory purposes as articulated by Congress and one that participates in
                        the corporate governance of a GSE.

                        As you know, FHFB still participates in FHLBank System business, which
                        we have stated in previous work and continue to believe is inappropriate
                        for a regulator and presents potential for conflict.7 For example, FHFB is
                        required to appoint six directors to each bank’s board and, until just last
                        month, approved applications for the Affordable Housing Program.8 While
                        FHFB has delegated some duties related to FHLBank System management
                        to the FHLBanks, the Chairman of FHFB told us FHFB cannot fully delegate
                        these types of duties because of statutory constraints.

                        Some critics of combining mission and safety and soundness have voiced
                        concerns that doing so could create regulatory conflict for the regulator. It
                        seems to us, however, that the tension caused by having both private and
                        public characteristics could be best understood and accounted for by
                        having a single regulator that has complete knowledge of financial
                        condition, regulates the mission goals Congress sets, and assesses efforts

                        6
                         GAO/GGD-91-90, pages 29-31. In commenting on the 1991 report, Fannie Mae, Freddie Mac, and FHFB
                        all agreed with our position that safety and soundness could not be effectively separated from
                        statutory activities (mission). HUD took no position.
                        7
                         GAO/GGD-91-90 and GAO/GGD-94-38.
                        8
                         The Affordable Housing Program Regulations are set forth at 12 C.F.R. Part 960. The Board’s approval
                        procedures are contained in 12 C.F.R. § 960.5.



                        Page 5                                                                          GAO/T-GGD-97-160
                      Statement
                      Housing Enterprises: Advantages of
                      Creating a Single Housing GSE Regulator




                      to fulfill them. The link between mission and safety and soundness is
                      established in the housing GSEs’ charters. All three housing GSEs’ charters
                      acknowledge that economic considerations of the activities undertaken
                      cannot be ignored, especially where special mission requirements, such as
                      low-income housing goals, are addressed.

                      Given the current financial strength of Fannie Mae, Freddie Mac, the
                      FHLBank System and the overall economic environment, we determined
                      that, for now, there would be little tension between mission compliance
                      and safety and soundness concerns. However, should economic
                      conditions change for the worse, more tension could be created as the
                      GSEs try to provide acceptable returns to their owners while continuing to
                      comply with their special mission requirements. In this situation, we
                      believe it is important that a regulator be responsible for both to help
                      ensure adequate balance is maintained.

                      In our report, we also point out that combining mission and safety and
                      soundness regulation would facilitate assessing Fannie Mae and Freddie
                      Mac for the cost of overseeing their compliance with housing goals.
                      Currently, the cost of Fannie Mae’s and Freddie Mac’s mission oversight is
                      borne by the taxpayer as part of HUD’s budget. However, OFHEO’s and FHFB’s
                      costs are paid by their respective enterprises through assessments. In
                      addition, of course, oversight by one regulator could facilitate
                      congressional monitoring of the housing GSEs.


                      The third area of our report that I will address is the possible structure for
Possible Structures   a single regulatory agency. A single regulator for housing GSEs could be a
for a Single          stand-alone agency or an independent office within an executive branch
Regulatory Agency     agency, such as HUD or Treasury. The agency could be led by a board or a
                      single director. What is important in our view, is to ensure that it has the
                      independence and prominence that would allow it to act independently of
                      the influence of the housing GSEs, which are large and politically influential
                      institutions.

                      One of the primary advantages of creating a stand-alone agency, rather
                      than an independent agency within a department, is that it should be
                      better able to establish independence and be further removed from the
                      potential political influence of a cabinet-level department and from the
                      specific interests of its parent organization. In addition, a stand-alone
                      agency, because it would not be affiliated with a government department




                      Page 6                                                       GAO/T-GGD-97-160
Statement
Housing Enterprises: Advantages of
Creating a Single Housing GSE Regulator




that has a particular focus, may be in a better position to ensure that safety
and soundness and mission are equitably overseen.

The advantages and disadvantages of having a new regulator that is set up
as an independent office within an executive branch agency would depend
on the agency. HUD and Treasury would be the most appropriate agencies
because of their roles in housing and finance. Although OFHEO has
functioned independently within HUD, having the housing GSE regulator
within HUD creates the potential for conflict with HUD’s role as a housing
promoter. However, HUD’s expertise in housing and the housing finance
system would be an advantage.

If the office were created within Treasury, it could benefit from Treasury’s
financial and regulatory expertise and prominence. In addition, this
affiliation would also reinforce the importance of safety and soundness
oversight as the regulator’s top priority. On the other hand, Treasury’s
objectivity and arm’s-length status could be questioned because of its two
specific responsibilities relating to GSEs: (1) power to approve the timing
and terms of new GSE debt issuances9 and (2) ability to authorize use of
conditional lines of credit held by the GSEs.10

Closely related to the stand-alone versus independent office structure, we
considered a board versus a single director structure for governing a single
regulatory agency. We found that the board structure best fits our criteria
for an effective regulator for many of the same reasons that a stand-alone
agency is preferable to an executive branch agency.

We believe one advantage would be that a new regulator led by a board
would best be able to establish the requisite independence in government
and would also allow Congress to provide balance for the regulator’s
decisionmaking body. Both HUD and Treasury could be represented on a
board, providing a structure where any potential conflicts could be
addressed. A disadvantage of a board structure is that it may make
determining individual accountability for actions difficult. This potential



9
 For years, Treasury scheduled GSE offerings to prevent timing conflicts among the GSEs that might
prove to be disruptive to the government securities market. On March 8, 1996, however, Treasury
eliminated its scheduling procedures for GSE securities offerings. GSEs have developed a voluntary,
cooperative scheduling system that eliminated the need for Treasury’s queuing process. Treasury’s
statutory authority to approve the timing and terms of GSE securities has not changed.
10
 The FHLBank System has a $4 billion line of credit with Treasury, while Fannie Mae and Freddie Mac
each have a $2.25 billion line of credit. However, use of the lines of credit is subject to Treasury’s
discretion.



Page 7                                                                          GAO/T-GGD-97-160
Statement
Housing Enterprises: Advantages of
Creating a Single Housing GSE Regulator




inefficiency could be addressed by placing a presidentially appointed chair
or chief executive officer in charge of daily operations.

Among the financial regulators, we could not find any examples of
stand-alone agencies that were not headed by boards or commissions or
independent offices that were not headed by single directors. It seems
there are good reasons for these structures being linked. That is, although
a stand-alone agency structure provides independence and prominence in
government, the board structure has the advantages of allowing different
perspectives, providing stability, and bringing prestige to the agency, as
well as allowing Congress to provide balance for the regulator’s
decisionmaking body by requiring that members have certain expertise.

In closing, Mr. Chairman, I want to mention one additional issue that may
need to be addressed in your deliberations.

If a single regulator for the housing GSEs were created, you may want to
consider whether it should be included or excluded from the
appropriations process. Most financial institution regulators, including
OFHEO and FHFB, assess the institutions they oversee for the cost of
regulation. Thus, they are not funded from tax revenues and typically are
not subject to appropriations. OFHEO, however, is subject to the
appropriations process and has less control than some other regulators
over its resources. The appropriations process could subject the agency to
budgetary pressures that could conflict with the agency’s needs as a safety
and soundness regulator. On the other hand, we recognize that the
appropriations process does provide an additional mechanism for
congressional oversight.


That concludes my prepared statement. My colleagues and I would be
pleased to answer any questions.




Page 8                                                      GAO/T-GGD-97-160
Page 9   GAO/T-GGD-97-160
Page 10   GAO/T-GGD-97-160
Related GAO Products


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

              Housing Enterprises: Investment, Authority, Policies, and Practices,
              GAO/GGD-97-137R,
                            June 27, 1997.

              Comments on “The Enterprise Resource Bank Act of 1996”, GAO/GGD-96-140R,
              June 27, 1996.

              Housing Enterprises: Potential Impacts of Severing Government
              Sponsorship, GAO/GGD-96-120, 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 views on the “Federal Home Loan Bank System
              Modernization Act of 1995,” B-260498, Oct. 11, 1995.

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

              Housing Finance: Improving the Federal Home Loan Bank System’s
              Affordable Housing Program, GAO/RCED-95-82, June 9, 1995.

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

              Farm Credit System: Repayment of Federal Assistance and Competitive
              Position, GAO/GGD-94-39, March 10, 1994.

              Farm Credit System: Farm Credit Administration Effectively Addresses
              Identified Problems, GAO/GGD-94-14, Jan. 7, 1994.

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

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

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



              Page 11                                                    GAO/T-GGD-97-160
         Related GAO Products




         Government-Sponsored Enterprises: The Government’s Exposure to
         Risks, GAO/GGD-90-97, Aug. 15, 1990.




233529   Page 12                                              GAO/T-GGD-97-160
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