Richard F. Syron's Speech to the Bond Market Association on April 22, 2004
Prepared Remarks for Richard F. Syron
Chairman and Chief Executive Officer, Freddie Mac
Bond Market Association
New York, NY
April 22, 2004
Thanks, Rob [Griffith, managing director, Credit Suisse First Boston], for
that introduction. It is a pleasure to attend this conference because I have
always believed that the capital markets are where public policy and the economy
meet. Nowhere is this more true than in the mortgage market. We at Freddie Mac
like to think we have a special relationship with you.
This morning, I'd like to do two things. First, to share my thoughts on the
market-based model we have developed together to fund housing in the United
States. Second, I also will talk about what we are doing at Freddie Mac to get
our own house in order. Both are topical in the context of the current policy
debate in Washington. We need to make sure that regulatory reforms improve the
system we have—not destroy the benefits we have created.
Housing, Markets & GSEs
Why is Freddie Mac such an important part of our nation's economy and social
fabric?
As a former central banker, regulator and CEO, I appreciate the unique role
that housing and the GSEs play. Housing will always be a national priority because
it affects so much that is important to us. Not just shelter, but many other
things, such as neighborhoods to raise a family; the quality of our schools;
local crime rates; the condition of our urban centers; the health of entire
economies; and, the means to create wealth and fund retirement. Clearly, housing
is the foundation of many parts of our lives.
America has a wonderfully unique way to finance homeownership. Most nations
finance housing through intermediary depository institutions. In those nations,
loans such as adjustable or short-term mortgages are the norm, and place more
interest rate risk and burden on the consumer. For instance, in Canada, the
typical fixed-rate mortgage is only seven years long, requires 25 percent down,
and imposes a stiff penalty for refinancing.
But in the U.S., we have two models: depository intermediaries who originate
and hold mortgages, and the markets enabled by the GSEs and you. Americans,
by and large, have shown a preference for fixed rate, longer-term debt—which
the markets model makes possible. Accordingly, the result has been the dominance
of the markets model. The long-term, pre-payable mortgage has become the loan
of choice here. Consumers gain protection against rising rates, flexibility
to refinance when rates fall, and the ability to build equity in their most
important asset.
The fixed-rate pre-payable mortgage is a win-win solution for working families
struggling to makes ends meet, to put their children through college, to start
their own business. The resulting consumer confidence and financial flexibility
have created enormous macro-economic benefits for the American and global economies.
Certainly, the markets model is not without its challenges. Quite simply, all
the pre-payment and interest rate risk has to go somewhere. Some believe that
transferring these risks from consumers to the capital markets creates a new
form of risk: systemic risk. While we all should be vigilant in managing this
dynamic, those who argue about systemic risk do not always emphasize that all
we are doing in the capital markets is redistributing risk. The same underlying
risk exists in all financing models. It is merely the result of the underlying
instrument.
The real question in 2004—and it is a public policy question—is:
Who is best able to manage that risk?
To answer that question, let me cite Roger
Ferguson, the vice chairman of the Federal Reserve, who has warned against
a return to relying only on the intermediary model. To quote him:
"The shift from an intermediary-based model to a market-based model
over the past two decades has, on balance, benefited mortgage borrowers...The
old model concentrated interest rate risk in depository institutions. When
interest rates soared in the early 1980s, the S&L industry suffered huge
losses with collateral effects on the real economy. In comparison, the market-based
model clearly seems to have spread the interest rate risk of mortgages throughout
the economy...[Indeed], new risk-transfer instruments—such as swaps and
swaptions—are playing an important role in transferring the interest
rate risk of mortgages to a broader and more diversified group of investors."
I couldn't say it better myself.
There are only four possible places to place interest rate risk: the consumer;
the depository intermediary; the capital markets without the GSEs; and, the
capital markets with the GSEs. When reviewing this list, it is clear that only
one solution works best. National policy suggests that consumers should not
bear this risk. Business practices tell us that intermediaries do not want that
risk when the yield curve moves against them. Common sense tells us that the
capital markets without the GSEs would not be in all housing markets and at
all times.
Instead, it is the GSE-enabled market model that works best. Freddie Mac has
demonstrated our ability to manage and distribute interest rate risk. Our disclosures
provide estimates of our duration and convexity risk. We keep our risk measures
consistently low and we report on a monthly basis. Indeed, we do this more frequently
and transparently than just about any other institution.
The markets model enabled by the GSEs is good public policy for our nation.
The GSEs ensure that U.S. homeownership remains a national priority rather than
merely an investment opportunity. After all, the GSEs cannot move on to the
next attractive opportunity when the desire arises. We lift the burden from
consumers, and transfer risk to where it can be best managed.
The capital markets have been relentless in innovating, in creating efficiencies,
in developing new markets and new executions. It is a market that works, and
works well. In fact, through GSE mortgage purchases and sale of our securities
overseas, we even have foreign governments financing U.S. homeownership.
Now, all this is not to say that intermediaries do not have their place. They
do. For instance, they fund mortgages by leveraging the funding advantage that
comes from federally insured deposits. Because they have been paying little
interest on these deposits in the past few years, they have been funding mortgages
and earning a substantial return on the spread. Indeed, depositories have been
more active than the GSEs in funding mortgages recently. But, when interest
rate conditions change and these positions become less attractive, these same
depositories look to sell their portfolios to the GSEs, where the risks can
be better managed.
Indeed, without the markets model enabled by the GSEs, the depositories would
be less willing to assume the risk of funding mortgages in the first place.
In that sense, the intermediary and markets models are mutually re-enforcing.
Relationship with Securities Dealers
None of this would be possible without you operating at the front lines of
the capital markets. With your vital help, we have scoured capital markets around
the globe, and made U.S. homeownership the #1 private investment in the world.
Together with you, we have created a highly liquid market that distributes the
interest rate risk of the mortgages we fund.
Let me give you an example. In recent years, as our use of derivatives began
to increase, we looked for alternative ways to lay off the interest rate risk
of the mortgages we purchased. The most important of these—callable debt—provides
investors with attractive returns while transferring risk from Freddie Mac to
global capital markets.
Working with Eric Foster and a BMA task force, we developed a standard option
pricing model that improves transparency in how callable debt is quoted and
priced. As a result, together we now provide large, liquid syndicated issues
and customized issues, where needed. Moreover, our callable debt outstanding
now represents one-third of Freddie Mac's overall funding.
Because of our work together, we have created a much better housing system;
one that has made possible the largest refinancing boom in our nation's history;
one that has stabilized our economy. All because we enable consumers to get
the lowest-cost loans virtually whenever and wherever they want. My hat is off
to the BMA and to all dealers who have helped us to expand homeownership.
Special Privileges & Responsibilities
The ability to use the capital markets to expand homeownership is one of the
special privileges the federal government has conferred on the GSEs. With that
comes special responsibility. We have the privilege to act as a public policy
instrument to house the nation. And, we have the responsibility to keep our
companies safe and sound, and to fulfill our mission.
For these reasons and more, Freddie Mac is a special company—one that
is poised to do so much social good. We have a lot riding on our shoulders.
Our job is too important—too essential—not to get it right. But, during
the past year, our ship has come upon rough waters. I need not recount the list
of transgressions. They have been widely reported in the media.
But, after 100 days or so on the job, I have come to the conclusion that we
need to rebuild confidence with the American people—and this will require
change. We must address honest criticisms of us. Accordingly, I have set our
company on a path to adhere to a higher standard of accountability, and to re-embrace
our mission. We cannot settle for what's acceptable. We must become a role model.
Only then will we be worthy of our charter from the American people—and
worthy of your continued support for our securities.
Higher Standard of Accountability
The American people need Freddie Mac to be a company that runs its business
well, believes in excellence in corporate governance, and embraces its special
responsibilities.
To run our business well, our first priority is to become to a reporting company.
Currently, we are rebuilding our accounting and financial reporting systems.
We are working hard to report our 2003 earnings. From there, we need to publish
financial statements on a timely basis, and register our common stock with the
SEC—under the Exchange Act. I want to see this job done fast—and done
right.
To make sure we get it right, we are supporting regulatory reform. The sheer
size and complexity of the GSEs have changed the dynamics for our regulation.
When I testified before Congress, I listed several principles to improve our
regulation. We need a regulatory structure that reaffirms the nation's public
policy commitment to housing, instills public confidence, and does not undermine
the value of our charter. I'm optimistic that Congress ultimately will produce
such legislation.
Of course, accountability begins at home, and the front door is corporate governance.
We have embarked on an orderly transition of our Board of Directors. We are
restructuring senior management, where needed. We have adopted guidelines that
fully meet the listing standards of the New York Stock Exchange—including
those for Board independence—as well as SEC guidelines for audit committee
independence.
Re-Embrace Our Mission
In addition to meeting a higher standard of accountability, Freddie Mac must
re-embrace its mission to expand homeownership. The American people need Freddie
Mac to be a company that acts as guardians of a public trust, one that acts
as a housing company.
Last year, Freddie Mac financed homes for 5 1/2 million families—one new
home every six seconds. We contributed to a housing sector that continues to
power our economy. But we need to do more. Here's why. Residential mortgage
debt is expected to double during this current decade. But, growth is occurring
in a different way than in the past. Currently, 75 percent of white American
families own their own home. But, the same figure for minority and immigrant
families is less than 50 percent.
I ask you: Is there any more important time—any more important task—for
Freddie Mac and for you? At the end of the day, we must serve those families
in need.
That's why we have already taken action. We are more directly tying senior
management compensation to our service to homeowners and renters. We have restructured
Board committees to enhance oversight of how we're serving homebuyers and renters.
Further, I have charged our business with renewing our commitment to America's
homebuyers. It is essential that Freddie Mac reach more minority families and
under-served borrowers than ever before.
Conclusion
Today, Freddie Mac is renewing itself. We have a proud history of being an
essential part of our housing finance system and the social fabric of our nation.
Many have benefited from our contributions and many more will. We have embarked
on a new direction to renew our commitment to the markets model to fund housing,
hold ourselves to a higher standard of accountability, and re-embrace our mission.
We owe it to the Congress that created us, to the consumers whom we serve,
to the investors who have entrusted their funds to us, to see all these actions
as a beginning—not an end. If we can keep moving in this new direction—and
show the fruits of our labor—we will create lasting value for all our stakeholders
and the American people will take us back into their hearts and minds.
Nothing less must be our goal.
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