<html><body><P align=center><STRONG><A class=eResources href="http://www.aei.org/events/eventID.742/event_detail.asp">Government Policy and Financial Market Stability: The Case of Fannie Mae</A></STRONG></P> <P align=center>February 6, 2004</P> <P align=center>Unedited transcript of Franklin Raines' luncheon address prepared from a tape recording</P> <P><STRONG>Proceedings:</STRONG><BR>MR. HASSETT:&nbsp; I want to thank everybody once again for coming to the American Enterprise Institute this morning.&nbsp; We're especially honored during our lunch to have a rare treat, the experience of seeing Frank Raines talk to us about what he sees are the most important issues regarding government-sponsored enterprises.</P> <P>I'm Kevin Hassett, director of economic policy studies here at AEI.&nbsp; And one of the things we do here at AEI is spend a lot of time thinking about the role in our economy of Fannie Mae and Freddie Mac and the other government-sponsored entities that have a very important function in our housing markets.</P> <P>Frank is the chairman and chief executive officer of Fannie Mae, which is a New York Stock Exchange company and the largest nonbank financial services company in the world.&nbsp; Before serving at Fannie Mae, Frank was a member of the president's cabinet for President Clinton and the director of the Office of Management and Budget.&nbsp; Frank asked me not to go through the very lengthy list of incredibly impressive accomplishments that he's had in his life, but if you're interested in seeing a CV or a description of a person's career that will humble you, you should read Frank's.&nbsp; That's in your packet.</P> <P>Frank is going to speak to us for a few minutes, and then he's going to take questions.&nbsp; Once again, we would ask that your statement be in the form of a question and the--</P> <P>[Laughter.]</P> <P>MR. HASSETT:&nbsp; The question-and-answer period will be last until about 1:30.&nbsp; One good rule of thumb, if you wonder whether your statement is in the form of a question, is if it begins with a word that starts with a W, that's probably a good start.</P> <P>So I will now hand it over to Frank.</P> <P>MR. RAINES:&nbsp; Well, thank you very much.&nbsp; I'm delighted to be able to join with you today.&nbsp; I want to thank the American Enterprise Institute for hosting this conference on our favorite subject.&nbsp; I've been hearing so much about what's been said about Fannie Mae here at AEI that I thought it might be a good idea to just come over and join in the discussion.</P> <P>In his last public speech, President Lincoln joked that he generally abstained from reading stories about himself in the newspaper because he wished "not to be provoked by that to which I cannot properly offer an answer."&nbsp; Well, today, since I've got the opportunity, I did want to answer some of the theories that we've been reading about Fannie Mae.</P> <P>Then I'd like to postulate a theory of my own, and that is that if advocates of free markets and limited government sat down and took out a fresh sheet of paper and set out to invent a mechanism to harness private capital to achieve the public benefit of home ownership in America, that they'd be hard-pressed to come up with something better than the secondary market that we have today.</P> <P>I say this as an advocate of free markets and limited government myself.&nbsp; I spent most of the last 25 years of my career in the private sector, first as an investment banker on Wall Street and then as vice chairman and CEO of this Fortune 50 financial company.&nbsp; The stretch in the private sector was broken only by my two-year term as budget director, where my job was to work with Congress to limit the size of government and produce the first balanced federal budget in a generation.</P> <P>One of my earliest mentors in my career was Daniel Patrick Moynihan, for whom I worked as an intern in the Nixon White House.&nbsp; Chris DeMuth, AEI's president, was then a Moynihan assistant.</P> <P>Pat Moynihan spent his career challenging the orthodoxy of both liberals and conservatives.&nbsp; And he did it by taking a distinct approach to policy analysis.&nbsp; He believed that serious policy issues deserved a serious approach to policy analysis.&nbsp; He believed in exhaustive research to garner indisputable facts, analyzing the facts with a high level of intellectual rigor, testing theory against reality, and then stating the conclusion unequivocably.&nbsp; Sometimes he paid a tough price for that.&nbsp; He often said that everyone is entitled to his own opinion, but not his own facts.</P> <P>Well, I believe the policy analysis regarding the secondary market should meet the Moynihan test.&nbsp; Right now, we're hearing a lot of discussion about the secondary market in Congress as lawmakers consider ways to improve the regulatory oversight of the housing GSEs, an effort that we support.&nbsp; As Congress has worked on this issue, however, there have been some, including some at AEI, who have sought to broaden the debate, raising fundamental questions about Fannie Mae's role in the housing finance system.</P> <P>How America finances home ownership is a serious policy issue that requires a serious approach.&nbsp; It should start with the indisputable facts, the analysis should be rigorous, theory should reflect observable reality, and policy analysts should be aware of the inevitability of unintended consequences of proposed solutions.&nbsp; Finally, the analysis must be consistent.&nbsp; If it's customized for Fannie Mae and would produce grossly distorted conclusions if applied to others, then it can't serve as the basis of serious policy making.</P> <P>So I say let's have a serious policy debate about America's secondary mortgage market, one that reflects the everyday realities of how the market actually works.&nbsp; We all want to avoid what Ronald Reagan used to say about liberals.&nbsp; He said it's not that they're ignorant, it's just that they know so much that isn't so.&nbsp; Well, in that light let's look at a few theories being advanced about Fannie Mae.</P> <P>The first theory is that there is an implied guarantee that the government would repay our creditors if we failed.&nbsp; This theory is perhaps the most fundamental point of departure for many skeptics of Fannie Mae.&nbsp; Fannie Mae has a federal charter, as do 9,000 financial institutions.&nbsp; Unlike many of the others, Fannie Mae does not benefit from an explicit government guarantee of our obligations.&nbsp; But some assert that we have an implied guarantee that the market relies on.&nbsp; Yet it's not clear what exactly "an implied guarantee" means.&nbsp; We don't know who's making the implication or exactly what's being guaranteed.&nbsp; Indeed, Treasury Secretary Snow has testified that there is no implied guarantee.</P> <P>Well, I believe the true value of our charter does not rest on a government guarantee of our obligations, implied or otherwise.&nbsp; Instead, our charter signifies that the government places such a high value on our mission of expanding home ownership and affordable housing that it goes to extraordinary lengths to ensure that the private management of our operations is closely supervised and that our private capital is matched to our risk, even under extraordinary circumstances--all to ensure our continued success.&nbsp; That's why we support legislation to ensure that our regulator has the authorities and resources necessary to do this important job.&nbsp; And this is the pact that the federal government has with investors.&nbsp; It doesn't cost taxpayers anything.&nbsp; And so far, it's worked very well.&nbsp; And this pact ensure that it's private capital that's at risk, not the taxpayer.</P> <P>And that leads to a second theory, that our so-called implied guarantee gives us a government subsidy and that we allocate this subsidy among home buyers, executive salaries, and shareholders.&nbsp; Well, it's certainly not a subsidy as Webster's defines it.&nbsp; We don't receive a nickel of federal money and we pay for our own regulation.&nbsp; Indeed, Fannie Mae's federal income tax expense and our core business earnings last year was $2.5 billion.&nbsp; Under normal federal credit budget rules, the calculation of our subsidy would also be zero.&nbsp; In fact, if you took away our charter, it would curtail our business, decrease our tax expense, and lower federal receipts.&nbsp; In other words, if we have a subsidy, it would be the first subsidy in history that had a negative fiscal impact when you take it away.</P> <P>Now, all the calculations of a subsidy for Fannie Mae that we've heard result from special analytical constructs developed solely for application to government-sponsored enterprises.&nbsp; And as David Gross described earlier today, these calculations produce absurdly high estimates of subsidies when applied to other financial institutions.</P> <P>Now, let me be clear.&nbsp; Our charter does provide significant benefits that lower our costs and allow us to lower mortgage rates for consumers.&nbsp; But Congress has also provided significant benefits to other financial institutions, specifically depositories that benefit from deposit insurance and access to the Federal Reserve window.&nbsp; Yet these benefits are rarely decried as subsidies to executives and shareholders.</P> <P>The critical question when looking at Fannie Mae is what do we do with our charter benefits?&nbsp; How do we make our charter benefits valuable in the marketplace so that we can accomplish our charter mission?</P> <P>Well, here's how it works.&nbsp; First, our charter allows us to market our debt and mortgage-backed securities in large volumes in the agency market to a wide range of investors all over America and the world.&nbsp; That increases their value and lowers the yield that we have to pay.&nbsp; Second, the law matches our capital to our risk.&nbsp; The Basel Committee judges residential mortgage debt to be 50 percent less risky than other assets that the banks hold.&nbsp; And residential mortgage debt is essentially all that we hold.&nbsp; So it makes sense that we need to hold less leveraged capital than banks do, and Basel's proposing that banks also begin to align their capital more closely with their risk.&nbsp; At the same time, our risk-based capital rule ensures that our capital requirements move up and down as our risk profile changes.</P> <P>And then we further lower our costs in five ways.&nbsp; We keep our credit rating exceptionally high, higher than most large financial institutions, even factoring out our GSE status.</P> <P>We keep our credit losses exceptionally low.&nbsp; Our credit-loss rate on mortgages is 1/30 that of banks, thanks to our data-driven underwriting, risk sharing, and loss mitigation systems.</P> <P>We keep our portfolio value high by substantially hedging against changes in interest rates.</P> <P>We keep our overhead exceptionally low.&nbsp; Our administrative costs per dollar of revenue are 1/5 that of banks, largely because we operate in the secondary market without retail costs and because of the efficiencies we achieve through our investments in technology.</P> <P>Finally, we make our securities especially liquid.&nbsp; Our mortgage-backed securities are the most liquid in the world.&nbsp; And we issue our benchmark debt securities in large volumes across the yield curve to serve a wide range of investors.&nbsp; Our charter mandate is to ensure and enhance liquidity of the secondary market, and we do that.</P> <P>Liquidity differences have a big impact on market yields, even when the credit ratings are the same.&nbsp; Fannie Mae mortgages trade about 4 to 5 basis points lower in yield than Freddie Mac, largely because of liquidity.&nbsp; In fact, liquid Fannie Mae securities, our bellwether MBS, currently trade 5 basis points lower in yield than our less liquid Fannie Mae securities, such as our quarter-coupon MBS.&nbsp; And our MBS trades between 20 and 25 basis points lower in yield than AAA-rated private label mortgages, whether they're jumbos or Alt-A mortgages.&nbsp; So with the same credit rating, the yields are lower by 20 to 25 basis points because of liquidity.</P> <P>Now, all of this--our charter benefits boosted by our business practices--lower our funding cost.&nbsp; So in turn, we can finance lower-cost mortgages and still turn a profit, as our charter intends.</P> <P>Our pre-tax core earnings go to three places.&nbsp; Last year, about 25 percent went to taxes.&nbsp; Nearly 57 percent went to increasing our capital base.&nbsp; And the remaining 18 percent went to shareholders as dividends.</P> <P>So you see, we don't receive a subsidy from the government in the normal sense of that term.&nbsp; The government doesn't fund us or guarantee our obligations.&nbsp; We're funded by debt investors and shareholders, and the security for that debt is the American home.&nbsp; And everyone benefits from this arrangement.&nbsp; The government gets billions of dollars in tax revenue every year without putting up any public funds.&nbsp; Home buyers save about $5 billion a year in mortgage costs.&nbsp; And investors who put up the capital get a fair return on their investment, as they should.</P> <P>The third theory is that, with a trillion dollars of debt, Fannie Mae poses dangerous risks to the financial system.&nbsp; In fact, two other federally chartered financial institutions, Citigroup and the new JP Morgan-Bank One, individually have more liabilities than Fannie Mae.&nbsp; And unlike Fannie Mae, they have an explicit government guarantee backing up a significant portion of their liabilities.</P> <P>Also, our debt doesn't exist in a vacuum.&nbsp; Our debt funds mortgages.&nbsp; And there's a home behind every one of Fannie Mae's mortgages.&nbsp; The $1.5 trillion in property value securing our debt represents some of the safest collateral in the world.&nbsp; And beyond this, we have extensive credit risk-sharing, such as mortgage insurance and loss mitigation mechanisms.&nbsp; We calculate that for every $2 in debt and liabilities we have access to about $3 in capital, collateral, and credit enhancements.&nbsp; For these and other reasons, Standard &amp; Poor's gives Fannie Mae a risk-to-the-government rating of AA-, and Moody's gives us a bank financial strength rating of A- on a scale where A is the highest rating.</P> <P>The fourth theory is that Fannie Mae and Freddie Mac face no effective competition in the secondary market.&nbsp; In reality, Fannie and Freddie not only compete against each other, we also compete against commercial banks, thrifts, the Federal Home Loan Bank systems, and others for the business of managing the interest rate risk and credit risk of mortgages.</P> <P>This chart, based on the 2003 third-quarter estimates from the Federal Reserve, shows that Fannie Mae holds in its portfolio about 12 percent of the $7.6 trillion of residential mortgage debt outstanding and Freddie owns an additional 8 percent.&nbsp; The largest holders of mortgages are large commercial banks, which hold 20 percent.&nbsp; Depository institutions as a whole hold 44 percent.&nbsp; The share held by the largest commercial banks over the past four years has grown by 4 percentage points.&nbsp; Fannie Mae's share has gone up, finally, 2 percentage points.</P> <P>Now, another theory is that Fannie Mae has engaged in mission creep, entering new lines of business to stay profitable.&nbsp; In fact, Fannie Mae principally manages just one asset, residential mortgages, through two lines of business.&nbsp; We have a mortgage portfolio business, which we've had since our creation in 1938, and we have a mortgage guarantee business, which we've had since our mortgage-backed security was created in the early 1980s.&nbsp; Both businesses expand liquidity in the mortgage market, which is what we were set up to do and what we've always done.</P> <P>Now, some people claim we favor our portfolio business over our mortgage-backed securities business.&nbsp; But over the past three years, our portfolio has had an average annual growth of 14 percent and our mortgage-backed securities outstanding have grown at a rate of nearly 23 percent.</P> <P>The last theory I'll discuss today is that the housing enterprises have a negligible effect on lowering interest rates for homeowners.&nbsp; A recent Federal Reserve working paper used this equation to calculate the effect of our lower funding cost on interest rate spreads between conforming mortgages, the kind that we finance, and jumbo mortgages--those that are above our loan limit.&nbsp; Just to help those of you who don't have your calculators with you, this formula concluded that our effect was about 7 basis points.&nbsp; However, the paper does concede, on page 31, that the data it used are "not up to the task" of measuring our impact on the market.</P> <P>The conclusion doesn't square with observable reality.&nbsp; Every Saturday in the Washington Post and other newspapers, there's a mortgage rate chart.&nbsp; And as you can see here, the rate chart is two columns.&nbsp; One has the interest rate for conforming loans that we finance, and the other has the jumbo rate for loans above our loan limit. When you look at the highlighted offerings, the spread between a conforming and jumbo loan is about 25 basis points.&nbsp; Historically, the spread ranges between 25 and 50 basis points.&nbsp; And for a mortgage right at the loan limit, a homeowner today will save about $20,000 over the life of a loan.</P> <P>And that 25 to 50 basis-point spread makes a huge difference to the behavior of home buyers.&nbsp; As you can see in this chart, mortgage originations spike right at our loan limit and then plummet.&nbsp; And every time our loan limit goes up, the spike moves with it.</P> <P>Well, these are a few of the facts about Fannie Mae that I hope will become the basis of further policy analysis.&nbsp; The risk of relying on disputable theories instead of observable facts is just too high.&nbsp; Let me tell you why I think that's true.</P> <P>This country is still growing.&nbsp; This decade alone will produce 30 million more Americans.&nbsp; They'll create 13 to 15 million new households and need 1.6 million new homes built every year.&nbsp; And they will demand an additional 6 to 7 trillion dollars more in housing capital by the end of the decade.&nbsp; Fannie Mae is a key supplier of housing capital.&nbsp; If we fail to apply the Moynihan task of policy analysis and adopt unwise policies, we risk creating the unintended consequence of a housing capital crunch.&nbsp; And that would only harm families that are trying to become homeowners, the housing sector, the housing trades, and the economy.</P> <P>Moreover, with Fannie Mae at its core, the American system of financing home ownership is the best in the world.&nbsp; Wherever I travel abroad, I'm asked about how Fannie Mae works and how they can go about creating a secondary mortgage market.&nbsp; In fact, the only country in the world where I hear questions about our role is in the United States.&nbsp; Well, if you believe in the market test and that imitation is the sincerest form of flattery, then I think America deserves to be proud of what we've created.</P> <P>But I also think that conservatives should share in this pride.&nbsp; As I mentioned earlier, I have my own theory to advance, that our system of financing home ownership is actually built upon market-based, conservative principles.&nbsp; Now, in order for me to prove my theory, you have to accept one premise, that our national policy should continue to promote home ownership.&nbsp; If you don't agree with that premise, if you believe our nation is over-invested in housing, then we should put all of our cards on the table and have a very different discussion.&nbsp; Because sometimes it appears to me that the criticism of us is really a criticism of the role of housing in our economy.</P> <P>Well, President Bush has let it be known where he stands.&nbsp; He speaks often about his vision for an ownership society.&nbsp; Just two weeks ago, he said, and I quote, "We want people owning their own home in America.&nbsp; We understand when somebody owns something, he or she has a vital stake in the future of this country."</P> <P>So if you're a free market, limited government conservative who wants people to own their own homes, what is the best mechanism to carry out this policy goal?&nbsp; Well, first, I believe a free market conservative would want to see a mortgage finance system that relies on private enterprise and private capital, not new government programs with public funding.&nbsp; In fact, free market conservatives have taught Washington a lot about the marketization of public policy initiatives.&nbsp; It was conservatives like Jack Kemp who taught us that enterprise zones are sometimes the best way to attract jobs and opportunities in inner cities.&nbsp; It was conservatives who taught us that emissions trading could lead to faster and less expensive reductions in air pollution.&nbsp; And conservatives have argued for strong patent protection and research and development and tax credits to encourage scientists to continue developing new inventions.&nbsp; So it stands to reason that if America wants a mortgage finance system that produces a constant flow of affordable capital on terms that consumers prefer, that America should have a system with market incentives for someone to invest that capital in the form and quantities demanded.</P> <P>Well, that's what Congress did when it rechartered Fannie Mae as a private company in 1968.&nbsp; At the time, the Federal National Mortgage Association had accumulated about $185 million in public capital after 30 years of operation.&nbsp; Today as a private enterprise, Fannie Mae has $35 billion of equity, all of it private capital.&nbsp; And with this private capital, as a private enterprise, Fannie Mae is still doing precisely what it was created and rechartered to do for the last 66 years; that is, to create a nationwide market for the best mortgage every created--the long-term, fixed-rate mortgage that can be refinanced at any time without penalty.&nbsp; This is the easiest way for a consumer to finance a home, and that's why fixed-rate mortgages are the choice of 70 to 80 percent of homeowners in America.</P> <P>This mortgage is rare outside the United States.&nbsp; And it would be hard to have here without Fannie Mae.&nbsp; Why do I say that?&nbsp; Remove us, and this country would revert back to a bank-based system of financing housing, the system that most other countries have today.&nbsp; Banks are simply not set up to finance these long-term fixed-rate mortgages.&nbsp; They mostly rely on short-term consumer deposits to fund mortgage purchases, so they prefer to fund short-term adjustable-rate mortgages.&nbsp; Plus, banks don't have to finance mortgages at all.&nbsp; Their appetite for mortgages rises and falls with consumer deposits, changes in the yield curve, and whatever other investments might produce a better yield.&nbsp; And because bank deposits are sensitive to the economic conditions, so is a bank-based housing finance system and the entire housing sector.</P> <P>With Fannie Mae, this country gets a market-based housing finance system that remedies the shortfalls of a bank-based system.&nbsp; We can raise capital from all over the world, which expands the supply and lowers the cost for home buyers.&nbsp; We can sell debt securities of all durations so we can fund long-term mortgages, and our mortgage portfolio business is set up to hedge and disperse the prepayment risk of these loans.</P> <P>Without Fannie Mae, there would be far fewer of these consumer-friendly loans available, and the mortgages would cost more.&nbsp; If you need proof of that, just look at the jumbo market, which is largely bank-financed.&nbsp; While 85 percent of our conforming market is fixed-rate, only half of jumbos are.&nbsp; And as I noted earlier, jumbos cost 25 to 50 basis points more.&nbsp; Well, that's what you get with private enterprise and private capital--a financial company that is focused on providing and is set up to manage the home loan that makes it possible for the average family to own a home.</P> <P>Now, some have argued that Fannie Mae's charter should be revoked.&nbsp; But they need to answer three questions.</P> <P>First, without this public charter with its restrictions and requirements to expand home ownership and lower costs, how would they ensure that private enterprise would deliver the desired public policy?</P> <P>Second, since Fannie Mae makes the consumer's favorite mortgage possible, are the proponents of revocation willing to accept a system where those loans are harder to get?</P> <P>And finally, what about the shareholders and bondholders?&nbsp; Private investors invested in this enterprise based upon the charter's existence.&nbsp; Their investment is private property. What are their rights, and what message will be sent to the market about investing in other or future such enterprises?</P> <P>If we all agree that American-style mortgages are the backbone of American home ownership and we want to ensure their availability with private enterprise and private capital, then we need to ask whether there is a better mechanism than the secondary market we have today.</P> <P>The principle I think a free market conservative would want to see in a system that promotes home ownership is the efficient dispersal of risk.&nbsp; Much of what's written about Fannie Mae assumes that we concentrate risk in one place.&nbsp; In fact, we transform risk so the market can spread it across a number of investors.&nbsp; As you know mortgages carry both credit risk and interest rate risk.&nbsp; We at Fannie Mae take on credit risk when we guarantee the timely payment of interest and principal on a pool of loans that we then convert into a mortgage-backed security.&nbsp; Our guarantee is what makes the MBS so liquid, producing what economist Susan Woodward has called true efficiency, because, as she says, it conserves resources that would otherwise squandered gathering information every time a security changes hands.</P> <P>But Fannie Mae doesn't keep all the credit risk.&nbsp; Under our charter, we must have some form of credit enhancement, such as mortgage insurance, on any mortgage with a down payment of less than 20 percent.&nbsp; An entire industry of mortgage insurance companies exists because of this charter restriction.&nbsp; And the mortgage insurers share the losses when any of these mortgages goes into default.&nbsp; In addition, we have recourse arrangements with lenders and other credit enhancements to share the credit risk.&nbsp; Banks, on the other hand, don't spread credit risk as efficiently.&nbsp; While they do require mortgage insurance on some portfolio loans, they keep most of the credit risk themselves.&nbsp; And when banks securitize mortgages, they often have trouble selling the riskiest of those securities.</P> <P>A private-label issuer of MBS doesn't guarantee the credit-worthiness of the underlying pool of loans.&nbsp; Instead, it carves out an issuance into senior and subordinate securities on the basis of credit risk.&nbsp; The senior piece will obtain a rating of AA or AAA.&nbsp; And obviously, it's easier, then, to sell those pieces.&nbsp; But the subordinate piece is a noninvestment grade security.&nbsp; And there's a very small universe of investors willing to hold it, so the issuer is often left holding that piece himself.&nbsp; As a result, the private-label issuance process doesn't spread credit risk, but leaves it more concentrated with the loan originator than if it were securitized in loans with Fannie Mae.&nbsp; In fact, the failure of Superior Bank in Chicago in July 2001 was largely due to retained subordinated bonds from private-label transactions.&nbsp; The lack of market appetite for these high-risk pieces means that the private-label MBS market cannot securitize the same volume that our market can, which is why we see less liquidity, higher mortgage rates, and a higher ARM share in the jumbo market.</P> <P>Our current system also does a good job of efficiently dispersing interest rate risk.&nbsp; As I noted earlier, Fannie Mae uses the capital markets to fund long-term mortgages with debt of the same duration.&nbsp; Then we hedge some of the prepayment risk of those mortgages by issuing callable debt.&nbsp; This makes it possible to retire debt when mortgages prepay.&nbsp; We can then fund new mortgages with new lower-cost debt, maintaining a healthy spread.</P> <P>For additional flexibility, we also enter into derivative contracts, which allow us to extend the duration of our debt or convert a portion of our fixed rate debt into callable debt.&nbsp; As Chairman Greenspan has noted, financial derivatives have "contributed to the development of a far more flexible, efficient, and resilient financial system."&nbsp; And we agree with him.&nbsp; We use derivatives to bring those benefits to the mortgage financing system.</P> <P>The proof of our effectiveness in dispersing risk can be seen in the stability of our return on assets and net interest rate margin, which, as economist Glen Hubbard has noted, is significantly less volatile than that of banks.</P> <P>Finally, I would think a free market conservative would want a mortgage finance system that becomes more efficient through competition.&nbsp; The trend in financial services is toward greater and greater consolidation.&nbsp; But there is a countervailing-trend technology; namely, automated mortgage underwriting, provided through the Internet, has allowed smaller financial institutions to offer big-bank mortgage services and compete with the big players.&nbsp; With automated underwriting, the local community bank, thrift, or credit union can have a virtual mortgage business without having to hire mortgage experts, build a back office, overload their portfolios, or take on all of the risks.&nbsp; They don't have to be experts in the secondary market, but they can get all the benefits.</P> <P>By keeping small players in the game and allowing new players to enter it, the technology is keeping the mortgage industry open and what economists call contestable.&nbsp; It's no accident that the number of mortgage brokers increased by 90 percent between 1995 and 2002.&nbsp; With automated underwriting, it makes economic sense for lenders to outsource loan originations to these brokers.&nbsp; And they've replaced the fixed-cost structure of the loan officer's salary with the variable-cost structure of a network of mortgage brokers, where the lender only pays if the broker delivers a loan.</P> <P>Well, Fannie Mae promotes competition through technology.&nbsp; We have the size, the economies of scale, and the data resources to build the market-leading mortgage underwriting engine and make it available to all lenders, small, medium, and large.&nbsp; And we have a unique mission and the market incentive to help them all compete.&nbsp; Unlike banks, we can't switch to another investment.&nbsp; Mortgages are all we do.&nbsp; And we can't originate mortgages.&nbsp; We rely on lenders to do that.&nbsp; So our success depends on our ability to help more lenders reach and serve markets that haven't been served yet, or served well, such as minority families.&nbsp; Our success depends on expanding the number of competing players in the mortgage market.</P> <P>I'd like to close now and leave at least a little time for questions.&nbsp; But let me leave you with a couple of questions of my own for those who might still want to radically change Fannie Mae and the secondary mortgage market.</P> <P>My questions are:&nbsp; Would housing an America be better off?&nbsp; Would mortgages be cheaper?&nbsp; Would buying a home be easier for people like teachers, police, firefighters, and the armed forces, and other Americans of modest incomes and savings?&nbsp; Would they have more mortgage choices that they want and need?&nbsp; Would smaller lenders have more opportunities to compete?</P> <P>I believe that any policy discussion about Fannie Mae needs to begin and end with a concern for the needs of the home-buying family.&nbsp; And I seem to be in good company.&nbsp; For instance, let me read you this passage.&nbsp; It says, "Home ownership is central to the American dream, and we want to make it more accessible for everyone.&nbsp; That starts with access to capital for entrepreneurs and access to credit for consumers.&nbsp; For those families and for all other potential home buyers, low interest rates make mortgages affordable and open up more housing opportunities than any government program."</P> <P>Well, that passage is from the 2000 Republican Party platform.</P> <P>Let me make one final comment.&nbsp; As we continue this policy analysis of Fannie Mae, let's remember these words of wisdom from Pat Moynihan.&nbsp; He wrote, What one can hope for is that in the day-to-day life of politics, those wielding power will seek to think as best they can about events in which they are caught up, that they will be serious about assembling such facts as can be had, compare them with what, if anything, is known of the past, and consider likely events of the future.&nbsp; And above all, try to be clear in their meaning and seek to understand clearly the meaning of others.</P> <P>Well, I hope we can strive to meet this standard as debates about the secondary mortgage market move forward in the next several weeks and months.&nbsp; I thank you for the opportunity to come and be a participant in this ongoing debate.&nbsp; Thank you.</P> <P>[Applause.]</P> <P>MR. HASSETT:&nbsp; I think we have some times for questions.&nbsp; And just like in the White House--they always call on the Associated Press--let me call on Burt.</P> <P>QUESTION:&nbsp; Thank you.&nbsp; Burt E. Lee.&nbsp; Frank, I'd like to come back to something you said early in your remarks about the scope of the debate, and specifically with regard to the secondary market.&nbsp; My question is, should the debate be limited just to the secondary mortgage market or should it be broadened to encompass providing housing finance in the most efficient manner possible, even if the most efficient manner of financing housing would not require a secondary mortgage market?&nbsp; Can we expand it beyond the secondary mortgage market?</P> <P>MR. RAINES:&nbsp; I think the answer to that is absolutely yes.&nbsp; This isn't just an issue about the secondary market by itself.&nbsp; And I tried to pose that question.&nbsp; If a free market conservative were designing a system, I'm postulating they'd end up with something that looks an awful lot like where we are.&nbsp; But I'm not opposed to a clean sheet of paper.&nbsp; If someone has a better way to achieve the goal, then as a matter of public policy we ought to do that.&nbsp; And they shouldn't fret for Fannie Mae and Fannie Mae shareholders.&nbsp; We'll think of something to do with $35 billion of equity.&nbsp; But we should be pursuing the best public policy.</P> <P>We happen to think that the system we have today is pretty good.&nbsp; And we haven't heard of one yet that's better for the consumer.&nbsp; We've heard of some that are better for some of our competitors, but we haven't heard of one that's better for the consumer.&nbsp; And that ought to be the test.&nbsp; It should not--our feelings will not be hurt if someone says, you know, we could achieve the same thing cheaper for the consumer.</P> <P>But most of the time, they're achieving less and the consumer is picking up a burden.&nbsp; They want the consumer not to have a fixed-rate mortgage because they're worried that some institution has to manage that risk--so let's let the consumer have that burden; let's let them suffer the consequences.&nbsp; Well, to me, that's not a good answer.&nbsp; But let's have that debate.&nbsp; I'm all in favor of that.</P> <P>I'm also in favor of broadening the debate from just these two companies.&nbsp; There are many people in the secondary mortgage market.&nbsp; There are many people who are holders of mortgages and managing interest rate risk, and there are many people that are taking credit risk.&nbsp; Let's bring them all in and let's compare, on a comparative basis, are we better off with this institution holding that risk or another institution holding the risk?&nbsp; I think those are perfectly fair issues and I hope that people will explore them.</P> <P>Because again, if we're not among the best at that, then maybe somebody else ought to do it.&nbsp; But so far, the evidence appears to be that we're pretty good.</P> <P>QUESTION:&nbsp; Pat Callahan, American Association of Small Property Owners.&nbsp; We look at public policy issues impacting landlords and small real estate investors.</P> <P>In the early discussion there were two aspects of--to parts that had increased your potential liabilities.&nbsp; One was mortgage defaults, and the other had to do with drop in housing prices.&nbsp; And I was thinking, on mortgage defaults, maybe there seems to be a little bit more creative thinking, perhaps minimize it through better servicing.&nbsp; Now, you've got some very good servicing companies, like ABN AMRO; you've got some terrible servicing companies.&nbsp; Some of them will work with the homeowner for loan modifications and other things like that.&nbsp; But maybe there could be an insurance product that could cushion a temporary nonpayment.&nbsp; The PMI does not benefit the homeowner, it benefits the system.</P> <P>On the drop in housing prices, I'm wondering if that could be accounted by an increase in home ownership equity, because currently, the first 10 years, as I understand it, is really going to pay interest.&nbsp; So I think we need to think of ways of increasing, through the mortgage payment system, a more rapid increase in equity.</P> <P>MR. RAINES:&nbsp; Well, we are, obviously, quite concerned about the credit performance of mortgages, given that we manage credit risk on so many.&nbsp; Our performance has been pretty good.&nbsp; Last year, our losses were .6 basis points on our total overall book of business to Fannie Mae, so that the record has been quite good.&nbsp; But I agree with you that in managing credit risk, it's very important to have very strong servicing.&nbsp; In fact, just the other day I was over at the AARP and we announced an alliance with them, in part that's to--keyed around keeping people in their homes.&nbsp; It's the most economical thing from our standpoint and it's obviously better for the family.</P> <P>We've gone from a point in the early part of the 1990s, we were able to rescue about 20 percent of the people who got into serious trouble.&nbsp; Now, about 50 percent of people who get into serious delinquency we're able to rescue and keep them from having to go into foreclosure.&nbsp; And we hope to move that number up.&nbsp; So it is a very important thing, and we have devoted enormous resources to this.&nbsp; We think we've done a pretty good job, but we know we can do better.</P> <P>With regard to home prices, you get a lot of different statistics.&nbsp; Just so that you understand what the risk level is, on our typical mortgage, we have about 40 percent equity on a market to market basis.&nbsp; Now, that ranges from people who have zero down payment today to people who've got a very low balance.&nbsp; But on average, it's about 40 percent.&nbsp; And we manage the lack of equity by having mortgage insurance and other kinds of protection for us and credit enhancement for us.&nbsp; We think it's very important to keep available low-down payment mortgages.&nbsp; And I'm not of the school that says if there's a chance people might fail, let's not give them the opportunity to succeed.&nbsp; I'm of the school, well, let's see how many people we can have succeed.&nbsp; We have to have a very high success rate in order to have our business work, but we've done that.&nbsp; And we've taken down the down-payment requirement, down from 20 percent to 10 percent to 5 percent to 3 percent.&nbsp; Now we're experimenting at zero.&nbsp; We think that gets more people into homes, but in our risk dispersal model, we're able to do that without raising the overall risk to Fannie Mae, because we do disperse that risk around the system.&nbsp; So we are, we're quite conscious of where we are.&nbsp; We're in a very conservative position overall, but we believe on the margin we can be doing everything we can to encourage people to get into homes and reduce the down-payment barrier.</P> <P>I would say in terms of--going back to Burt's comment, one of the things that the government is proposing to do, is in fact doing, the president proposed a down payment assistance program that was authorized at $200 million.&nbsp; I think it's an excellent idea.&nbsp; It's something the government can do that's pin-point right on target, and then allow us and others to finance that loan after the government has made that contribution.</P> <P>QUESTION:&nbsp; I'm Mark Felsenthal with Reuters.&nbsp; Mr. Raines, you said that Fannie Mae supports a stronger regulator, and that's what Congress is currently debating, not changing your charter.&nbsp; If so, why is Fannie Mae fighting so hard to prevent the creation of a new regulator with meaningful new authority, such as the ability to adjust minimum capital or to approve or reject new activities?</P> <P>MR. RAINES:&nbsp; Well, we're not.&nbsp; In fact, we are big supporters of the legislation.&nbsp; We worked very hard with Chairman Oxley in the House.&nbsp; Chairman Oxley, I believe, was very close to getting a very large vote, bipartisan vote in his committee to support such a bill, which we supported.&nbsp; I testified in the Senate as well, agreeing with the administration on the need to give our regulator the kinds of authorities and funding that they need.&nbsp; And if they want to move the location of our regulator, we've not opposed that either.</P> <P>But as in all things--and I told you about unintended consequences--you have to get legislation right.&nbsp; Some of you might have been around and studying these issues after the S&amp;L debacle, and you saw what happened when the leverage requirement on financial institutions was raised dramatically.&nbsp; And we had a credit crunch.&nbsp; And regulators had to go around and take extraordinary steps to get money flowing again.&nbsp; We don't want to have a credit crunch in the housing business.&nbsp; And if we already have capital equal to 350 times our credit losses, you've got to ask the question, what's the need for a change.</P> <P>But we're open to honest discussions on this issue.&nbsp; We've said that we don't see an issue that's not bridgeable.&nbsp; So we would like to see legislation, we'd like to see it this year, we'd like to have our regulator have the kinds of authorities and powers that they need for us to have a modern regulatory system.&nbsp; That's in Fannie Mae's interest.&nbsp; And so Fannie Mae's in favor of that.&nbsp; If anyone tells you that Fannie Mae's not in favor of that, you tell them you heard directly from me that Fannie Mae is-- [tape change] --characteristics.&nbsp; But other than that, you know, Congress now has to sort through all of the things that they're hearing and come up with the best deal possible.</P> <P>MR. HASSETT:&nbsp; [Inaudible.]</P> <P>MR. RAINES:&nbsp; What's your name again?</P> <P>QUESTION:&nbsp; After hearing a lot of that, I'm not sure.</P> <P>Let me see if I understand this correctly, then, Frank.&nbsp; You're saying that Fannie Mae supports the idea that the regulator would have authority to modify in some way your capital as well as control your mission and your new products.&nbsp; Because those are the two things that the administration is favoring and, I guess a lot of us had understood, you were opposing.&nbsp; You've just said that you favor those things?</P> <P>MR. RAINES:&nbsp; Well, we're--</P> <P>QUESTION:&nbsp; Fannie Mae will support them?</P> <P>MR. RAINES:&nbsp; There's testimony actually written--I gave it in person--saying that we favor giving the regulator total control over our risk-based capital.&nbsp; There's a lot of restrictions in the law now that limit what the regulator can do.&nbsp; And I said we are favoring it in total control over that.&nbsp; We've also--what was the second part that you said?&nbsp; Oh, in terms of--we don't believe--</P> <P>QUESTION:&nbsp; Mission and products.</P> <P>MR. RAINES:&nbsp; We believe-- Our mission has to be established by Congress.&nbsp; I mean, no regulator has control over the mission of the regulatee.&nbsp; The legislative body establishes the mission.&nbsp; But in terms of products, we have always said, from a safety and soundness, of course the safety and soundness regulator has to be able to look at what you're doing and determine that the product is safe and sound.&nbsp; And that's not just at the beginning--at any time.&nbsp; And we've never opposed that.</P> <P>Now, let's be clear, though, what we're talking about here.&nbsp; There are some who would say that we want the regulator to say Fannie Mae shouldn't do this product because it might hurt a competitor.&nbsp; We're against that.&nbsp; We don't believe a safety and soundness regulator should be regulating competition by saying that Fannie Mae should have inferior products and other people should have superior products.</P> <P>But if you're talking about safety and soundness, we want a strong safety and soundness regulator.&nbsp; Why?&nbsp; Because we have to raise billions of dollars every day.&nbsp; Our investors want to be sure that there's someone watching.&nbsp; My whole statement here is predicated on what is it the government brings to the party?&nbsp; I mean, why do we have a regulator at all?&nbsp; We don't have insurance.&nbsp; We don't have a guarantee.&nbsp; Other companies that are established don't have regulators when they don't have a government guarantee or insurance.&nbsp; The reason that we have regulator is the government's part of the deal is to ensure these companies are operating safely and strongly so that people have faith they're going to be there tomorrow.&nbsp; And so we need to have that.</P> <P>We think our regulator, you know--I know our regulator's gotten a lot of criticism--we think our regulator's done a pretty good job.&nbsp; If you compare our risk-based capital standard to Basel, I think they've done a pretty good job.&nbsp; People criticize that it took 10 year; Basel's not done yet.&nbsp; I think they've done a pretty good job.&nbsp; They have said they need new authorities; we agree with them.&nbsp; So we do favor that.</P> <P>QUESTION:&nbsp; Okay.&nbsp; May I just have follow-up question?&nbsp; You mentioned risk-based capital.&nbsp; Would you agree that your regulator can have the authority to adjust your leverage ratio?</P> <P>MR. RAINES:&nbsp; Well, I guess I'm of the old school on leverage ratios.&nbsp; And that is, I've got the same position that Alan Greenspan had and that most of the regulators had at the time of [inaudible], which was that leverage ratios should only be used during the period before you've got a solid risk-based capital standard in place.&nbsp; That has been the position of regulators for quite some time.&nbsp; And so I am a little concerned about exactly why someone would want to move our leverage ratio around.</P> <P>&nbsp;I'm int--you know, I'd be willing to sit down and talk to them about it, and if properly structured, maybe we would have no concern.</P> <P>But a lot--there's been--if we can put a--we've got a little chart here that I think may illustrate this point.&nbsp; No. 12.&nbsp; You know, sometimes people talk about leverage ratios as though the requirement for them came down with the Ten Commandments.&nbsp; In fact, European banks have no leverage requirement.&nbsp; The U.S. is one of the only countries--I think is the only major country that even has a leverage requirement for banks.</P> <P>And if you look at what happens: the U.S. has a leverage; if you look at the leverage ratio of 25 banks, averages about 6.3 percent, European banks 3.1, Canadian banks 4.&nbsp; Now, look on a risk basis.&nbsp; What does a leverage requirement cause?&nbsp; If you have a leverage requirement that's too high, an intelligent bank will put on more risky assets in order to justify that additional capital they're required to have.&nbsp; So look at the risk weighting:&nbsp; American banks at 80 percent, European banks down at 41.&nbsp; On a risk-based capital basis, they're all indistinguishable.&nbsp; So what happens with a high leverage requirement is you get riskier banks.&nbsp; You don't get safer banks, you get riskier banks.&nbsp; So they increase their risk to match the capital.</P> <P>So I think you have to be very careful when you talk about leverage.&nbsp; It's not an unmitigated benefit.&nbsp; So that's why I think Congress needs to be careful as they think about the issue.</P> <P>Are we willing to talk?&nbsp; We're always willing to talk.&nbsp; But you don't want to have that circumstance.&nbsp; You don't want to have a circumstance where Fannie Mae has a financial incentive to bring on more risk.&nbsp; That would be a bad result.&nbsp; Today, because of our risk-based capital standard--that's in place, being enforced every quarter--we have an incentive to reduce risk.&nbsp; Because if our risk is lower, our capital requirement's lower.</P> <P>But if you're a bank in the United States, you reduce your risk, you get no capital credit whatsoever.&nbsp; That is a bad system, in my view, because it encourages behavior, as you see here, which is to bring on riskier assets.&nbsp; I think our system works better.</P> <P>MR. HASSETT:&nbsp; Dawn has the last question.</P> <P>QUESTION:&nbsp; I'm Dawn with Dow Jones.</P> <P>Mr. Raines, regulators took a number of actions this week that are fairly restrictive.&nbsp; The Fed; OFEO sent new corporate governance standards to OMB that would separate your duties as chairman and chief executive; HUD sent new affordable housing goals, that I don't think anyone's seen yet, to review, for OMB to review; and they also indicated that they're going to go after a $6.25 million charge against you and Freddie, for the first time ever, to regulate the enterprises.</P> <P>Could you comment on any of those--how it might impact your operations--or, hopefully in the best of worlds, all of those regulatory moves?</P> <P>MR. RAINES:&nbsp; Well, I'm at a disadvantage because I haven't seen any of the regulations.&nbsp; You may have, but we haven't seen either the HUD regulation or the OFEO regulation.&nbsp; So I can't comment on those.</P> <P>I can comment on the Fed because they made a public statement of what they're doing.&nbsp; What the Fed did--and they've been in the process over time of aligning all of the people who utilize the Fed for clearing purposes in the payment system, trying to get them aligned and ensuring that there's no inadvertent subsidies or encouragement for people not to have their full funding in the system at all times.&nbsp; And so they proposed to modify their treatment of us.&nbsp; And if that's what they think is better for the payment system, it's fine with us.</P> <P>But in all of these things, I just--let me close, since this is the last question on this point.&nbsp; We have a fully developed housing finance system in the United States, and it's working pretty well.&nbsp; Home ownership, highest level ever, end of last year.&nbsp; Last year, $3.7 trillion of mortgages financed.&nbsp; Housing has been credited with having powered the economy through the recession.&nbsp; so it's a pretty good system.&nbsp; Not that it's perfect, but it's a pretty good system.</P> <P>Anyone who seeks to change it, anyone who wants to pull strings from the tapestry that makes up that system needs to bear in mind Moynihan's caution about unintended consequences.&nbsp; You can't move big things around and assume that there's no effect.&nbsp; And so just as we have to be careful as we carry out our business, so do those who would seek to change how we do our business, in terms of the unintended consequences.&nbsp; Not that people mean for something to go wrong, but it just so happens that when you change systems, things happen, things change, there's an impact.</P> <P>So that is my only urging in this, that we have serious analysis, we try to find out what the facts are as opposed to what any of our opinions may be.&nbsp; We see where that drives us, and we're very conscious of both the intended and unintended consequences.&nbsp; If we do that, I think we can have a wonderful debate and I think we can strengthen the housing finance system.</P> <P>Thank you all very much.</P> <P>[Applause.]</P> <P>MR. HASSETT:&nbsp; This conference is adjourned.&nbsp; Thank you very much for coming.</P></body></html>