Richard F. Syron's Speech at the National Association of Home Builders Annual Convention on February 8, 2007

Prepared Remarks for Richard F. Syron
Chairman and Chief Executive Officer, Freddie Mac

National Association of Home Builders Annual Convention
Joint Meeting of Executive Board, Budget and Resolutions Committees
Orlando, Florida
February 8, 2007

I'm pleased to be with the Home Builders again. It's always good to be among friends. Especially in a period like the present.

I want to congratulate Brian Catalde on becoming your new President. And I look forward to developing with him the same kind of great relationship I've enjoyed having with Dave Wilson and David Pressly. I hope they feel the same way. And of course we are deeply appreciative of the efforts of Jerry Howard and his staff.

Freddie Mac and the Home Builders have worked together on many important projects over the years. This year, we take our cooperation an important step further.

Today, I am pleased to announce that Freddie Mac has made a $225,000 contribution to a program that will help rebuild and revitalize the Gulfport area of Mississippi. Working with Bobby Rayburn and the Home Builders Institute, we are enabling workers – many of whom were affected by the hurricanes – to be trained in homebuilding skills specific to concrete building technologies. By teaching them how to build homes that can withstand 180 mph winds, this program will serve three important needs at once: housing, job training and rebuilding the Gulf.

We meet at a time of challenge for both the Home Builders and the Government-Sponsored Enterprises, or GSEs. For you, this will be a year of decreased homebuilding activity, and Freddie Mac will do everything we can to help more families buy the homes you build. For us GSEs, it will be a year of continued pressures in the financial markets – and in the public arena.

I want to talk with you this morning about how we can address these challenges together, to build a stronger future for the entire housing sector. But to do so properly, I need to step back and provide some perspective on the future demand for housing and the essential role of the GSEs.

The driving force in housing is going to shift dramatically in coming decades, from the Baby Boom generation to minorities and immigrants. Demographic projections indicate about 15 million new households in the United States in the next decade, and some 10 million of them will be minorities. Recent immigrants will likely account for 5 million of these new households, and many will be unfamiliar with U.S. banking and mortgage finance.

Adding in second homes and replacement of existing homes, over the next decade America will need 20 million additional homes – on average, about 2 million a year. Given recent estimates, that many starts a year doesn't sound bad.

Financing this many new homeowners will place huge demands on the housing finance system. Over the next decade, the amount of residential mortgage debt outstanding will double – and we will need to finance an additional $13 trillion in residential mortgage debt. That will make even larger what already amounts to the largest debt market in the world.

The same demographic trends underscore the challenge of simply maintaining the current homeownership rate of 69 percent, much less lifting it higher. Today, 76 percent of white non-Hispanic families own their homes, but only half of minority families are homeowners. If as a nation we allow this unacceptable 26-point gap to persist, the fundamentally changing demographics of U.S. households could erode our recent gains in homeownership – and would eliminate them entirely by 2050. On the other hand, if we can narrow the homeownership gap by half over the next generation, we can maintain today's hard-won rate of homeownership at about 70 percent.

There's another factor I'd like to mention. We clearly won't do much for homeownership if we bring families in the front door of homeownership and in a couple of years they all get pushed out the back door through foreclosure.

About 200,000 loans entered foreclosure proceedings during the third quarter of 2006. Based on our experience, about 60,000 of these families will ultimately lose their homes. If that rate continues, nearly a quarter-million families will lose their homes to foreclosure during the coming year. This is an issue we are quite concerned about.

Freddie Mac has had very encouraging results in our efforts to combat foreclosure. Under our workout policies, we found that delinquent borrowers who enter a home-retention workout program are 80 percent more likely to avoid losing their homes than similar borrowers who don't enter a workout program. Among low- and moderate- income borrowers, the success rate is 69 percent more likely.

This means that Freddie Mac's efforts in anti-predatory lending, homebuyer education and foreclosure prevention – working with you, our lenders, Congress and our regulators, HUD and OFHEO – are all more critical than ever. This is true not only because of where we are in the economic cycle. It is also true because issues of economic inequality are rightly assuming center stage in Washington.

As we know, building and sustaining homeownership, particularly for new Americans and minorities, is one of the best means there is for building and sustaining a large and vibrant middle class. In my own view, the two greatest challenges the United States faces in the 21st century are race and income inequality. Housing is where they come together.

So let's recap and look ahead. The need for housing is burgeoning in the coming decades. Much of that housing will be for minorities and immigrants. Meanwhile, affordability challenges have risen for everyone. And the GSEs' affordable housing goals and subgoals continue to rise rapidly.

Simply put, the future demands on housing finance will be greater than ever – as will the need for the GSEs.

There is another big economic change underway that will make the GSEs all the more necessary. For more than a decade, the private-label mortgage market has been a very attractive and relatively easy business to be in – partly because the risk premiums demanded by investors have been at historic lows.

Yet there are mounting concerns that this situation cannot last, and that when this change comes, it will not be pretty. Last month, prominent economists including Lawrence Summers and European Central Bank President Jean-Claude Trichet warned the World Economic Forum in Davos that in the current worldwide glut of liquidity, risk is being seriously underpriced.

When the current complacency ends, some players are going to be hurt. And when this happens, a number of institutions will face strong pressures to pull back from mortgages.

What all this means is that the GSEs will be more important than ever. For the mortgage business will become harder as investors become more wary of risk and pricing for perfection comes to an end. And this, in turn, will only increase the need for mission-responsive institutions in housing finance.

Fortunately for the public, the GSEs' congressional charters oblige us to be responsive to a standard to which private equity firms, hedge funds, and even publicly held banks and financial institutions cannot be held accountable. Our charters specify that we must be a continual presence in the mortgage market, providing affordability, liquidity and stability. All of which begs the question, Why overly hamper us just when you're going to need us most?

Despite all this, unfortunately, in some people's minds the notion seems to be that the best GSE is the least GSE. The loudest voices in the debate have been those demanding not only to tighten oversight of the GSEs – which we agree with – but to diminish our tools and shrink the box within which the GSEs can operate.

An outside observer might surmise that this kind of tightening is simply the way the entire regulatory pendulum is swinging in America these days.

In fact, however, a recognition is developing that pendulums often swing too far. Too often, today's solution becomes tomorrow's problem.

From Treasury Secretary Paulson and a number of other key financial leaders, we have heard wise calls for "striking the right balance" in regulation – warning that "[e]xcessive regulation slows innovation, imposes needless costs on investors, and stifles competitiveness."¹ However, no one is talking this way about the GSEs.

"Hold on," you may be thinking. "You GSEs brought this on yourselves."

In many ways, you're right. Freddie did understate its earnings – and for that we will be in the penalty box until our financial reporting is current. We lost the public trust on this front and it is up to us to earn it back. We don't flinch from this responsibility one bit.

It's also clear to me the institutions were insulated, arrogant and run in an imperial manner. We have to make sure the GSEs never again make those mistakes.

But the fundamental question here is, What are the implications of all this for the future? Why change the basic business model of the GSEs when – as I discussed earlier – we will be more needed than ever to help sustain the world's most liquid and successful housing finance system?

That is exactly the unintended consequence I am saying we need to worry about. I'll explain why as succinctly as I can.

Freddie Mac's business model has been, for the most part, fairly simple. One basic market with pretty low risk; appropriate capital requirements; high leverage; and high volume.

Now, look at some of the issues that are still very much a part of the GSE debate, thanks to our most hard-line critics.

Some critics would like much higher capital – capital not tied to our inherent risk. Severely limited retained portfolios. Cumbersome restrictions on new products and programs. And no increase in our ability to help high-cost states such as California, New York, Florida and other areas where the challenges of housing affordability – and changing demographics – are most acute.

That's a pretty damaging set of demands. Whatever it is they answer, it's not the wise call I cited earlier for "the right regulatory balance." Instead, these changes would make the GSEs less competitive, less profitable and less relevant.

Ultimately this would put us in a tight box that doesn't work for our mission, our shareholders, or I would respectfully add, for you. If that's what results from this process, fine – but let's realize that we won't succeed in satisfying anyone, and let us go on to doing something else.

Capital is one key issue on which we ought to be very leery of unintended consequences. It's especially puzzling to contemplate a dramatic increase in required capital for the GSEs, at the same time as our main competitors may have their capital requirements substantially eased under Basel II. In a recent study for the Mortgage Bankers Association, Professor Mark Flannery of the University of Florida found that even at current GSE capital levels, big banks under Basel II may be required to hold less than half the equity capital of the GSEs against prime mortgage credit risk.

That will put a big squeeze on the GSEs' securitization business – the one area where there is the least controversy over what the GSEs do.

Let's look at another issue: new program authority. With the demographic changes I noted earlier, the mortgage market, including the GSEs, will need to be more innovative and agile than ever. Yet some critics insist on new program restrictions that would force us to wait for regulatory approval before purchasing any innovative new product or undertaking any new activity. Such changes would harm homebuyers and home builders alike.

Another key issue is higher loan limits in high-cost states. I spent much of my life as a regional economist, ultimately becoming head of the Federal Reserve Bank of Boston. And I can tell you, assuming a uniform cost of living across the United States simply does not make sense.

You've heard me talk about the retained portfolio before. In 2003, the GSEs held 21 percent of U.S. mortgage debt. Last year it was 13 percent. That trend doesn't sound like market dominance or an increased concentration of risk to me!

Without a healthy and robust retained portfolio, Freddie would not have been able to do nearly as much after Katrina as we have. For example, we bought $1 billion of state and local mortgage revenue bonds in the Gulf Region, and pledged to purchase up to $300 million of mortgages that our lenders had in the pipeline – even if the homes behind these mortgages were now damaged or the homeowners no longer had steady incomes because their workplaces were destroyed.

Both of these initiatives depended heavily on our retained portfolio, and its ability to spring quickly into action. Our rapid response also would have been hampered by the new program restrictions that some of our critics seek.

One source of opposition to our retained portfolios is that they can be profitable. But that's an indispensable part of the GSE model:there need to be profits. And if the extremists in this debate get what they want, the results will bleed the GSEs dry – death by a thousand restrictions.

"Profit" is not a dirty word in talking about the GSEs. It is what allows us to be private-sector institutions, using private-sector methods to respond to market realities. The congressional genius in designing the GSEs was to benefit millions of America's homeowners and renters every year, without direct federal aid. If something bad befalls the GSEs, the first line of defense is not the taxpayer, it's roughly 100 billion dollars in private shareholder capital. But shareholders demand an adequate return on their investment. And if that return falls too low, the model simply will not work.

Don't get me wrong. We do favor GSE oversight legislation. And I personally supported a specific bill back in March of 2004. However, this is so important to what we do, it would be irresponsible not to have an opinion on what's going to happen now. To the contrary, our fiduciary duties to our shareholders – as well as our housing mission – oblige us to have a view. The uncertainty for everyone has gone on too long, and speaking solely for myself, we need legislation, but we need to get it right.

It's not just the GSEs' future that depends on appropriate legislation – which strengthens our oversight but also enables us to meet our expanding mission. The truth is, we are talking about the fundamental shape of the housing finance system in this country. And that has implications for the health of the Home Builders, the entire housing sector and our nation's economy.

I framed my discussion with you today in terms of the demographics of housing demand and the growing need for the GSEs. Because this is not about politics or spin or special pleading. It's about what's best for homeowners and for this country.

This meeting is one of the most astute audiences I speak to every year.

That's why I trust you know the matters we are discussing here today are of profound interest to us both.

And that together, we should act on them accordingly.

Thank you for having me. I'd be happy to take your questions.

¹ Treasury Secretary Paulson, speech to Economic Club of New York (November 20, 2006).