WRITTEN STATEMENT OF LELAND C. BRENDSEL
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FREDDIE MAC
BEFORE THE SUBCOMMITTEE ON CAPITAL MARKETS,
SECURITIES
AND GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON BANKING AND FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
MAY 16, 2000
Good morning Chairman Baker, Congressman Kanjorski and Members of the Subcommittee. It is a pleasure to be here. I am Leland C. Brendsel, Chairman and Chief Executive Officer of the Federal Home Loan Mortgage Corporation, known as Freddie Mac.
I want to thank you for the opportunity to discuss Freddie Mac, our vital role in the nation's mortgage finance system, our commitment to making the American dream of decent, accessible housing a reality and our views on H.R. 3703, the "Housing Finance Regulatory Improvement Act," introduced by Chairman Baker.
Since our beginning in 1970, Freddie Mac has purchased more than $2 trillion in residential mortgages, financing homes for more than 25 million families. Because of the high level of support provided by Freddie Mac and the secondary market, America enjoys the world's best housing finance system. Mortgage rates are lower, saving homeowners thousands of dollars in interest payments. Low-downpayment loans are more readily available, enabling people to purchase their first homes. Families can count on the availability of mortgage credit whenever and where ever they need it.
In fact, our nation's mortgage finance system works so well that most Americans take for granted a reliable supply of low-cost mortgage credit in communities across the nation, every day.
This was not always the case. The development of America's mortgage finance system, with Freddie Mac as a private company created to serve a public purpose, is a tremendous Congressional success story.(1) This system ensures that America's future generations continue to receive its many benefits.
Freddie Mac appreciates your efforts to assess whether the regulatory structure established in the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the 1992 Act) is working effectively and efficiently to ensure that we are operating safely and soundly and fulfilling our public mission. Freddie Mac shares Chairman Baker's desire to ensure a strong, independent and effective safety and soundness regulatory structure. However, we believe the proposed bill in its current form would not accomplish this objective. America's housing finance system works incredibly well, and changes to it run the risk of reducing the availability and affordability of mortgage credit for America's families and threatening the stability of the $5 trillion residential mortgage market.
Freddie Mac brings significant benefits to the mortgage market, including: lower mortgage costs; greater stability; increased innovation; and expanded housing opportunities. We bring these benefits at no cost to the government.
Before commenting specifically on H.R. 3703, I would like to provide an overview of Freddie Mac and our operations in the global capital markets, review the benefits we bring to lenders and consumers, and dispel, once and for all, some myths that have emerged about Freddie Mac and how we meet our mission.
I. FREDDIE MAC'S OPERATIONS IN THE CAPITAL MARKETS
Freddie Mac was created by Congress in 1970 to establish and maintain a national secondary market for conventional residential mortgages. In our charter, Congress articulates four purposes for Freddie Mac:
· Provide stability in the secondary market for residential mortgages
· Respond appropriately to the private capital market
· Provide ongoing assistance to the secondary market for residential mortgages (including mortgages on housing for low- and moderate-income families)
· Promote access to mortgage credit throughout the nation (including central cities, rural areas, and other underserved areas)
Congress further specified that Freddie Mac accomplish the latter two purposes by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing.(2)
Freddie Mac fulfills these purposes every day by purchasing mortgages from our nationwide network of lenders, overseeing the servicing of nine million loans, providing tools to keep mortgage lenders at the forefront of a changing market, issuing debt and mortgage-backed securities to meet investor needs, managing our retained mortgage portfolio, and maintaining sufficient capital to meet existing and future market needs. Through superb execution of these functions, we bring stability and liquidity to the housing finance system. This ensures that mortgages are continually available at lower cost to an increasing number of America's families, of all incomes, in all neighborhoods.
Freddie Mac is a secondary market company. We do not make mortgage loans. Instead, we provide our benefits to the mortgage market and America's families by purchasing loans originated by primary market lenders. We finance these loans in two ways: securitization and debt.
Securitization Financing. Under this method of financing, we purchase mortgages and package them into guaranteed mortgage passthrough securities, called Mortgage Participation Certificates, or PCs. We sell these mortgage securities through security dealers to investors in the capital markets.
Debt Financing. Under this method of financing, we purchase mortgages and mortgage-related securities for our retained portfolio and finance them with a variety of debt securities. We sell these debt securities through security dealers to investors in the capital markets.
Freddie Mac's mission requires us to provide a continuous supply of mortgage credit for U.S. homebuyers in all economic environments. Freddie Mac flexibly employs both mortgage security and debt financing on a daily basis to accomplish this. We pioneered the development of the markets for mortgage-backed and debt securities that expand the investor base for America's housing. By using both of these financing methods, Freddie Mac assures mortgage lenders and America's families a stable supply of mortgage money at the lowest rates the capital markets have to offer.
Debt, in particular, has enabled Freddie Mac to expand the investor base for America's housing worldwide. A fixed payment schedule attracts international investors, bringing greater stability and liquidity to the U.S. mortgage market and making housing more affordable for the nation's families.
Freddie Mac's participation in the U.S. mortgage market and global securities market serves to link America's homebuyers with the world's capital markets. Fulfilling this role requires Freddie Mac to meet the challenge of improving access to low-cost mortgage financing while maintaining the financial strength that attracts capital to housing.
Freddie Mac's business is financing the high-quality mortgages backed by the equity in people's homes. Our mortgage risk management is second to none. Moreover, we hold sufficient capital to withstand extreme changes in both interest rates and credit conditions. As a result, Freddie Mac is among the strongest financial institutions.
II. KEY BENEFITS PROVIDED BY FREDDIE MAC
BENEFIT: Freddie Mac Lowers Mortgage Interest Rates for Borrowers
Freddie Mac and the secondary market lower mortgage rates and make housing more affordable. As the 1996 studies by the General Accounting Office, HUD, Treasury and the Congressional Budget Office each concluded, interest rates on mortgages that Freddie Mac can buy are lower than on other mortgages. An independent study commissioned by the four governmental organizations found that conforming fixed-rate mortgage rates (i.e., rates on mortgages of a size eligible for purchase by Freddie Mac, currently those up to $252,700 for one-unit properties) are approximately 25 to 40 basis points, or more, lower than rates on loans exceeding the conforming loan limit.(3)
You don't have to rely on these estimates, just look at the mortgage rates reported weekly in The Wall Street Journal. On May 5, 2000, for example, rates on jumbo mortgages were 30 basis points higher than rates on the mortgages Freddie Mac can buy.(4)
As a result of the lower mortgage rates Freddie Mac and the secondary market provide, homeowners save approximately $12,000 in mortgage interest on a 30-year mortgage. Collectively, every year America's homeowners save $15 billion in mortgage interest payments.
Freddie Mac and the secondary market also ensure that mortgage credit is available at virtually the same mortgage rates nationwide. Because we support a national market, mortgage funds flow freely to communities across the country to meet the needs of the nation's homebuyers.
By attracting investors for long-term securities worldwide, Freddie Mac makes fixed-rate mortgages more available. As a result, when interest rates rise, mortgage borrowers are protected from higher costs.
What might we expect if Freddie Mac and Fannie Mae were no longer looked to as pillars of the housing finance system? One only need examine the segments of the U.S. mortgage market we do not serve, the mortgage markets in other countries(5) or the U.S. market before Freddie Mac was created. Mortgage rates, downpayments and the use of adjustable-rate mortgages would all be higher, which would increase the cost of housing for America's families, reduce homeownership and put borrowers at greater risk of foreclosure.
BENEFIT: Freddie Mac Brings Proven Stability to the Nation's Mortgage Markets
Freddie Mac and the secondary market provide a reliable flow of mortgage credit, supporting the nation's housing finance system in good times and bad. Despite extraordinary upheavals in the mortgage and real estate industries during the past decade, America's families enjoyed an uninterrupted flow of mortgage credit.
· During the savings and loan crisis from 1986 to 1989, when the nation's primary source of mortgage credit was failing, Freddie Mac provided more than $300 billion to meet the credit needs of America's families.
· When commercial banks tightened lending standards in the early 1990s as a result of commercial real estate losses, the nation's small businesses experienced a "credit crunch" but housing credit remained readily available. Freddie Mac provided nearly $370 billion to finance housing during that period.
· When interest rates fell in 1993 and 1994, homeowners in record numbers wanted to refinance their homes, and Freddie Mac provided more than $350 billion in mortgage credit.
· During the fall of 1998, worldwide turmoil in the financial markets led to a liquidity crunch in several domestic market sectors, including commercial and subprime residential mortgages, as investors fled many investments and poured funds into U.S. Treasury bonds. Because demand for Freddie Mac's debt securities remained high, Freddie Mac was able to keep funds flowing into the residential mortgage market.
Our ability to issue both mortgage-backed securities and debt to finance mortgage purchases is essential to the smooth functioning and stability of the housing finance system. A study by Capital Economics stated that our debt-funded purchases "stabilized home loan rates during the credit crunch of 1998. For consumers in the home loan market during the financial crisis of 1998, mortgage credit remained available and affordable."(6)
BENEFIT: Freddie Mac Pioneers Innovation in Housing Finance
Throughout our history, Freddie Mac has been a pioneer in innovation, exploring new frontiers that create a faster, more efficient and less costly mortgage finance system. Our innovation in financial instruments attracts more investors to finance America's housing, which ensures mortgage money is available at lower cost for homebuyers. We also innovate to streamline the mortgage process, which reduces the time and up-front costs of getting a mortgage.
Following are examples of the many milestones in the development of the mortgage market that can be traced to Freddie Mac.
· In 1971, Freddie Mac issued a passthrough security backed by conventional mortgages, developing the market for securities that expand the investor base for housing.
· In 1973, Freddie Mac joined with Fannie Mae in standardizing mortgage loan applications and single-family appraisal forms.
· In 1983, Freddie Mac issued the first multiclass mortgage security, the forerunner to today's Real Estate Mortgage Investment Conduit (REMIC).
· In 1984, Freddie Mac facilitated the first paperless, computer-to-computer delivery of mortgages to the secondary market.
· In 1985, Freddie Mac's mortgage-backed securities began trading electronically in the book-entry system rather than in paper form.
· In 1995, Freddie Mac introduced automated underwriting to the market with Loan Prospector (r).
· In 1999, Freddie Mac introduced Loan Prospector on the Internet.
· In 1999, Freddie Mac launched the first corporate debt financing calendar.
All of these innovations deliver benefits to America's families. Freddie Mac operates in the U.S. mortgage markets and the global capital markets, and as the examples above demonstrate, we have brought innovation to both.
The markets we have developed for mortgage-backed and debt securities have attracted a global investor base to finance America's housing. This was not always the case. In 1970, residential mortgage debt outstanding totaled about $0.4 trillion, most of which was held by thrifts. Now more than $5 trillion in mortgages and mortgage-backed securities are held by a diverse investor base worldwide. The single- and multiclass mortgage security markets we developed in the 1970s and 1980s significantly increased the share of mortgage debt held by pension funds, insurance companies and commercial banks. More recently, Freddie Mac's innovations in the debt markets have attracted an international investor base. This increases the global demand and liquidity of our securities, which enables us to reduce costs for homebuyers and renters.
For 30 years, Freddie Mac also has lead the way in streamlining the mortgage process, reducing the time and cost to get a mortgage loan. Freddie Mac's automated underwriting service, Loan Prospector, has fundamentally transformed the way mortgages are originated. With Loan Prospector, approving mortgages is easier and faster, costs are lower and the application of objective underwriting criteria is more consistent. Additionally, by more accurately measuring risk, Loan Prospector extends the benefits of the mortgage finance system to more borrowers.
Freddie Mac uses technology, such as automated underwriting, to make the mortgage finance system more objective and fair. We also take specific, additional steps to ensure that our automated underwriting technologies and other recommended statistical tools are used in a way that promote access to credit and fairness in the mortgage process.
To further distribute the benefits of faster, more accurate approvals and lower costs throughout the mortgage market, Freddie Mac introduced an Internet version of Loan Prospector in July 1999. Loan Prospector on the Internet (LPI) is a web-based version of Freddie Mac's automated underwriting service that delivers a Freddie Mac purchase decision within minutes at the point of sale. LPI permits lenders to compete in the age of electronic commerce by bringing the benefits of Loan Prospector to America's homebuyers as quickly, easily and efficiently as possible.
Automated underwriting services such as Loan Prospector can reduce origination costs by up to $650, and when combined with other online efficiencies, the potential savings from Internet-based automated underwriting services increase to $2,000. These services also can shorten the time to loan closing and allow approval of loans for borrowers with less traditional credit profiles and limited savings. Based upon U.S. Census Bureau estimates, a reduction of $1,000 in origination costs could help an additional 116,000 renters afford to become homeowners and a reduction of $2,000 in origination costs could make it possible for an additional 314,000 renters to afford a home.(7)
BENEFIT: Freddie Mac Expands Housing Opportunities
Freddie Mac serves families at all income levels, in all kinds of communities, in all parts of the country. In fact, Freddie Mac's purchases closely mirror the activities of the primary market in terms of the share of business from central cities, suburbs and rural areas, as well as by the distributions of borrower income and census tract income. Freddie Mac takes great pride in these accomplishments. At the same time, we are continuously improving our business activities to make homeownership attainable for even more families.
In 1999 alone, Freddie Mac purchased nearly $241 billion of single-family and multifamily mortgages, financing homes for 2.3 million families.(8) Nearly 1.3 million of these mortgages, representing more than 55 percent of our total purchases, funded housing for very-low-, low- or moderate-income families or families living in underserved areas.
Single-Family Housing (One to Four Units). Freddie Mac purchased $233 billion in single-family mortgages, financing homes for 2.1 million families. Our home-purchase financing included 178,000 first-time homebuyers, who accounted for 25 percent of the home purchase loans we bought in 1999. By financing approximately one in eight first-time homebuyer mortgages originated last year, Freddie Mac played a significant role in boosting the national homeownership rate to 67 percent. In addition, Freddie Mac's purchases in 1999 funded mortgages for more than 259,000 minority families.
Multifamily Housing (Five or More Units). Freddie Mac's multifamily mortgage financing in 1999 totaled $7.6 billion, financing rental housing for 191,000 families, and 90 percent of these units were affordable to low- and moderate-income families. In addition, with $244 million in investments in rental housing eligible for Low-Income Housing Tax Credits in 1999, our total investments surpassed $1 billion.
Freddie Mac Achieved Our Affordable Housing Goals in 1999. As a result of our continued efforts to extend the reach of the mortgage market to low- and moderate-income families and those living in underserved areas, combined with favorable economic conditions, Freddie Mac met all three of the affordable housing goals established by HUD in 1999:
· The low- and moderate-income housing goal for 1999 was 42 percent of the total number of dwelling units financed by our mortgage purchases. During 1999, 46.4 percent of the units Freddie Mac financed were affordable to low- and moderate-income families. These purchases totaled $80 billion and financed housing for more than one million families.
· The underserved areas goal for 1999 was 24 percent of the total number of dwelling units financed. During 1999, 27.6 percent of the units Freddie Mac financed were located in underserved areas. These purchases totaled $51.8 billion and financed housing for 619,000 families.
· The special affordable housing goal for 1999 was 14 percent of the total number of dwelling units financed. During 1999, 17.3 percent of the units Freddie Mac financed were affordable to low-income families in low-income areas or to very-low-income families. These purchases totaled $22.5 billion and financed housing for 386,000 families. The multifamily housing target within the special affordable goal was $988 million. In 1999, $2.3 billion of Freddie Mac's purchases eligible for the special affordable goal were multifamily mortgages.
Serving Minority Families. Freddie Mac is an active and creative force in reducing costs and making mortgage money available for minority families. The benefits we bring to the housing finance system are making homeownership a reality for those who previously considered it out of reach. We are proud of our achievements in serving the diversity of America's families. From 1996 through 1999, our mortgage purchases financed homes for 835,000 minority families, including 200,000 African-American and 307,000 Hispanic families.(9)
More remains to be done. While homeownership rates for minority families have increased to record levels during the past decade, overall homeownership rates for African Americans, Hispanic Americans, and Native Americans remain well below those for non-Hispanic whites. Freddie Mac is committed to increasing minority homeownership rates across the country.
In achieving this objective, we use a multifaceted approach that includes working with minority-owned lenders, creating targeted loan products, reaching out to minority-based organizations and designing homebuyer education that enables families to achieve and maintain good credit.
Our newest initiatives will help even more families achieve homeownership. Examples of our recent initiatives include:
· Five-Year Alliance with the NAACP -- In early 1999, Freddie Mac and the NAACP announced a new five-year alliance designed to increase minority homeownership. As part of the initiative, Freddie Mac has committed to purchase up to $500 million in mortgages originated by Bank of America and other participating lenders.
· Consumer Credit Education: Freddie Mac has launched a homebuyer and credit information initiative aimed at explaining the role that good credit plays in obtaining the most affordable mortgages in the market. Our series of credit education brochures, sponsored with each of these organizations - the NAACP, the Mortgage Bankers Association of America, the National Association of Real Estate Brokers and the National Association of Realtors - helps consumers understand the importance of good credit.
Freddie Mac has also announced a joint, multi-year, multi-million dollar Consumer Credit Initiative with five of the nation's Historically Black Colleges and Universities (HBCUs) aimed at increasing minority homeownership rates by helping consumers better understand credit and develop and maintain solid credit records.
· Freddie Mac/Wall Street Project Minority Homeownership Initiative: In April 2000, Freddie Mac and the Rainbow PUSH Coalition/Wall Street Project entered into a joint campaign to increase homeownership among minority families. Freddie Mac committed $1 million to help leverage the infrastructure of the Wall Street Project's "One Thousand Churches Connected" economic literacy effort to provide information about the benefits of homeownership and the mechanics of the homebuying process, as well as about mortgage loan products available as part of the initiative. As part of the campaign, Freddie Mac has committed to purchase up to $1 billion in mortgage loans made to minority families by Bank of America and minority-owned lenders over the next five years.
Freddie Mac's Steps to Combat Predatory Lending. Subprime loans are an important option for borrowers with past credit problems, and not all subprime loans are predatory. At the same time, there are clear examples of abusive lending practices in this market segment. This is one reason Freddie Mac's participation in purchasing and securitizing higher-risk mortgages has been gradual and deliberate. We want to take the time to be sure we promote responsible lending and enable families to build wealth through homeownership.
Based on our experience in the subprime market, Freddie Mac has taken vigorous steps to address predatory practices, and to begin establishing standards that can be used across the entire market.
· HOEPA Loans - Freddie Mac will not purchase high-rate or high-fee loans that are covered by the Home Ownership and Equity Protection Act of 1994 (HOEPA) and current implementing regulations published by the Board of Governors of the Federal Reserve System.(10)
· Single-Premium Credit Insurance - Freddie Mac will not purchase loans where single-premium credit life, property, disability or unemployment insurance is financed out of the loan proceeds.
· Credit Reporting - Freddie Mac requires lenders we do business with to report monthly borrower mortgage payments to all three major credit repositories so that borrowers with good payment records can obtain lower-cost loans when their credit improves.
· Good Business Practices - Freddie Mac monitors the practices of lenders we do business with, and we have refused to do business with some of the largest lenders in the subprime market segment due to concerns with their lending practices.
· Servicing Tools - Freddie Mac provides loan servicers with tools that enable them to identify homeowners most at risk of foreclosure and work with them to reduce foreclosures and to avoid late fees that can drain equity.
Freddie Mac is also bringing benefits to the subprime segment of the market by providing a wider range of mortgage products which make credit less costly and more sustainable for borrowers. We are continually introducing innovative new loan products aimed at giving borrowers with impaired credit greater mortgage product choices. Some of our recent products and initiatives include:
· CreditWorksSM - This is a $100 million initiative in which we purchase a market rate mortgage for borrowers who successfully participate in a debt management counseling program with a nonprofit counseling service. These borrowers otherwise would likely pay higher rates in the subprime market.
· Affordable MeritRate MortgageSM - Our new mortgage product for borrowers with impaired credit in which the borrower's interest rate is reduced after two years of timely payments.
· Lease-purchases - Working together with state and local housing authorities, our lease-purchase initiative allows borrowers to use rental payments toward purchase of a home.
The steps we are taking to promote responsible lending and the new mortgage products and initiatives we are bringing to the subprime segment of the conventional mortgage market promise to bring standardization, increased competition, a broader variety of mortgage products and lower costs. These actions protect borrowers who are vulnerable to abusive lending practices. We have been commended for the steps we are taking by legislators, consumer advocates and the mortgage industry.(11)
Freddie Mac opens doors to housing in many ways, and we are constantly seeking new ways to bring the benefits of home financing to a broader array of America's families.
Freddie Mac Provides These Benefits at No Cost to the Government
Because Freddie Mac was established by Congress to harness the private sector to fulfill a public purpose, Freddie Mac benefits America's homebuyers and renters at no cost to the government. We receive no appropriated funds. We receive no federal loans. Our securities are not guaranteed by the government. Indeed, Freddie Mac is one of the country's largest federal taxpayers. Freddie Mac has paid approximately $3 billion in federal income taxes over the past five years.
III. SETTING THE RECORD STRAIGHT
In discussions about Freddie Mac, our role in the housing finance system and the effectiveness of our regulatory structure, a number of myths about Freddie Mac have emerged. I would like to take the opportunity today to set the record straight.
MYTH: Freddie Mac Is the Next Thrift Crisis Waiting to Happen
REALITY: Freddie Mac Is Among the Strongest Financial Institutions
Freddie Mac's assets are the high-quality mortgages backed by equity in people's homes. The tools we have developed to manage both credit and interest-rate risk are second to none. We pioneered the development of automated tools that enable us to accurately assess credit risk and help families avoid foreclosures. By funding mortgages nationwide, the geographic diversity of our mortgages mitigates the risk of local economic downturns. We are further protected through the use of third-party credit enhancements on a large share of our mortgage purchases. Freddie Mac's world class interest-rate management encompasses funding mortgages with a variety of mortgage securities, callable debt and other financial instruments that enable us to closely match the maturities of our assets and liabilities.
Not only is Freddie Mac highly skilled at managing risk, we are extremely well capitalized for the risks we take. Freddie Mac holds enough capital to withstand 10 years of severe, adverse economic conditions - much like the Great Depression. This is similar to the risk-based capital standard Congress established for Freddie Mac and Fannie Mae in the 1992 Act, which OFHEO is in the process of finalizing.(12)
In 1996, at OFHEO's request Standard and Poor's Corporation (S&P) rated Freddie Mac AA- on a stand-alone basis. Currently only six bank holding companies and no thrifts have ratings this high.
The difference between Freddie Mac and the thrifts could not be more stark. Thrifts in the 1980s were funding long-term mortgages with short-term deposits, and taking credit risk they could not manage.
Even today, the thrift industry has nowhere near the capital strength of Freddie Mac. Thrift capital requirements are based on a percentage of their assets. No matter how much risk a thrift takes, its capital standard remains the same. By contrast, the risk-based capital standard for Freddie Mac and Fannie Mae is dynamic and depends on how well risk is managed.
In a 1999 study, thrift-industry expert IPS-Sendero applied OFHEO's capital standard for Freddie Mac and Fannie Mae to the thrift industry and found that it could not survive for five years of the 10-year stress test. The study concluded that the industry would need "more than three times their current capital level" to meet this capital standard.(13)
Recently, we asked former FDIC Chairman Bill Seidman to assess the relative stringency of this capital standard. He concluded that "the risk based capital standard set forth in the 1992 GSE Act creates a very stringent capital standard, one that could be devastatingly stringent if applied to most other financial institutions."(14)
The fact is, if the thrifts had held as much capital relative to risk as Freddie Mac does, there would never have been a thrift crisis.
Freddie Mac Has No Federal Guarantee: Thrift deposits are backed by the full faith and credit of the federal government. Freddie Mac has no such guarantee. Our charter explicitly states that Freddie Mac's securities are not guaranteed or otherwise backed by the full faith and credit of the United States. Furthermore, the documents offering every security we issue clearly state that investments in Freddie Mac instruments are not in any way backed by the government.
MYTH: Freddie Mac Is Expanding Beyond the Charter
REALITY: All of our Activities Are Mission-Related
Over the past decade, Freddie Mac has played an integral part in reducing the time, cost and complexity involved in getting a mortgage - changes that directly benefit consumers and fulfill our public mission. As we consider the housing finance needs of the next generation of borrowers, the drive to innovate will only intensify. The dynamic nature of mortgage markets requires us to constantly improve the housing finance system to meet lender and borrower needs.
Some participants in the mortgage industry are threatened by these dramatic changes and react by attempting to impede market innovation, claiming that our activities go beyond our charter. What are we being criticized for?
· Using the latest technology to reduce the time and cost of getting a mortgage
· Responding to lenders who want to sell mortgages over the Internet
· Improving practices in the subprime sector
Each of these are about making mortgages more affordable, making the mortgage process easier for lenders and borrowers, and opening doors to homeownership. Each of these provides direct benefits to consumers and falls squarely within our charter and our public mission.
MYTH: Freddie Mac's Debt Is Growing Unnecessarily
REALITY: Our Debt Attracts Investors Worldwide to Finance America's Housing, Reducing Costs and Keeping Mortgage Credit Available
Much has been made of comparisons of the size of our debt with Treasury's. The truth is both Treasury debt declining and Freddie Mac debt increasing reflect positive developments for America's families. Mortgage debt has grown in response to the increase in homeownership, and is backed by the safest form of collateral - the equity in people's homes.
America now has a record 67 percent homeownership rate. More than 70 million families own their own homes. As homeownership rates increase, so does the amount of mortgage money needed to finance those homes. This is illustrated by the fact that Freddie Mac's growth is consistent with the growth of the mortgage market.
Issuing debt is one of the tools we use to ensure the smooth functioning of the housing finance system and a key way we hold down the cost of financing homeownership.
Freddie Mac's mission requires us to provide a continuous supply of mortgage credit for U.S. homebuyers in all economic environments. To accomplish this has required us to accept this challenge: expand our investor base with financing that meets investors' varying needs while also managing our risk. To this end, Freddie Mac developed a combination of short-term debt, long-term callable and non-callable debt and other financial instruments that enable us to manage the interest-rate risk of debt-funded mortgages. By using both mortgage-backed securities and debt to finance our mortgage purchases, Freddie Mac is able to provide a stable supply of low-cost mortgage money.
Debt, in particular, has enabled Freddie Mac to expand the investor base for America's housing worldwide. International investors have little experience with long-term, fixed-rate mortgages, which are largely unavailable outside the U.S. They prefer the certainty of debt's fixed payment schedule. As a result, Freddie Mac's use of debt to fund mortgage purchases attracts additional investors and brings greater stability and liquidity to the U.S. mortgage market, making housing more affordable for the nation's families.
In the fall of 1998, for example, international capital markets were in turmoil. In many markets, credit was expensive and hard to get. Freddie Mac provided liquidity and stability to the mortgage market by purchasing mortgage securities for our debt-funded retained portfolio. As a result, there was no disruption to the mortgage market we serve. This was confirmed by the Capital Economics report referred to earlier, which concluded that Freddie Mac and Fannie Mae stabilized residential mortgage rates during the international financial crisis of 1998 by providing liquidity to the secondary market for conforming home loans.
MYTH: Freddie Mac Dominates the Mortgage Market
REALITY: The U.S. Mortgage Market Is Highly Competitive
The United States enjoys the best mortgage finance system in the world. Every single day America's families are served by a system that works to make their housing dreams a reality. The housing finance system works so well that its infrastructure is virtually invisible to most consumers. Behind every mortgage is a highly competitive, intricate network that links together thousands of mortgage lenders, loan servicers, mortgage insurers and secondary market entities.
A wide range of lenders compete daily to originate mortgage loans in the primary market. Federally insured banks, savings and loan associations and credit unions and mortgage bankers, finance companies and other financial services companies compete to attract homeowners and homebuyers who want a mortgage loan. Private insurance companies compete with federal agencies such as the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) to provide coverage for the risks attendant with certain mortgage loans. Secondary market entities, such as Freddie Mac and Fannie Mae, compete against each other as well as against Ginnie Mae, the Federal Home Loan Banks, federally insured depository institutions and other financial service providers to fund mortgage credit.
No single institution or group of institutions dominates the housing finance system. Fierce competition and changing market conditions work to create a dynamic and fluid system where the relative roles of the different participants can--and do--change dramatically from period to period.
The constantly changing and intensely competitive mortgage market environment in which Freddie Mac operates is reflected in dynamic changes in our market share. For example, in 1990, Freddie Mac's purchase share of total conventional single-family mortgage originations was 15 percent; this rose to 25 percent in 1993 as millions of homeowners refinanced their mortgages. By 1997, however, the refinance boom had passed, and Freddie Mac's share fell back to 15 percent. It is hardly the case that we dominate the market.
The truth is that because of Freddie Mac there is more competition in the industry than ever before. Thousands of lenders in the mortgage banking industry are able to compete to make mortgage loans to homebuyers because there is a secondary market able to fund those loans. The entry of new mortgage lenders using electronic commerce to expand homeownership opportunities demonstrates that the mortgage industry is still highly attractive and competitive.
IV. COMMENTS ON H.R. 3703
Let me now turn to the specifics of H.R. 3703, the Housing Finance Regulatory Improvement Act, which would amend the regulatory framework Congress created for Freddie Mac and Fannie Mae in 1992. As I stated at the outset of my testimony, Freddie Mac shares Chairman Baker's desire for a strong, independent and effective safety and soundness regulation for Freddie Mac. We believe, however, that the best means of ensuring this outcome is to let OFHEO complete its risk-based capital regulation. We have concluded that a number of the provisions in the bill would delay implementation of risk-based capital, stifle innovation and increase costs for homebuyers and renters.
Proposal to Consolidate Regulatory Oversight
H.R. 3703 would reorganize the regulatory oversight of Freddie Mac and Fannie Mae, creating a single regulator with both safety and soundness and mission oversight duties. The bill also would confer on this same regulator responsibility for overseeing the Federal Home Loan Bank System. We have several concerns about whether this consolidation proposal would enhance our regulatory structure.
First, this is not the right time to consider fundamental changes in regulatory oversight. With respect to safety and soundness, the highest priority should be the implementation of risk-based capital regulations. OFHEO is close to finalizing regulations that will be the toughest, most sophisticated capital regulations in the financial services industry. Congress should permit OFHEO to complete this work. H.R. 3703 could delay the implementation of final risk-based capital regulations just as OFHEO is finalizing its regulations. Moreover, implementation of a final risk-based capital rule will give Freddie Mac clarity regarding the amount of capital that should be held relative to certain business activities.
Second, by combining regulatory oversight of Freddie Mac and Fannie Mae, on the one hand, and the Federal Home Loan Bank System, on the other, the bill would not achieve the legislative intent of regulatory efficiency, effectively requiring the creation of two, separate regulatory regimes housed under one roof. The Federal Home Loan Bank system has entirely distinct statutory authorities and purposes; entirely distinct capital standards and profiles; entirely distinct risk management profiles and capabilities; and distinct approaches to the use and volume of non-mortgage investments. As a result, consolidation would not provide the benefit of regulatory efficiencies and could compromise focus on Freddie Mac's and Fannie Mae's safety and soundness.
Proposals Regarding Regulatory Controls on Business Activities
The bill also would rewrite the existing regulatory requirements relating to Freddie Mac's business activities. These provisions depart significantly from the regulatory framework established in 1992. The 1992 Act requires strong regulatory oversight yet ensures that the regulator does not stifle innovation by needlessly intruding on Freddie Mac's secondary market operations. Our ability to respond appropriately and effectively to rapid developments in the mortgage and capital markets is essential to our success in lowering the cost of mortgage credit for millions of families. Thus, Freddie Mac believes that, so long as we are adequately capitalized and our business initiatives are statutorily authorized and further our public purposes, regulatory intrusion in our business should be limited.
Burdensome Review of New Activities. H.R. 3703 contains a provision that would revise the process that Congress established in 1992 for regulatory review of new mortgage purchase programs. Freddie Mac believes the existing process provides for appropriate regulatory oversight while ensuring that unnecessary regulatory delay or micromanagement will not prevent Freddie Mac from responding to the ongoing needs of the mortgage and capital markets.
H.R. 3703 would create a burdensome regulatory oversight process that would impose significant costs and delays on new activities. The provision is flawed in many respects. Among other things, it would broaden the scope of review to encompass virtually every activity and business process that we undertake. Moreover, Freddie Mac would be obligated to await public comment and hearings before implementing any business plans. The result would be the stifling of innovation in the mortgage marketplace and the impeding of our ability to respond to the market. Last, this provision would be totally inconsistent with the direction of other financial services legislation and regulation that have sought to minimize unnecessary regulation and intrusion on business activities.
Unnecessary Regulation of Non-Mortgage Assets. H.R. 3703 also would require promulgation of new regulations governing Freddie Mac's non-mortgage assets. However, both of our oversight regulators already are authorized to act in this area and already are exercising that authority. Every non-mortgage investment Freddie Mac makes directly assists us in fulfilling our statutory purpose. These investments constitute a small but essential part of how we meet our mission. They are highly liquid and high quality. We hold these investments to manage the billions of dollars in cash flows we handle every month and to provide a diverse source of liquidity to ensure that we can purchase mortgages under a wide variety of financial conditions.
Both HUD and OFHEO already possess the authority under current law to oversee our investment activities effectively. HUD has required us to submit information on these investments for purposes of conducting mission oversight. OFHEO examines our investment activities as part of its safety and soundness oversight responsibilities and has concluded that our activities are safe and sound. Because HUD and OFHEO are appropriately exercising their existing authority in this area, additional regulation is not necessary.
Proposal to Repeal the Treasury's Securities Purchase Authority
I'd like to address the recommendation to repeal the Treasury's authority to purchase $2.25 billion of Freddie Mac and Fannie Mae securities. This provision would repeal a critical component of the framework that Congress established to support homeownership.
As you know, in March 2000, the Under Secretary of the Treasury testified in support of repeal of this provision as "consistent with the Congressional requirement that all GSE securities carry a disclaimer that they are not backed by the U.S. government."(15) This statement resulted in serious disruption in the mortgage-backed securities and debt markets. These events demonstrate the importance of careful consideration of the consequences of any real or perceived change in a well-established policy, since these types of proposals can unintentionally damage the housing finance system and increase the cost of homeownership.
First, it is important to understand what the Treasury's authority is and is not. This authority is often mistakenly referred to as a "line of credit." In fact, it merely authorizes Treasury to purchase up to $2.25 billion of our obligations - solely at the Treasury's option - to provide liquidity to the mortgage markets. Treasury has never exercised this authority. Given the rigor of our safety and soundness controls and the strength of our capital base, it is extremely unlikely that the Treasury ever would need to consider exercising this discretionary purchase authority.
However, we believe Treasury's purchase authority has important value. An examination of the legislative history shows that Congress, in adopting the provision, intended to signify that homeownership is a national priority and that Freddie Mac's accomplishments in providing low-cost mortgage money to the housing finance system enjoys the support of Congress. Furthermore, the purchase authority is one component of an intricate and longstanding framework that has allowed for the development of the best mortgage finance system in the world. In repealing this provision, Congress runs the risk of uprooting the overall framework and thereby increasing costs to homebuyers. We, therefore, cannot support repeal of the Treasury's discretionary purchase authority.
Other Proposals
Financial Disclosure. Freddie Mac believes that our financial disclosures regarding the risk of our business activities, including our management of interest-rate risks, are among the most transparent in the financial services industry. Section 103 of H.R. 3703 would authorize the regulator to issue regulations to make public information that it determines would increase the efficiency of the secondary mortgage market. We find the new financial disclosure requirements problematic and agree with Under Secretary Gensler, who recognized in his testimony that this provision fails to recognize that some data are proprietary and would not be appropriate for public disclosure.(16)
Fundamentally, we do not believe that the sweeping regulations required by H.R. 3703 are necessary because Freddie Mac already takes extraordinary steps to ensure that investors and market participants have all the information necessary to evaluate our business practices and results. Freddie Mac publishes substantial and extensive information that is comparable to what would be required for an SEC-registered company.
We recently retained PricewaterhouseCoopers to independently compare the completeness and transparency of our risk management disclosures to a group of large financial institutions whose financial disclosures are considered "best in class," or "best practices." PricewaterhouseCoopers found Freddie Mac's periodic risk management disclosures to be among the best of the disclosures made by this exemplary group.
Rating Agency Reviews. The bill also would require annual reviews and a credit rating by two rating agencies that would be included in an annual report to Congress. We support a role for rating agencies in the regulatory process, since they can provide valuable supplementary information for the regulator to consider in their assessment of the safety and soundness of an enterprise. In fact, the 1992 Act already allows OFHEO to obtain these ratings. We do have some concerns, however, regarding whether it is appropriate to make public the rating.
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Thank you for the opportunity to appear today. Freddie Mac is a great Congressional success story. We look forward to working with Chairman Baker, Representative Kanjorski and Members of this Subcommittee to ensure that the Congress has confidence that Freddie Mac is meeting our very important mission in a safe and sound manner. We are committed to making the world's best housing finance system even better for future generations of America's families.
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1. As the Senate Committee on Banking, Housing and Urban Affairs
observed in 1992: "Congress created [Freddie Mac] under private ownership and
management to bring the entrepreneurial skills of the private sector to bear on the
accomplishments of public purposes relating to housing," Senate Report No. 282, 102nd
Cong. 2nd Sess at 25 (1992).
2. 12 U.S.C. § 1451.
3. Cotterman, Robert F. and James E. Pearce, "The Effects of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation on Conventional Fixed-Rate Mortgage Yields," in Studies on Privatizing Fannie Mae and Freddie Mac, ed. by U.S. Department of Housing and Urban Development, 97-168 (1996).
4. The Wall Street Journal, W14.
5. The most common mortgage: in the United Kingdom has a 20 percent downpayment and the interest-rate adjusts at the lender's discretion; in France requires a 30 to 40 percent downpayment on a fixed-rate mortgage; and in Japan has a subsidized mortgage interest rate but requires a downpayment of 40 percent or more. Ellen Roche, "Loans Around the World," Secondary Mortgage Markets, April 1997.
6. "An Economic Analysis of Freddie Mac's (and Fannie Mae's) Contribution to Liquidity in the Residential Mortgage-Backed Securities Market During the Credit Crunch of 1998," Capital Economics, May 2000 (emphasis in original).
7. "Who Can Afford to Buy a House in 1995", by Howard Savage, U.S. Census Bureau, Current Housing Reports H121/99-1, August 1999, Table 5-3.
8. These numbers refer to purchases eligible for reporting to HUD for affordable housing goals. Freddie Mac's total 1999 purchases were $272 billion. "We Open Doors to America's Housing," Freddie Mac's Annual Affordable Housing Report for 1999, March 15, 2000.
9. The share of Freddie Mac's purchases of loans serving minority families essentially mirrors the share of loans serving minority families originated in the primary market, when appropriately measured. Freddie Mac's performance in serving minority families is often evaluated using Home Mortgage Disclosure Act (HMDA) data. These comparisons create a misleading and inaccurate impression about Freddie Mac's service to minority borrowers - particularly African-American and Hispanic borrowers - for a number of reasons. First, HMDA data include manufactured housing and subprime loans that are not generally purchased by Freddie Mac, which have disproportionately high shares of African-American and Hispanic borrowers. In addition, HMDA data include low-downpayment loans without mortgage insurance, which Freddie Mac generally cannot buy. It is simply not accurate to compare our purchases with data that include these sectors of the primary market.
10. 12 C.F.R. §226.32 (1999).
11. "Freddie Mac's announcement today puts the subprime lending industry on notice that there is no secondary market for predatory loans. By saying 'no' to loans with single-premium credit insurance, 'yes' to timely payment reporting, and by monitoring lender practices, Freddie Mac will further help homeowners build wealth for themselves and their families, and not unscrupulous lenders." Statement of Rep. David E. Price; "I am pleased that Freddie Mac is taking these steps, which will help reduce abusive and unfair home lending practices. Helping create an environment that discourages abusive practices that strip wealth and equity from homeowners who can least afford it will help strengthen neighborhoods throughout our country." Statement of Sen. Paul Sarbanes, the Ranking Democrat on the Senate Banking, Housing and Urban Affairs Committee, March 24, 2000; "The bottom line is that Freddie Mac is committing to bring responsible lending to the most vulnerable homeowners in the mortgage market. I especially commend Freddie Mac for its leadership stand on upfront credit insurance, one of the largest causes of home foreclosure in America today." Statement of Martin Eakes, President and CEO of the Self-Help Credit Union and national spokesperson for the Coalition for Responsible Lending, "Freddie Mac Announces Steps to Protect Borrowers from Predatory Lending Practices," March 24, 2000.
12. The 1992 Act requires Freddie Mac to meet a state-of-the-art risk-based capital standard that requires us to pass a stringent economic stress test. Under this test, Freddie Mac must hold sufficient capital to withstand a 10-year period during which credit losses equal, on a nationwide basis, the worst actual two-year regional experience. In addition, capital must be sufficient to survive interest-rate fluctuations of up to 600 basis points - greater interest-rate volatility than ever experienced by Freddie Mac in our 30-year history. Beyond this, Freddie Mac must hold capital of an additional 30 percent above the stress test level to absorb any possible management and operations risk.
13. "Thrift Industry Analysis: Implications of Risk-Based Capital Stress Test Requirements," IPS-Sendero, August 19, 1999.
14. L. William Seidman, Jacqueline Pace and David S. Chung, "Analysis of OFHEO Risk-Based Capital Standard," Memorandum to Freddie Mac, March 29, 2000.
15. Treasury Under Secretary Gary Gensler, House Banking Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises, March 22, 2000.
16. Ibid.