A MESSAGE FROM THE CHAIRMAN

To ouR SToCkholDERS:

In 2007, our sector suffered the most severe housing correction since the Great Depression. In my 35 years as an economist, central banker, regulator and businessman, I have never witnessed a situation quite like this one –– in which a housing bubble has played such a central role in bringing the world’s largest economy to the brink of recession.

Freddie Mac’s financial results last year were acutely affected by the extraordinary downturn in housing; later in this letter I will discuss them with you fully. But before detailing our performance, it’s worth taking a closer look at how and why the housing finance environment became so challenging. If you’ll bear with me, I’d like to describe what we’ve observed, what we’ve been doing about it, and what we think it means.

WhAT hAppEnED?

While many of the difficulties began in the subprime mortgage market, it’s important to understand that what the markets face today is a broader problem of transparency and confidence. In one area after another, markets have ceased functioning as creditors have lost confidence in the portfolios of their lending partners.

Looking back over the problems of the past year, at least three factors contributed to the sharp declines we saw. First was a global glut of liquidity, resulting in part from the rapid rise of the world’s largest emerging economy, China, as a net exporter of both capital and, in effect, of labor. Second were advances in technology and financial engineering that separated lending decisions from investment decisions. Third was a decline in underwriting standards, as too many lenders and borrowers threw caution to the winds.

In the process, the subprime mortgage was transformed from a niche product and used far more indiscriminately than in the past. Housing finance was stretched beyond the breaking point by evermore exotic mortgages that enabled more home buying on the front end but carried unacceptable risks of home loss on the back end as soon as home prices stopped rising.

Of course, markets correct –– and this time, they did so rapidly and viciously. Indeed, the markets may have already overcorrected in pricing and in underwriting certain products, such as jumbo mortgages, outside the conforming space. To a large extent, only the conforming market served by the housing government-sponsored enterprises (GSEs) has continued to function normally, in the process diminishing risk and saving families thousands of dollars in payments over the lifetimes of their loans.

SoME lESSonS lEARnED

In recent months, many policymakers have discussed options to ease stresses on the housing and mortgage markets. Many of these efforts have merit, most specifically the fiscal stimulus program to avert the risk of recession. While the Federal Reserve has been creative and responsible in dealing with the problem, we also need to realize that there are very real limits to what monetary policy can do in a situation like this. It is, as often said, a very “blunt” instrument. So we should all applaud the Administration and the Congress for delivering a timely stimulus package. To my mind, when it was passed is more important than all the exact elements of what it contained.

The problems in the subprime market remind us of a longstanding truth that was nearly obscured during the last years of the long housing boom: not every family that wants to own a home is financially ready for homeownership. To understand why this is so, consider the subprime market, which can be roughly divided into three parts.

The top group of subprime loans might have been eligible for prime credit, but for one reason or another ended up in the subprime category. A middle group of loans are legitimately in subprime, but should benefit from enhanced underwriting standards and more reasonable reset terms. Finally, a sizable bottom group of subprime loans may not have been repayable in any reasonable scenario unless home prices continued to escalate.

I am an ardent proponent of the long-term benefits of homeownership. That also makes me an ardent opponent of practices that unduly raise the risk of foreclosure. We need to face the fact that, as a matter of both policy and attitude, our nation did not sufficiently question whether homeownership is the right thing for every household in America at every point in time. For most homeowners in the bottom group of subprime today, it may be better to be renters than homeowners at this point in the cycle. That’s how it was when many of us grew up.