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2001 BW 50



Q&A with Fannie Mae's Jamie Gorelick
The vice-chairman sees "a very, very strong 2002" and says Fannie and Freddie are "managed safely"

In the wake of the Enron disaster, Federal National Mortgage Assn. (Fannie Mae) and Federal Home Loan Mortgage Corp. (Freddie Mac), the federally chartered mortgage banks that experienced explosive growth in 2001, have come under increased scrutiny. Once again, Republicans in Congress are threatening to conduct an investigation into the activities of the two -- No. 7 and No. 2, respectively, on this year's BusinessWeek 50 list of top performers -- some say in hopes of revoking the portions of the Fannie and Freddie charters that gives an implicit government guarantee to their borrowing.

BusinessWeek Associate Economics Editor Margaret Popper spoke with Fannie Mae Vice-Chairman Jamie Gorelick for BW Online about the prospects for the coming year. Edited excerpts from their conversation follow:

Q: Are you worried about attacks on the implied guarantee of the U.S. government that backs your credit?
A: From time to time, someone suggests changing our charter in some way that might affect the perceptions of our debt in the marketplace. The proposal that was on the table last year to do so got no co-sponsors. And given the importance of housing to the economy, the ballast we have provided to that sector, and the care that we take to operate in a safe and sound manner and consistent with our charter, I am not concerned that there would be any such legislation.

Q: What do you say to criticism that Fannie and Freddie control too large a portion of the mortgage market?
A: In terms of concentration, the largest banks have greater concentration than we do and are growing at a faster rate. The critical questions are whether we are managed safely, and would the kind of credit and interest rate risk that we manage be managed better elsewhere?

We believe we are managed safely. We are very pleased that Moody's gave us an A-minus in the area of bank financial strength -- without a reference to the government in any way. Fannie Mae is among the handful of top-quality institutions.

Also, we are very highly regulated. We have auditors. We have examiners here on premises every day. And we have consistently exceeded every standard that the examiners have set for us.

Q: How did last year's economic turmoil affect your credit losses?
A: We are very well protected against credit losses, which fell to their lowest level in a generation -- since 1983 -- last year. They went from four basis points [0.04%] down to under one basis point [0.01%] of our outstanding portfolio. We believe that while credit losses may rise somewhat in the aftermath of the recession, they are likely to remain quite low in 2002.

Q: And why is that?
A: Well, our business is backed by homes with a considerable amount of equity. When I tell people that our portfolio consists of homes with an average equity exceeding 40% of market value, they are astonished. And 35% of the mortgages have third-party credit enhancement.

So we carefully monitor potential areas of credit loss. We try to keep our portfolio balanced across the country so that any particular area of credit exposure doesn't disproportionately affect us. We hedge demographically, we hedge geographically, we hedge with third-party credit enhancement. We hedge with equity, and we are data hogs.

We also follow the trends in credit. We follow all the macroeconomic indicators to most effectively manage credit losses. So we're pretty confident that we should do fine. Obviously we don't have a crystal ball here, but we are basing our projections, which have been pretty accurate over the years, on the numbers we currently have available to us.

Q: In 2001, you had the advantage of falling interest rates and a refinancing boom to fuel earnings growth. Will your business fall off dramatically in 2002 without those phenomena to help it?
A: We have managed our earnings through every kind of interest rate environment. That's why during these past 15 years, with volatile interest rates and the economy going through good times and bad, we have had double-digit operating earnings per share growth over all those 15 years.

We do that because in some respects we are a naturally hedged business. When interest rates are dropping, [mortgage] originations rise. When interest rates are rising, there are fewer liquidations [because of mortgage prepayments]. Therefore, we have considerable ballast in our earnings.

We expect mortgage originations for 2002 to drop somewhat but still be the second-strongest year ever, at $1.6 trillion, and we expect mortgage debt outstanding to grow at almost 9%. So while it won't be the complete blowout year of 2001, we are expecting a very, very strong 2002.

Q: What's driving the housing boom?
A: Well, there are a number of factors. One, a lot of people have withdrawn their money from the stock market and decided to put it into homes. Second, I think there is a very strong nesting instinct that has been underscored by the uncertainties of the last six months. And finally, the demographics are very strong for increasing rates of home ownership and increasing housing prices.

If you look at the sources of supply and the places where builders can build, they're increasingly limited by public policy, and yet you have the demographics of our population in the peak home-ownership years.

Q: Aren't baby boomers getting older and downsizing their homes as their kids move out?
A: The highest rate of home ownership is among those in the 64-plus range, and then the next highest is age 55 to 64, both of them in the 80% range. We are seeing people principally staying in their homes. When they downsize, they don't downsize to a lower-cost property predominantly, although some do. They might move closer to the city, into a smaller unit.

But the investment in home ownership among baby boomers is quite high, and our data show that when you marry the high home-ownership rates among baby boomers with the echo boomers moving into the high home-ownership age range, it's very powerful. There is a huge jump in home-ownership rates between the ages of 35 and 44.

Q: If there is all this pent-up demand for housing, why would mortgage originations drop next year?
A: It's interest rate-sensitive, primarily. We think long-term rates will be in the 7% to 7.5% range. That is slightly higher than it was in 2001, but still very modest by historical standards.

So it's a good market for people refinancing to take cash out. It's a good market for people to continue to buy homes, and we expect new and existing home sales to decline very slightly.

New home sales were at 906,000 in 2001. We expect them to be at 892,000 in 2002, and similarly for existing home sales, a very small decline of 2.2% -- from 5.29 million to 5.18 million in 2002.

Q: If the Federal Reserve starts to raise rates, how would that affect your bottom line?
A: We essentially don't make interest rate bets. We spend more than half our revenues on hedges, which no other financial institution does -- with the exception of Freddie Mac.

We forego the potential bonanza [when rates are low] in order to have steady earnings growth in every interest rate environment. Last year could have been an absolute blowout to a greater extent even than it was, but we spent a good bit of that revenue on hedging future interest rate moves.

MARCH 3, 2002

Edited by Beth Belton

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