Richard F. Syron's Speech to the National Association of Home Builders Annual Convention on February 13, 2008

Prepared Remarks for Richard F. Syron
Chairman & CEO, Freddie Mac

National Association of Home Builders Annual Convention
Joint Meeting of Executive Board, Budget and Resolutions Committees
Orlando, FL

February 13, 2008

Thank you, Brian [Catalde, outgoing NAHB President]. There's never been a doubt that the Home Builders have had a strong advocate with you at the helm.

Let me also congratulate Sandy Dunn on her new role. I look forward to working closely with you this year. Even if we all live, unfortunately, in a too-interesting time.

I want to say at the outset how much we value our strong working relationship with the Home Builders. It's a tremendous asset when we're on the same side of an issue – and even more important on those relatively few occasions when we disagree.

It's good to be back with the Home Builders. These days, when this many people from the housing sector come together, it's usually for a prayer meeting.

I'm glad to see you've kept both your usual format and your sense of humor.

Of course, these are serious times for housing and the economy, and there's not a lot to joke about. Unless you're over 80, the housing correction that's underway is the most consequential we've seen in our lifetimes. The downturn has affected not only the U.S. housing sector and related industries, but the global economy, as well. The effects have spread to the consumer credit sector both domestically and internationally, and show no sign of stopping there.

This is a tough time for home builders, and we all recognize that. When the boom ended and demand turned down, builders responded promptly. You've been aggressively slowing the hammers – cutting back supply as demand has waned – and while the housing slump is deep, you've done your part to manage the problem.

All that is good for you and it's better for the economy. But none of us pretends it's enough. Before discussing what else we can do – together – going forward, I want to take a few minutes to examine where things stand and how we got here.

The housing boom in the first half of this decade was fueled by lots of cheap credit, brisk home sales and solid price appreciation. In the early stages, all of this could be interpreted as signs of a healthy housing and mortgage market.

One factor that helped fuel the boom was the massive flow of capital and, in effect, labor from the world's largest emerging economy, China. Another was private-label securitization and the development of exotic financial engineering techniques that separated loan origination decisions from investment decisions.

Eventually, the market began to get ahead of itself. Prices continued to rise faster than household incomes, stretching affordability not just in high-cost markets, but in other areas of the country as well.

In response, there was a proliferation of new "affordability" mortgage products aimed at lowering the initial costs of financing a home. While most of these products worked reasonably well when house prices were rising, many could be dangerous if prices stagnated and began to fall. Part of the danger was the high debt levels people took on. For example, under today's market conditions, a 95 percent loan-to-value (LTV) mortgage originated two years ago may be effectively 110 percent LTV today. By contrast, during the boom, this same 95 percent LTV mortgage would have been down to an 80 percent LTV after two years.

As we've all seen, the double-digit price increases year after year just weren't sustainable. Now that the market has turned, the landscape looks entirely different. As House Financial Services Committee Chairman Barney Frank said recently, "The world's changed."

In fact, a vicious cycle in the financial markets is underway – one I've seen before, when I headed the Boston Fed during the New England credit crunch of the early 1990s.

Today, with house prices falling in markets across the country, many subprime borrowers can't refinance out of their adjustable-rate mortgages. Delinquencies and foreclosures have predictably risen.

Uncertainty about just where subprime exposures may lie has roiled the financial markets, with investors shunning many products because of concerns that unexpected exposures could pop up almost anywhere. This restricts credit outside of prime conforming mortgages, and this lack of credit has, in turn, further weakened home sales.

These conditions have exacerbated the slump in home prices. As I'm sure you've seen all too frequently, many potential buyers are waiting until prices reach bottom. People are afraid that buying a house is like catching a falling axe. Even for homeowners who might want to trade up to a larger house – or buy a new construction home – the uncertainty about their ability to sell their existing home is keeping them on the sidelines.

With all these negative factors reinforcing one another, new home sales dropped 40 percent between December 2007 and a year earlier. And inventory is now 9.6 months, compared to 6.2 months in December 2006.

Because housing is local, as you know, the impacts of the downturn are uneven. Areas like California, Michigan and Florida have seen steeper house price declines, while home prices are actually still rising in Utah and oil-rich Oklahoma and Texas.

The housing finance markets also present an uneven picture. Many observers have noted that the only part of the market behaving more or less normally is the conforming market, the one in which Freddie Mac and Fannie Mae – the government-sponsored enterprises, or GSEs – primarily operate. By contrast, borrowers in the jumbo market are paying up to a full percentage point more for a mortgage. That's a record high, and about four times the normal spread.

Unfortunately, the market situation is likely to get tougher before it gets better. I think we're well into the housing correction, but still short of the inflection point. All of this has begun affecting consumer confidence and behavior. The decline in housing-related activity that took a full percentage point off real GDP growth in 2007 will continue to be a drag on economic growth this year. Even if we're lucky enough to avoid an official national recession – and that's very much in question – housing will subtract at least a percentage point from growth in the first half of this year.

Freddie Mac is currently forecasting that housing activity will begin to turn by the end of 2008 or early in '09. That said, we're also projecting that home sales will be down 12 percent in 2008, and housing starts will be down an additional 22 percent relative to last year.

The transformation from housing boom to bust has been almost disorienting. In less than a year, we've gone from an era of new TV shows like Flip This House to an era of new websites like CondoVultures.com.

All right, that's the current situation. What are some solutions?

First, we have to acknowledge there is no silver bullet. We have substantial excess housing inventory, and it will need considerable time to be absorbed. Still, there are useful things we can do.

The Fed is acting aggressively by pumping liquidity into the system and lowering interest rates. But this cannot ensure the availability of credit to homebuyers in every market segment. In these circumstances, the legislative and executive branches can help in a way that the Fed cannot. While monetary policy is a blunt instrument, other policy changes can aim the help where it can do the most good. That's why the executive and legislative branches were right to come together on a stimulus package that is, in their words, "timely, targeted and temporary."

As you know, the stimulus package contains a temporary increase in the conforming loan limit for high-cost areas such as parts of California. I want to make a couple of main points about the increased loan limit.

First, I've always felt this was a good idea. But it's one where the "when" is even more important than the "what." We've been working to get loan limits raised because the sooner we do so, the better off we all are. This is the kind of thing we're supposed to do as a GSE. The higher limits should allow the GSEs to inject liquidity and thus help enable reduced rates within the jumbo market, which in total includes some half a million families – including hundreds of thousands of middle-class families in high-cost markets. By providing liquidity and stability and giving the jumbo market time to recover, we’ll be doing the right thing for our mission, and for the country, during this time of special need.

Second, just to keep this in perspective, this will be no boon for Freddie Mac. It’ll take considerable effort and resources to develop the systems to handle jumbo mortgages, particularly because we’ll be going from one loan limit in the contiguous 48 states to dozens of different price ceilings. Moreover, buying or simply securitizing these loans will take a good deal of capital – which is a particularly scarce resource for us, given the 30 percent surplus capital cushion that we maintain. Put all that together with today’s distressed market and credit conditions, and you can see why this new responsibility will be no windfall for Freddie Mac.

That being said, we embrace this new obligation. It’s our duty as a GSE. And we're going to find a way to get it done.

I want to talk for a few minutes about the fundamental design of Freddie Mac and Fannie Mae – because it's something that keeps getting overlooked.

The GSE model is a remarkable design that has worked. Congress created us as private institutions – fueled by private capital – that serve a broad public mission. When events force other investors to flee the market, the GSEs step up and even increase our activity. We've done that time after time – through the Russian debt crisis of 1998 and the collapse of Long-Term Capital Management; following 9/11; in the aftermath of Hurricane Katrina; and again today.

I'm reminded of lessons learned during the New England credit crunch in the early 1990s when I was heading the Boston Fed. During that time of economic distress, it was essential to find a way to balance the need for maintaining safety and soundness, while at the same time assuring adequate credit flows.

That experience is very relevant to today's GSE debate. Finding the right balance between preserving capital and providing liquidity is not easy, and there are legitimate differences of opinion. But we all need to acknowledge that difficult tradeoffs are sometimes necessary. And while it may be unpopular to mention shareholders in this context, it is they who provide the capital on which the GSE model depends. Preferred shareholders just injected more than $13 billion into the two GSEs.

Shareholder capital is the U.S. taxpayer's first line of defense against any GSE problem, remote as that may be. Without an expectation of a reasonable return, investors in the GSE system just may decide to take their money elsewhere – and that would be a very bad outcome for all of us.

To ensure that we can continue to provide liquidity in both good times and bad, capital levels must be consistent with the inherent risks of the assets we hold, while considering the important mission the GSEs must serve. This isn't just about our ability to attract shareholders. It's about our ability to carry out our mission. Our continued access to capital markets is critical in our mission to support the future growth of the U.S. housing finance system. I'm glad you understand that – and I also want to thank NAHB for coming out against any "systemic risk" capital requirement.

As for the affordable housing component of our mission, there needs to be greater flexibility to ensure that the GSEs can meet the housing goals and other proposed commitments in all economic environments. We need to ensure that the goals – however well intended – do not result in an over-stimulation of mortgage credit that leads to a situation like we're in today. I think this aligns well with the point you made in your recent Senate testimony: namely, the affordable housing goals should be set consistent with the affordable product that the primary market produces.

There are those who feel the GSEs haven't done enough for our mission since housing slowed and the subprime crisis first emerged last year. Speaking for Freddie Mac, while I'm sure anyone can always improve, we've done a lot:

• In February of last year, we were the first major secondary market player to insist on higher underwriting standards for certain subprime mortgages.



• We followed that in April with a commitment to buy $20 billion in consumer-friendly mortgages that provide better choices for subprime borrowers who seek to refinance out of problematic loans. We met this commitment in November.



• Since May, we've bought about $42 billion of mortgages that financed borrowers who previously could have found themselves in subprime.



• In so doing, last year we quadrupled over 2006 levels the amount of Home Possible® and similar affordable business we purchased.



• Freddie Mac introduced SafeStep Mortgages^SM, which are designed to give subprime borrowers more sustainable mortgage options.



• We've also consistently been at the forefront of efforts to help borrowers avoid foreclosure. Last year, Freddie Mac and its servicers helped nearly 47,000 borrowers avoid foreclosure and keep their homes.



• Now add to this list the new duties we'll be taking on – to add liquidity and stability and lower costs in parts of the jumbo market.

The fact that lawmakers have decided to expand the role of the GSEs shows how markedly the debate has been transformed. It wasn't long ago that many said the market has matured to the point where we don't need the GSEs anymore. Private-label securitization was supposed to be the answer for any potential credit need.

So I want to congratulate the Home Builders. In recent years, you have faced a decision that boils down to, essentially, whether the GSEs are still needed. You decided to stand with us. And your judgment has been richly vindicated.

Everything we're doing to keep the markets functioning today is possible only because of the GSE model.

While we're all preoccupied with today's problems, we also must think about how to deal with tomorrow. Because it's not enough to simply say we need the GSEs. We need them to be strong and vibrant. And they cannot be healthy and robust if the GSE model is damaged or neglected – if our economics don't work or our regulatory structure doesn't take into consideration the inherent balance of interests in our design.

Which brings me to the last major subject I want to raise with you today.

I know there is a lot of unhappiness with Freddie Mac's recent price increases. I'm committed to an open and honest dialogue with you, so I want to address this issue head on. The bottom line is, the reasons behind the price increases are overwhelming. As business people, I think you'll understand even if you don't agree. Here are the facts.

The housing boom was fueled in significant part by a worldwide mispricing of credit. Now the world is repricing credit, and that's an ongoing process. And because the price of credit has fundamentally changed, our prices have to change if we are to remain viable into the future.

As a nation, we need to face some difficult realities and answer some tough questions about the kind of housing finance system we want. The first is, fundamentally, whether or not we want to have housing GSEs. Assuming we do, then we have to ask: Do we want them to be privately owned, or a government corporation with an explicit government guarantee, like the Tennessee Valley Authority or any of a number of other GSEs?

If we decide we want private ownership, then the needed capital must expect to earn a market return on equity. That return on equity is the result of a simple ratio: the return divided by shareholder equity.

This is a very difficult balance. If capital goes up, return must go up and that has implications for pricing. This would also make it extremely difficult to provide a minimum return to shareholders and threaten the viability of the enterprises. It would call into question the current congressional model of the GSEs as publicly traded companies.

The U.S. financial system has been the gold standard for global capital markets in good part because our regulations have respected investors' interests. Regulations that lose sight of this point risk harming that invaluable reputation.

You can also think about it this way. When the price of lumber goes up, home builders raise prices. Well, capital is our lumber. The fact it's not a physical commodity doesn't make its high cost to us any less real. If we ignore that, we run into a brick wall.

Moreover, we still pass through significant savings to homeowners by linking the conforming mortgage market to capital-market interest rates. And let me be absolutely clear: even with our recent price increases, we're still heavily cross-subsidizing the affordable part of our business. As a GSE, that's costing us plenty. Roughly two thirds of our expected credit losses come from our goal-eligible products.

The turmoil in the markets has fundamentally changed the economics of our business. As a housing GSE, we have no choice but to be in these markets, even though things are tough. Freddie Mac reported more than a $2 billion loss in the third quarter of 2007 – and as you know, market conditions didn't improve in the fourth quarter.

Now, much of our reported losses are the result of accounting methodologies, but some of those are real losses. For example, the day we buy a loan and issue a credit guarantee, we have to mark the credit to market – and in this environment, that's generating big current period losses. In today's environment, both Wall Street and our own accountants have in effect criticized our pricing.

As a result, we and you are in a box. Those are the facts and I want us to be candid with one another. Under the GSE model, there are unavoidable tradeoffs between capital and credit and prices. All other things being equal, if credit worsens or capital is increased, it puts pressure on us and then on you.

I've devoted my remarks this afternoon in large part to the ways the markets have changed since housing began to turn downward. But there are very important long-term aspects of demography and demand that have not changed – and that are favorable. America remains a growing, developed nation. Compared with Europe and Japan, our rates of birth, net immigration and household formation are high. Housing demand will grow for many years to come.

Simply put, the long-term trends for our industry remain strong. And we must not get discouraged and lose sight of that. Despite all the pain the home building industry is going through now, the changes many of you have made to your business model in recent years should help you to negotiate this downturn better than you might have in the past. Not only are you managing the crisis, you're doing it pretty responsibly, too.

At Freddie Mac, we know we couldn't do our jobs without all of you on the front lines. The Home Builders have been one of the GSEs' most vocal champions over the years, and a valued partner – and that's not something I take for granted. We appreciate that your recent written testimony on the GSE bill was supportive of us in a number of different ways, based on a sound understanding of our common interests. We have similar missions, and I think similar dreams for this nation and its families.

Our fates are clearly intertwined, during every market cycle, but particularly so at this moment. When the GSEs are more successful – providing liquidity, stability and affordability to the housing finance market – home builders are more successful as well. So whatever comes our way in 2008, let's continue to stand together. Because in these tough times, that is what will make us both strong.

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