Richard F. Syron's Speech to Chief Executives' Club of Boston on September 29, 2005

Prepared Remarks for Richard F. Syron
Chairman and CEO Freddie Mac

Chief Executives' Club of Boston
Boston, Massachusetts
September 29, 2005

Thank you, Jack [Joyce]. It's good to see so many old friends here.

I want to talk to you about three related subjects this morning.

One, is there a housing bubble in America today?

Two, what about the impact of the Gulf hurricanes – particularly Katrina – not only as a vast human tragedy and regional housing crisis, but also as a shock to our economy with far-reaching consequences?

And finally, what is Freddie Mac and what role do we play in all of this?

That's a lot to cover so I'll get right to it.

Housing commands unprecedented attention in America today. And for good reason.

More than a dozen years of sustained growth in housing prices have turned many middle class homeowners into millionaires; put countless children through college; and made the family home the most valuable egg in the American nest.

Home equity wealth has doubled in the past seven years. While it still represents only about $10 trillion out of $50 trillion in total U.S. net worth today, for most Americans, it's their largest asset.

It's a bit ironic that we face questions about whether the housing sector today is overheated, or too big a piece of the American pie. Because when I came up as a young economist, housing in this country was not the 800-pound gorilla, it was the 98-pound weakling.

In economic terms, housing used to be "procyclical" – meaning that when the economy got the sniffles, housing would get double pneumonia – thereby driving the broader economy deeper into recession.

Today, housing has gone from being the whipping boy of the economy to a pillar of the economy. Without its strong influence, the most recent recession would have been longer and more severe. And the economy would have underperformed significantly in the four years since.

Housing consumption and investment has accounted directly for about 20 percent of GDP growth in the past three years. And housing-related sectors have accounted for almost a million of the 3.6 million jobs added. These are our estimates; many others place the figures higher.

But with housing now the locomotive pulling our economy, the stakes are raised for the question, "Are we in a bubble?" For even a modest downturn in housing would be felt throughout the economy – from construction jobs to the banking and real estate professions to such big related employers as Home Depot and Lowe's.

This doesn't justify going overboard to keep the boom going. But it does make it critical not to pull the rug out from under housing precipitously.

Now, the term "bubble" doesn't simply mean large price increases – even if they go on for years. It also requires a level of heightened speculation that becomes unhinged from economic fundamentals.

In the case of housing, the key fundamentals include local jobs and incomes; the supply of existing homes and land; regulatory limitations; and of course, the cost and availability of mortgage money.

You'll note I mentioned local jobs, incomes and so forth. That's because housing is not one giant market, but a localized set of markets.

Given the underlying fundamentals, we do not see a nationwide decline in housing prices. There's been no such collapse since the Great Depression. And it's just not in the cards today.

I get asked the bubble question all the time as I travel around the country. Candidly, the right answer depends on which city I'm in. Here where we're standing, in Boston, we have seen a bit of a bubble, particularly at the high end.

More broadly, our research tells us that in the last two years, the average home value in New England is up 28 percent – but only about a third of that increase can be attributed to fundamentals such as income and population growth.

On the other hand, throughout most of the Midwest, the South and much of the nation, there plainly is not a housing bubble.

I'm not in the business of issuing crystal ball predictions about the exact trajectory of house prices. But as an economist, I will say this. I believe we're seeing enough excess exuberance in enough markets so that the resulting local corrections, taken together, will have an impact on overall economic growth by dampening consumption.

We got here through an unusual confluence of circumstances. There has been very high liquidity worldwide. Investor tolerance for risk has increased substantially. And alternative investment opportunities have been lacking. For all these reasons, a lot of money has flowed into housing.

And now, after Hurricanes Katrina and Rita, the country faces added challenges and uncertainties. We've never absorbed a one-two punch before that knocked out this much energy refining capacity; created this many evacuees; disrupted transportation systems, the chemical industry and agriculture; or required such a vast rebuilding effort – including more than 200,000 homes badly damaged or destroyed.

So even if this is not essentially a housing crisis, it is a macroeconomic event with major implications for housing, as well as the broader economy.

Freddie Mac can't directly bring down energy prices or undo Katrina's impact on inflation and GDP. But on both a humanitarian level and as a vital part of the housing finance system, there's a great deal we can do to ease the terrible effects of the hurricane and be a force for stability at this uncertain time. To date we have:

• committed more than $10 million to relief efforts;

• suspended mortgage payments for affected borrowers for up to 12 months; and

• returned September payments to cash-strapped victims.

• In addition, we are working with our servicers to modify troubled loans, and will use our retained portfolio to make it easier for borrowers to protect their credit and get back on their feet.

• We are working to donate housing units from our own small inventory.

• We are telling our servicers to get insurance money into the hands of borrowers, faster and easier.

• Finally, we are infusing up to $300 million of liquidity into the affected area, by using our retained portfolio to purchase mortgages on impacted properties in our lenders' pipeline.

All these steps underscore Freddie Mac's capacity and commitment to help protect America's homeowners, our housing finance system, and the broader economy, from the shock of unexpected events.

In a broader sense, however, the most important thing we are doing is not any special hurricane initiative – it's our mission. Our everyday job is to bring liquidity, stability and affordable housing opportunities to local housing markets, while responding appropriately to the broader capital markets. That's the mission Freddie Mac and Fannie Mae were chartered to do by Congress, as government-sponsored entities, or GSEs.

When times are good, the GSEs' mediating role – tapping the global capital markets to support housing in America – may seem easy to take for granted. But when times are not so good, as in the aftermath of these hurricanes, it's shown to be critical. By being a large-scale shock absorber focused on housing, the GSEs help homeowners and lenders, while maintaining investor confidence in the nation's housing markets.

And that brings me to the final topic I'd like to cover with you this morning: Freddie Mac's role as an enduring source of stability for housing and the broader economy. For we have played a similar stabilizing role before, in prior times of stress and crisis. The examples are telling; they are repeated; and they are not hard to find:

• When New England went through a regional credit crunch in the 1980s, I was with the Boston Fed. And I recall how the GSEs stepped up and supported the conforming residential mortgage markets – even as other sectors, including construction lending and commercial real estate, were taking a hit.

• When the Texas oil patch collapsed in the 1980s, Freddie Mac was there to prevent a bad situation from getting worse.

• In Southern California after the aerospace layoffs – and in Northern California at the end of the dot.com boom – we kept funding the housing markets, even when banks and other sources of liquidity left for greener pastures.

• In 1998, after the Russian debt crisis and Long-Term Capital Management, interest-rate spreads between the GSE conforming market and the jumbo mortgage market more than doubled. That means the big banks were pulling out of mortgages – and the GSEs were buying them up, using our retained portfolios. Our monthly volume figures reflect this. The consumer benefited because we did our job.

• Last but not least, 9/11. The bond markets shut down and no one knew what to do. The GSEs took the lead by issuing debt, providing a mortgage bid, and helping the mortgage markets keep on going. So the housing sector was remarkably unaffected – and in fact, it soon became the engine of the subsequent economic recovery.

In short, responding to the current devastation on the Gulf Coast is not a one-off for Freddie Mac. This is the kind of thing we do, the kind of crisis we were built for. And it is why fundamental changes to our structure would be so counterproductive. For this is a time to draw on the GSEs' unique strengths – not to sacrifice them.

The GSEs also enhance stability routinely, in a more systemic way. We make sure that households do not have to bear the interest-rate risk associated with their mortgages – unless they choose to. Working within the free-market system, we manage and disperse this risk out to the capital markets, which are better equipped to handle it.

We do this largely by supporting longer-term, fixed rate prepayable mortgages – what I've called "the American Mortgage." As shown by recent research for the U.K. Treasury and by the International Monetary Fund, this kind of lending is good for a nation's economy, making it less prone to boom and bust. It's also good for households.

The American Mortgage is a major national advantage. Its broad availability in this country is almost unique in the world. The key reason is the GSEs.

But all this is not free. The risk has to go somewhere. By having the GSEs manage and distribute a good share of the risk – even if our share has become limited by competition – the U.S. incurs less systemic risk than by relying solely on depository institutions and hedge funds.

There are a number of reasons why the current GSE system involves less risk than a pure depository model. For one thing, the GSEs provide more risk disclosures and satisfy more demanding capital stress tests than anyone. On the interest rate risk side, we mark-to-market our exposure daily and publish the average monthly. On the credit risk side, we make extensive disclosures; use credit enhancements; and produce credit losses at a tenth the rate of depository institutions' residential mortgage portfolios. And we pass a stress test for capital that simulates a collapse worse than any since the Great Depression.

Second, we have a big comparative advantage in keeping our mortgage portfolios in balance, thanks to our extensive use of callable debt. This vehicle is especially well-tailored for creating a tight match between our assets and liabilities. Freddie Mac finances roughly 50 percent of the fixed-rate mortgages in our retained mortgage portfolio with callable debt. By contrast, most depositories rely far more on short-term deposits to fund mortgages. This leaves them vulnerable if interest rates increase dramatically.

Third, we use derivatives far less than depositories – and we use them only to reduce risk, not to place bets. Our three federally insured competitors employ more than 55 percent of all notional derivatives outstanding – more than 60 times the exposure of Freddie Mac. So if the real concern is about derivatives, then the GSEs' critics are barking up the wrong tree.

Fourth, we have mortgage risk expertise that few other institutions can match. This is the only thing we do. We have the data, the models, the systems and the people in place to manage the risk.

My fifth point is about our critics' claim that the GSEs pose unacceptable "concentration risk," meaning that even if we're well managed, we are just too big and something could go wrong. They emphasize that thousands of banks own U.S. mortgage-backed securities – but ignore the fact that fully 40 percent of these MBS are concentrated among three large banks. Since 2001, the very largest banks have increased their share of mortgages substantially, so they will soon rival us in the size of their mortgage portfolios.

As a result, eliminating the GSE retained portfolios would only further concentrate risk in the financial system, as the largest banks would grow even bigger. Lacking our access to callable debt, they would be forced to choose between leaving their mortgage holdings unhedged, or increasing their already large position in derivatives. The result would be more systemic risk, not less. And it would also mean, over time, less support for the fixed-rate mortgage that is good for the U.S. economy and household sector.

Finally, our critics dismiss the detrimental effect on mortgage rates if the GSEs were barred from buying mortgages and issuing debt. They claim that GSE debt and mortgage-backed securities are simply fungible – including in the eyes of foreign investors. This is belied by history; unsupported by sound research; defies common sense; and is not consistent with the real-world views of the financial markets. Frankly, the two instruments are not close substitutes – foreign central bankers tell me that.

If GSE debt were out of the picture, we estimate a disinvestment of hundreds of billions of dollars from certain investors leaving the U.S. housing sector. It's untenable to claim this wouldn't affect the markets, cost consumers or raise mortgage rates. Instead of risk reduction, this would be market experimentation – with high stakes, under conditions of uncertainty.

We've tried the one-model system before, in which depositories with an explicit federal guarantee fund the majority of fixed-rate mortgages. The unhappy result was the Thrift Crisis. There, you had plenty of seeming diversification – thousands of Savings & Loans – but they all faced the same interest rate risks and inherently bet the same way.

Today, we have a better system, with our eggs spread in two baskets: the depository model and the capital markets model of housing finance. This dual system has a proven track record of success. We should let it keep working.

You've been very attentive. So let me wrap up.

This is a delicate and uncertain time, both for housing and our broader economy. The hurricanes, particularly Katrina, have only heightened that – adding inflationary pressures, job losses, relocation and housing needs, you name it. From energy and chemicals to transportation and the insurance industry, we're in uncharted territory here.

At times like this, where our nation has some solid sources of stability, the last thing we want to do is kick a leg out from under the stool.

I don't hear anyone saying out loud these days that housing is not worth a special investment by our nation. Or that the minorities and new immigrants in our next generation of homeowners don't deserve the same opportunity for homes to call their own.

The genius of Congress was in setting up a secondary market, with two competing GSEs, that attract private capital to serve a public mission. For more than thirty years now, the results have been clear: it's working.

Does Freddie Mac want strong oversight? You bet. Let's have a strong regulator and reinforce market confidence. But this is the worst possible moment to make the GSEs play permanently with one hand tied behind our backs.

To the contrary, if ever the country needed us to do all we can and provide a steadying influence, now is that time.

So let's not foul this thing up. Let's get to work instead.

Thanks very much. I'm happy to take your questions.