Plus, as you pointed out and I hope some of the members can come this afternoon to our hearing on this subject, there are going to be alternative financing methods that are going to be needed. If you allow somebody to get into the business at this advantageous time, you won't even have to be too well managed to make out relatively better than somebody who had been performing a function that you asked them to perform in the past, namely, to lend out mortgage credit, under the then prevailing rates and types of mortgages.

Now, what concerns me about the competition and the timing is, aren't we really authorizing you to become that new kid on the block, just when it is most opportune or advantageous?

Mr. BRINKERHOFF. Well, let me answer your first question first and your second question second.

As to the issue of aren't we going to change the way that we do business after the restructuring, as I said, the major issue for us on the table is the capital to do our business.

The kind of business to which we have directed ourselves—as we were instructed by Congress when we were created-is the conventional loan market. That has been the main thrust of our business. The majority of the FNMA business has been the FHA-VA market. We do not intend to change our way of doing business. We do not intend to direct our activity to the FHA and VA market because FNMA and GNMA are there doing an adequate job.

If they want to move into our traditional market, we don't care, but we will not move into their traditional business.

FNMA has traditionally borrowed money. We go through the passthrough markets. We will not be competing with FNMA in the debt area. If they come to the passthrough market, which is our traditional mode of doing business, we say welcome into the marketplace.

We wouldn't be going their way in types of sellers or types of financing or types of loans purchased.

No. 2, on your issue of starting a new entity at this time, the Mortgage Corporation was started in 1970. We bought all of the same types of loans at the same rates over the entire decade of the 1970's that FNMA bought. The reason that our situations are different, primarily, is that we elected a different financing approach in that we sold the mortgages we bought over that period. There is nothing in FNMA's statute that precluded them from also selling the mortgages they bought. It chose managerially a different

course.

During the midseventies, the FNMA course yielded tremendously expanded profits over ours; they borrowed short and lent long. When our profits in 1975 were $15 million, their profits were $115 million after taxes.

We never asked Congress to hold them back. We chose managerially not to take the risks and exposures they took.

As a result, we now a profitable situation and they do not. I don't believe you have the situation where you are creating a new entity. We were subjected to all of the same risks during the seventies that FNMA was subjected to. We had no more protections than they had. We took a different fork in the road managerially and I don't think we should be penalized for that.

Moreover, I don't believe that it is in the interest of national housing policy to hold back an entity which is doing an effective job in the marketplace in light of another entity which took a different kind of approach.

Chairman GONZALEZ. Will the gentleman yield at this point?
Mr. LUNDINE. Certainly.

Chairman GONZALEZ. În a way, Mr. Brinkerhoff, that isn't quite accurately presenting the reality of what FNMA has to confront. It leads to one of the questions I intended to ask.

As you know, FNMA has the Secretary of HUD intervening and saying, "Now look, you have got to divert to low- and moderateincome housing markets." This is where the rub is.

FNMA is in a crisis situation; there is no question. So anything that is done here, whether through advertence or inadvertence, which permits you to come in to compete will actually trigger off a real ongoing crisis.

You are right that there is a difference between FNMA and FHLMC.

You are under no compulsion to serve the low and moderate income, which is the real area of need. These are the range of mortgages that are below $100,000. FNMA has to have them.

In fact, FNMA would like nothing better than to remove that. This is what I think your investment advisers were telling you about on Government regulation.

My question was going to be-and I think we raised this at our breakfast meeting-what objection would you have or would it be a crippling restriction to provide a similar restraint in the case of FMAC?

Mr. BRINKERHOFF. We have operated during the seventies under the exact same mortgage purchase provisions that FNMA has operated under. The issue of buying low- and moderate-income homes is one on which we share your concern.

I would like to share with you one bit of factual data that I think you will find of interest.

In 1977, 1978, 1979, and 1980, the average home purchase price on mortgages purchased by the Mortgage Corporation was less than the U.S. average price of existing homes and less than the U.S. average price of new homes in this country.

The Mortgage Corporation has been serving that portion of the market that is less than the average in this country for both new and existing homes. The issue of what segment of the population is served, low and moderate income versus high income, if you will, doesn't have anything to do with the question of how you finance those mortgages.

We have packaged and sold those low- and moderate-income mortgages through our PC just as we have packaged and sold any kind. That option was available to FNMA during the periods as well. The Secretary of HUD, I believe you will find in an analysis of their dialog over the years, encouraged FNMA to sell mortgage loans.

They did not say to FNMA, make low- and moderate-income loans and hold them.

They said, yes, go into the low- and moderate-income area, but on numerous occasions encouraged and directed the management of

FNMA to develop a program to sell mortgage loans of the same kind we have.

I don't believe, No. 1, they have purchased a greater percentage of low- and moderate-income mortgages than we have.

I don't think that posture precluded them in any way from developing the same kind of financial program we did.

Mr. WYLIE. Will the gentleman yield for a clarification?

You suggested that in effect what we are doing is creating a new savings and loan. I suggest that FNMA has acted like a savings and loan and is seemingly like an old savings and loan now.

FHLMC has acted more like a mortgage banker.

What we are really doing is expanding the role of the mortgage banker rather than creating a new savings and loan.

Mr. BRINKERHOFF. I think that is the point I am making when I answered Mr. Lundine and said we will not go into the areas of traditional FNMA service.

I think there is one more point relative to Mr. Lundine's question. As I said in my testimony, I truly, sincerely do not believe this activity will have a major negative impact on FNMA. I said I would submit for the record that analysis referred to earlier by the investment banker. I am also providing for the record an analysis of FNMA by Dean Witter.

[The Dean Witter analysis follows. The analysis of the investment banker requested by Congressman Lundine may be found on p. 252.]

*This Scenario is consistent with the current Dean Witter Reynolds economic outlook and represents our current best estimate. NM-Not meaningful

E-Dean Witter Reynolds estimate.

QUARTERLY EARNINGS OUTLOOK

Fannie Mae's actual and forecasted quarterly earnings per share are summarized below: (See pages 18-25 of this report for our detalled earnings model.)

ADDITIONAL INFORMATION ON COMPANIES MENTIONED IN THIS REPORT IS AVAILABLE ON REQUEST. The Information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed, and the giving of the same is not to be deemed an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities. COPYRIGHT 1982 DEAN WITTER REYNOLDS INC. 5 WORLD TRADE CENTER, NEW YORK, N.Y. 100

TELEPHONE (212) 524-2222

DEAN WITTER REYNOLDS INC.

SUMMARY AND INVESTMENT OPINION

The Federal National Mortgage Association (FNM or Fannie Mae) is the nation's largest purchaser of FHA, VA, and conventional residential mortgages. With total assets of about $61 billion, It ranks as the nation's fifth largest corporation. Chartered by Congress in 1938 for the purpose of providing a secondary market for newly issued FHA and VA mortgages, Fannie Mae became a stockholder-owned corporation in 1968. In 1970, Fannie Mae was granted approval to purchase conventional mortgages in addition to those backed by the government.

Fannie Mae's traditional method of operation had been to borrow short and Intermediate-term to finance the purchase of long-term fixed rate mortgages. This worked well during most of the 1970's, a period characterized by stable interest rates and a positive yield curve. The persistently high and volatile Interest rates that have prevalled since late 1978, however, have caused Fannie Mae's spread (the difference between the net yleid on mortgages and the average cost of debt) to continue to deteriorate, resulting in Increasing losses.

Fannie Mae's spread reached a high of a positive 61 basis points in May of 1978 and a low of a negative 186 basis points in October of 1981. At year-end 1981 the spread was a negative 157 basis points; the slight Improvement a result of lower short-term borrowing costs in November and December. Fannie Mae's annual earnings peaked In 1978 at $209 million, or $3.47 per share, with $0.97 earned in the second quarter of 1978, an all-time quarterly high. Earnings declined substantially in 1979 to $2.68 per share and then deteriorated to only $0.23 per share in 1980. These declines were a direct result of increasing interest rates, as the cost of borrowings increased more rapidly than the yield on the loan portfollo due to the mismatch in maturities. Compounding the problem was the fact that mortgage pay-offs diminished as rates Increased and housing activity slowed. As interest rates remained at record levels throughout 1981, Fannie Mae continued to be plagued with the problem of continually replacing low coupon maturing debentures with new debt at a substantially higher cost. The company reported losses in all four quarters - of 1981, for a net loss of $3.22 per share for the full year.

We have developed a detailed quarterly earnings model for Fannie Mae for each of the next eight quarters (calendar years 1982 and 1983) under two interest rate scenarios.

Scenario A-"Modestly Optimistic" (See Scenario A, Page 16)
Scenario B-"More Optimistic" (See Scenario B, Page 21)

For each of these two Scenarios, documentation is provided in the form of five tables:

Table 1-Interest Rate Forecast

Table 2-Income Statement Forecast
Table 3-Balance Sheet Forecast
Table 4-Cash Flow Forecast
Table 5-Spread Forecast

The most Important variable in the determination of Fannie Mae's earnings potential is the spread, and to a lesser extent, the growth in the mortgage portfolio and mortgage pay-offs.

The major Items Impacting the spread are the absolute level of interest rates, the volatility of rates, and the shape of the yield curve. Scenario A assumes rates trend downward slowly this year, but remain at a relatively high level In 1983. Under this Scenario, short-term discount notes average 13.4% In 1982, (versus 15.5% in 1981) and 12.0% in 1983. Scenario B assumes Interest rates trend downward more rapidly in 1982 and stabilize at a lower rate in 1983. Short-term discount notes are assumed to average 12.25% In 1982 and 10.0% in 1983.

Under Scenario A, the mortgage portfolio is assumed to grow 11.5% In 1982 (versus 7.4% In 1981) and 10.4% in 1983, with mortgage pay-offs at 3.2% for both years. For Scenario B, mortgage portfollo growth is estimated at 10.4% In 1982 and 8.2% In 1983, with mortgage pay-offs 3.6% in 1982, and 4.8% in 1983.