Congress created several government-sponsored housing enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, to accomplish public purposes.
Fannie and Freddie buy and securitize mortgages to support mortgage liquidity, while the Federal Home Loan banks provide wholesale loans and products to banks, thrifts, and other intermediaries to support their retail mortgage lending.
The tension between the limited public purpose and operating authority set forth in their charters, and their private business structures, implies a need for regulatory oversight that differs from many other financial institutions. The public mandate implies a regulatory responsibility to monitor not only their safety and soundness, but also their strategic activities, to assure that they achieve their public purpose without encroaching into areas not intended by Congress.
Regulators have traditionally focused on determining whether a bank or other financial institution is adequately capitalized to conduct its business safely. They have asked accounting questions: Are the books accurate, and do they show that the bank has the capital necessary to support its business?
Recently regulators have been more forward-looking. They have asked not only whether the bank's condition is sound today, but whether its business operations appear sufficiently disciplined to remain so tomorrow.
Examiners often rely on audits to confirm the current state of the bank's books and capital. They focus on reviewing whether the bank's policies and procedures are adequate to control the costs and risks of the business, and so ensure the ongoing integrity of capital.
They occasionally go further by asking whether the bank, through its strategic planning and implementation processes, is controlling the risk that changing business conditions could render its operations obsolete and threaten its survival tomorrow.
But where Congress mandates that operations not only be safe and sound, but remain capable of accomplishing certain public purposes, regulators need to ask questions going beyond whether capital appears sufficient today, or whether risks appear controlled for tomorrow.
Where Congress mandates, for example, that a government-sponsored enterprise support the stable and economical distribution of home mortgage financing, now and tomorrow, the regulator must satisfy itself regarding additional issues going beyond financial condition and risk controls.
The regulator needs to focus on five key questions:
- Is the enterprise in a safe and sound condition today?
- Has it controlled the risks that could impair earnings and capital tomorrow?
- Is it adequately planning its activities so that today's revenues will continue tomorrow?
- Are its activities too narrow to accomplish its mandated mission?
- Do its activities exceed its mandated authority?
The first three questions concern safety and soundness. The fourth and fifth ask whether the enterprise is fully achieving its public purpose while not overstepping it.The creation of these enterprises to accomplish express purposes necessarily implies that their regulators must explore all of these questions. The third question - whether the institution is managing its strategic risks - is necessary because the enterprise can accomplish its public purpose only if its operations remain viable.
Assuming a congressional mandate for continued accomplishment, the regulator must ask whether the GSE's product research and development processes are sufficient to manage the vulnerability of its revenues and earnings to changing market conditions. This, together with its assessment of risk and cost controls, allows the regulator to assess whether operations are strong enough to maintain a sound net worth, much like an investor projects future cash flows to assess present value.
However, the regulatory inquiry must go beyond safety and soundness because of an instability inherent in all such arrangements.
Government-sponsored enterprises are created by a congressional charter that sets forth and limits their purpose and activities in return for the advantages of public sponsorship. Yet their structure is similar to that of private firms, and their personnel are motivated to develop their activities in any direction the enterprises, by virtue of their experience and resources, are competitively advantaged to pursue.
Over time it is unlikely that charter boundaries will coincide with the contours the enterprise would adopt if freely left to shape and grow its business. It is also unlikely that the enterprise, if governed solely by its perceptions of profitable business opportunities, would engage in the full range of activities that might contribute to accomplishing its public mandate.
For example, a GSE might find itself well positioned to pursue growth opportunities in consumer finance or investment arbitrage outside its housing mandate, yet disinclined to offer less profitable products benefiting hard-to-service, lower income markets within its mandate.
Over time a GSE's activities will tend to test its congressional corral. Its activities will become both overinclusive and underinclusive as it expands into areas where it sees opportunity and avoids those where it does not. Therefore, if Congress continues to believe that these enterprises are worth having, but should be strictly confined to achieving their mandated purpose, there is a necessary regulatory cost to endure.
Constant regulatory oversight will be required to adjust the irreducible tension between a fixed public charter and enterprises structurally motivated to pursue their own business advantage. The regulator will have to constantly explore not only whether the enterprise is safe and sound and organized to remain so, but also whether its activities have fully occupied the corral without overstepping its boundaries.
Mr. Berns is the director of the Federal Housing Finance Board's Office of Supervision. These are his views, and are not necessarily those of the Finance Board.
|Note to Readers|
"Viewpoints" is a regular feature in American Banker, appearing every Friday. It serves as a forum for discussion and debate on a wide range of issues in the financial services industry, including management approaches and strategies, legislative and regulatory matters, and public policy in general.
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