FIRlnGLlne WILLIAM F. BUCKLEY JR. LELAND BRENDSEL "MORTGAGES AND THE AMERICAN ECONOMY"

Transcription

1 The copyright laws of the United States (Title 17, U.S. Code) governs the making of photocopies or other reproductions of copyrighted material. If a user makes a request for, or later uses a photocopy or reproduction (including handwritten copies) for purposes in excess of fair use, that user may be liable for copyright infringement. Users are advised to obtain permission from the copyright owner before any re-use of this material. Use of this material is for private, non-commercial, and educational purposes; additional reprints and further distribution is prohibited. Copies are not for resale. All other rights reserved. For further information, contact Director, Hoover Institution Library and Archives, Stanford University, Stanford, CA Board of Trustees of the Leland Stanford Jr. University. 0 FIRlnGLlne HOST: GUEST: SUBJECT: WILLIAM F. BUCKLEY JR. LELAND BRENDSEL "MORTGAGES AND THE AMERICAN ECONOMY" FIRING LINE is produced and directed by WARREN STEIBEL. This is a transcript of the Firing Line program (#977/2306) taped in New York City on July 27, 1993, and telecast later on public television stations. copyright 1993 NATIONAL REVIEW

2 Our guest today is the chairman of the Federal Home Loan Mortgage Corporation, hereinafter Freddie Mac. Along with its stepsister, Fannie Mae, it dominates the mortgage business in America. That is good news as some view it; qualified good news as others view it. Freddie and Fannie are adopted children of the federal government. What this means is, if there were massive illiquidity, if millions of Americans, say, suddenly found that they couldn't meet their mortgage payments, the federal government could be counted on to intercede. That is not good news for competitive mortgage lenders, who are required in order to stay in business to offer mortgage loans at competitive rates. This means that their margin of profit is very small. This means that they have a problem attracting investors. This means that investors tend to flock to Freddie Mac. This means that Freddie Mac is wonderfully prosperous, as indeed it is: It averages 20 percent in its earnings. But this also means that we are coming closer and closer to federalizing the mortgage business. We have some idea of what this can mean, not having walked away yet from the heavy load of the collapse of the S&Ls a few years ago. If we lost one or two hundred billion dollars through them, we could stand to lose--what?--ten, 50, 100 times as much if the government ended up more or less directly in the mortgage business. Well, to talk about this we have Leland Brendsel. He is a graduate of the University of Colorado with a PhD from Northwestern, and he has been the boss at Freddie Mac since about I will begin by asking him a few basic questions so that terminology won't bog us down. I suppose the first question is: Why do we need Freddie Mac, a secondary mortgage institution? If a bank lends John Doe $50,000 to finance his purchase of a house, why does that bank have to turn around and sell you the mortgage? I think the best way to illustrate why we need us, like Freddie Mac, is that we really have increased the availability of mortgage money for housing in the nation. For both homebuyers, as well as investors in apartment buildings, it has provided a kind of a reliability, a steady source of mortgage loans in good times and bad. overall it has inured to the benefit of people that buy or own homes. They've had lower mortgage rates on average. They've had a greater number and type of mortgage loans available to them to fit their individual situations. And finally, it's really all been done with little or no risk to the federal government. And it's all been done with private investors' dollars. After all, we are a privately owned company. 1

3 Well, you are privately owned, but you are licensed by the government. You don't pay taxes, so there is a sense in which your relationship is very special, plus also the president appoints five of your 13 directors, right? Not quite. Two things I want to correct, Bill. Number one, we do pay taxes. We pay federal income taxes. In fact, I am told that we are one of the largest--100 largest- corporate income tax payers in the nation. The reason is, of course, because we have been consistently profitable over time and we pay our fair share of the taxes on those profits. Second-- have to pay? Well, what tax do you not pay that other people We do not pay state and local income taxes. On the other hand, the offset to that is really our effective federal tax rate is higher than what typically a corporation would have because we are in a single line of business with fewer opportunities, frankly, to shelter income or whatever else from the federal tax collector. The second point about the governance of the company is that we have 18 members on our board of directors. Eighteen, yes. Thirteen are elected by the shareholders and five are appointed by the president of the United States, all with, though, fiduciary responsibilities to the shareholders of the company as well as responsibilities to operate the company to achieve the purpose for which it was chartered. Well, let's instruct our viewers on this point, namely that you didn't exist until 1970, which makes us wonder, given your flaunted indispensability, how did we manage to reach the year 1970 without Freddie Mac? [laughter] Not as well as we have been able to do since Well, now, particularize on that. What did we have since 1970, in the ensuing 20 years, that between 1950 and 1970 we so sorely lacked? I think what we saw prior to 1970 was a housing finance industry, frankly, that was heavily subsidized by the federal government. It was subsidized in a form of, of course, FHA, VA mortgage insurance, but more specifically and more importantly it was subsidized in the form of the savings and loan industry through two means: number one, federal deposit insurance on savings institutions' deposits, where the premium 2

4 charge on those deposits was way below what was justified based on an actuarial basis; and second-- Do you approve of that? Secondly, it was subsidized in the form of reduced tax burden paid by the thrift institutions. Their effective federal tax rate was far below that of other financial institutions that were not chartered to invest in residential mortgages. Well, you know, I am glad you brought that up, because don't we all acknowledge that there wouldn't have been an S&L crisis, which cost us what--$175 billion--if there hadn't been a creeping protection by the government of these FDIC loans, which had the direct effect of encouraging reckless activity on the part of thrifts who sought to compete, after the repeal of Regulation Q, with other lenders by offering higher and higher rates? So I guess what I am asking you is this. If you want easy money for mortgages and the government gets into the act, all it has to do is guarantee mortgages. Now, what is the line that protects the American taxpayer from a responsible, as distinguished from an irresponsible, loan to somebody who wants to buy a house? Basically sound operations is really what it comes right down to. Let me comment a little bit more on the thrift industry. What you saw in the structure of that industry, in the way it was set up, it was really set up to fail in the sense that they were a group of institutions that funded long-term mortgage loans with short-term deposits. And this was really a reflection of the structure, the federally authorized activities of the institutions. Secondly, as we of course know, with the tremendous interest rate risk that they took, the tremendous increase in rates in the economy, they got into a situation where they were hopelessly insolvent, and that led to the expansion of their charter and-- But they couldn't-- --to a variety of other-- They couldn't have expanded except that the people who banked with them were protected. Now that exercise in caution which would have saved the country vast amounts of money was not exercised because people didn't worry about their investment. Isn't that correct? That's correct. Okay. So therefore, what I am asking is, what does Freddie Mac do, other than simply to blur the line between 3

5 friendly government behavior--for instance, not taxing interest on mortgages--and indirect subsidies? We describe the principal features of the company, what we do and why it is very sound from a taxpayer point of view and at the same time is able to benefit residential mortgage markets in the nation. Number one, we are a company really with a single line of business, and frankly, it's a high quality business in that we are authorized by Congress--we're really just chartered by Congress instead of what you might find in a typical company chartered in a state- but the expressed charter is to really make a secondary market in residential mortgage loans. We can't buy commercial loans, loans on office buildings, we can't make business loans and whatever else. So we're largely limited to high quality assets-- That's a social objective, right? We're not talking about economics now. We're saying that Congress wants to make it easier for people to finance the purchase of a home, and therefore they create Freddie Mac to give them what, a realistic or an unrealistic protection against the vicissitudes of the economy? I think what we've determined, Congress has decided, that housing, adequate housing, in particular home ownership is a desirable social objective-- Oh, yes, George Washington knew that. --and secondly, that in order to enable the average person to buy a home, they need to have a steady and reliable source of mortgage money available at market rates. Well, can you illuminate us on this point? Per 100,000 Americans, what was the rate of home building post-1970 compared to pre-1970? Let me use different statistics, all right, which I think might get more to the point. Number one is that the rate of home ownership in the nation really pre-'70s, pre- 160s, in that range, was down below 50 percent, percent, in that range. Now you're in the mid-60s, 65 percent or so. Well, how much of that is attributable to an increase in net income? I think it's attributable to a variety of things. One is an increase in net income, but another certainly is the availability of long-term, fixed-rate mortgage loans, mortgage credit. 4

6 ,Q>.. - Well, if you hadn't happened--granted that your advent was auspicious--what would you predict would have been the percentage of homeowners today? Or can you predict? Can you extrapolate on the basis of a correlation between homeownership and GDP? I think you'd have seen--i can't give you a precise number, other than to say that I think what you would have witnessed in the 1980s, when there was tremendous demographic pressures and income pressures, in fact, on particular segments of the population, who experienced low income growth, to lead to reduced home ownership rates. Instead, home ownership rates during the 1980s were largely flat. And I attribute that to really the continued availability of mortgage money at attractive rates, at the same time, by the way, that the financial system was going through a major cataclysm in the sense that the thrift industry, which had been the dominant lender of mortgage loans in the '70s and up to the early '80s was really withdrawn from the mortgage market. So they had held virtually all the mortgage loans up to then, and during the 1980s and the latter part of the 1980s, they were a net disinvestor in mortgage loans. Well-- What happened is that investors--life insurance companies and pension funds, to name two; banks, to name another; foreign investors, to name another--really stepped in to replace that source of money for mortgages. That was made possible because of the efficiency, the reliability of the secondary mortgage market that Freddie Mac is a major part of. Well, now, can you give us a hypothetical human being who today would be seeking to buy a house and would not succeed in doing so but for Freddie Mac, but can do so because of Freddie Mac? Let's say this man is earning $40,000 a year and there were no Freddie Mac. And he goes to a bank and says, "I want to buy a $150,000 house on a 15-year mortgage or a 30- year mortgage." Is he going to be turned down now were there no Freddie Mac around the corner, but would not be now that there is Freddie Mac around the corner? Okay, now, does that-- Let me give you two-- --that you can afford an exposure that the bank could not afford? 5

7 Let me give you two examples which would illustrate my point, that don't necessarily mean that we are taking any more risk at all, because we bring other benefits to the mortgage market. Certainly we have brought a lot of competition among mortgage lenders to the marketplace. We have really increased the number of mortgage lenders that are in the typical community available to make a mortgage loan to this hypothetical homebuyer. I've give you two types of examples. First, certainly the availability of lower down payment conventional mortgage loans is by far more available today than it was 20 years ago where they-- Why? Because of Freddie Mac and Fannie Mae, for that matter, in the secondary mortgage market. But why doesn't this bank or this insurance company, why doesn't it have the drawing power based on the market availability of funds, plus the shrewd judgment of people to whom they lend those funds, that you do? We are better able to bear, let's say, risk-- Catastrophe-- --the catastrophe, which-- Lloyds of London used to say that, didn't they? --in the residential mortgage market is very small relative to what Lloyd's of London insures. Again, you are dealing with-- Trillions of dollars. --mortgages backed by homes worth almost double what the mortgage is worth. On average, for example, right now the mortgage is backing--or the homes backing mortgages in our portfolio are worth about 70 percent more than the mortgage balance itself, obviously providing a tremendous amount of protection. So that's one source. Now a typical thrift or bank would have that available to them too, but what they don't have that we have is diversification. You're an investor, I am certain, in mutual funds, bond funds or whatever else. One of the principles that is well known and understood today is that you can reduce your risk significantly from economic events, market events, by diversifying your portfolio. Nowhere is that more true than in the case of credit risk or the risk of loss. Because we can operate in all markets throughout the nation, we are able to reduce the risk of loss in portfolio mortgages by about two thirds. 6

8 I'm glad you brought that up because that focuses our attention on the extraordinary profit that you generate. Now incidentally, I am all in favor of profit and I am sure a lot of that profit is due to your splendid executive leadership. But you do make about 20 percent profit per year, which would be considered egregious if it were made by the Ford Motor Company or the Chase National Bank. Now, if a representative of those two institutions were here, they would say, "Well, of course they make 20 percent profit, because they've got in effect the government pulling for them, plus these immunities. Therefore, they attract money in copious sums." Now, what is it that immunizes you from the competitive forces that tend to keep prof its of companies down to six, seven, eight, nine percent? The main reason why we've been able to earn a return on equity of 20 percent, between 20 and 25 percent, is again, because we are dealing in a high-quality asset, and we have been able to diversify the risk, credit risk, as well as we take no interest rate risk, which in contrast, again, to a thrift or the bank, which takes typically significant interest rate risk, even today. We take virtually no interest rate risk. What do you mean, you take no interest rate risk? Explain that, if you don't mind. When we buy mortgage loans--maybe I could illustrate a typical transaction-- --again, coming back to a hypothetical borrower. We buy mortgage loans from, frankly, a few thousand lenders throughout the country-- --that make the loans to the individual homebuyer. In turn, we take those loans and we package them or pool them, as we call them, to back mortgage-backed securities. We then sell those securities--auction them off really--in a competitive auction to investors worldwide, all kinds of institutional investors. These mortgage-backed securities really have the characteristic that they carry--they leave us with almost no interest rate risk, because the payments that are collected on the mortgage loans are in turn passed on through to the investors, and in turn we receive a fee for guaranteeing and issuing and packaging the securities. Now are you responsible for the collection of those monthly payments? 7

9 The primary servicer-- Stays in the picture. That's right, the lender. Who decides to foreclose, him or you? We foreclose, but it is done through our agent or the servicer. policies-- loan? So-- The servicer is acting according to the The servicer is the bank that made the original Or it could be another bank that has taken over that servicing. So Mr. Jones is delinquent for six months. What happens, and at what point does it hurt you? Jones. What happens will depend on the situation of Mr. Certainly after Mr. Jones has been delinquent two months--or even if he got one payment delinquent, there would be certainly some telephone calls to encourage him to make the payment. After two or three months there will be more serious discussions with the borrower to determine whether or not there is some chance that the borrower will be able to make up the payments. Then depending on those discussions, maybe after six months or eight months, we will begin foreclosure, depending upon the assessment of the individual situation. Would you initiate that or the-- The servicer will be in conversation with us. To the extent that our written policies and guidelines aren't clearly understood by the servicer, they will certainly check with us. Well, now, if you had a severe depression, say in the state of California--where you have a semi-severe one now- in which you found that 750,000 homeowners were delinquent on their mortgage, when would that impinge on your earnings? 8

10 Again, dealing with a national portfolio, what we have to look at is California relative to the Midwest, relative to the South, relative to the Northeast, just to name a few regions of the country. So what we see right now in the economy is a recession in California, stagnation in the Northeast--maybe a little bit of improvement in the Northeast--significant strength in the Midwest and recovery in the South and Southeast, with the net result that overall, we are-- You're at equilibrium. --able to maintain a 20 percent or so rate of return. We are well-capitalized, as has been determined by any number of studies, including rating agencies relative to those risks. Well then, suppose Congress got out of the picture, what is it that their departure-- What about their departure would precipitate a crisis in your operations? Anything? Well, Congress is out of the picture right now. So it hasn't cost them anything. That's right. So you really don't need Congress. We are chartered by Congress. I know. They set the laws under which we operate, and those laws being that we are privately owned with a board of directors elected by the shareholders and five presidential appointees. Well, now, this rate of profit is surely absorbed into the price of your securities, right? That is to say, a competitive buyer would look at a price-earnings ratio and surely the value of your equity would rise to the point of causing that 20 percent to come down to a competitive level, wouldn't it? 9

11 So how can it continue to be 20 percent year after year at the same time that the equity value rises in the market? I think the question is, what is the competitive--the right competitive level-- --for return on equity over time? Certainly-- What is your PE? Your price earnings ratio? The PE right now is approximately 15 to one. That low? Which may reflect shareholders' assessment of the growth-- Contingent-- --the growth opportunities going forward, would be one example. After all, we have been through a tremendous growth period in the secondary mortgage market and the prospects going forward are certainly for that rate of growth to be less than it was in the past. Okay, now let me ask you this question-- So I would expect that the return on equity would not be as high as we have experienced for the last five or 10 years. What is your counterpart, say, in Great Britain, or is there a counterpart? There is really none that I know of. Is that because it hasn't occurred to them? I don't know. Or is the housing situation there, does that reflect the absence of a Freddie Mac or a Fannie Mae? I think what you--from what I understand about the housing finance system in Great Britain--and I might comment, you know, in general that we have any number of countries that come to visit to understand more about the secondary mortgage market because they have seen the benefits that it has brought here in this country. But more 10

12 ... specifically, with regard to Great Britain, the system is quite different, the economy is quite different. After all, if you go back to the origins of the secondary mortgage market, we were created in 1970 because existing residential mortgage lenders were unreliable. They couldn't attract the deposits at all times that were necessary to make mortgage loans. That was the year before we had wage and price controls, wasn't it? That's right. One of the reasons why this was a problem as well is because there were deposit rate ceilings. Five seconds to go. Second, because some areas of lot of savings, other areas had very little. created to replace that. Great Britain does situation, as I understand it. the county had a And so we were not have that same Thank you very much, Mr. Brendsel, the chairman of Freddie Mac, the Federal Home Loan Mortgage Corporation. Thank you, ladies and gentlemen. 11