Chairwoman Herseth Sandlin, Ranking Member Boozman, members of the Committee:

Good afternoon.  My name is Don Bisenius, and I am the Senior Vice President of Credit Policy and Portfolio Management at Freddie Mac.  Thank you for the opportunity to address the subcommittee today, and to offer some of our thoughts on the subprime mortgages crisis and the effects it may be having on America’s veterans. 

Freddie Mac’s Role In the Mortgage Market

Freddie Mac is a government-sponsored enterprise, or GSE, created by Congress with a public mission to bring liquidity, stability and affordability to the nation’s residential single and multifamily mortgage markets.  Unlike the Federal Housing Administration or the Department of Veterans Affairs, we are not part of the federal government.  We are a shareholder-owned corporation, capitalized entirely by private-sector money.  We currently guarantee about $1.75 trillion of mortgage-backed securities, providing homeownership opportunities for nearly 11 million families.

Historically, Freddie Mac has guaranteed mortgages in the conventional conforming segment of the mortgage market – so-called “prime” mortgages for no more than the “conforming” limit, currently $417,000.  Today, the conventional conforming market, supported by Freddie Mac and Fannie Mae, and the government market for mortgages insured by FHA or guaranteed by the VA, are the only well-functioning segments of the mortgage market.  Long-term fixed-rate mortgages are widely available and rates are low.  The market shares of the GSEs, the FHA and the VA all grew significantly in 2007, especially in the second half of the year, as the supply of funds from other investors disappeared.  We are doing the job that Congress assigned us:  helping to maintain stability by providing liquidity to the markets that we were created to serve.

The GSEs, like the VA, do not originate mortgages.  We do not control what loans the primary market originates.  What we can do is define what mortgages we are willing to purchase and guarantee.  Because of our size and constant presence in the marketplace, in most economic environments the GSEs can influence what loans the primary market chooses to originate.  Over the past 3 or 4 years, however, our influence waned as subprime originators found investors who were willing to assume more risk than we felt was prudent.

We do not track whether mortgages we buy are made to veterans, so I cannot tell you how many veterans’ homes we have financed over the years.  I am not aware of any data that would tell us how many veterans have subprime loans, but it is reasonable to assume that the impact of the crisis is at least as severe on veterans as it is on other borrowers.  

We do offer mortgage products that help active-duty service members and recent veterans buy homes.  In 2006, we extended our flexible Home Possible® Neighborhood Solutionsaffordable mortgage products (originally targeted at teachers, police, fire and other public sector employees) to members of the Armed Forces and recently separated and retired military and military reservists.  These are prime mortgages that permit eligible families with limited credit or down payment savings to finance up to 100% of the value of their new home.  Together with our lender customers, we have specific initiatives for military communities at Fort Benning, Fort Riley, Fort Drum and the naval installations in the Virginia Tidewater that focus on financial literacy and homeownership opportunities for active-duty service members.  Deployed service members qualify for capped interest rates on mortgages sold to Freddie Mac under the Servicemembers Civil Relief Act.  

The subprime issue

When the subprime crisis erupted as a national issue about a year ago, the conventional wisdom blamed the structure of short-term 2/28 and 3/27 subprime adjustable-rate mortgages (ARMs), in which interest rates are fixed for the first two or three years of the loan, and then adjust periodically.  The theory was that “exploding” interest-rate resets caused large increases in monthly payments that made mortgages unaffordable for many families, and public policy responses focused on blunting the effects of payment shock.  This remains a concern, but the Federal Reserve Board’s continuing cuts in short-term interest rates will help avert “payment shock” for recent subprime borrowers by significantly lowering upcoming increases in their monthly payments.

We have come to understand that resets are not the only or necessarily the most important element of the story.  More fundamentally, the subprime foreclosure crisis derives from a combination of (1) looser lender underwriting standards, especially with recent originations, that allowed speculation and may have put families into homes they could not afford to keep without continued house price appreciation; and (2) subsequent house price depreciation that makes it impossible or uneconomic for stretched borrowers either to sell or to refinance into new higher-balance loans as they might have in the past.

This does not mean that subprime mortgages are intrinsically bad; many subprime loans perform as agreed, even in today’s market.  Historically, they have helped families with weak credit become homeowners, in return for a higher interest rate to compensate the lender for the higher risk of default these loans pose. 

Freddie Mac has participated in the subprime market as a responsible and prudent investor.  We have not historically purchased or securitized subprime mortgages directly, and instead have limited our participation to investing in the highest-rated, least risky segment of the subprime mortgage securities market (also known as the subprime “private label” market).  This participation reflects our charter objectives to bring additional liquidity to the mortgage market.  It has also been an important contributor to our efforts to meet our HUD-mandated affordable housing purchase goals.  In fact, by carefully tailoring our securities purchases, nearly 80% of the units financed by our 2007 subprime purchases met one or more of our three affordable goals – the low- and moderate-income goal, the special affordable (or deeply-targeted) goal, and the underserved areas goal.  This approach has proven to be very prudent, given the losses others are taking in this market.

In addition to providing liquidity, Freddie Mac has taken a leadership role in addressing some of the excesses of subprime lending.  As an investor in the least risky subprime securities, we have a limited ability to influence the market’s practices.  Nevertheless, last winter we were the first to announce that we would restrict our subprime investments in securities backed by short-term ARMs to those that have been underwritten to a fully-indexed, fully-amortizing level.  We also restricted the use of stated income in lieu of more traditional documentation standards and encouraged subprime lenders to escrow borrower funds for taxes and insurance. 

Last April, we pledged to buy $20 billion in consumer-friendly mortgages that provide better choices for subprime borrowers.  We have already exceeded that pledge.  Since May 1, 2007, we have bought about $42.5 billion of prime mortgages that financed borrowers whose credit profiles might have otherwise relegated them to the subprime market.  These purchases have helped nearly a quarter of a million families.   

As part of this commitment, we created our SafeStepSM subprime alternative product, introduced in July and designed to give subprime borrowers more sustainable alternatives.  But through the end of 2007, we have bought only $207 million of these mortgages.  It is not that our credit parameters on the product are particularly conservative, but we did require originators to validate borrowers’ incomes, property values and other information, and most borrowers simply could not qualify.  This illustrates a dilemma that we all face in trying to clean up the subprime mess – that there are too many borrowers stuck in subprime loans who simply cannot qualify for prudent, sustainable mortgages. 

This dilemma is greatly compounded by the significant decline of house prices in many areas.  Many families bought a home over the last couple of years that are now worth less than they borrowed to buy it.  If this family can afford the monthly payment and does not need to sell the house, this may not pose an immediate problem.  It can be a problem, however, if the payments are too high or the family wants to move or sell for some other reason.  It is difficult for even a credit-worthy borrower to refinance or sell when the house is worth less than the total of the outstanding mortgage debt.  

Thinking About Solutions

At Freddie Mac, we spend a lot of time thinking about how to address this situation.  Like almost everybody else, we have concluded that there is no silver bullet, and that, unfortunately, things are going to get worse before they get better.  For the moment, the combination of lack of borrower capacity and falling house prices demonstrates that there are no easy solutions to this problem. 

Nevertheless, let me suggest some things that can be done to mitigate its effects:

• Focus servicing practices on keeping borrowers in their home whenever possible.  Loan modifications, repayment plans and other foreclosure prevention initiatives are important.  The Hope Now subprime loan modification program and the related Project Lifeline project fall into this category.  At Freddie Mac, we have found that early intervention can help some borrowers avoid foreclosure, and last year helped nearly 47,000 borrowers keep their homes.  I understand that the VA uses a similar approach.

• Help some borrowers refinance into innovative mortgages like SafeSteps and FHASecure.  It may be appropriate to consider other approaches that take house price declines into account.  But unless the borrower has the capacity to afford the monthly payments, a refinance simply sets up both the lender and the borrower for a repeat of the earlier failure.

• Support, with the participation of the public and private sectors, community stabilization efforts of local and national non-profits and state and local governments hard-hit by the crisis.  In many communities, such as Las Vegas, we have to deal with the problem of foreclosures on investment properties.  While no one wants to “help” speculators, a foreclosed investment property is just as damaging to a community as a foreclosed family home.  Moreover, foreclosures on investment properties often throws tenants out of their homes and cuts the supply of affordable rental housing.

• Help families transition to more affordable housing.  Despite all our efforts, not all borrowers can afford the house they are now living in.  For these families, short sales and deeds-in-lieu of foreclosure can help make the transition smoother.  We should consider ways to help these families buy less expensive homes or shift into affordable rental housing.

I wish I could be more sanguine, but the housing crisis is going to be painful and take time to resolve.  Freddie Mac is committed to working with Congress, the Administration, our customers and other industry participants to find and implement effective solutions to this very difficult problem.

Thank you for the opportunity to appear today, and I will be happy to answer your questions.