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Legislative Updates

January 18, 2005

GSE Regulatory Reform Front and Center for 109th Congress

As the 109th Congress begins its two-year life this January, changing the regulatory structure for government-sponsored enterprises (GSEs) is at the top of the agendas for the House Financial Services and Senate Banking committees.

What has added momentum to a bill that has been considered by Congress for the last two years? Last month, the Securities Exchange Commission (SEC) determined that Fannie Mae consistently misapplied accounting principles, resulting in approximately $9 billion in improperly recognized income. Unlike Freddie Mac's accounting errors, in which it essentially hid $5 billion in earnings through derivatives transactions, the SEC charged that Fannie Mae actually inflated earnings.

Fannie Mae's problems have resulted in the departure of its CEO and CFO. The SEC has directed the corporation to restate earnings for the past four years, which will threaten its capital adequacy and trigger harsh regulatory oversight for the foreseeable future.

The capital hit to Fannie Mae and the blow to senior management's credibility will serve to change the dynamics of the legislative environment this year. The urgency for legislation has increased, while the ability of Fannie Mae to fight some key elements of the reform legislation has weakened. For Fannie Mae and Freddie Mac, the debate will start on the regulator's capital-setting and receivership authority but may drift into the range of permissible new business activities.

While not the primary focus of the legislation, Federal Home Loan Banks will be affected by the bill, and the stakes for them and their stakeholders are high. As GSEs, FHLBanks operate under a federal charter enabling them to meet the housing and community development credit needs of more than 8,000 member institutions and the communities they serve. They are distinctly different in their business model, corporate structure and other fundamental ways that warrant different treatment than that accorded Fannie Mae and Freddie Mac. To do otherwise could spawn significant harm.

In the coming months, the Senate Banking Committee and the House Financial Services Committee will hold hearings with an eye to working on legislation, possibly this spring. It is expected that the starting point for legislation will be S1508, a bill passed last year by the Senate Banking Committee that generally treated FHLBanks in an equitable manner. The bill placed housing GSEs Fannie Mae, Freddie Mac and the FHLBanks under a single, new regulatory agency called the Federal Housing Enterprise Supervisory Agency (FHESA). FHESA would be an independent agency, outside of any cabinet department and funded through assessments on the regulated entities. A director, nominated by the President and confirmed by the Senate, would administer the agency.

Throughout the debate over GSE regulatory reform, the FHLBank of Pittsburgh has advocated four basic principles to be considered in any legislation. These included:

1. The regulator of the FHLBanks must be independent. If the regulator is housed within Treasury, the independence must be established in a manner similar to the Office of Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS).
   
   
2. The regulators of all three housing GSEs should possess the supervision and enforcement powers that mirror those of federal banking regulators.
   
   
3. Neither the Treasury Department (nor the independent GSE regulator unit) should have the ability to impede or limit the FHLBanks' access to the capital markets (other than the current "traffic cop" role served by Treasury).
   
   
4. The legislation must ensure the regulatory structure recognizes the unique characteristics of the FHLBank System. If the regulator also has jurisdiction over Fannie Mae and Freddie Mac, the legislation must ensure that the differences between the two classes of GSEs warrant separate approaches to supervision and new-product approval.
   

Overall, the FHLBank of Pittsburgh believes that last year's Senate Banking Committee legislation followed the spirit of these principles. As Congress takes this legislation up again this year, it will be important for all stakeholders and those with an interest in the future of the FHLBanks to be vigilant in assuring future generations of Americans will continue to be served by these important institutions.