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Our Role Enables the Availability of the 30-
year Fixed-rate Mortgage
As you can see in Exhibit 8, there is a dramatic increase in share of adjustable-rate
In many bank-based systems in other countries, consumers only have access to the
By making the long-term, fixed-rate mortgage more affordable and more available to
homeownership more affordable and more available in communities around the nation. I believe that Congress can build on that success, strengthening our regulatory regime to enhance our ability to achieve our mission and benefit millions of families in the future.
PREPARED STATEMENT OF RICHARD F. SYRON
FEBRUARY 25, 2004
Prior to joining Freddie Mac, I was Executive Chairman of Thermo Electron Corporation, an S&P 500 firm with 11,000 employees. Prior to that, I held a number of positions, including the Chairman and Executive Officer of the American Stock Exchange, President and Chief Executive Officer of the Federal Reserve Bank of Boston, and President and Chief Executive Officer of the Federal Home Loan Bank of Boston. I also served as assistant to then-Federal Reserve Chairman Paul Volcker, and earlier as Deputy Assistant Secretary for Economic Policy of the U.S. Department of the Treasury.
It is a great privilege to lead Freddie Mac, which plays such a critical role in financing homes for America's families—and providing strength and resiliency to America's economy. I could pire to no greater legacy than to restore public trust in an institution chartered by Congress to ensure the stability and liquidity and accessibility of the Nation's mortgage markets.
The issue of regulatory oversight reform of the housing Government Sponsored Enterprises (GSE's) is vitally important to our Nation's economy and to homeowners. My views on this important topic have been profoundly shaped by my experiences as a former regulator. My firm belief that capital should be tied to risk stems directly from my tenure at the Boston Federal Reserve, where I was deeply involved in restructuring New England's banking system following the credit strains of the late 1980's and early 1990's. My views on homeownership, however, have more personal roots. I grew up in Boston in a two-family home financed by a VA loan that my father was able to obtain when he returned from World War II.
Today, in my comments to this Committee, I will focus on three areas: • Why GSE's exist-and what they have accomplished; • The imperative of regulatory oversight reform; and • My top priorities for Freddie Mac, particularly how we are remedying our past
accounting errors. Why GSE's Exist and What They Have Accomplished
One advantage of being a newcomer is the ability to ask provocative questions and there is no more provocative issue in the housing world than the role of the GSE's and the benefits they bring. Since arriving at Freddie Mac just 8 weeks ago, this question has been vigorously discussed in the halls of Government, by national think tanks, in newspapers-and just yesterday in this chamber by Alan Greenspan.
I approach this question from the perspective from what we know that is, the current system of housing finance and its known benefits—and weigh it against what we do not know, that is, what housing finance would look like without the GSE's.
What we know is based on 70 years of mortgage history. In the aftermath of the Great Depression, Congress chose to provide explicit Government insurance to both the housing and banking industries to entice investors back to housing. While the plan worked, it also put the government directly on the hook for the risks associated with loaning individual homebuyers large sums of money for long periods of time. Mortgages carried significant credit risk because of the differences in the ability of borrowers to repay their loans. However, interest-rate risk was more vexing. Even if a borrower did not default over the course of 30 years, money would be tied up in a fixed-rate asset whose value was subject to the vagaries of interest-rate movements over prolonged periods.1
To address this issue, Congress found an ingenious way to stimulate long-term investment in housing without exposing the public fisc to the risk of substantial loss: Create financial institutions with a limited nexus to the Government and give them the singular job of making markets stable and liquid, at all points along the business cycle.
The GSÉ model of housing finance has been a Congressional success story. By providing attractive returns on capital, the GSE's have proven to be effective man
1 These risks are real: Recall the huge credit losses that resulted from the "oil-bust" in the early 1980's, and the taxpayer bailout of the S&L's, which were in the untenable position of holding 6 percent mortgages in an 18 percent interest-rate environment.
agers of the credit risk of the mortgages they buy. Further, by maintaining exclusive focus on the residential mortgage markets, as required by law, the GSE's have developed extraordinary expertise in understanding the credit characteristics of borrowers. This has resulted in a steady lowering of downpayment requirements within the conventional market to the point at which the GSE's, with no explicit subsidy, are able to provide nearly the same benefit to borrowers as the Government provides through its on-budget FHA and VA mortgage programs.
Management of interest-rate risk also has been a notable success. Through the creation of mortgage-backed securities, the issuance of callable debt and the use of derivatives, the GSE's routinely and efficiently transfer interest-rate risk from individual households to global capital markets. Not only do the GSE's make it possible for originators to lend money to individual homeowners for long periods of time at better rates than many corporations can borrow, but they also permit borrowers to "put" the mortgages back whenever they desire to do so and at no penalty. This extremely valuable option makes the 30-year, fixed-rate mortgage the product of choice among U.S. homeowners; in 2003, 82 percent of all conforming purchasemoney originations were fixed-rate mortgages. Homeowners were able to profit from falling interest rates by refinancing into lower-cost loans, adding billions of dollars to our economy. Prepayable mortgages also help diminish friction in our economy by facilitating the mobility of the Nation's labor markets.
These innovations in mortgage financing made possible by the GSE's produce valuable benefits. Low-cost mortgage money is readily available. Families can get their loans approved in minutes. (In fact, during this hearing, Freddie Mac likely will have financed mortgages for about 2,000 families.) Today, more people own homesand higher quality homes—than at any time in our Nation's history and than in virtually any other part of the world.2 And wealth created through homeownership will help bear us into old age, taking some of the burden off Social Security and allowing us to pass something along to the next generation. Not a bad track record for Congressional inspired institutions that need no budget authority, pay significant Federal taxes, and employ thousands of people.
In United States, we tend to take these benefits for granted. However, very few countries can boast of such an efficient and effective mortgage delivery system.3 Despite the integration of world capital markets, the United States is still the only place where a long-term callable mortgage product is broadly available. Countries that want to provide long-term prepayable mortgages to their own citizens are considering creating GSE's. The European Union is currently considering the creation of a GSE-type agency to "enable lenders to provide their existing mortgage products at better prices and introduce long-term, fixed-rate mortgages without redemption penalties.”
Let us now consider U.S. housing finance without the GSE's. There are three key arguments I would like to address.
First is the view that Government sponsorship is no longer needed to attract capital to housing or to provide an abundant supply of 30-year, fixed-rate mortgages. This optimistic view contradicts the experience in other developed countries. That is, if homeowners in Northern New York or Washington State lived a few miles to the north in Canada, they would typically be restricted to a 7-year, fixed-rate mortgages, they would be locked into higher interest rates or have to pay heavy penalties if they wanted to prepay, and they would have to put 25 percent down.
This sanguine view of markets also reflects our collective amnesia about where we are in the credit cycle. History reveals that certain industries will slump, that certain regions will experience economic downturn, which, in turn, causes house values to fall and defaults to rise. We also know that with interest-rates at historic lows, the mortgages put on the books today, in all likelihood, will require financing for decades to come. In short, it is easy to dismiss the risks of mortgage lending when times are good.
GSE's were created precisely for those times when things are not going so well, however. GSE's absorbed significant losses during the oil bust in the 1980's and during the weakening of the economy in Northeast in the early 1990's. They also stabilized residential mortgage rates during the international financial crisis of 1998— and again after-September 11-by continuing to provide liquidity to the secondary
2 “As a result of the very favorable conditions in the housing sector, the U.S. homeownership rate climbed to 68.2 percent in the third quarter of 2003—equal to its highest level on record,” 2004 Economic Report of the President, p. 89.
3 Marsha J. Courchane and Judith A. Giles, “A Comparison of U.S. and Canadian Residential Mortgage Markets," March 2002.
4 Richard Adams, “Banks Back Cheaper Mortgage Plan,” The Guardian, November 17, 2003. 5 These percentages are based on data published by the Bureau of Economic Analysis, U.S. Department of Commerce for 1996 through 2003 and data for the same years available upon request from Freddie Mac.
market for conforming home loans. Their actions ensured that mortgage credit remained available and affordable.
A second argument concerns the allocation of capital to housing. The housing market has an enormous impact on the economy, directly accounting for more than one-third of the nominal growth in GDP over the past 3 years.5 And this does not begin to account for all the indirect support for consumption generated by record levels of refinancing in the past few years. Housing played an important countercyclical role in supporting the recent weak economy, as noted in the President's 2004 Economic Report:
Despite the similarities between the recent business cycle and previous ones, this most recent cycle was distinctive
in important and instructive ways. One noteworthy difference is that real GDP fell much less in this recession than has been typical . . . This relatively mild decline in output can be attributed to unusually resilient household spending. Consumer spending on goods and services held up well throughout the slowdown, and investment in housing increased at a fairly steady pace rather than declining as has been typical
in past recessions. 6 Finally, there are arguments about size and systemic risk. Residential mortgage debt outstanding grew at an annualized rate of 8.6 percent over the past decade. Not surprisingly, the GSE's also have experienced significant growth. But GSE size is not an accurate proxy for risk. On average, there is approximately 40 percent collateral in homeowner equity behind the loans Freddie Mac has guaranteed. Interestrate risk also is well-managed. Freddie Mac strives to maintain an extremely closely match between the duration of our assets and liabilities. Throughout 2003, for example, a period of extreme turbulence in financial markets, Freddie Mac's duration gap never exceeded 1 month.
Finally, there is no way that mortgage debt and the risks of investing in it would disappear by downsizing the GSE's or making other changes to the GSE charter. Rather, the burden of managing mortgage credit risk would shift from these institutions to those with explicit Government support, while interest-rate risk would shift onto individual households. Another likely outcome is that higher costs of conventional mortgage financing could cause borrowers to shift into the FHA market, thereby actually increasing Government subsidization of housing. For homeowners, restrictions on GSE growth likely would result in reduced availability of 30-year, fixed-year, prepayable mortgages and higher costs.
These uncertain benefits must be coupled with the potential risks of dismantling a highly efficient and successful housing finance system. We can get a glimpse of a world without GSE's by looking at the jumbo market. On any given day, it is possible to look in a newspaper and find that mortgage rates on conforming loans are regularly one-quarter of a percentage point lower than those in the higher-balance jumbo market. Borrowers in the jumbo market not only pay higher rates, but they are also more likely to have to settle for an adjustable-rate mortgage (ARM's).
ARM's have the obvious advantage of lowering monthly mortgage payments in the first few years of homeowning, but they require borrowers to bear the interest-rate risk on the loan-rather than the capital markets bearing this risk. This results in higher borrower defaults over the long-term. Jumbo borrowers also typically make larger average downpayments than conforming borrowers. Higher mortgage-interest rates and larger downpayments make it significantly harder for low- and moderateincome families to become homeowners.?
In summary, we are a Nation of homeowners—and from all I can tell, we want to keep it that way. While discussions of the optimal allocation of the Nation's capital have their place, I believe this Nation made the right decision 70 years ago to lend housing a helping hand. (You will have to excuse my passion on this subject, but homeownership was part of my Ph.D. dissertation 30 years ago.) Bi-partisan support for Federal housing policy has paid enormous dividends. Families build wealth. Kids do better in school. Neighborhoods are safer. And, in recent years, housing has been the backbone of our Nation's economy. Support for homeownership—whether explicit or implicit clearly has been good for this country.
But the task is not finished. There are millions of families still waiting to participate in the American Dream, and the homeownership gap between white families
6 2004 Economic Report of the President, pages 30, 32.
7 Roberto Quercia, George McCarthy, and Susan Wachter, “The Impacts of Affordable Lending Efforts on Homeownership Rates,” Journal of Housing Economics (Vol. 12, 2003), pp. 29–59,