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Rep. Baker Urges Treasury to Oppose Amendment that Would "Degrade" GSE Regulator Authority

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Location: Washington, DC


Rep. Baker Urges Treasury to Oppose Amendment that Would "Degrade" GSE Regulator Authority

U.S. Rep. Richard Baker, R-Baton Rouge, a senior member of the House Financial Services committee and a cosponsor of the "Federal Housing Finance Reform Act of 2007" (H.R. 1427), legislation aimed at strengthening regulatory oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, today wrote to Treasury Secretary Henry Paulson to express his concern about a proposed amendment that would limit a new regulator's authority over the enterprises' portfolio holdings.

In the letter, Baker says that "at issue is the scope of authority the proposed regulator may exercise to protect the enterprises from risk emanating from external sources and to prevent the enterprises from becoming a source of risk," and outlines the historical precedents for and contributing factors to those risks.

Baker writes in the letter: "Regulatory oversight to prevent the enterprises from becoming a risk to financial markets, domestic and global, is essentialÂ…. To deny the new regulator the authority to act in advance of identifiable market crises to protect the enterprises and the American financial system would be reckless. And, denying the regulator authority to protect the financial integrity of the enterprises from external shocks that may further destabilize markets under duress is not world-class regulation."

The letter concludes: "The new regulator of the enterprises must be fully vested with authority to take action on any risks associated with the enterprises' portfolio holdings. I strongly encourage the administration to oppose any degradation of the regulatory authority currently provided in H.R. 1427."

The full text of the letter appears below:

May 10, 2007

The Honorable Henry M. Paulson, Jr.
Secretary
United States Department Of Treasury
1500 Pennsylvania Avenue, NW
Room 3330
Washington, DC 20220

Dear Secretary Paulson:

I write to convey my concern regarding a proposal to alter the substance of H.R. 1427, the "Federal Housing Finance Reform Act of 2007," which, in my view, degrades the supervisory authority of the new regulator for the government sponsored enterprises.

At issue is the scope of authority the proposed regulator may exercise to protect the enterprises from risk emanating from external sources and to prevent the enterprises from becoming a source of risk.

Authority to mitigate such risk is imperative and warranted in view of past market experience. The near collapse of Long Term Capital Management in 1998 posed a significant threat to global financial markets. The threat to the American financial system was direct as well, as several dozen banks served as loan counterparties for the hedge fund. While the financial institutions in question took no direct action to cause the crisis, the third-party exposure to Russian currency markets placed the American financial system at substantial risk.

The enterprises have significant exposure to global markets through the volume of derivative contracts employed to mitigate risks associated with their retained portfolios. The total combined notional amount of outstanding derivatives contracts at the enterprises exceeds $1.46 trillion. Further, Fannie Mae reports as of December 31, 2005, that seven counterparties accounted for 79 percent of the total outstanding notional amount of its derivatives instruments. Concentration of counterparty risk on this magnitude at even one enterprise is troubling.

The evidence of counterparty concentration heightens concern of potential counterparty overlap at the enterprises. Counterparty overlap will expose the enterprises to simultaneous duress should counterparties be unable to meet contractual obligations. As noted by Freddie Mac, "Our economic loss, as measured by our potential additional uncollateralized exposure, may be higher than
the uncollateralized exposure of our derivatives if we were not able to replace the defaulted derivatives in a timely fashion." The potential of both enterprises in the market for replacement derivative contracts may create the very loss scenario Freddie Mac envisions.

I raise these issues to express my strongly held conviction that such examples demonstrate the need of the regulator to have a broader perspective to properly regulate the enterprises and protect American taxpayers. Corrective action notwithstanding, the enterprises have unfortunately demonstrated a need for supervision. Regulatory oversight to prevent the enterprises from becoming a risk to financial markets, domestic and global, is essential.

To deny the new regulator the authority to act in advance of identifiable market crises to protect the enterprises and the American financial system would be reckless. And, denying the regulator authority to protect the financial integrity of the enterprises from external shocks that may further destabilize markets under duress is not world-class regulation.

The new regulator of the enterprises must be fully vested with authority to take action on any risks associated with the enterprises' portfolio holdings. I strongly encourage the administration to oppose any degradation of the regulatory authority currently provided in H.R. 1427.

Sincerely,
[signed]
Richard H. Baker
Member of Congress


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