May 19, 1998

Dear Senators D’Amato and Sarbanes:

I am writing to convey my objection to S. 1986, the "Federal Home Loan Bank System Regulatory Restructuring Act of 1998" (Bill). The Bill would eliminate the existing effective regulatory oversight of the Federal Home Loan Banks (FHLBanks), which are indeed banks, focused on safely and soundly advancing a mission of lowering the cost and expanding availability of housing and economic development funding for the public. In place of effective oversight would be substituted an unprecedented "corporate welfare" program dedicated to using the federal subsidy to the FHLBanks for the private benefit of the member financial institutions. Rather than requiring the regulator to ensure that the government sponsored enterprise (GSE) cost advantage is passed on to individuals in need of housing finance, the Bill would direct the regulator to see to it that this advantage is used to benefit the bottom line of these financial institutions through dividends.

There are three critical areas of concern:

First, I am aware of no other instance in which the Congress has used a GSE subsidy to enhance the payment of dividends to private entities. By mandating that the federal subsidy for the FHLBanks be used in this manner, the Bill creates a "corporate welfare" program that not only is inconsistent with the historical purposes of the FHLBank System, but that also would effectively transform the System into one lacking any meaningful public purpose. The Bill would impose on the Office of Federal Housing Enterprise Oversight (OFHEO), the proposed safety and soundness regulator for the FHLBanks, an affirmative duty to ensure that the FHLBanks are able to pay dividends that are sufficiently high to make their stock "a competitive investment" for their members.

Although mission is eliminated as a statutory mandate under the Bill, ensuring the ability of the FHLBanks to pay high dividends to their members would become one of the principal duties for OFHEO. Enhancing dividends, and ultimately the profitability of private financial institutions, does nothing to increase the availability of housing and community investment credit. It could be pursued primarily through investment activities wholly unrelated to expansion of such credit. Whenever Congress has conferred a federal subsidy through a GSE it has done so in order to advance an important public purpose; that no longer would be the case under the Bill.

Second, the Bill would repeal the existing mandate that the Federal Housing Finance Board ensure that the FHLBanks carry out any housing finance mission. The General Accounting Office in its recent report on GSE nonmortgage investment, has emphasized the critical importance of mission oversight for GSEs, stating that "[w]ithout effective mission oversight, the incentives to use the benefits of government sponsorship to increase shareholder value could, over time, erode the public mission. If this were to occur, long term nonmortgage investments could become an increasing part of the housing enterprises portfolios." The Bill explicitly abandons such oversight.

The level of the non-housing related investments held by the FHLBanks has been a concern to members of Congress, the Administration, and the GAO, in large part because it has been thought inappropriate to use the federal subsidy to finance investments unrelated to the public purpose of expanding the availability of housing finance and community investment. This Bill, to the contrary, encourages the FHLBanks to focus solely on profitability and to invest even greater amounts in obligations that do not facilitate the availability of credit within their districts.

Third, this Bill also would create a weak and ineffectual regulatory regime for the FHLBanks and would shift to the taxpayers regulatory costs that currently are paid by the FHLBanks. The Bill would split the regulatory functions now performed by the Finance Board into two agencies, OFHEO (for safety and soundness) and the Department of Housing and Urban Development (HUD) (for limited other matters). GAO has recommended against this structure, repeatedly finding that a single regulator with full knowledge about the financial condition and programs of the housing GSEs is more effective. The recent challenge by Fannie Mae to the authority of HUD, its general oversight regulator, to limit the GSEs’ nonmortgage investments, is based in part on the division of authority between HUD and OFHEO. This is a prime example of what occurs when one regulator can be played off against another.

The Bill would assign solely to OFHEO the power to supervise the FHLBanks and to promulgate and enforce the regulations necessary to carry out the statute. The scope of HUD’s authority over the FHLBanks would be even less than its quite limited regulatory role with respect to Fannie Mae and Freddie Mac. Furthermore, HUD would be deprived of the regulatory and enforcement tools necessary to implement even this limited authority, a prescription for ineffectual regulation that would bar HUD from any meaningful oversight of the types of assets and products of the FHLBanks that should receive the benefit of GSE financing.

Under current law the FHLBanks pay the full costs of their regulation through assessments imposed by their regulator, similar to the manner in which the Office of the Comptroller of the Currency is funded. The Bill would retain this approach for the expenses incurred by OFHEO, though it also would require Congressional approval through the appropriations process. However, the Bill would not authorize HUD to assess the FHLBanks for the additional costs of its oversight expenses. This burden would fall on the taxpayers, competing with other priorities for a share of the HUD budget. I believe that the costs of regulating the FHLBanks should be paid as they always have been, by the Banks themselves, and not by the intended beneficiaries of the GSE subsidy.

In addition to these three significant concerns, the Bill would create a serious conflict of interest in assigning to OFHEO, the safety and soundness regulator of Fannie Mae and Freddie Mac, the responsibility for issuing the debt obligations of the FHLBanks. This would require OFHEO to compete directly in the capital markets with Fannie Mae and Freddie Mac. The prospect that a major issuer of GSE debt would have direct regulatory authority over its principal competitors would be unprecedented and would place OFHEO in a conflict between its regulatory duties and its duty to obtain the most competitive terms on the FHLBank System debt.

In summary, the Bill would have the perverse effects on the FHLBank System of eliminating the mission mandate, substituting a weak and ineffectual regulatory structure, and transferring the federal subsidy from consumers to financial institutions. I fail to see the public purpose that would be served by such changes, which would only benefit the members of the FHLBanks and encourage the FHLBanks to make even greater investments of the type that have prompted concern in Congress and the Administration. In closing, I wish to note that the views expressed here are my own and do not necessarily represent those of the other directors of the Finance Board or of the Administration.

Respectfully,

Bruce A. Morrison

Chairman