Don Bisenius' Speech at the Federal Reserve Board Advisory Council on June 18, 2008

Prepared Remarks for Don Bisenius
Senior Vice President of Single-Family Credit Guarantee Business

Consumer Advisory Council's Community Affairs & Housing Committee
Federal Reserve Board
Washington, DC

June 18, 2008

My name is Don Bisenius, and I am senior vice president of the Single-Family Credit Guarantee business at Freddie Mac. In this role, I am responsible for the products, programs and policies by which Freddie extends our credit guarantee – both to fulfill our statutory mission and to compensate shareholders. We currently guarantee the credit on $1.8 trillion of mortgages. Last year, we guaranteed about one-fifth of new mortgage originations.

Let me spend the next 15 minutes discussing how government-sponsored enterprises are supporting the mortgage market today. I will describe the many actions that Freddie is taking. I will explain our credit and pricing policies. And I look forward to posing questions back and forth between us, particularly on affordable housing.

I come here today with one message: During the worst mortgage crisis since the Great Depression, the GSEs are a stabilizing force in an unstable market:

• Together, we are almost single-handedly keeping the conforming market liquid
• Our market presence is keeping conforming mortgage rates low and affordable
• We are stabilizing a new market for us – called conforming jumbo – where, due to our participation, mortgage rates have declined dramatically
• We are helping homeowners in financial difficulty avoid foreclosure

Our performance during this crisis reflects the public purpose of our congressional charter. And it reflects the wisdom of our structure as a private corporation with a public mission. However – and let me underscore this point – for Freddie Mac to continue fulfilling our mission, it is essential that we return to profitability as soon as possible.

A Troubled Market

While everyone hopes for a turnaround, the mortgage market remains in a troubled state. Falling house prices and questionable lending decisions have made two things more common: loan delinquencies and home foreclosures. They are both climbing to levels not seen in decades.

Freddie Mac has not been immune from these negative forces. Net incomes have turned into net losses. Our credit costs have gone up significantly. And we have had to raise additional capital. These higher costs of credit and capital – coupled with a turbulent housing market – explain why we have raised prices and tightened credit.

Still, being a GSE means supporting the mortgage market in good times and bad. And that is precisely what we are doing, while keeping our company safe and sound.

Keeping Mortgage Markets Liquid and Credit Affordable

Today, the GSEs have become the main source of liquidity for home loans. Together, Freddie and Fannie are financing roughly 80 percent of all loans – more than double our market share during parts of the housing boom. With the collapse of the private market, keeping mortgage markets liquid has become a top priority for the nation – and for us.

At Freddie Mac, we are working overtime to purchase loans from lenders. Our single-family portfolio is growing three times faster than the overall market. This liquidity is keeping mortgage rates low for conforming borrowers. On average, they are paying 110 basis points less on their loans than a jumbo borrower. Put another way, borrowers outside our charter are paying 7.4 percent. Borrowers within our charter are paying just 6.3 percent.

With this success in mind, a few months ago Congress raised our loan limits in 224 high-cost areas. Counties and cities like the DC metro area. Our mandate: Get this segment lending again, and at better rates for the consumer. Since the GSEs entered what some describe as the conforming jumbo market, the spread between conforming mortgage rates and this new segment has declined from a high of 136 basis points to just 15-20 basis points. That's a dramatic improvement in a very short period of time.

So in the markets we are supporting today, you can really see the GSE difference.

Balanced Credit and Pricing Policies

Now, I mentioned that we are supporting mortgage markets while keeping Freddie Mac safe and sound. In the Single-Family business, this comes down to how well we manage credit and price for risk. Here, we are following a two-fold approach: More stringent underwriting principles and more expansive risk-based pricing.

More stringent underwriting means staying away from certain lending practices that contributed to the housing bubble. By that, I mean staying away from loans with too many high-risk factors, such as 100 percent financing, with little or no documentation, to borrowers whose credit histories indicate that they are already stretched financially. In industry jargon, this is known as “excessive risk layering.” In plain English, this is setting up a borrower for failure. And we are saying “no” to this practice.

As for risk-based pricing, this is not a new practice for us, but we have expanded our use of it. Here's why. Average pricing works well if you have a narrow band of risks, with small distinctions and little cross-subsidy between lower- and higher-risk borrowers. And for years, all this was true for the single-family portfolio at Freddie Mac. Looking back a decade ago, we had a small, uniform book of business: $800 billion worth of mostly plain-vanilla loans.

But today, we have a much bigger book of business – $1.8 trillion – and we see greater distinctions within it. For example:

• Our loan-to-value ratios range from as low as 30 percent on certain seasoned loans to as much as 105 percent for certain affordable loans
• Debt-to-income ratios range from as low as 10 percent to as high as 65 percent
• And borrower credit profiles are more widely dispersed than before

A book of business this diverse stretches the boundaries of cross-subsidy. So instead, we have turned to risk-based pricing. By tying pricing to the risk and expected future cost of individual loans, we can generate enough revenue to offset credit costs, support a broader range of loans, while staying true to our more conservative view on risk.

Keeping Borrowers in Homes

Keeping mortgage markets liquid and affordable are critical activities that the GSEs are performing today. But we are also doing something else: helping families in financial difficulty hold on to their homes. Freddie Mac has a long track record of leadership when it comes to foreclosure prevention:

• Servicing policies that require lenders to pursue workouts
• The use of non-profit financial counselors to contact hard-to-reach families
• A workout rate that is two times the number of our foreclosures
• 17,000 workouts in the first quarter of 2008

Now, compared to all loans now in default, our workout numbers seem small. There's a good reason for that: A majority of these defaulting loans are not owned by GSEs nor are they serviced on our behalf. At Freddie, we have just over 100,000 seriously delinquent loans. Not a small number, but one that pales in comparison to industrywide figures.

Still, on the loans we do support, our actions demonstrate that when it comes to foreclosure prevention, we take our role seriously.

How Best to Support Affordable Housing?

We also take seriously our role in helping families buy homes without getting in over their heads financially.

For example, we had a long-standing policy that required additional downpayment on loans made in markets where house prices were falling. This policy was designed to protect both the borrower and Freddie Mac. We are concerned for borrowers that buy a home that soon becomes worth less than the mortgage they just took out. And as a risk manager, these situations provide less incentive for borrowers to pay the mortgage.

So this policy made a lot of sense. But in recent months, after talking with lenders and consumer groups, it became clear that lenders were not exactly sure how to implement our policy in a given market. To eliminate this confusion, we have suspended our policy. Instead, we have established a minimum downpayment of five percent in all markets while reinforcing the importance of appraisals. To support affordable housing, we have exempted from this requirement certain programs, which we call Special Affordable.

This leads me to my final point. And it is not a point so much as it is a question: How should affordable housing be supported going forward? When it comes to GSEs, some look at whether conforming mortgage rates are lower than in other markets – which they are. And others look at whether we meet our main HUD goals from the prior year – which we have.

But there is no question that much of the current mortgage crisis is a direct result of putting people into homes they could not hold on to. So if the industry and consumer groups believe that current delinquency rates are not socially acceptable – and they are surely not -- then what is the right level? How can we best achieve it? And what does this mean for affordable housing? I would like to hear the Committee's views.

Conclusion

Let me sum up.

In the current environment, GSEs have become a stabilizing force in an unstable market.

In the short run, it is important to keep mortgage markets liquid and stable until they ultimately can recover. And we are focused on this task. While others have left the market, Freddie Mac and Fannie Mae remain consistent suppliers of mortgage funds. Because of our liquidity, mortgage rates are dramatically lower in the markets that we support. The value of the GSEs has never been clearer.

But in the long run, all of us need to figure out how to best support housing in general and affordable housing in particular. On the one hand, we cannot over-react to the current crisis by arbitrarily shutting the door on families. On the other hand, we cannot simply repeat the mistakes of the past.

I believe that how we address the current mortgage crisis and the longer-term solution to affordable housing will define each one of us for many years to come. For Freddie Mac as a company, and for me personally, we look forward to constructing a positive outcome in both areas.