Statement of Bruce Morrison
Federal Housing Finance Board
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises
Committee of Banking and Financial Services
U.S. House of Representatives
The Housing Finance Regulatory Improvement Act of 2000
March 22, 2000
Good morning Mr. Chairman, and members of the subcommittee. I would like to thank you for the opportunity to appear today to testify on the Housing Finance Regulatory Improvement Act of 2000 (H.R. 3703). I should point out that the Board of Directors of the Finance Board has not reviewed my testimony and it does not represent the Administration's view or position.
I would like to preface my comments by commending you, Mr. Chairman, and Chairman Leach for your work on this legislation that embodies the concept of a single housing-finance GSE regulator. I would also like to thank Mr. Baker and Mr. Kanjorski, as well as Mr. Leach and Mr. LaFalce for the vote of confidence they gave the Federal Home Loan Bank System with their leadership in the passage of the Federal Home Loan Bank Modernization Act as part of the Gramm-Leach-Bliley legislation in October. The legislation effectively ends the debate about the viability of the FHLBank System and gives it the structure and tools for the new century.
The small-bank provisions in particular will greatly increase access to FHLBank liquidity for these institutions, and allow Main Street institutions the chance to compete with Wall Street institutions, and to serve their communities more effectively.
Let me now return to H.R. 3703. The issue of consolidating the regulators of the housing-finance GSEs was before this subcommittee most recently in July 1997. At that time, I testified that I agreed with the underlying premise of the legislation: that a single independent agency regulating safety and soundness and mission for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks is preferable to the current structure. Since my views are substantially unchanged, I have attached a copy of my testimony previously delivered to this Subcommittee on July 24, 1997. My further comments presented here will expand upon those views and discuss provisions specific to H.R. 3703.
II. Effective Mission Regulation is Central to GSE Oversight.
Congress long ago decided that promoting homeownership is desirable and worth the cost of granting special advantages to homebuyers, such as the mortgage interest tax deduction, and the establishment of specially advantaged GSEs to facilitate housing finance and other socially desirable activities. In exchange for public support, the American taxpayer has the right to expect responsible behavior by the GSEs. It is obvious that it is critically important to protect the taxpayer from potential loss by monitoring and regulating GSE financial risk. It is also critically important to ensure that the low cost-of-funds and other advantages entrusted to the GSEs are well directed and ultimately reach their intended beneficiaries. There is a risk that much of the governments benefit is absorbed as profits in the GSE conduit. Mission regulation ensures that this valuable GSE benefit passes through to its rightful beneficiaries and makes the difference between helping consumers and enabling corporate welfare.
GSEs are created to accomplish statutorily prescribed missions and are provided with advantages, including state and local corporate tax exemptions and a U. S. Treasury line of credit, which taken together produce lower cost of funds and operations. It is up to the regulator to ensure a public benefit at the rightful price for that lower cost and to enforce the mission prescribed by Congress.
Mission regulation and safety and soundness regulation are closely related. H.R. 3703 recognizes this by giving the new board authority to limit nonmission-related assets. Many assets are perfectly safe and sound from a financial point of view. But, because the GSEs were created for very specific purposes, only some assets are consistent with the mission of those GSEs. A GSE may be less profitable if certain assets are prohibited and this could have safety and soundness consequences. A combined safety and soundness and mission regulator can weigh the tradeoffs between profit and mission suitability to determine the proper policy much more safely and efficiently than can two separate regulators where the responsibilities for safety and soundness and mission are housed in different agencies.
Some in the GSE community believe that mission regulation should be left entirely to congressional oversight, but I believe that is unworkable. As much as we would like statutes to unambiguously prescribe behavior in every circumstance, the reality is that financial sector regulators face questions of statutory interpretation on an almost daily basis. Legislation alone can never be nimble enough to handle the day-to-day realities of regulating multi-billion dollar businesses.
Additionally, the best way to ensure that the GSE benefit is passed through to consumers is to create a structure where market competition forces the distribution of subsidy through the GSE conduit. A single regulator for the housing GSEs would facilitate this by creating a level playing field for the three GSEs and by design create equalizers such as competitive capital levels and competitive product authorizations. H.R. 3703 allows for this by specifying a common new activity approval process for the three GSEs.
I recommend the FHFBs pilot approval process as a model. Starting in mid-1995, the Finance Board encouraged the FHLBanks to engage in activities aimed at improving housing finance and community lending opportunities in their respective districts through limited scale, and therefore limited risk, pilot programs. The most visible success resulting from this initiative is the Mortgage Partnership Finance (MPF) product developed by the FHLBank of Chicago. The Finance Board's role was to ensure oversight of safety and soundness, legality, and mission suitability, and to require appropriate control, regulatory review, and examination procedures at all stages of development.
III. GSE Oversight Requires Independence in its Regulator.
Regardless of the particular structure of GSE regulation, certain characteristics are crucial if independent regulatory judgments are to be made. H.R. 3703 contains some improvements in this area, but could do more.
The proposed legislation removes the Office of Federal Housing Enterprise and Oversight from the appropriations process. I fully endorse this provision. OFHEO is dependent on Congress to set the formula for its funding, a process that could prevent the agency from responding rapidly to emerging problems, and limits its flexibility and resources in ensuring that Fannie Mae and Freddie Mac are operated safely under changing economic scenarios.
The proposed legislation also calls for the President to designate an appointed director to serve as chairperson of the board, with this privilege expiring with a change of administrations. I would favor a provision to allow the chairman to be nominated by the President and confirmed by the Senate as chairperson for the duration of his or her term. Such a provision would increase the independence and credibility of the new board and add prestige to the position, which would, I think, result in more effective regulation of the GSEs.
I also recommend expanding the board from five to seven members. The Administration is amply represented by HUD and Treasury. An expanded board would allow for a more diversified view and a wider range of expertise. The positions other than the Chairman should be part-time. This not only saves money in salaries, but it also encourages more prominent and experienced individuals to accept these positions than would normally be the case given the sacrifices of full-time government service.
IV. Avoid Raising GSE Costs Without Benefit.
Some aspects of H.R. 3703 acknowledge the reality that the government has created special GSE benefits which must be safely administered and directed toward public benefit. Other provisions seem intended to reduce the benefit, but do not achieve any real reduction in public sector risk. Such changes impose costs without real benefits.
H.R. 3703 would eliminate the so-called "superlien" that is granted by statute to the FHLBanks. I believe this would impose a cost on the FHLBanks which could raise prices to members with no real benefit.
The superlien was created by Congress under the Competitive Equality of Banking Act of 1987. This provided that any security interest granted by a member to a FHLBank would be entitled to priority over the claims and rights of any other party, including the Federal Deposit Insurance Corporation (FDIC) as a receiver or conservator. The only exception is with regard to claims of other creditors of a member that have been secured by a more senior perfected security interest. Prior to 1987, the FHLBanks could achieve the same priority status by perfecting their security interest in specific assets of the member, but doing so would have been time consuming, cumbersome, and expensive. But since the FHLBanks and the insurer of most of their members, the Federal Savings and Loan Insurance Corporation (FSLIC), were both under the control of the Federal Home Loan Bank Board, there was little concern over competition between the two in liquidations.
If the superlien were eliminated, the FHLBanks would be forced to perfect their security interests on an asset-by-asset basis rather than using a "blanket lien" as they do for most of their lending today. The expense of this process would not result in any benefit to the FDIC insurance funds, because the perfected security interests of the FHLBanks still would be entitled to a priority over the claims of other creditors, including those of the FDIC.
As deposits are disintermediated from banking institutions to the capital markets, FHLBank advances serve to recapture those funds and return them to local use. It would seem that a member banks use of safe and nonvolatile FHLBank advances would be preferable to relying on brokered deposits and other sources of "hot money" that caused the industry and the taxpayer so much grief in the past. Borrowing from the FHLBanks should remain as efficient and inexpensive as possible.
The proposed legislation also would eliminate the lines-of-credit the GSEs have with the U. S. Treasury. This, I believe, would send a wrong message to purchasers of GSE debt. Granted, the $4 billion FHLBank System line of credit is insignificant when viewed in the context of the $500+ billion in outstanding obligations of the System. But, the line-of-credit now exists and it contributes to the lower funding costs supplied by capital market pricing of FHLBank System consolidated obligations. Removal of the line-of-credit could adversely affect these costs with no reciprocal reduction in government exposure. These increased costs will raise the prices of FHLBank products.
That concludes my testimony for today. I will be happy to answer any questions you may have. Thank you.
Statement of Bruce A. Morrison
Federal Housing Finance Board
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises
Committee on Banking and Financial Services
U.S. House of Representatives
Report of the General Accounting Office
Creating a Single GSE Regulator
July 24, 1997
Good morning Mr. Chairman. Congressman Kanjorski and other Members of the Subcommittee. My name is Bruce A. Morrison. and I am Chairman of the Federal Housing Finance Board. I welcome the opportunity to appear before you today to testify regarding the recent report of the General Accounting Office on the advantages and disadvantages of creating a single housing GSE regulator. Please note that the views I express will be my own; this statement has not been reviewed by the Board of Directors of the Finance Board. It does not represent a statement of Administration position or views.
At the outset, I wish to thank all of you for your support of the Federal Home Loan Bank Act amendments that are included in the Financial Services Competition Act of 1997, H.R 10. In particular, I warmly and strongly commend Chairman Baker and Mr. Kanjorski for their leadership and skill in developing and successfully advocating the adoption of these amendments. The Federal Home Loan Bank System is financially strong and has a long and positive track record of service to its members and the communities they serve. However, like other financial services providers, the System needs to adapt to changing conditions. The amendments address the need for a strengthened capital structure, make membership fully voluntary, remove the regulator from inappropriate involvement in the Bank governance process, rationalize the REFCORP burden, and recognize the usefulness and appropriateness of a broader Bank System as a wholesale funding mechanism for community banks. The amendments, if enacted, would empower the FHLBanks to be active and effective in meeting community credit needs in the next century.
Turning to the GAO report, I wish first to note that, in my view, it is always timely for Congress to review Executive Branch structures in an effort to achieve cost savings and operational efficiencies. Such reviews certainly should not be confined to times of crisis. Indeed, the fact that there currently is no significant problem, much less any crisis, affecting the regulation of the housing GSEs should contribute to a more measured approach to evaluating the merits of the consolidation being proposed.
Conceptually, I am in accord with the premise of the GAO report that a single independent agency regulating safety and soundness and mission for Fannie Mae, Freddie Mac and the FHLBanks is preferable to the current structure. And, it is likely that some cost savings ultimately could be realized through such an agency consolidation as redundant positions were eliminated. We have not attempted to quantify such possible savings, but I expect they would be modest, given the small size of the existing agencies. As the report correctly notes, there would be some transitional costs associated with a merger, as well as some operational disruption stemming from the general employee anxiety accompanying such situations, and the need for internal restructuring. I doubt the transitional cost or disruption would be significant.
The central question for this Committee to consider is whether consolidation will yield more effective regulation. I believe that the answer is "yes". Regulatory effectiveness would be enhanced at a number of different levels. The consolidated agency's larger mission would make it a more interesting place for employees, thus helping to attract and retain high-quality professionals. It would bring the agency a broader working knowledge of the mortgage finance marketplace that is the foundation of the operations of the housing GSEs and their members and customers. Most importantly, as GAO points out, the broader mix of competitive entities to be regulated would enhance the independence of the oversight process, particularly in evaluating the competitive effects of regulatory decisions, and assure to the extent possible, more evenhanded regulatory treatment. The net result should be more effective, consistent regulation.
As a structural matter, I believe GAO outlines precisely the right approach to take in advocating the unification of regulatory responsibilities for ensuring both mission compliance and safety and soundness of the regulated entities. My experience at the Finance Board has convinced me that a unified mission and safety and soundness regime offers the most appropriate way to administer a regulatory framework. A bifurcated approach necessarily will require greater staffing levels and more expense without any assurance that it will yield improved results. In circumstances where there is no conflict between safety and soundness and mission regulation, there is no reason to place responsibility for them in separate places. Where there is a conflict, separation only invites making the balancing of the two policy objectives more awkward and less precise. Instead of one Board or Administrator, who is thoroughly familiar with the competing priorities, making a balanced judgment, the conflict must be negotiated between regulators, offering the regulated entities the opportunity to play one regulator off against the other.
Before leaving this point, let me stress my conviction that it is entirely necessary and appropriate for the regulator of a government-sponsored enterprise to oversee that GSE's mission compliance. GSEs are created to accomplish statutory prescribed purposes and are provided with special privileges, such as tax exemptions and a U.S. Treasury line of credit, that create an implied federal government backing for their obligations. In extending these benefits, it has been standard Congressional practice to authorize each GSE's regulator to make sure that the regulated institution is doing what it was created to do. That this is as it should be may seem entirely clear to you, but I note from the GAO report that some in the GSE community believe that mission regulation should be left entirely to Congressional oversight, a wholly inappropriate structure except to those seeking to minimize their public obligations.
Some claim that regulatory bifurcation comes to us as a lesson of the thrift crisis. If so, it is a lesson that has been very unevenly applied, as all the federal banking regulators, including the Office of Thrift Supervision, have important mission responsibilities -- extending beyond chartering to Community Reinvestment Act and consumer disclosure compliance matters - as well as safety and soundness duties. In fact, I suggest that the real structural lesson of the thrift debacle is that the job of administering federal deposit insurance is sufficiently large and important that it should remain independent from unrelated regulatory duties. I find unsupportable the thesis that the events leading to the thrift crisis point to the need for a bifurcated, OFHEO/HUD-style approach to GSE regulation. It would be unfortunate if one of the ultimate negative consequences of the thrift crisis were mistaken lessons leading to inappropriate regulatory structures.
GAO in my view is correct on the issue of independence. In the case of the housing GSEs, independence would be a considerable virtue. The regulated entities in question are economically and politically powerful organizations that can be expected to make unusually strong, continuing efforts to affect their regulatory treatment. Placing responsibility for their oversight in an independent agency offers the regulator important insulation from political pressures, while offering Administration policymakers some detachment from controversies which otherwise would invite trade-offs with other concerns and priorities.
I agree with GAO on the general point that independent, arms-length regulation requires a structure where business governance is fully delegated to the regulated entities. In the case of the FHLBank System, the Finance Board already is delegating these matters to the extent allowable by statute. I have already mentioned that H. R. 10 would complete this job by fully removing the Finance Board from governance as opposed to regulatory issues.
While I thus agree with GAO on the need to distinguish between regulation and business governance, I disagree with GAO's assertion that the Finance Board's appointment of the public interest directors of the FHLBanks compromises this agency's ability to be an arms-length regulator of the Banks. This is a highly theoretical point. In practice, there simply is no instance of which I am aware of the Finance Board or its predecessor seeking to steer the management direction of the Banks through selection of public interest directors. Frankly, the rulemaking and supervisory processes would offer the regulator a vastly easier and more effective way to influence Bank policy than would the appointment of public interest directors, who enjoy four year terms (often outlasting the terms of the appointing Finance Board members) and can be dismissed only for cause. Public interest directors are an appropriate feature for a GSE, and I believe there is great merit in keeping their appointment at the regulator level, as the regulator has a strong, overriding interest in identifying and selecting individuals with backgrounds and personalities that will add real strength to the boards of the Banks. Presidential appointment exchanges theoretical independence for the intrusion of political considerations wholly unconnected to enhancing the public interest perspective on the boards.
Mr. Chairman, this concludes my remarks. I will be happy to answer any questions you may have.