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We are also increasing our presence in the rural multifamily market. This area of the multifamily market has traditionally been the province of Federally sponsored programs, because most primary market lenders find it unprofitable

to originate conventional mortgages on small, rural multifamily properties, but Federal budget cuts have diminished the amount of credit available to these properties. We have recently committed that this year we will buy loans to fund preservation and rehabilitation of properties financed in the past with loans made by the Rural Housing Services, while leaving the low-cost RHS loans in place. We are working with RHS to expand our activities in this underserved sector.

Another area in which we have been increasingly active is the market for small (5–50 unit) apartment loans, an area of the multifamily market that is important source of affordable housing and which HUD has previously identified as underserved by the secondary market. Last year alone, we financed about 180,000 units in about 12,500 small multifamily properties. Like other small properties, 5–50 unit mortgages are expensive to underwrite, and as a result most of our purchases came through portfolio transactions with large lenders specializing in these properties. We are using the knowledge gained from these purchases to help us better understand their special characteristics, with the aim of bringing efficiencies and liquidity to this sector and increasing sources of credit for these properties.

As many witnesses have stated before this Committee during the last several months, Mr. Greenspan testified on February 24, 2004 that it is crucial to have an appropriate and thoughtful process for GSE liquidation in the case that a GSE fails. He not only argued that it was important on safety and soundness grounds, but also that it was one of the few credible ways that Congress could combat the impression in the investment community that the Federal Government will bail out the GSE's in the event of a crisis. Chairman Greenspan emphasized the current conservatorship authority of OFHEO as evidence that Congress will bail out the GSE's with taxpayer funds if one of them fails. Q.4.a. Do you believe that the current OFHEO conservatorship authority helps reinforce the impression that the Federal Government will bail out the GSE's in a crisis? Why or why not? A.4.a. We believe that the conservatorship provisions of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the 1992 Act) help reinforce the impression that the Congress has reserved for itself the full range of resolution options in the event a GSE were to experience significant financial difficulties.

The conservatorship provisions of the 1992 Act are designed to allow the conservator to operate a GSE that is experiencing extreme financial distress as a going concern. These provisions contain no mechanism for the use of taxpayer funds to resolve an insolvent GSE; rather, the conservator must use funds generated by such a GSE's business operations to pay the GSEs' creditors.

The Congress carefully constructed the conservatorship provisions of the 1992 Act in recognition of the unique role of the GSE's in expanding, and lowering the cost of, homeownership. In passing the legislation that created the current regulatory oversight structure for the GSE's, the Senate Banking Committee stated,

This judgment takes account of the important role that the Enterprises play in our Nation's economy and their central role in the functioning of the residential housing finance sector of the economy. The Enterprises are clearly distinguishable from even the largest insured depository institutions, each of which may cease to be able to compete as a provider of financial services with varying degrees of economic impact. If the appointment of a conservator for an Enterprise were ever to become imminent, the Congress would have the opportunity to consider the reasons for the Enterprise's condition and the options then available to address that condition. S. Rep. No. 282, 102d Cong., 2d Sess.

26 (1992). While we cannot represent what an individual investor or investors as a group might think, the current conservatorship provisions together with the legislative history contemplate that the Congress would decide how best to resolve an insolvent GSE in the unlikely event of extreme financial distress.

In addition, as required by law, all of the Freddie Mac's obligations and securities state clearly and conspicuously in bold type that they are obligations of Freddie Mac only, and are not guaranteed by, or debts or obligations of, the United States or any agency or instrumentality of the United States. Q.4.b. If it does, how can the liquidation authority for the housing GSE's be clarified in order to combat the investor impression that the GSE's will be bailed out with taxpayer funds in a crisis, while at the same time, ensuring that the housing mission of the GSE's is not unduly harmed in the process of liquidation? If it does not, do you think it is appropriate for Congress to make any changes to the current OFHEO conservatorship authority? Why or why not? A.4.b. We believe that current law provides ample conservatorship powers for restoring an insolvent GSE to sound financial condition. A conservator appointed for such a GSE has all the powers the shareholders, directors, and officers of the GSE have to operate the GSE as a going concern. For example, a conservator may pay a GSE's creditors to the extent that funds may safely be made available for this purpose.

It is imperative that the GSEs' regulatory structure provides rigorous oversight and ensures the continued safety and soundness of the GSE's. Strong, credible regulatory oversight is key to preventing financial difficulties that could lead to the need to appoint a conservator.

Although we believe that current law contains sufficient conservatorship powers, we would be willing to consider whether these powers could be enhanced to make sure the Congress, the public, and investors are confident in our safe and sound operation. Q.5. In his testimony, Chairman Greenspan reiterated his opinion, albeit admittedly minority opinion, that Fannie and Freddie should be privatized. Do you think that the GSE's should be privatized? Why or why not? How do you think it would affect the housing market and the Nation's housing finance system if Fannie and Freddie were privatized. Please elaborate. A.5. We do not support privatizing the housing GSE's. To do so would effectively dismantle a proven housing finance system in exchange for uncertain benefits. Advocates of privatization set forth several arguments, none of which make a convincing case.

First, privatization advocates believe Government sponsorship is no longer needed to attract capital to housing or to provide an abundant supply of 30-year, fixed-rate, prepayable mortgages. This optimistic view contradicts the experience in other developed countries. In Canada, for example, homebuyers typically are restricted to a 7-year fixed-rate mortgage, must make a 25 percent downpayment, and are locked into higher interest rates or have to pay heavy penalties if they wanted to prepay.

This view also ignores our own jumbo market, which is not served by the GSE's. 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). 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 longterm. 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 moderate-income families to become homeowners.

This sanguine view of markets also ignores 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 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. 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 in-
creased at a fairly steady pace rather than declining as has

been typical in past recessions. The ability of the GSE's to purchase record amounts of mortgages during the past several years is a principal reason why the housing market remained strong in an otherwise weak economy. Privatization advocates have yet to demonstrate who other than the GSE's would be able to provide such high amounts of liquidity regardless of economic or market conditions.

Third, privatization advocates raise concerns 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. For every mortgage Freddie Mac guarantees, whether it is securitized or held in the retained portfolio, there is approximately 40 percent collateral behind the loan in the form of homeowner equity. We actively manage interest-rate risk and other related market risks and take a disciplined approach to risk management. Freddie Mac strives to substantially match the duration of our assets and liabilities. Throughout 2003, for example, a period of extreme turbulence in financial markets, Freddie Mac's duration gap remained low. Moreover, mortgage debt and the risks of investing in it would not 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 (such as Federally insured depositories), 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.

In other words, we believe that those who call for privatization have not begun to demonstrate how this would be better for homeowners, the housing finance system, or the economy. Q.6. It is my understanding that Freddie's compliance with the Securities and Exchange Act of 1934 is being delayed due to its ongoing revisions of its financial statements. Freddie is expected to release its revised earnings sometime soon. Have you communicated with the SEC regarding when you expect to come into compliance with the Securities and Exchange Act of 1934? When specifically do you believe that you will be able to do so? A.6. Our most pressing priority is to bring Freddie Mac's financial statements current. On November 21, 2003, the Freddie Mac Board of Directors and management team announced the release of the company's restated and revised financial results for the years 2000 through 2002. The restatement was a significant step in Freddie Mac's progress toward achieving accurate and timely reporting. In addition, we issued our annual report for 2002 on February 27, 2004 and will hold the related annual stockholders' meeting on March 31, 2004.

We intend to return to timely financial reporting as soon as possible. However, we currently are not able to predict when we will do so. Significant revisions to our accounting systems are necessary to implement the revised accounting policies adopted in connection with the restatement, as well as new accounting guidance applicable for 2003, so that those accounting systems can fully support the preparation of consolidated financial statements in accordance with GAAP. As a result, the public release of our 2003 financial results has been delayed. Our objective is to release combined quarterly and full-year 2003 results by June 30, 2004 and to provide our 2003 annual report and hold our related stockholders' meeting as soon as practicable thereafter. However, there can be no assurance that we will meet this objective.

We have been in ongoing discussions with the Securities and Exchange Commission (SEC) on various issues since our initial announcement that we would register our common stock with the SEC under the Securities Exchange Act of 1934. SEC rules require us to bring our financial statements "current" before we can finish the process of becoming an SEC registrant. We will complete our voluntary registration with the SEC after we return to timely financial reporting. Q.7. Some witnesses before the Banking Committee have recommended placing your new regulator in the Department of the Treasury and letting it have oversight over the GSEs' housing mission, as well as their safety and soundness. However, are you aware that in an October 1, 2003 letter, Treasury gave notice to the National Cooperative Bank, a private nonprofit corporation originally created by Congress that has been and still is extensively involved in financing affordable housing that it was intending to increase the interest rates of its long-term loan by 700 basis points? If enacted, that interest rate would have been devastating to the affordable housing mission of the National Cooperative Bank. Doesn't this letter, at a minimum, demonstrate a desire by Treasury to promote safety and soundness to the determent of the National Cooperative Bank's housing mission? Why or why not? A.7. We have not seen the letter you cite and are not familiar with the issue involving the National Cooperative Bank, so we cannot knowledgeably comment on it. However, to address the general concern you are raising, we would like to reiterate points we made in our testimony on establishing an effective regulatory oversight structure for the GSE's.

World-class regulatory oversight is critical to the achievement of Freddie Mac's mission and to maintaining the confidence of the Congress, the public, and financial markets. Freddie Mac strongly supports the enactment of legislation that provides strong, credible regulatory oversight. Accordingly, the new GSE regulatory structure must: • Engender public confidence through world-class supervision and

independence;

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