Richard F. Syron's Speech at the Housing Boston 2012 Conference on April 27, 2007

Prepared Remarks for Richard F. Syron
Chairman and Chief Executive Officer, Freddie Mac

Housing Boston 2012 Conference
Boston, Massachusetts
April 27, 2007

Thank you. I'm pleased to be here. It's always good to come back to Boston, especially at Tom's invitation. I still consider myself a Bostonian – and what a job Tom has done with the city!

I'm also delighted to see so many other old friends, including Chip Case. And it's an honor to share this podium with Chairman Barney Frank – who leads the House Financial Services Committee with wit, intelligence and bipartisanship.

Chip talked about three economic effects of the housing downturn. I want to focus on the essential role of housing finance in affordability, but also on its limitations. I'll also talk about the subprime market and what we're doing about it.

We're all here because we believe there's something special about housing. It's even more than a source of shelter and wealth creation. It builds stronger communities, better social outcomes and a stronger nation.

I believe most of us agree that the housing finance system has done a great deal for homeownership in this country. In fact, the United States has the most liquid and developed housing finance system in the world.

Freddie Mac and Fannie Mae play a vital role in this system. We have lowered costs, increased uniformity and fairness, and made the long-term, fixed rate, prepayable mortgage attractive and broadly available to millions of consumers. America is the only country in the world where this type of mortgage is broadly available. That's a huge advantage for us because this option helps to reduce house-price and economic volatility. And by providing more funding at times when other investors are pulling back, the GSEs – Freddie and Fannie – further support a stable credit supply and mitigate the boom and bust nature of the housing cycle.

Mitigate, but not eliminate. Even the U. S. housing finance system – by itself – can't do everything it's been asked to do recently. And what has happened in recent years with subprime mortgages in part reflects that.

Three factors came together to create the subprime dilemma. The first is a worldwide abundance of liquidity: domestic and international investors searching for yield, and willing to take on almost any risk to get it. A contributing factor has been securitization – an efficient and very good thing overall, but one which alters the system and changes incentives. This has become a transaction business.

The second factor is rapid home price appreciation: a long bull market resulting from a sustained period of relatively low interest rates and relative prosperity in much of the United States – especially along the coasts and in "success cities" such as Boston.

A year and a half ago you couldn't go to a cocktail party without someone telling you how much their house had gone up in value. Now they are telling you how they can't sell the place. Those two things are not unrelated.

The third factor is an active desire on all our parts to expand homeownership to a broader segment of the U. S. population. This is a laudable goal, in itself. While subprime borrowers don't fit any one mold, they are more likely than prime borrowers to be lower income or a minority. And with most U. S. household growth in the next decade coming from minorities and new immigrants, the goal of broadening homeownership is not only laudable, but vitally important.

For a time, this all worked. The lending frontier was expanded by allowing borrowers with blemishes in their credit history to obtain a mortgage loan. Between 2001 and 2006, the subprime share of originations more than tripled, reaching about 20 percent of lending in 2006. Here in Massachusetts, such lending also grew rapidly – with the subprime share of loans outstanding growing 55 percent in the last three years. And for a number of people, the same subprime products that today look so unwise got them successfully in the door.

Then the world changed. The yield curve twisted flat and then inverted, pushing interest rates up, especially for ARMs. Home prices rapidly stopped climbing and in some places – such as Boston – they started to fall. And for subprime borrowers facing a mortgage reset, the safe harbor of refinancing – once cushioned by house price appreciation and low rates – was no longer within easy reach.

It's tempting to identify this entire problem as subprime lending, laying all the blame on lax underwriting by lenders, and on borrowers who overstated their income for low documentation loans.

But in many ways the subprime dilemma is a symptom, fed by a variety of forces – particularly diminished housing affordability. And so we saw all kinds of layered risks in the market – teaser rate ARMs, no amortization or even negative amortization, stated income, you name it – to try and stretch mortgage money impossibly far. The underlying problem is that the gap between house prices and incomes had simply grown too large.

Consider what happened to housing affordability in the United States. Between 1995 and 2005, the median homeowner's income increased by 37% while the median home price grew 99%. In Boston, during the same period, the median homeowner's income increased by 35% while the median home price grew 128%. So as you can see, U. S. incomes strained mightily to keep up with house prices. And Boston fell behind even more.

Is there an economic model that can explain these developments? Speaking as an economist, prices are determined by demand and supply, each of which is determined by the interplay of income growth, interest rates, construction costs, and other factors. Using a simple regression framework, an economic fundamentals model can explain most – but not all – of the run-up in house values since 2000. For example, here in Boston, house values grew about one-third more than can be explained by changes in interest rates, local employment and construction costs.

That's a significant gap. And in truth, it was always unrealistic to think that mortgage innovations by themselves could stretch to cover the entire affordability gap between incomes and house prices. That's a bit like taking someone who needs to fly from Boston to San Francisco and putting them in a hang glider instead of a 747. They can stay aloft for a while under ideal circumstances – steady ridge lift, rising thermals, favorable winds. But as soon as conditions change from perfect, it's back down to earth and a possible hard landing for the borrower. And that's not the sustainable experience we all want homeownership to be.

The hard landing I'm talking about is foreclosure. And this is another phenomenon that tells us housing finance is only one part of a much larger story. For the U. S. foreclosure rate generally is not affected by the absolute level of house prices or interest rates. But it is affected by changes in the rate of growth in house values, which can generate either a home-equity cushion or erase all net wealth in the home. And markets where house values shot up and exceeded their true economic value – as may well have occurred here in Boston – are also vulnerable to a fall in value and a rise in foreclosures.

Of course, prior to foreclosure proceedings a loan must be in default – an event not triggered by mere declines in value. The most common default triggers are unexpected job losses or major illness, which we have found to be the primary hardship reasons in nearly two-thirds of all defaults. Once in default, house value declines do substantially increase the likelihood of foreclosure.

The three states with the highest foreclosure rates are Indiana, Ohio and Michigan – even though house prices there are some of the nation's lowest. California, a high-cost state, is nonetheless ranked low (around 40th) in the rate of foreclosures, because jobs and incomes remain strong. Massachusetts' middle-of-the-pack foreclosure rate confirms what you already know – that recent employment gains here have been less than robust.

The unemployment rate during the first quarter of this year averaged 5. 0 percent here, compared with 4. 5 percent nationwide, and payroll employment growth was only 1. 1 percent over the past 12 months – unfortunately, below the national gain of 1. 5 percent. With home values currently soft, foreclosure rates are poised to rise further – especially for subprime, which already accounts for the bulk of new foreclosures in Massachusetts.

So if it's a mistake to look at housing finance alone to make housing affordable, where else can we look for help? One obvious place is the supply side.

I recognize that's tough politically. Building more housing, especially near existing homes – now that's a hornet's nest. Nonetheless, we have to ask: Why does it cost so much, beyond the cost of land itself, to produce new housing units in highly desirable cities like Boston?

A number of researchers, including Ed Glaeser of the Kennedy School, have done interesting work here in Boston on the effects of zoning and other local restrictions on housing prices and new housing supply. They found that a quarter acre of land here is worth about 20 times more if it sits under a new home than if it extends the lot size of an existing home – and concluded that the right to build is itself worth a great deal. By their estimates, the "zoning tax" in Boston, as they call it, is over $140,000 per quarter acre.

Internationally, the Organization for Economic Cooperation and Development has come to similar conclusions. Looking at the United States and four other countries, it found that housing prices rose most where the man-made barriers to building new supply were highest.

I realize that here in Boston – far from drawing on a blank slate – we've got more than 350 years of history and development to deal with in urban planning. I'm simply encouraging us all to take a broad focus on this issue – as you are doing in this conference. And I applaud what Boston has done, under Mayor Menino's leadership, to develop more than 18,000 units of affordable housing in Leading the Way One and Two.

The truth is, making housing more affordable is going to take a full-court press from all of us. It will require contributions not only from housing finance, the supply side, and the many innovative approaches you are looking at – but also from broad public policy areas such as transportation, education, and other approaches to the burgeoning problem of income inequality that has left too many Americans with too little money to pay for housing.

Housing finance must remain part of the solution. But I do hope we can educate the public not to look solely to innovations in housing finance to cover the entire affordability gap. The subprime problem has shown the dangers of following that path.

So what can housing finance do to address the problems in subprime? And is there a special role for the GSEs – especially considering our very limited prior involvement in this market?

Last week, Freddie Mac announced that we will purchase up to $20 billion in fixed-rate and hybrid ARM products that will provide lenders with more and better choices to offer subprime borrowers. We are acting to assist families caught up in the subprime crisis and to make the market more stable and transparent for all borrowers. Our products – currently under development and due to be introduced by mid-summer – will limit payment shock by offering reduced adjustable rate margins; longer fixed-rate terms; and longer reset periods.

Last week's announcement continued a Freddie Mac tradition of responsible leadership to protect subprime borrowers. Two months ago, we became the first secondary market participant to announce that we will cease purchasing subprime mortgages that pose an unacceptable risk of excessive payment shock and possible foreclosure. In the future, we will only buy subprime loans and securities backed by such loans that qualify borrowers not merely at the teaser rate, but at the fully-indexed and fully-amortizing rate. Just as important, we will limit the use of low-documentation underwriting to help ensure that future borrowers will have the income needed to afford their homes. We also will strongly recommend that lenders collect escrow accounts for taxes and insurance, as is customary with prime mortgages.

Freddie Mac cannot force lenders to adhere to these standards. But we are convinced that doing so is both the right thing and the smart thing to do. All of us in the mortgage industry have to realize that the public is watching to see if we can put consumer interests and sound underwriting ahead of short-term profits.

The subprime dilemma also reminds us of a basic truth. We need to broaden our focus from increasing homeownership – which will always be an important goal – to the broader concept of sustainable homeownership. And that means developing homes that families can afford to buy and keep.

Toward this end, Freddie Mac has provided leadership in three areas:

Homebuyer Education: After looking at the performance of some 40,000 loans, Freddie Mac learned that homebuyer education is an effective way to foster long-term homeownership success. But one of the problems we encountered was a lack of high quality credit education materials.

So we developed a credit education curriculum called CreditSmart®, which is designed to give consumers information on avoiding credit traps and establishing good credit, the benefits and responsibilities of homeownership, and the steps to homeownership. We have extended the reach of this award-winning program by developing bilingual versions, CreditSmart Español® and CreditSmart Asian®, and we provide support for organizations that want to bring these programs into their communities.

Anti-Predatory Lending Initiatives: Freddie Mac has long been a leader in working with our customers to combat predatory lending. We don't do business with institutions that engage in predatory lending practices. We don't invest in mortgages that require mandatory arbitration or single-premium credit insurance. And we refuse to invest in mortgages with excessive costs or fees, or in subprime mortgages with prepayment penalty terms exceeding three years.

We also attack this problem with information designed to help borrowers make good mortgage choices. Our Don't Borrow Trouble® consumer awareness campaign helps families avoid deceitful lending practices and predatory lending, such as exorbitant interest rates and excessive fees.

It's important to note that Don't Borrow Trouble was developed right here in Boston – under the leadership of Mayor Menino. It's the kind of smart local experimentation that succeeds, grows and is worth celebrating. Today, this program has assisted more than 100,000 consumers – and it's working in some 50 communities nationwide.

Foreclosure Prevention: Finally, Freddie Mac has taken innovative steps to prevent foreclosure over the years. These range from our development of automated tools in the 1990s to identify distressed loans and underwrite borrowers for workouts, to our research today on the use of credit counselors for borrower outreach.

In recent years, we have confirmed that appropriately underwritten workouts with eligible borrowers can lower the odds of home loss through foreclosure by up to 80 percent overall, and by 68 percent among low-and-moderate income borrowers. We view our foreclosure prevention policies and tools as key parts of our effort to foster sustainable homeownership and affordable housing.

In sum, the subprime problem is not one Freddie Mac attacks in isolation. We've been addressing these issues for some time now with borrower education, anti-predatory lending initiatives, foreclosure prevention and other pro-borrower policies. Because we consider it our responsibility not only to get families in the front door of homeownership, but to help keep them from being pushed out the back door, through foreclosure. That's part of what it means to be a GSE with a public mission and a charter – and the public accountability that comes with it.

So the GSEs can do a lot to address tough situations like the subprime problem. And we are doing so. Going forward, I think all of us will get the most accomplished if, as a country, we don't try to have housing finance work by itself. Instead, let's bear in mind that it's only one part of the full-court press we need to make housing more affordable, stable and accessible – in cities like Boston, and throughout this country.

Thank you.