FROM THE OFFICE OF PUBLIC AFFAIRS

May 3, 2005
JS-2425

Remarks of Greg Zerzan, Acting Assistant Secretary for
Financial Institutions
Before the Federal Home Loan Bank Directors Conference
Washington, DC

Thank you very much for inviting me to speak to you today. It is a privilege to appear before an audience of men and women dedicated to ensuring Americans have access to financial services. Of particular importance is the role that your institutions play in increasing homeownership opportunities by ensuring that mortgage credit and other programs are available for this purpose.

Increasing homeownership is near and dear to the heart of the President. Under the President's leadership a record number of Americans have come to own their own homes. In fact, over 69 percent of Americans have now realized the American dream of homeownership: that's over 73 million Americans, the most in our nation's history.

The President has also set a goal to increase the number of minority homeowners by 5.5 million families by the end of the decade, and through his homeownership challenge, he has called on the private sector to help in this effort. More than two dozen companies and organizations have made commitments to increase minority homeownership - including pledges to provide more than $1.1 trillion in mortgage purchases for minority homebuyers this decade. The President's efforts are already showing success: for the first time ever, over 50 percent of minorities have achieved homeownership.

The President and this Administration are committed to homeownership for a number of reasons. It is not simply the fact that the housing industry provides an important source of jobs and growth in our economy, though certainly this is important. It is because there is a societal good associated with homeownership that we must not forget – owning a home is an investment in one's family, one's future, and one's community. The President supports homeownership because he knows that homeowners make good citizens – people who are involved in the civic life where they live.

And it is because of the importance of homeownership that the President has called for reform of the regulation of our nation's housing government sponsored enterprises.

A little more than a year ago I appeared before many of you in this room to discuss the Administration's proposal for GSE reform. At that time, I told you that certain powers were so essential to any competent regulatory scheme that any attempt at reform would be incomplete without them. These powers included the ability of a regulator to set minimum and risk-based capital levels; the power to review and approve all business activities of a GSE, on both a prospective and on-going basis; and the power to place an entity in receivership, should that prove necessary. One year later it continues to be the case that these are essential to establishing a world-class GSE regulatory framework. Furthermore, since I last appeared before you, much has happened to not only reinforce the need for these critical reforms, but also to make clear that still more is needed.

Questions regarding accounting issues at Fannie Mae and Freddie Mac caused well publicized restatements and significant executive turnover at those companies. Meanwhile, among the Federal Home Loan Banks, increases in interest rate risk and decreased profitability caused credit downgrades for several banks. Also, some banks entered into consent agreements with the Federal Housing Finance Board to spur changes in their corporate governance regimes, capital structure, and other practices and procedures. Though none of these events posed serious threat to the long-term health of the housing finance system, they did once-and-for all abolish any misperception that the housing GSEs could forever continue operating without regard to the normal rules and regulations that apply to America's other financial services participants.

And particularly in the case of Fannie Mae and Freddie Mac, they highlighted the one persistent danger that the housing GSEs do pose to the long term health and vitality of the housing finance systems: the specter of unacceptable systemic risk. The nature of this risk is easily understood; as outlined by Secretary Snow and others, it starts with the fact that the market's mistaken belief that some form of government guarantee exists allows the housing GSEs to borrow at below-market rates. In turn, this creates arbitrage opportunities which take the form, particularly in the case of Fannie Mae and Freddie Mac, of the purchase of mortgages and mortgage related securities. As these assets carry interest rate and pre-payment risk, Fannie and Freddie hedge at least in part through the use of derivatives, almost all of which tend to be concentrated in five or six money center banks.

Adding to this web of concentrated risk is the fact that six out of ten institutions in the banking industry hold as assets GSE debt in excess of 50 percent of their capital. Because of the tremendous size of Fannie and Freddie's mortgage portfolio, the concentrated hedges they hold against them, and the widespread use of GSE debt for capital purposes by America's banks it should be obvious that a financial crisis at one of these entities will produce a ripple effect that could seriously harm the financial system. Unfortunately, allowing unrestrained growth in the GSEs mortgage portfolio only increases this risk.

In order to promote the safety and soundness of the housing finance system as a whole, and to mitigate systemic risk, the Administration has called for limiting the retained portfolios of the housing GSEs. As Secretary Snow has stated, the GSEs' mortgage portfolios should be limited to an amount of mortgage investments that are necessary to carry out their mission to create a liquid secondary market for mortgage backed securities.

Some have objected that holding large portfolios of mortgages does in fact help the GSEs carry out their mission, or are necessary for other reasons. These claims are unfounded. As a recent Federal Reserve study noted, the GSEs' mortgage investment portfolios do not provide any benefit in reducing mortgage interest rates beyond that provided by securitization. Additionally, the market for mortgage related investments is broad and deep; any reduction in demand created by reductions in the GSEs retained portfolio would likely be quickly replaced by private investors. And it is very important to remember that greater diversification of mortgage prepayment risk among a broader pool of investors addresses our fundamental concern by reducing systemic risk.

Giving the new regulator the power to place limits on the size of the GSEs retained mortgage portfolios, according to strict criteria defined in law, is a critical element of reform without which no reform package would be complete.

The Administration looks forward to continuing to work with Chairman Shelby, Chairman Oxley and Congressman Baker on their efforts for reform. Although there is more work to be done, the foundation for meaningful reform exists provided that the key elements outlined by the Administration are incorporated in any final legislative proposal. All of us should look forward to the day when we can stop worrying about the regulation of the GSEs and focus instead on their success in performing their mission of promoting homeownership in America.

It has been my privilege to appear before you today. Thank you again for the work which you do, and for inviting me to visit with you.