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. 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). More recently,  the FHLBanks initiated programs to purchase mortgages directly from  their members and hold them in their retained portfolios. 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 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. 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. 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. 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. While HUD’s ability to ensure adequate resources for  its GSE oversight responsibilities is limited, its mission oversight  responsibilities are increasingly complex. 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. 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. 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. 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. The criteria could include the extent to which the mortgage  portfolios enhance the GSEs’ housing mission, increase financial risks, and  raise financial stability concerns. Without the authority to police  such practices, the new regulator would not be able to fully carry out its  oversight responsibilities. Capital Structure of the Federal Home Loan Bank System. Federal Housing Finance Board: Actions Needed to Improve Regulatory  Oversight. Government-Sponsored Enterprises: Development of the Federal Housing  Enterprise Financial Regulator.
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.