<html><body>American Enterprise Institute January 16, 2009 [Edited transcript from audio tapes] <TABLE cellSpacing=1 cellPadding=1 width="100%" border=0> <TBODY> <TR> <TD> <DIV class=BodyText>1:45 p.m.</DIV></TD> <TD> <DIV class=BodyText>Registration</DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText>2:00  </DIV></TD> <TD> <DIV class=BodyText>Introduction: </DIV></TD> <TD> <DIV class=BodyText><A class=eResources href="http://www.aei.org/scholars/scholarID.58/scholar.asp">Peter J. Wallison</A>, AEI</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText>2:15  </DIV></TD> <TD> <DIV class=BodyText>Presenter: </DIV></TD> <TD> <DIV class=BodyText>Edward Pinto, financial services industry consultant</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Discussants: </DIV></TD> <TD> <DIV class=BodyText>Alan Boyce, Absalon</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Jay Brinkmann, Mortgage Bankers Association</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Paul Miller, Friedman, Billings, Ramsey Group</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Moderator: </DIV></TD> <TD> <DIV class=BodyText>Peter J. Wallison, AEI</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText>4:00</DIV></TD> <TD> <DIV class=BodyText>Adjournment</DIV></TD></TR></TBODY></TABLE>   Proceedings: Peter J. Wallison:  -- program, which I think will be very interesting.  We have a very interesting presentation and a group of people who are particularly qualified to comment on it. I m going to do a little bit of an introduction and then, after that, I ll turn it over to Ed Pinto, who I will introduce for the principal presentation.  And then as they will be commenting on Ed s presentation, I will introduce each of the extraordinary members of the panel that we have been fortunate enough to attract for today s conference. In his letter of resignation from Citigroup s board, Robert Rubin wrote, My great regret is that I and so many of us who have been involved in this industry for so long, did not recognize the serious possibility of the extreme circumstances that the financial system faces today. He isn t the only one.  Most analysts failed to foresee the financial crisis.  Most government policymakers were and are behind the curve, always trying to catch up with the latest disaster that s going on as we speak.  And now, it s clear that even the top officials in the financial industry itself failed to grasp the seriousness of what was coming at them.  A dozen or so CEOs are now unemployed because they didn t see the disastrous future and failed to arm their firms with sufficient capital when they could. Even today, judging from the pronouncements coming from analysts and others about recovery starting in the second half of this year, there seems to be little realization of the scope of the problems that lie ahead. The policymakers are still groping in the dark.  The new TARP legislation allocates only $40-$100 billion for mortgage modification.  The big debate on the Hill now is about cram-down legislation.  But is the bankruptcy court system ready for the number of bankruptcies that might come out of 25 million Alt-A and subprime loans? For over a year, as the losses on housing began to come to light, the stock market confined its losses to something between ten and 15 percent.  It was only after the failure of Lehman and the government s call for $700 billion in TARP funds that the stock market seemed to grasp that something truly unusual was underway.  But even now, it doesn t seem to have fully taken on board what it means to have the kind of mortgage and housing problem that will be outlined today. There are probably a lot of explanations for all of this, but it seems to me that one of the key issues is the failure to understand -- perhaps even a refusal to understand -- how large the number and dollar amount of subprime and Alt-A mortgages are. Most people who have had a vague understanding of the U.S. housing market, and I was certainly one of them, believed that subprime and other non-traditional mortgages were an exception to the rule.  The standard mortgage, we believed, was a 30-year fixed, with a 20 percent down-payment, and that, after all, is what the homeowners were offered in the 60s, the 70s, and the 80s.  Subprime and Alt-A loans were, at most, we believed, a few percent of the total. As they say, Not! As you will hear in today s conference, the percentage is much larger than a few.  It s closer to 40.  And in the bubbliest years of the bubble, it approached 50 percent of all mortgages originated. Now these mortgages are failing at an unprecedented rate and we are only at the beginning of that crisis.  The banks have set aside reserves for the losses they see in the future, but these reserves do not take account of the re-flow effects on the economy, generally, of the housing defaults that will be occurring in the future. Why is it that this information was so slow in coming out?  The answer, I think, is that the reporting of data in the housing field is faulty and was made so or enhanced by Fannie and Freddie s exemption from registration with, and hence reporting to, the SEC.  In addition, the fact that Fannie and Freddie were seen in the markets as government-backed reduced or eliminated any interest in their risk-taking.  So no one was motivated to really find out what they were actually doing.  This is a classic example of moral hazard impairing market discipline. As a result, neither of these GSEs reported any of their risky loans during the 1990 s or through 2007.  The fact that they now hold $1.6 trillion in nonprime mortgages of one kind or another will be a revelation to many people.  Then, even when they started to report to the SEC, they obscured the quality issue by reporting their credit losses in the aggregate, without breaking out their losses on nonprime lending. Finally, when Fannie and Freddie reported their purchases to mortgage information aggregators, such as a company called Loan Performance, they reported all of their mortgages as prime.  Consequently, anyone who asked Loan Performance, which is one of the key data sources for data on subprime loans outstanding, did not receive information on about half of the total subprime loans that existed in the housing economy. Ed Pinto, a former chief credit officer for Fannie Mae -- he left in the late 80s -- has done the enormous spadework necessary to uncover the bodies in this area.  He has found some startling facts about how serious the mortgage problem actually is.  The purpose of this conference is to make sure Ed s remarkable and important work gets out to policymakers and to the public.  I think you ll find Ed s data as startling as I did when I first encountered it. Let me introduce Ed and then, as I said, we ll go through the rest of the people who are on the panel.  Ed Pinto has provided credit and marketing consulting services to the mortgage-finance industry for the last 20 years.  He was the executive vice president and chief credit officer at Fannie Mae from 1987 to 1989, senior vice president of marketing and product management there from 1985 to 1987, and prior to his work at Fannie, he worked for the Mortgage Guaranty Insurance Corporation as a senior legal counsel and for the Michigan State Housing Development Authority as general counsel.  He has also worked with the Loan Performance Corporation, I mentioned them before, to develop their delinquency database, which is now the industry standard.  He has appeared as an expert witness in real estate finance and related litigation and has published in a number of newspapers.  Ed, the floor is yours. Ed Pinto:  Thank you, Peter, for that kind introduction.  My remarks are primarily post-active, however, I believe it would be useful to mention a couple of factors that I think led to the situation that Peter just described. The first, that lending standards were loosened and that loosening really started in the early to mid-1990 s and has been going on for quite some time.  Secondly, high leverage in the mortgage finance industry, both with respect to Fannie Mae and Freddie Mac and others (but they were principals), and the high loan-to-values and combined loan-to-values that occurred over the last 15 or 20 years also contributed.  And thirdly, extremely low interest rates that Fed Chief Greenspan provided in the early part of this decade certainly helped fuel some of the things going on earlier in this decade in terms of house price increases. This led to a period of literally 15 to 16 years where overleveraged borrowers, overleveraged lenders, overleveraged government sponsored entities created a housing bubble and that s its aftermath we re living with today.  And it s really the most serious mortgage crisis that we have seen since the Depression.  And in some respects, I think, and I ll try to point this out, it may actually exceed the Depression in terms of its seriousness relative to housing. So the first question is how big is the problem?  There are 57 million, approximately, mortgage loans in the United States and fully 25 million or 44 percent are nonprime.  That s roughly double the estimates that a number of people were making pre-September 2008, and it also startled a lot of people to find out that Fannie Mae and Freddie Mac had ten million of these 25 million loans or about 40 percent of the total.  Then you throw in FHA, which has another three and a half million or another 14 percent and you re looking at the federal government having direct involvement in well over half of the total of subprime and Alt-A lending or nonprime lending. The added factor is that fully 15 million of these loans have FICO scores below 660, and that s basically the demarcation point between prime loans and subprime loans.  And that s about a little over 25 percent of all the loans.  So you start with a situation that, from a risk perspective, is very high risk. As a result, instead of there being seven million subprime loans as was thought, there are actually 17 million subprime loans.  Instead of there being three and a half million Alt-A loans, or liar loans as they re called, there is 8.1 million Alt-A loans and neg-am loans, negatively amortized, and other various and sundry permutations that, again, added substantially to the total.  This resulted in 14.6 million unexpected nonprime loans totaling $2.4 trillion. Peter alluded to the fact that Fannie and Freddie were not making disclosures pursuant to the SEC requirements.  There were a number of things that they were doing that really obscured the level of nonprime lending that they were doing.  I ll just mention one.  They had a truly tortured definition of subprime, and that definition was subprime are loans made to people that have some type of impaired credit, hence the below 660 FICO, and that s the general definition.  However, there is another definition, which is subprime is what a lender who originates subprime called subprime, and if they don t call it subprime, it s not subprime.  And we espoused that second definition; therefore, we don t do any subprime. And literally, Freddie, to this day, says they did zero in terms of loan purchases, and Fannie says they did all of $8 billion out of the total exposure approaching $2.5 trillion and they did $8 billion.  So you can see where a reader might get or an analyst might get confused. This chart shows where all the various percentages of what Fannie and Freddie did.  34 percent of all of their outstanding subprime loans -- excuse me, 34 percent of all outstanding subprime loans were either purchased or enhanced or touched somehow by Fannie and Freddie, 60 percent of all outstanding Alt-A loans.  And you might ask, Well, how in the world did they get all of those Alt-A loans other than they did a lot of them?   Well, you have to remember that they did the smaller loans.  And so when you have an average Wall Street number that might be $300- or $350,000 for an Alt-A loan, and Fannie and Freddie s might be $150,000, they did roughly two Alt-A loans for the same number of dollars as Wall Street would do.  And at the end of the day, foreclosures are caused by loans going bad, not the dollars.  The dollars are important to severity, but in terms of the actual number of loans going bad, they did a lot of Alt-A loans.  And so again, the fact that these numbers weren t readily available had an impact.  You need to think of Fannie and Freddie and the impact on this whole question is, really, they have two portfolios.  They have their prime portfolio, which is called the other 66 percent or the good portfolio, and it s performing, up to now, quite well.  The delinquency rates are slightly higher than traditional, which is actually pretty amazing given the circumstances, running a little -- it s hard to tell because as Peter said, they don t break it out, but I ve estimated it somewhere around a half a percent, give or take, serious delinquency.  But their nonprime, the third that s nonprime, is running about ten times that. And we also know, and again, you have to interpolate it.  It s very hard to get at it from their data, but if you sort of look at it and interpolate here and there, you can conclude that 90 percent of their losses are coming from the third that s nonprime, which means that only ten percent of their losses are coming from the two-thirds of its prime.  And that also is fairly incredible. And so again, what they did with the $1.6 trillion has had a very large impact and is continuing to have a large impact on the marketplace, particularly because while they were doing this for a long period of time -- they really increased their volume tremendously in 2005, 2006, and 2007 and so 2007, when a lot of the other players had really exited the market, they really jumped in and went all in, as they say in Texas Hold Em.  And so they really have a relatively unseasoned portfolio in addition to this $1.6 trillion.  Compared to the rest of the marketplace, it s relatively unseasoned.  And that s another problem that the new administration is going to face. In this next slide, I want to ask you to try to read it, as here, it s really the background that provides the information on the previous chart.  The thing to remember when you look at this background and there are different lines for deduped and nondeduped.  One of the problems that you run into, and Fannie and Freddie ran into and so did much of the other portion of the industry, the subprime industry and the Alt-A, as they so called, is they had multiple risk factors. And so if you want to add up a loan that had a low FICO, and then you look at loans that all had high LTVs, and then you look at all the loans that had interest-only ARMs, you could have loans at all three characteristics.  And so you need to dedupe these numbers.  And again, Fannie and Freddie don t do a very good job of that either and so you have to -- but they do provide some information that allows you to do that on your own but you actually have to do it on your own.  And so that s what this chart does.  It also incorporates a couple of areas that they tend to ignore, one of which is the FICOs between 620 and 660, which are below prime, but they tend to not talk about those very much but they have a lot of those loans.  And secondly, and that s in here -- I know.  Those are all combined.  They re mine.  And the other thing is they did a lot of loans that had combined firsts and seconds.  They didn t insure the second but they insured the first with a second.  And that raised the effective loan-to-value up to 100 percent in many cases.  And again, this is something that they don t talk about very much.  It s buried on Page 128 or something of their 10-Q lately.  They didn t talk about it until very recently.  And again, it s another layer of risk that is just as high a risk, from a foreclosure perspective, as the 100 percent LTV loans they were making, but they really don t talk about it very much. This chart, they do publish this, this is Fannie Mae s example, and this type of information is relatively recent, up until a year or so ago, or in 2008, they didn t publish anything along these lines.  And so again, it was very hard to even find out what was going on with their various book years.  But you can see the hockey sticks, as you call them, starting in 2005, 06, and 07, and believe me, when 2008 develops, it will be another hockey stick, as will 2009.  But you can see this is their entire portfolio.  So if you remember the fact that 90 percent of their losses are coming from a third of their loans and they don t publish their hockey sticks for the third.  But if you were to just extrapolate these hockey sticks, you would be up in the next floor up of the building.  And that s, again, the problem.  They have this very high-risk portfolio that is a third of their business that they don t really adequately break out in terms of how it s performing along by book year.  And as I said, these are performing extremely poorly and driven initially by the Alt-A performance, which was really the first group to go bad but the high LTV and low FICOs are going to be the next group that really starts hitting their high default levels -- because again, as I said, these loans are relatively unseasoned.  This 2007 book is, at the time of this data, third quarter 08, those loans are about a year old and yet, they were already having a 0.6 -- the whole book was having a 0.6 default rate.  And normally, Fannie Mae would consider that to be about normal for an entire development of an entire book of business, that it might end up being between 0.6 and one percent.  And you can see that if you look out in 2002, 2003, in fact, 2003 had basically a default rate that s roughly at the same level as 2007, but the 2003 book, of course, is five years old and the 2007 book is one year old.  So you can see how this is going to impact the next four years in terms of default rates and the number of modifications they re going to have to undertake. Slide 4, I ve already mentioned some of these things.  I would just add that California, Nevada, Florida, and Arizona, known in the industry as the Sand States, really represent heretofore the large portion of the default.  They re about 55 percent of Fannie and Freddie s defaults, and give or take, that s about the percentage for the rest of the marketplace.  And I have some additional charts that will elaborate on that, but it s important to recognize that the defaults, up to this point, have been relatively concentrated geographically and they have not been spread evenly across the entire country. This is a chart showing the OFHEOs home price index, the Regulator Office of Housing Enterprise Oversight, their home price index that they get from the data that Fannie and Freddie collect.  And you can see that the house prices peaked in 2007, which was actually about a year after, nine months after the Case-Shiller Index, which actually tracks a somewhat different group of loans, and has declined about ten percent through October, this is data through October of 08, and declined about ten percent through October and is currently declining at about one percent a month and is expected to continue at that rate for at least the two months, at the end of last year and probably the next 12 months of this year. And if one were to look at this chart, you can see that there are at least two points in which the line starts -- it breaks out from its traditional slope.  One is in around 1997 and the other is in around 2000.  And Peter and I have an op-ed piece that will appear shortly that talks about the history of Fannie and Freddie in that period of 1992 to 2000 and 2005 and the impact it had.  And it appears that it had at least two impacts.  The trend in house prices was relatively gentle through, as I said, 1997.  Fannie Mae and Freddie Mac started their affordable housing programs in large dollar amounts in 1994 and grew the home ownership rate during that first six or seven years substantially, from 63 percent and change to about a 68 percent.  And that was a historic proportion in terms of change, that it never happened before in such a short time period. And so if you follow the lower slope and you go out, you ll end up with about a 30 percent price drop in order to get back to the normal trend line.  If, on the other hand, you worked off of your 2000, which is that next little jump, and that s when house prices and incomes got out of whack.  There was a traditional relationship between the two and those got out of whack in around 2000-2001.  And you then see house prices taking off and causing that result.  And if you go out from that trend line at about 2000, you end up with a 24 to 30 percent price drop. And so I think I conclude from that that in terms of the OFHEO conforming house prices, you re looking at somewhere between 25 to 30 percent ultimate price drop and probably a little bit more on the -- when you use Case-Shiller and when you blend the two, you end up about somewhere in between.  The Case-Shiller Index is the next chart and it shows that the cumulative decreases have been more substantial, but again, it s a more limited index.  It s 20 cities.  It s more urban.  It tends to focus on the higher priced areas.  And I ll come back to that higher priced issue in a moment. I believe there is a lot to be learned from what happened during the Great Depression, relative to housing.  I do believe that what we re facing today, it has nothing to do with what occurred, relatively, in the 1980 s, the late 1980 s, the early 1980 s, the Texas example that has been used, the California example that occurred in late 80s, early 90s, or the early 1970 s.  It really goes back to the kinds of price drops and impacts that occurred during the Great Depression.  This shows that, and the solid line or the nominal prices, it shows that house prices actually started declining in 1925, in advance of the onset that people consider of the Depression, and declined until 1933, and ultimately declined about 30 percent. The next chart, and this gets back to the geography, and you re not going to be able to read this and that s not the point, it s the colors.  This shows, between 2006 second quarter and 2008 third quarter, how the country has done, state by state, in terms of house price change.  And you can see that the lion s share of the country in terms of square miles is in green and yellow and there are the pockets of red.  They are populated pockets and unfortunately, tend to be places, for the most part, with higher loan prices, like California and some of the coastal areas of Florida.  And you ve got Virginia and Maryland.  You ve got Michigan, which is a relatively low-cost area. But you can see that it has not been uniform in terms of geography.  And that also means that not all the areas had the same run up in prices and they don t as far to drop in terms of getting back to what normal might be considered.  And certainly, California and Florida have been the two stellar cases of what it takes to get back to normal.  In the Central Valley, they ve had 50 percent price declines because the prices just ran up to unsustainable levels, relative to income. They used the affordability tools that were endemic in the weakened underwriting, neg-am, ARMs, and low start rates and high LTVs, simultaneous seconds.  They used all those tools simultaneously, allowed people to get into homes for $300,000 or $400,000 home with something on the order of a $600 monthly payment.  And when the merry-go-round stopped and the house prices started declining, they not only were hit with declining prices, they were hit with increasing monthly payments, and many of them were done as liar loans so they didn t actually have a lot of the income that they said they had in the first place. This all leads to where are we today relative to lending and what s important for lending.  And those of you that are familiar with mortgage lending know that there are basically three underpinnings to underwriting a loan; the collateral of loan, and that s really the most important; the second is the credit of the borrower or willingness to pay; and the third is the capacity or ability to pay.  And so the first is really the property and all of the pieces around it.  The second is their credit and willingness to pay.  And the third is their income and their debts and what their capacity is to handle the mortgage debt. And what has happened over the last 15 years, which reached its crescendo in the last four or five years, was a weakening across the board of all three of those core underpinnings of mortgage lending, starting with collateral.  As of the end of last year, I d estimate the value of all homes at about $18 trillion.  But 30 percent of those homes are owned free and clear.  So you really only have about $12.6 trillion of home value backing the roughly $12 trillion of mortgage debt, homes with mortgages.  And that gives you an effective LTV of the loans with mortgages of 95 percent. At the same time, I think it s very important for the new administration to realize that 70 percent of all mortgage debt has now been nationalized or guaranteed by the federal government.  You ve got Fannie Mae.  You ve got Freddie Mac.  You ve got FHA.  You ve got Federal Home Loan Banks.  You ve got FDIC.  There is very little that s left that isn t on the federal government s balance sheet, one way or the other, where they are ultimately responsible. And it reminds me of Pogo, you ve seen the enemy, it is us .  When they talk about cram-down, they re talking about cramming down their own loans that they re responsible for, in effect.  I project that as of 12/31, based on home value decline of one percent a month during 2008, that the value of all homes will decline to $15.9 trillion.  The value of homes with mortgages will now be $11.1 trillion.  And the mortgage data on those homes with mortgages will be $12.1, which yields an average loan-to-value of 109 percent, which -- I was talking with Alex Pollock earlier and I said, I don t believe in the history of the world that that s ever happened.   And he said, That s a tough statement to make.   And I said, Yes, but try to think of something that s ever been in a situation on residential property with people s homes where they actually owed more, in aggregate, than the value of the homes.   And then we both had a very hard time coming up with any example that might be the case.  In the Depression, 1933 -- and if you go back to the chart, the bottom was 1933 in terms of house prices -- the debt to value of all homes was 20 percent. Today, if you take the $15.9 trillion versus the $12 trillion, those two numbers, you get a 75 percent effective loan-to-value.  So we re going into this recession that s been going on for a little over a year, we re going into it with a 70 percent loan-to-value.  And in the Depression, the depth of the Depression was 20 percent. Likewise, the other two components also give a lot of pause in terms of what the impact is going to be.  In terms of credit, as I said before, we have 25 million nonprime loans, 15 million of which have FICOs below 660.  That s, I estimate, roughly double the percentage of loans below 660 that existed in about as recently as 1993 or 1994.  So again, we re going into this.  There were no FICOs during the Depression so it s hard to tell.  But again, my guess is the credit quality of these homeowners, going into this downturn, is actually much worse than the credit quality going into the Depression. Lastly, capacity, and that s the one area that people tend to take some comfort in.  Well, we re not going to get to 20 or 25 percent unemployment, and I think I would agree with that.  Can we get to ten percent?  I think definitely.  Can we get to 12 percent?  Perhaps. Well, what they didn t have during the Depression were the liar loans.  And so you look at the 57 million loans and you have roughly six million liar loans, which is ten percent.  Those people don t need to lose their job to default on the loans.  Normally, unemployment is what drives and the LTV is what drives.  Here, we ve had a default rate in 2008 that s double the default rate during the Depression at its worst.  And so again, why was that?  Because this was driven, primarily, by very poor underwriting. I ve already pretty much covered this.  Let s see, yes, the foreclosure rates in the Great Depression were 1.4 percent at the peak in 1933.  They re three percent today.  There is a vehicle, a modification vehicle that was used during the Depression, and Alex Pollock has written about it extensively, called the Federal Homeowner s Loan Corporation.  It was a special purpose company.  It was a corporation, a federal corporation.  It was designed to exist for a short period of time, do its job, and go out of business, and it actually did that.  It s one of those cases, Ronald Reagan couldn t find one, but there actually exists one.  They did their job and they actually turned over some money to the Federal Treasury and went out of business after they completed their job. They purchased one million delinquent loans between 1933 and 1936.  Alex tells me that they actually had about two million loan applications so they turned down 50 percent because they actually underwrote these loans and wanted to turn them into what today is called a sustainable loan.  These loans, while they only equal 3.4 percent of the value of all homes, due to the low incidence of mortgage debt, they actually amounted to 13.4 percent of all residential mortgage debt.  And in today s dollars, that s something on the order of $1.5 trillion. The predominant loan was short-term, interest-only and they refinanced these into 15-year fully amortizing loans.  Borrowers had to qualify based on income.  They were certainly helped by declining rates and they had to meet an LTV maximum of 80 percent. We have the declining rates for the time being but we don t have much of the other parts of this.  They did very well.  Of the million loans, 20 percent were foreclosed upon, but 80 percent -- and again, every one of these was delinquent when they started -- 80 percent were turned into what I would call today sustainable loans that preserved and helped build up homeowner equity and actually helped lead the way out of the Depression, as home values stabilized at their low level in 33 and then started inching up very slowly. So the challenge for President Obama is that we re facing an environment that, in some ways, is more challenging, as I ve just outlined, than the situation that was faced in the 1930 s.  The vast majority of delinquent loans are upside down in terms of loan-to-value.  I just saw some statistics for California that showed the average loan being foreclosed upon is $400,000 and the average loss is $180,000.  Excuse me, that s a misstatement.  The average value of the home after foreclosure was a loss of $180,000 so it was worth $220,000.  The lender, of course, has some more loss beyond that.  Once they get the home in foreclosure, they have to sell it and fix it up and do all of that.  So you re looking at a 45 percent severity in California before you actually disposed of the property.  And that $180,000, that s a huge number and it s because the average house price in California is so large. So qualifying, putting together a modification program where people qualified based on income has problems and putting together one where their credit, even before they got into this problem, is also difficult because the FICOs of 70 percent of the nonprime loans are below 660.  Another ten percent of the loans were made to speculators.  They were going to flip the houses because they were going to keep going up.  And those properties are vacant, by and large, today.  Freddie Mac finds that when they go and foreclose, roughly 45 percent of the houses are vacant because a lot of them were these liar loans to speculators. Rates are down now but we don t know how long, for how long.  I would still say that the only way to undertake a modification program, and this is a hot topic today, the goal of any modification program must be the same as the 1930 s, they really did do it in a way that I think can provide some guidance here.  Create sustainable loans that preserve and build up homeowner equity.  Existing programs do not do this. The latest numbers from the Office of the Comptroller of the Currency, which keeps track of modifications on about 60 percent of the loans out there, institutional loans, is finding that 60 percent of the modifications are re-defaulting within eight months.  Sixty percent are re-defaulting within eight months.  I don t think they re going to have the same result with those modification programs that the Homeowners Loan Corp. had during the depth of the Depression when they ended up with only 20 percent foreclosing.  They need to get back to the three Cs, collateral, credit, and capacity, and design a program around that.  What it means for President-elect Obama is that we re going to have probably 8.8 million one in six mortgages that will either go through foreclosure or have to be modified but that will go through foreclosure unless something is done over the next four years.  The vast majority of those foreclosures will be in the 7.5 million junk loans, 7.5 million of them.  They will have losses that are probably on the tune of $700 billion going forward in those four years.  And then the 32 million traditional loans will have a much lower default rate, four percent incidence, but still adding up to 1.3 million foreclosures and losses of $100 billion. We already know the parties who are responsible for this.  It s Fannie, Freddie on the government side and FHA, and then on the private side, the tranches of the private mortgaged-backed securities are a large part of the $400 billion in that quadrant.  It s hard to quantify the federal government s ultimate portion of that.  I d estimate that, one way or the other, through FDIC banks and Bear Stearns backups and everything else, that they re going to be on the hook for $100 billion of that.  Their other $300 billion has either been written down for a large measure by the holders or they paid cash for them and they know they re worth a lot less, but they actually paid cash for them.  It was real money. And so the federal government probably has around $500 billion of losses that have really has recognized very little, the whole -- just on credit of Fannie Mae and Freddie Mac, as I say, is probably $200 billion and they have not appropriated that $200 billion to pay for that.  They just are pouring in loans and other things that they keep on their books as if they re going to get them back. The Congressional Budget Office, on the other hand, shows the $200 billion, they just came out with this report last week, as $200 billion as being the number that they really should write down in 2009 for the credit losses that the federal government took over when they took Fannie and Freddie over. And then they talk about continuing losses for the new books that are being put on successively after 2008 because this is continuing.  For the first time, we re really continuing a relatively high level of lending as house prices are going down one percent a month.  During the Depression, that did not occur.  During the mid-1980 s, 1985, that did not occur.  During the early 1990 s, the lending was stopped.  It was stopped primarily because there was a underwriting rule that said if house prices are declining, you can t get a loan.  That rule has been waived. In fact, Fannie is now talking about refinancing loans of up to 120 percent LTV.  I m not sure how they do that exactly, but they ve been talking about that.  But they ve waived that declining value requirement and so they re actually lending into the wind of these declining values of one percent a month.  FHA, in the last quarter of last year, 25 percent of all loans, and they re usually three percent or four percent.  So their volume is going way up.  Their systems can t handle it.  And Fannie Mae and Freddie Mac basically account for the rest; 97 percent of all the loans made in the last quarter of last year were done by Fannie, Freddie, or FHA, and that s it. And so they re going to have, this year, they ll probably do, among the three of them, something on the order of $1.8 trillion and perhaps, there s a ten percent embedded loss in those that hasn t been recognized but being really taken on.  And you could call it a type of stimulus. I won t go over the last part.  I ll just refer to Appendix 1, are some ideas of how to address the immediate foreclosure problem along the lines of what I mentioned earlier in terms of having a sustainable loan coming out of it.  I d only say that in fighting an out of control fire, it requires an effective fire break.  And I think it s clear that none of the modification programs that have been put in place yet provide that effective fire break.  And so the challenge for the new administration is coming up with one that does provide an effective fire break that will, and it has to be based on sustainable loans that will start putting a floor under some of these housing values.  I m not saying that housing values are going to be going up.  I think that s overly optimistic.  I think the goal needs to be to try to put a floor under some of these values. Appendix 2 tries to talk -- outline what might be done long term to address some of the problems that we face, and long term in terms of the mortgage lending system.  The mortgage lending system, as we know it, is completely broken.  Fannie Mae and Freddie Mac and FHA may still be working, but they re wards of the government.  And in order to get back to some type of primarily private system, it is going to be a difficult road to go down. And what I think has to be recognized, and I try to put it in a simple narrative here, in the 1960 s, if you had your 80 percent financing that Peter referenced, with a 20 percent down, by a borrower, their equity and eight percent thrift capital, you ended up with a 2.9:1 leverage.  Pretty conservative.  It didn t protect you from all the problems but it was pretty conservative. In 2007, and I ve estimated that Fannie and Freddie, who were doing 25 percent of their lending, was 100 percent LTV and then FHA was doing their own stuff along the same lines but they were doing 100 percent lending 25 percent at the time.  That the amount of capital behind that loan, there was zero equity, $450 was the amount of capital they needed, 0.45 percent, 1.6 percent if the lender took back the mortgaged-back security that they guaranteed.  It was the amount the capital lender needed and if they would have had MI and that would have been another roughly $1,000, you re looking at $3,000.  That s a 33:1 leverage ratio on a loan that is four to five times more risky than the 80 percent loan that had the 2.9:1 leverage ratio.  That, in a nutshell, explains, along with all the advantages that Fannie and Freddie had in really stimulating, overly stimulating the market, that really explains, in a nutshell, what happened over the last 15-20 years. And that concludes my remarks. Peter J. Wallison:  Ed, thank you very much.  That was excellent.  I want to point out to everybody that in your packets, you have Attachment 6 to Ed s testimony before the House Oversight Committee in early December.  And that goes through a calculation of how he got to 25 million subprime and Alt-A mortgages.  So take a look at that Attachment 6.  It s a useful thing to follow. Okay, we ll go right ahead with the commentary, and I want to start with Alan Boyce.  Alan is the chief executive officer of Absalon, which is a joint venture between George Soros and the Danish financial system, that is assisting in the organization of a standardized mortgage-backed securities market for Mexico.  Actually, in a few months, we will be going in more depth into what Alan is doing on this question because there are some very interesting developments in mortgage finance that you all might be interested in for the United States.  Before this, Alan was the senior managing director for investment strategy at Countrywide Financial Corporation, and I guess you ve heard of that organization, where he was responsible for secondary markets, the hedging of mortgage servicing rights and the balance sheet for Countrywide Bank and Balboa Insurance.  He s also been the director of special situations at Soros Fund Management from 1999 to early 2007, and there, he managed a portfolio of assets for the Quantum Funds and had principal operational responsibilities for the bulk of the Fund s investments in Latin America.  I will turn it over to you, Alan.  It s your turn. Alan Boyce:  Thank you very much, Pete.  First of all, I d like to praise Ed for his diligence in trying to put together what I view to be one of the better assemblies of how many mortgages are outstanding and what the underlying risk is.  It s actually one of the big questions in the mortgage system today.  It s actually figuring out how big the problem is.  Secondly, I ve been in the mortgage industry for 24 years.  I spent most of that time arguing for standardization and transparency and arguing against opaque practices, which I was afraid might lead to problems like this.  Sadly, I failed so that s my mea culpa. It doesn t help that everybody s behavior was encouraged.   That everyone involved in the U.S. mortgage system participated in this problem is not an excuse.  It was a virus that the entire industry got and it was probably encouraged by politicians, the press, regulators.  It was part of a global situation where investors couldn t get enough risk and the mortgage industry, in particular, in the United States, was the most able to create risky assets earlier this decade.  But there were other financial industries around the world that tried equally hard.  They were just less successful at creating trillions of dollars of risky assets. I d like to try not to focus so much on the past and more on the future.  And let me just go through a few things.  First, on Ed s approaches and data, I think he s got a very creative use of statistics.  I think that his estimates of Alt-A and subprime loans are a little bit high.  I d add up the numbers to be about $3.5 trillion, not $4.5 trillion.  Let me explain some of the reasons. The mortgage banking industry actually allocates loans into securitization structures based on the best execution of the underlying structure.  So it turns out, there were lots of prime conforming loans that were blended into Alt-A and jumbo nonconforming structures.  So that s one place where there s actually a lot of conforming loans that aren t counted. The estimates of the subprime, in particular, miss, however, what I refer to be the sort of paramutualization of subprime.  Investors around the world couldn t buy enough subprime assets.  So through the miracle of the ABX Index and bespoke CDS interest rate swaps, Wall Street created three or four times the footings of subprime risk. Now, those footings had a long and a short, but the problem is that the winners and losers were very concentrated.  So we created a bunch of winners who aren t the banks and investors of the world, and we created a bunch of losers who are the banks and investors of the world.  So in that respect, the effect of the subprime market was dramatically bigger on important bits of the world financial system than anyone can ever imagine. The argument about Alt-A, I wouldn t say that all Alt-A are liar loans.  I d say a lot of Alt-As and the original concept of Alt-A was that it was either a thin file or a fat file loan.  In particular, the thin file loans tend to be people like teachers and firemen and consultants and people that depend on annual bonuses or stuff like that.  They ve got second incomes.  Sometimes, those things are reasonably hard to pin down. Secondly, the fat file borrowers, this is the United States, this is the country of second chances, and we pride ourselves on risk taking behavior in this country.  It s part of our shared DNA that we give people a second chance.  That if people didn t get a second chance, a lot of the brighter ideas and better companies that this country has spawned would never have happened.  So it s hard to just completely dispense with the Alt-A. However, I d say the biggest problem with the Alt-A, and even in the conforming side, was the original borrower fraud, and in particular, it was the single borrower problem.  That was the probably the risk layer that should have been sniffed out sooner rather than later.  And that single borrower problem was probably the most likely explanation of all the risk layering factors together of somebody that s really investor property. Peter J. Wallison:  Can you just give us a little bit more detail on the single borrower problem? Alan Boyce:  Well, the single borrower, you basically got a married couple, right?  Not every household in the United States is an individual and the husband says he is the single borrower on one mortgage and the wife says she s the single borrower on the other and each have an income, and that second house is really a spec.  Now, it may actually be that they ve moved into the new house and they plan to rent the old house so they re legging their housing migration path.  Another nice thing about the United States is that labor is mobile and we have a range of housing stock, and at any point in your life cycle, you need a varying degree of housing services.  So if you ve got twins on the way, you need a bigger house. So sometimes, it s how do you like that trade?  Do you sell your house now and get short a house and then try to find another one?  Do you buy the next one and then try to sell your house?  So there are a lot of those things going on.  Separately, we built an enormous amount of second homes in the United States earlier this decade.  By some measures, 40 percent of new home construction was second homes. Now, I ve lived in the Northeast for a long time and the winter is not -- every day is like this.  But boy, Florida is really nice to go down and you go down and then you see that the next step of the path of staying in an expensive hotel is a time-share condo and then the next step after that is well, I could just buy a condo here and it s not that expensive.  Maybe you can rationalize it by, This would be a good place to retire to, but the fact is that a significant percentage of those transactions are a cause of speculation, whether the homeowner recognized it at the time or not, whether they are honest with themselves.  So it goes to explain why places like Florida, like, wow, did we overbuild that place, okay? I have some question on Ed s analysis when he s counting the risk of the GSEs, whether he was talking about their guarantee book or their portfolio.  They re actually things run by separate departments to the extent that the portfolio bought subprime assets that weren t guaranteed.  I would classify that as an unforgivable sin. The fact of the matter is while they were buying AAA subprime, there were lots of other investors that were dying to buy them and people were upset that they were competing with the GSEs.  And that may have actually driven the ABX market to synthetically create assets, that there was more demand for them than could be supplied by the mortgage banking industry. Let s talk about things that Ed should probably follow up on a little bit.  First of all, there is a debate that is hard to resolve about what is the source of delinquency.  The orthodox argument is that it s a dual trigger.  You need to have negative equity and some life event.  I think it s very clear that in the 70s and 80s and early 90s, that was correct.  It became something that we all believed, as if it was written down in stone.  I m not sure that the next generation, the children of the people who that database was conditioned upon, behave the same way.  Instead, I believe that those people exercised the second option, the ruthless default.  My house is underwater.  I may be in a recourse state but nobody comes after me if I mail in the keys.  My loan far exceeds the value of my house today.  I m out of here. So I think it s a real big branch of research that has to be done.  Loan Performance data said it is the best but it s not all-encompassing.  They don t carry enough fields so we can analyze this perfectly.  Everybody in the United States that are tangentially involved in the mortgage system is trying to get their hands around it.  This is something that needs to be organized because it s very hard for the incoming administration to make any decisions without understanding all these details. More emphasis on, I really question what FICO scores mean.  I question their validity.  I believe that starting two and a half years ago, FICO scores began to become gamed.  There are half a dozen Web sites out there that have been there for three years.  But just like Kaplan helps you get your SAT score up, you can, with a few things, make your FICO score appear 30 to 40 points better than it really is. Male Voice:  The credit rating [indiscernible] Alan Boyce:  Yes, that is correct.  And I also question its predictive power.  I think that current loan-to-value ratio is the most important determinant in whether somebody goes delinquent.  The corollary of that is I believe that all the most commonly used methods to try to work out a bad loan, sadly, they result in a subsequent delinquency.  The OCC data is 60 percent within six months because none of them address the issue that the loan exceeds the value of the house.  So what that ultimately leads to is there needs to be some sort of systemic cram-down.  And I don t want to get into that argument because a systemic cram-down raises a -- it s a contract clause of the U.S. Constitution.  We need the Supreme Court in this room to give us their advice on it before we start to debate how we solve that problem. I think that the third party origination channels, that all the big mortgage originators were the vector of some of the biggest problems.  Those were the places where the principal agent issues were most extreme.  I d say today that the third party origination channels, that all the existing mortgage bankers have been put in a very tiny box, and I think that that vector of problems does not exist in today s origination.  And that s probably been the case for at least 12 months, maybe 16.  And as every month goes by, that box for the third party origination channels gets smaller. I think we really need to explore the brewing problems that are coming out of FHA.  It s 50 percent of the count of purchased loans in the United States and maybe more than 35 percent of the volume.  Let s exclude the refis right now because we re in the beginning phases of a really big refi wave.  I would call this huge pickup in FHA lending as the re-nationalization of subprime.  The private sector subprime market was the privatization of subprime with no act of Congress earlier this decade, but people should also be aware of.  It s something that the press does not talk enough about. The private sector decided they could do FHA and Ginnie Mae s job better for them with no government support.  They took the risk.  They thought they were doing it right and it turned out they didn t do it all that well.  And now, the government has re-nationalized it.  FHA takes a three percent down payment.  There is an enormous amount of risk that has been running through these FHA loans right now. One positive here, I must say that an Alt-A loan, a low-loan balance loan, a loan made in a geography where housing prices are weak, if the GSE-guarantee department put their implicit government guarantee on that security, that security is actually worth more than any other loan type because those people are less likely to pre-pay.  Remember, there are two competing risks that the U.S. mortgage market has.  You ve got credit risk and we have 30-year callable mortgages.  So that means the bond market is short 360 distinct call options to the homeowner and interest rates in this country move. So to the extent that you ve got the same credit risk, you ve got an implied government guarantee, everybody would want to buy the cash flows of the homeowners, less likely to efficiently exercise their call option.  And the portfolio managers and Fannie and Freddie were absolutely correct, absolutely positively correct, something that drove me and all of my private sector bond traders crazy, they went through and tried to grab every one of those loans.  And I think Ed s statistics are picking that up, thinking of it in a different way.  I think it was completely, thoroughly the right way for them to do it.  Now separately, whether they should have been guaranteeing those loans in the first place, that is a very valid question. But let me go through a couple of other things.  I think it s very hard to ask that we cut the leverage in the U.S. mortgage system from an insanely high 33:1 back to 4.5:1, like Ed proposes.  That s an extra trillion dollars of capital that has to be injected in the system on top of the trillion dollars or so of capital that has to replace the existing losses.  Wow, we ve gone a long way from Senator Dirksen talking about a billion here and a billion there.  The word trillion, I m amazed at how we sling that word around. Here are some other things that need to be focused on.  On December 29th, the day when very few people were reading newspapers, Fannie Mae announced their new loan-level price adjustments, which otherwise is known in the industry as their pooling fees.  And these loan-level pricing adjustments are enormous and they re on top of four separate increases done in the last 15 months.  And these are massively restricting the availability of the only mortgage market that works in the United States. And let me put it another way.  The loan-level price adjustment increases are striking the spot in the homeownership sector.  These are performing homeowners that have an existing conventional loan that s being guaranteed by Fannie and Freddie.  They re probably paying a 6.5 percent interest rate.  And these price adjustments mean they don t qualify to refinance into a Fannie Four today that s trading at par.  The coupon stack in the agency land is trading very tight.  So what that means is the price difference between a Fannie Four and a Fannie 5.5, both 30-year callable mortgages, is only 2.5 points. If you have to pay 2.5 points of these loan-level pricing adjustments, that means in today s current market, you, that 80 LTV, 700 FICO borrower that s not quite perfect by their matrix, has got to pay an extra 2.5 points.  That means your mortgage today goes into a Fannie 5.5.  That means your mortgage rate today is six percent. This isn t that hard to figure out how people price mortgages in the United States, but this is significant because the bond market says mortgage rates should be 4.5 percent, but they are not available even to the people who qualify for an agency mortgage guaranteed today at that rate.  There is only a small percentage of the existing performing borrowers in the United States that can actually get the mortgage rate that the free bond market, the freely traded bond market is offering to people. A little talk on implications, Ed actually had this in his presentation, but I want to highlight some of these because I think the end of his presentation is the most important and it s the kind of stuff, that I hope we have a time to discuss here, that everyone in this room should leave with.  Where do we go from here?  In particular, today is the best time in my career to try to change the U.S. mortgage system on a going-forward basis to build this house correctly. To use an analogy, the patients leaving the emergency room are the most receptive for a little talk from a physician or a medical professional about, You almost had a heart attack and died.  This might be a particularly good time to cut back on French fries and Marlboro Lights, okay?   And I m not trying to be glib here, but this is a particularly good opportunity for the United States to try to get it right. However, I ve also heard from a very wise man that it s very easy to say yes to the right thing, but it s hard to figure out what the right thing is now, given that there are so many other problems circling the financial market today.  I think that the migration from where we are today to where we want to get to in the future is the most important thing.  I think getting started, if you immediately try to improve the horrendous situation that the U.S. housing market is in, mostly driven by the complete withdrawal of available housing finance, is something that needs to be done immediately.  I think the only requirement today is that we allow that, as we migrate on the path to building a better system, that we allow for best practices to enter in, that we don t box ourselves in. Peter J. Wallison:  Thank you, Alan.  We ll have an opportunity -- or I should say Ed will have an opportunity to reply to Alan s comments as well as the comments of Jay and Paul.  So Ed, you just take some notes and when they re finished, you can then respond. Okay, we re up to Jay Brinkmann.  And Jay is the chief economist and senior vice president of research and economics for the Mortgage Bankers Association.  He has been on our panels many, many times.  His responsibilities there include economic forecasting, mortgage industry analysis, benchmarking, industry profitability, and providing support for legislative and regulatory initiatives.  Before he went to the MBA, he worked in Fannie Mae s Portfolio Strategy Group and was on the faculty of the business school at the University of Houston, where he specialized in financial institution regulation and energy derivatives.  Jay, it s up to you. Jay Brinkmann:  Peter, thank you.  First, the usual disclaimer that the comments are my own and do not necessarily represent those of the MBA, so please, send any angry letters to me, not to my boss. To start off, I very much enjoyed reading through this as an approach tool and I think where the disagreement is, maybe like I m a little bit around the edges on some of this, but then first, what I d like to do then this afternoon is talk about, first, how big is the problem and then secondly, when we try to put all these loans together by whatever measure, FICO or whatever, whether or not they re expected to perform the same in all areas of the country and dig down more into the state differential and performance.  And then maybe spend a few minutes on really what I see as some of the more macro failures were perhaps that led to Fannie and Freddie s problems and how that has spread through the entire mortgage industry. First of all, we pegged the number of loans a little bit less than the 57, 58, about 52.  We have gone through this quite a bit and really, I think the difference is when you look at the housing survey enough [sounds like], there are a number of loans where the house has a home equity line but without a first.  And so since we look just at first mortgages and what we do, we tend to think more about the 52 million number in terms of first, realizing that some unknown factor on top of that in terms of home equity lines, that one would hope that those are performing more like a pretty safe first than some of the typical [indiscernible] that we see. Also, the big unknown is this is anything we do, we have to try to estimate the investor share, and so that is probably some of that cushion in between.  But when you look at this, we see about 34 million prime fixed, seven million prime ARM, three million subprime fixed.  Subprime ARM amounts to about three million.  This is rounded up.  The subprime ARM category is of course falling.  FHA-VA at five million and increasing. How to define this?  Well, we, as Ed said, we re in a group that sort of relies on how is a loan being serviced, realizing there s a good amount of spillover between categories.  Some of the largest services, we actually ask them to break it out by type according to some criterion or criteria, depending on what they end up using. But I don t know that FICO would be the best one going, for a variety of reasons, as Alan has mentioned, that for example, Wachovia Securities came out with a great report probably about six months ago titled, Is 700 FICO the New 600?   That all loans then with high FICOs performing as poorly as what you d expect, some of the loan FICOs that do, you end up with differences in order of payment.  Some of the traditional views are people paying the mortgage first, the credit cards and car last had been completely flipped on their head.  That the mortgage, in some cases, is now the last to pay, the reference to FICO fraud because of some of these Web sites. There s also a Fed study that came out about a year ago, I think, that talked about sort of mean reversion of credit scores, the impact perhaps of some of the counseling programs that help people then to qualify for a mortgage and how to improve their credit, what then is the behavior after the mortgage.  And you tend to see sort of FICOs then drift down as they go back then to previous performance. So how are these then performing?  Just as sort of as a base line, we see, of course, subprime ARM is way up here, quarterly, the start rate and the foreclosure process at 6.47, to get an annualized rate multiply it by four, so clearly, the serious problem there.  Subprime fixed has not been the same issue and the blue line right below that is the prime ARM.  Prime, in the loosest, most general sense of the term because this includes the Option A stuff for many services, their Alt-A product with an adjustable rate feature.  FHA being flat, keep in mind there, there is a denominator factor that is your increased loan volume underneath it, your rates that are going to shrink, just the actual numbers increasing that the denominator is increasing faster, assuming that you re not having this FHA loans going to early payment default the same way we re having the subprime stuff.  One would expect that percentage to stay down for a while. And then the prime fixed line down here seems somewhat benign just because of the scale.  But if you actually looked at the numbers behind it, you can see how much higher we are than we were just a year ago or two. But getting behind that a little bit is a little of the Sand State analysis.  I have to confess it s probably my term.  I was, a couple of years ago, sitting in the office as we re first getting the results and we were keeping a close eye on California and Florida.  And when they started to shoot up rather quickly, the concern was bringing the rest of the states, I then said, Well, obviously, we ve got a problem with states with large coastlines.   And my Cracker Jack research staff pointed out to me that even though I probably studied geography in New Orleans public schools, I should realize Nevada and Arizona don t actually have extensive coastlines. So I said, Well, okay, well then, let s call them the Sand States for now until we figure out a better name, unfortunately, it sort of passed on to the extent that some number of months ago at the Chicago Fed, there was actually a presentation entitled, Moving Beyond the Sand States: The Growing Problems in the Clay States. So apparently, the soil composition perhaps is driving delinquency but I don t think that s in anyone s models.  But in this chart, what this shows is that if you look at the average foreclosure start rate at about 1.08 percent in the last quarter, what states were above average and what states were below?  If they re in red, very much above the national average.  This is supposed to be some sort of pink.  These are still above the national average but not by as much.  All of the blue states are below the national average and considerably below. If you then look at that by loan type, in the prime ARM space, again driven by the four Sand States as well as a little bit in the upper Midwest and then Rhode Island, which has the highest percentage of job losses than of any state in the country with clear economic-driven issues there. In the subprime space, again, it s the four states here setting subprime ARM, setting the national average, driving the numbers up.  Most of the country is still well below except for -- well, at least, somewhat below, except for Rhode Island. You then look, okay, what s the trend?  And this was actually what we had looked for -- were looking at with the Sand State discussion.  The black line represents the top line public numbers that we ve been putting out at the MBA since -- well, we ve been putting out many, many years, but time series is 2004, which currently pegged foreclosure start rates at about 1.08 percent.  Because of home price appreciation in those four states and some of the speculation, there are a good number of remedies for someone who would get in trouble.  Refinancing, selling the property, finding a greater full lender down the street that will take on the loan, and that the very low rate and the size of those states actually depressed the reported national level of what was going on. However, once we hit about the second quarter of 2007, as those states started to go up, you can see how they then pulled up the national number.  But the rest of the country combined has gone from about 50 basis points to something in the range of, say, 75 to 80.  It s an increase, a disturbing increase, but by no means, the same dramatic increase of looking at a low from here going up to above one. By loan type, and again, even with the problems of measurement, it somewhat tells the same story.  Prime fixed loans, the impact to those four states, and in this case, it s more of Florida phenomenon than California.  California was not as much of a prime fixed state but pulling up the national number relative to what it would have been.  For prime ARMs, very dramatic to me in terms of how low it was, shooting up, in those four states, to a quarterly start rate of over 2.5 percent, as opposed to the rest of the country. Subprime fixed, same phenomenon.  And this one is perhaps the most interesting thing to me because I had no idea I was going to get these results when I looked at the chart.  But in subprime ARMs, the national average would have been this, still at five percent, an unacceptable foreclosure start rate in a loan product.  But the degree to which the U.S. numbers have been held down all during this period where a number of the debates were taking place over the performance of these loans, how that then started shooting up but the rest of the country has been pretty much flat since the fourth quarter of -- since 2007. So I don t know what this says then going forward.  I don t have access to all the information that you have, but it s clear to me that there needs to be some sort of geographic breakdown in this, but perhaps, some of the prime loans in these four states are going to be performing worse than perhaps subprime or worse, credit.  Perhaps you don t have the same degree of fraud in other areas.  You certainly aren t going to have the same degree of home price deterioration. The other issue, and this is sort of going forward, is to where we may be.  As we go through this transition, I think that perhaps, we re going through where the drivers of performance were primarily loan type, loan quality now, to economic-driven mortgage market, that with unemployment and job losses in most of the country then driving it, what do the roll rates look like? Job losses drive delinquencies.  Home prices and that tend to drive the conversion from the delinquency to foreclosure.  This is a very rough measure.  It looks at the one payment past due in the MBA survey, one quarter as opposed to, then, how many loans have foreclosure started on them in the next quarter, and it looks at four states.  The red state is Texas, clearly, a problem with home prices in Texas back to the oil patch days in the mid-80s.  The green line represents Michigan with their ongoing problems and no home price appreciation really since back in 2001 and just month after month, quarter after quarter job losses in that state, we still see the conversion, now high by historical standards at about 30 percent. However, look at the rapid escalation in Florida and California, that we had hit a point, I guess, last quarter where if a loan had gone one payment past due in California, there was about an 80 percent chance then that we re going to have a foreclosure action starting some time later.  That, then, was a correspondence.  And I think what this says is that some of the loan modification programs and that clearly, there are some things, perhaps, that are working in some states, it won t work in these states, and I think it also serves as perhaps as a predictor that we may not see the same conversion to foreclosures going forward. What was behind it?  Housing starts per capita in these states, certainly overbuilding was a factor.  If we look now at what is the vacancy rate in these states, that if a house was built before 2000, owner occupied, we still only have about a two percent vacancy rate.  Our problems are really in these areas where the houses were built after 2000.  So this is the newer areas outside of Washington D.C., the outer suburbs of Atlanta, entire cities in California and Arizona, condos up and down Miami.  This is this new construction but we haven t had these levels of new construction then throughout the country. And so I think as we move through these problems, we may then see less of an issue with the older established houses.  Certainly then, the regional nature of where the job losses are coming from, California and Florida, we talked about overbuilding, house prices, these are the states now with the biggest job losses on a year-to-year basis, followed by Michigan, one of the more traditional ones, Arizona, not that large of a state but still had a major loss in employment, compared to, say, Texas.  But if it wasn t for Texas, the national job numbers would be a lot worse. Having lived in Texas, I would recommend -- it s a nice place to live.  But I don t think we can have the entire country then move to Texas and then to support the housing market. The other thing is what is the impact, and I think it s often overlooked, is what was the impact stimulus to the economy from home equity injections or injections from the home equity that was out there?  I used to work for the Federal Reserve -- Male Voice:  Is that extraction? Jay Brinkmann:  Extraction.  What do I have? Male Voice:  You have extraction.  You said injections. Jay Brinkmann:  Oh, I meant equity extraction.  I apologize, sir.  The original slide actually said extinction.  And so that s a whole another argument. Male Voice:  A Freudian slip. Jay Brinkmann:  That was a Freudian slip but I did pitch that there and corrected that one, and here, I can t even say it correctly now.  Alan Greenspan used to work at the Federal Reserve, probably, you ve heard of him.  He was very interested in what the stimulus effect was coming out of the housing market.  So he and Jim Kennedy, that I worked very closely with him for a number of years, put together their series on the degree of home equity extraction and how that equity was put to use. This sort of lays it out, and I m not trying to concentrate on any one area, but if you look at the top line, $250 billion, this is on a quarterly basis with some of the peaks, that was a large amount of stimulus going into the economy.  Perhaps more importantly is the stimulus tended to be local.  So you had this procyclical effect of pulling the equity out of homes where you had the biggest home price increases that then led to what I think some events that took place. So then, what s the role, and since Ed s piece did talk about Fannie and Freddie going forward, what are some of the things then we perhaps have to think about?  One, I think, is that when you talk about individual lenders, we ve got thousands, or at least we used to.  But then, if you look at the [indiscernible] numbers, who s originating loans, individual lenders can t make individual decisions based upon what they see going on in the economy. And I think what has led to some of the failures of Fannie Mae and Freddie Mac and how some of those failures have impacted the rest of the economy is the models.  They had responsibility to look at the macro effects of their lending decisions, not just to look at historical models, criteria such as LTV, FICO, et cetera, but say what s going on in this economy because we can take a more global view to look at issues like overbuilding.  What s truly driving these home prices?  Is this temporary?  Is the employment -- a lot of people building houses who are then using the proceeds from that to then buy their own house, everyone building each other or their own house, building each other houses, how long can that continue?  Some pricing perhaps for what happens with their models going wrong. Yesterday s results are not always the best predictor.  Alt-A loans, fundamentally a good product in years past, how then would those dealt with performing?  And I think certainly, the last line was some of the issues in terms of the housing goals conflicting with earnings and some safety things in terms of the ABS structures they ended up buying, how that supported the market.  So there is plenty of blame, I guess, here to go around.  Thank you, sir. Peter J. Wallison:  Thank you very much, Jay.  Okay, our last commenter is Paul Miller.  Paul is well known to all people who read newspapers, who still read newspapers.  He is the managing director and head of financial institutions research at the Friedman, Billings & Ramsey.  He is well known in the financial services investment community for providing in-depth, fundamental analysis and investment recommendations for mortgage finance companies.  He covers a number of different institutions, including mortgage-banking companies, mortgage insurance, small-cap thrifts, and large-cap thrifts.  He was recognized in the Wall Street Journal s 2006 and 2007 Best on the Street awards for thrifts, and he also won an award for Bearish Best Calls, which actually puts him in a distinctly small group. Okay, Paul, here, take the mic. Paul Miller:  Thank you very much and pretty much, [audio glitch] with everybody on this panel so far, I mean, 90 percent of it.  And I think somebody asked me, we re talking about how cold it was outside.  I thought they were referring to the stock market.  I don t know if you guys -- when this panel started, I think you had B of A, Wells Fargo, PNC, some of the big giant financial institutions that were pretty much immune from the big downside in the stock market down in the neighborhood of ten to 15 percent.  I think Wells Fargo is breaking new lows today, as low as $17.00.  All of this is on the front of B of A coming out and saying that they misjudged $15 billion of losses at Merrill Lynch about a day after the shareholder vote. So I agree that -- I m not going to say, Ed, that we re heading for a Depression, but it sure feels that way.  I mean, the bottom line is that what has happened and what we ve done over the last ten years is create a false sense of security in the housing market to the point where we -- I think that the mortgage data, outstanding one, from $5 trillion to $11 trillion in about five years.  So put that in dollar numbers, that 25 per second growth per month really explodes all the numbers way out there.  And even though I don t know if it s as high as 70 percent that s held by the government, but there is about $3.5 trillion of mortgage debt, both not only in first lien mortgages but also second lien mortgages, which is even the worst type of stuff on banks balance sheets.  And couple that with banks only having roughly three to five percent capital, why, because we thought that was a good tangible capital equity ratio to have, and you can pretty much bet that the banking system, in general, is insolvent and that s why we re going through what we re going. So I guess, Alan, you made a comment, We need to do something.   The Obama administration needs to do something, but what is it?  There are a lot of proposals out there of what to do, but it seems like not one of them really -- nobody really wants to really dive into that one proposal to fix it.  We saw Hank Paulson start with maybe we ll just make sure that Bear Stearns doesn t fail and what not.  Take over Fannie and Freddie, that was another move to try to stabilize the market.  And then it was that Lehman failed.  And then after Lehman, there was a domino effect and then you got into a situation where we need $700 billion to buy all the bad assets off the banks balance sheets. I think that proposal lasted about a week.  I m not quite sure because then, it went into we re just going to get TARP funding to the banks and that s going to solve all the problems.  And now, we re in our second, third round of TARP funding and we re going to ask for another $350 billion. I don t know what the solution is.  I do know the solution is that the banks need capital.  Either they have to do -- they either have to get it directly from the government because basically, the private markets are not going to put the money in until they figure out what the government is going to do, or they re going to have to buy the assets.  I mean, there are many different ways you can get capital into the banking system and you have to get solid, tangible common equity into the banking system. And until the government makes that step, which I hope they come to that conclusion quicker rather than later, we re going to just go from crisis to crisis to crisis to the point that the government will slowly take over the whole financial institution of this country.  That has its own negative impacts with creativity, future job growth, and future employment growth, where you have such a -- when the financial industry is controlled by the U.S. government, you re just not going to get the same creativity and the same type of a multiplier effect you would get if these assets were held in private hands. But the bottom line is they got to find a way to get to this $3.5 trillion of mortgages, which are underwater substantially, off the banks balance sheets.  And I have not seen any really good proposals.  I think that TARP buying bad assets is one way to do it, but I was talking to Peter earlier, you have a price discovery issue.  And it s just not -- it s what the government thinks the asset is worth, it s what the banks think the asset is worth, and where do you come, where do you figure out where it s going to be because the banks think it s worth a lot more than the government is going to think it s worth. But at this point, it s like I don t really care anymore.  As a U.S. citizen, you got to find a way to get capital into these banks.  Are we going to wake up one morning and you don t a stock market or 2,000 or 3,000 on the Dow?  You re going to find most of the banks taken over by the U.S. government.  So that s one of the things that we, over at FBR, have really been pushing. And one of the reasons why they try to get me in the papers everyday is, it s really the philosophy of FBR, is that the government needs to wake up.  They need to act, they need to act now, and they need to get capital in these banks now to deal with some of the things that Mr. Pinto has been talking about, is that we just have an overvalued housing market that needs to be dealt with. Some of the things though that I would question in your presentation are a few things.  It s just a lot of minor things, is that you mentioned that I believe that Fannie Mae had $2.5 trillion of exposure.  I think it s closer to $1.5 to $1.7.  And I think you have to be careful about double counting because there is their portfolio and there is the guarantee and they were owned -- some of that overlaps.  Relatively speaking, they own their own securities.  They own each other s securities. And the other issue is on the AAA securities.  You re right, they own the AAA pieces, but there is like 25 percent guarantees in there and all you need is a 25 percent enhancement relative to the market.  And so you almost have to get a 50 percent default rate and a 50 percent severity rate.  Now, we re heading to that severity rate very rapidly, but we re not at the 50 percent default rates yet to start to really breach those enhancements. So we ve always, when we wrote about it, we always thought that as long as you can hold those assets for a long period of time and we felt Fannie Mae could because of backing of the government, you really don t have to take an impairment on those assets.  Now, it doesn t mean that you might take some impairment, but it would be very difficult, I think, for those things, not the cash flow. But saying that, on a liquidation basis, you re definitely not going to get par on those assets.  I think Alan quite [sounds like] has a better position but they re probably trading $0.60, $0.70 on the dollar if you re lucky, according to ABX.  And that s mainly due to leverage issue. The other issue is foreclosures.  Both Jay and Mr. Pinto talked about foreclosures.  And the one thing, when we talk about foreclosures, is trying to define a foreclosure.  I mean, even if you start talking about the servers of the foreclosures, you have three steps to foreclosures.  You have notice of default, notice of trustee-actual sale, and the pull-through rate of the notice of default to the actual foreclosure.  And Jay, you might have a better example of that, but it s very low.  It s not that high.  I think it s below 25 percent. So when a loan defaults or when the foreclosure has started, it doesn t necessarily mean that house is going to be taken over by the bank.  Those loans do occur somewhat, that servers always start a foreclosure because it gives them the highest leverage against the borrower.  When they start to work with the borrower through a loan modification or through some other loss mitigation, they will start a foreclosure just to have a high leverage.  And as long as the borrower is working with them, they will eventually, maybe, pull that notice of default out of it. So when you start seeing these realty tracks or these headline numbers about foreclosures, I believe it s overstating the foreclosure process.  That s not to say we don t look at the trend.  The trend is still very disturbing.  It s very disturbing across the board.  I mean, you re talking about Fannie and Freddie probably losing $100 billion apiece on their books.  I m not trying to cheapen the fact that foreclosures are not important.  The thing is that the issue is, as I think the foreclosure data sets overstate the actual process that s taking place in the industry. And Jay, the other issue I want to mention to you is about the Sand States.  You said there are only four states.  But I mean, when you put that in dollar volume, it s almost 40 to 50 percent of the entire market, right? And so when you talk about the housing market, the first thing you should ask is how s California doing because that s anywhere from 25 to 35 percent of the housing market and that s where most of this new stuff came from.  Where did all these new buildings come from?  What Jay said, it came from Nevada, Arizona, California, down in Florida, and up in Virginia.  And those are the areas most hit.  It s the track housing.  The two-track housing, I like to talk about as condos, which is track housing in inter-cities, they got hit first.  They got hit the hardest so they re not coming back at all, I don t think. And then you got the track housing outside the inter-cities, San Bernardino County.  Jay talked about Central Valley and so did Mr. Pinto.  Those are the areas that are getting hit the most.  Those are the brand new houses that where most of, we believe, the investor-related properties ended up.  I mean, when we go to Central Valley, you hear a lot of stories about people coming out of L.A. and San Francisco that could not afford a house in San Francisco but went out and bought a house in Modesto and tried to rent it out to get involved in the housing market.  Everybody wanted to get into the housing market.  If I couldn t buy a house in L.A., I m going to go out to the Central Valley and buy a house and that s where I m going to speculate. If you go to Vegas, realtors in Vegas are estimating 70-80 percent of the demand for housing in Vegas came from California.  Nobody ever wanted -- these people had no interest at all going and living in Vegas.  They just wanted to play the Vegas housing market.  So the investor-related properties, or Alan called the single -- what did you call them?  I never heard of that term.  Single borrower was definitely a problem out there.  And that s one of the things driving up, I think, the vacancy rates. So one of the things that we really look at, and as the data said, that kind of blew out about two years ago, was the unoccupied homes for sale, which has completely basically doubled from roughly a million, 0.2 million, 0.3 to three million homes, roughly in those numbers, and until you work through those unoccupied homes, I don t think you re going to see any floor on housing prices at all. But it s all driven by those big states, California, Florida, the two big ones.  Throw in Vegas, Nevada, and also Virginia.  Those five states are going to determine where all these losses go. But the big issue here is that the bank, getting back, and I ll end it up here, is the banks need capital now.  The residential market is taking the capital out of the system.  And that s why they re not going to lend.  They might say they re lending, but they re really not.  They re de-leveraging and de-leveraging in a big way. We re concerned about taking this one step farther, which a lot of people are not talking about, is the commercial real estate market, the C&I market.  That s falling apart very rapidly.  Rental properties in New York City are falling 20 percent on a regular basis.  That puts cash flow at risk and these loans at risk inside the New York rental market, apartment market.  That s going to start showing its ugly face probably in the next couple of quarters. So on that point is that the Obama administration, he has to deal with the housing market, but the first thing he has to deal with is the insolvency of the U.S. financial system and he has to do it quicker rather than later.  We don t have 12 months before he de facto takes over the U.S. banking system.  And until he solves that problem, we re not going to solve anything with the floor in housing prices or the employment problem or the direction of the economy. Peter J. Wallison:  Do you have anything pessimistic to say about the future [indiscernible]?  Well, okay, let s give Ed an opportunity to respond to some of the points that were made here, and then the other members of the panel also can talk about what others said.  Please, Ed, and then we ll go to questions from the audience.  So do it as quickly as you can, Ed. Ed Pinto:  Thank you, Peter.  And thank you, the panelists, for your comments.  Just following up on one of the last comments, not only has the residential housing market taken capital out of the banks and really destroyed their capital base, but it s done the same thing to the American middle class.  If you think about what the wealth of the American middle class is, it was only two things.  It was their investments, stock market, various portfolios, IRAs, et cetera, and primarily, their homes, the equity they had in their homes.  And you see from the numbers that the equity from their homes has been destroyed in many areas.  I mean, again, it s lumpy but the numbers are not good in terms of the trend.  And of course, you know what s going on with the investments. A couple of things.  One is, and I think this applies to a number of the comments, the same suspects are causing the problem today.  And I m not talking about the banks, although one could.  Here s an article from 1991, July 5th, 1991, Wall Street Journal, Haste makes quick homes loans have quickly become another banking mess.  Lenders that didn t require usual data on borrowers find delinquency rising inflating the income figures. And I ll just read one quote.  It s under the title, Disillusioned Prophet.   At one time, I was a prophet of low dot [sounds like].  The problem is that it went much too far.  Human beings are basically rotten.  If you give them an opportunity to screw up, they will -- Angelo Mozilo, president, Countrywide Funding, Pasadena, California, 1991. We ve been through this.  We went through it in the late 80s and early 90s.  The rest of the high-risk loans, for the most part, we went through in the mid-80s, early to mid-80s.  Investor loans, I mean, when I started at Fannie Mae, they were just rampant and I remember going to people and saying, How many investor loans are you doing?   We don t know.   And I said, Find out.   And then they tell me and I say, Lower the price.  Raise the fee.   Oh, that will cut the volume.   Well, that s what we want to do.   And we do that and we do that and they say, Oh, we re down to 7.5 percent.   I say, Well, raise the fee again.   And we finally got it down to five percent.  And because I said, We have no business being heavy in that part of the market.   And there were lots of other areas like that, neg-am and all the other stuff. So that s when -- what was different this time that you saw the California stuff back in the late 80s, early 90s.  On the one chart, you saw Texas in the mid-80s in the peaks and things.  And I think what s different is what I said in the beginning.  Fannie and Freddie, starting in the mid-90s, really started loosening things up at the behest of government policymakers, and they grew and grew and they really took over the conforming and conventional loan market by 2003, and the leverage and all the other advantages they had basically created this huge stimulus and this run-up in house prices, which then, Wall Street really piled on in 2004, 05, 06, and 07, which is when the subprime and Alt-A really took off. So a lot of the same culprits in terms of loan types, they re all existing.  And so what s different this time and I think that s what s different.  FICO has changed.  I ve seen statistics because I have been following FICO since it was born in 1989, which was when it was really started, and the quality of a 660 FICO is not the same today as it was in 1989 and 1994.  It s not your father s Oldsmobile, as they say.  And it s probably doubled the risk, at least, of what it was back then, and we re doing, as I said, twice as many.  And so you re really looking at perhaps, in terms of the system, four times as -- essentially four times as much risk. FHA today, they just came out with some numbers earlier this week, and as was mentioned, you got a denominator problem because they re growing very fast and it depresses their delinquencies.  But they did actually publish seasoned FHA statistics.  FHA is the original subprime.  The private market did take it over and now, FHA is taking it back but in a much bigger fashion that they never had imagined before, 30 percent of the market. But what is their seasoned loans serious delinquency, and all of FHA loans are pretty much a fixed rate, is eight percent, 7.9 percent.  And if you go look at the MBA statistics for, and they re seasoned because they haven t been making any more of them, the subprime fixed rate, it s 7.9 percent.  It s the same. And so what have we done?  We just substituted FHA for the fixed rate subprime lending.  An eight percent serious delinquency rate is not a sustainable loan, particularly one that you want to do 33 percent of the time or 30 percent of the time. I would also add that Fannie Mae, when I looked at the $1.6 trillion, I basically looked for the high risk loans, and it turns out those high risk loans all have FHA-like serious delinquencies and growing.  And so -- and I don t think I really had any double counting because I was really looking at their total mortgage risk book.  And so yes, there s probably a little -- the little bit of double counting would be if Fannie bought some of Freddie and Freddie bought some of Fannie, but I didn t count those anywhere.  I just took their mortgage risk that they published, which totals $4.6 trillion.  And I don t think there s any double counting in that total. As far as the tranches, my main reason for including those wasn t so much from the risk, the loss perspective.  It was really what they were touching.  They ve been saying for years, We didn t have anything to do with it.   Well, it turns out when you add up all the numbers, they touched 60 percent of the Alt-A that are out there today.  They either own them or they bought the AAA tranches.  And most of it, they bought and securitized.  And so I think it s important in terms of the discussion of what they actually did do. They also, the last point is Fannie and Freddie knew.  In 2004 and 2005, there was a hearing at the House Oversight Committee that I testified at and they had a lot of -- the committee had a lot of information from Fannie and Freddie that they disclosed that much became public.  One of which is a 2000, I think it s July or June 2005 strategic review at Fannie Mae called At the Crossroads.   Do we keep low -- they were viewing themselves as low risk.  Do we stay low risk and toe the line on risk and take public stands on this and try to bring things back, or do we meet the market?  And they basically decided they had to meet the market to meet two things, their market share goals, which they felt they were under attack from Wall Street in terms of market share, and to meet their affordable housing goals and accomplish those which they could not go to HUD and say they couldn t meet them, particularly given their weakened condition after the two scandals, Fannie s in 04 and Freddie s in 03. And so I think all of those things are part of this, but I really appreciate the comments, and I will be doing some follow-up on a number of the items, but that s my overview. Peter J. Wallison:  Thank you very much.  Okay, I think we have some questions.  Okay, we ll try to get to all of you as quickly as possible.  We ll start over here and we ll work across, so -- and please identify yourself and speak into the mic and -- Mike Furlough [Phonetic]:  Mike Furlough with the BNA s Banking Report. Peter J. Wallison:  Speak up a little more. Mike Furlough:  Sorry.  There has been a lot of talk about using the second half of TARP for a loan modification program.  Barney Frank has said the Sheila Bair model should be employed and there has been talk of redoing Hope for Homeowners once again.  But I wonder what are your views on A) what President-elect Obama will maybe do and B) a lot easier, what he should do, whether using TARP to either guarantee or buy mortgages? Ed Pinto:  I think the second question is easier.  The experience at Fannie Mae that we ve had when we had large situations of modifications and workouts is it s really -- there are two components to it.  There is the loss on the business side and then there is the impact on the loan side.  And those are two different pieces of the puzzle. As I said in my remarks, the loss on the business side is pretty well known.  What hasn t been recognized is that the federal government is really on the hook for $400-$500 billion of that and they haven t allocated that money.  And they re talking about all these other things, but if they would allocate that money, and Fannie Mae and Freddie Mac is a place to start because they have $200 billion in embedded losses, and figure out a way for then taking that hair cut on the business side, which would then allow somebody, either them or a homeowner s loan fund or whatever, to go and modify the loans and do the principal write-downs, you then can connect the two. Somebody has to recognize these losses.  They re there.  It s going to be $800 billion and again, 60 percent of it is the federal government.  So I think that s what they need to recognize.  And what they re talking about is a lot of stimulus over here for different things.  They ve got to pay for these losses that are embedded so they can actually do the modifications that are needed which are going to require principal write-downs. And I know Peter and I have gotten a little bit of flak on this, we re the last people in the world that really love to do principal write-downs, believe me.  But the issue is, and this is I think an important point, when you talk about all these numbers, and it was mentioned about the impact in the areas that the last point about the areas that just got built last, and the American people need to understand this, the lower the LTV, loan-to-value in the neighborhood -- excuse me, the higher the loan-to-value in the neighborhood, the faster house prices will go down. And what s going on is these places that got done, I m talking about North Virginia, they got done last, and this happened in Texas in the mid-80s.  It happened in San Bernardino in the early 90s.  It happens every time.  They are the places with the least amount of equity and they had a run-up in prices.  And when the music stops, the declines hit the hardest.  And so the people that actually put a lot of money down are going to get hurt just like the people who didn t.  And we ve got to stabilize those areas and the only way to do it is to get the equity situation back in alignment. Peter J. Wallison:  Anyone else on the panel want to say something? Jay Brinkmann:  I would just like to add, without getting into a lot of details, one of the issues maybe to address is whether or not any of the money could be used to get rid of the seconds because when you look at the modification process, it s often the seconds will sit there and delay it.  They realize that they have, in a sense, little chance of getting anything.  Their best chance is to delay it and see if they can get some cash out of the holder of the first.  If there was something, to perhaps give them some set percentage, get out of the deal and let us move forward with the principal or the modification.  A great term, whatever is appropriate, that certainly is one use. Peter J. Wallison:  I d also say that there is really a lot of urgency here.  I think everyone would agree that we re talking about a housing problem here, but you can see how the housing problem is turning itself into a problem for the economy in general, recession, depression, job losses, that kind of thing.  We have to put a floor in some way under these housing prices as soon as we possibly can. All right, we re moving across in this direction, right here. Robert Sherretta:  Robert Sherretta with International Investor.  There is one group in the middle, and Mr. Boyce, I appreciated your remark about not enough data.  It s a shame it hasn t been collected in this.  That s why I appreciate your efforts, Mr. Pinto.  But the group in the middle, we ve got the homeowners on one side, Fannie and Freddie on the other, but the mortgage brokers that were involved in this, if we re ever going to right this system and make it better in the future, we ve got to wrestle with this issue.  And I m surprised that in all the discussions that I hear about this, we don t have good data on the number of times that a broker was involved in the loans that were going bad now, the foreclosures, the delinquencies. Besides the issue of fraud, just in terms of the number of times that the brokers were involved as an intermediary, why aren t we looking at that zone in the middle, if you will? Alan Boyce:  I believe that the mortgage originators and the GSEs know pretty darn well that loans that came through third party origination channels have order of magnitude higher credit problems.  [Audio glitch] for a very long time [indiscernible]. Peter J. Wallison:  They bought them anyway. Jay Brinkmann:  And they had some choice.  I got to mention Angelo Mozilo back in 1991, he s also had some choice comments, I think, about the brokers.  You can also look at the number of lenders who have spoken with their feet by essentially eliminating their broker channel.  And some of the issues with the new appraisal agreement has essentially put an end to broker ordered appraisals because of some of the issues involved in that.  So we ll [indiscernible] the incremental changes going forward. Ed Pinto:  But just to make sure we don t throw the baby out with the bathwater here, small community banks and mortgage brokers in small remote towns around the United States are a valid third party origination channel.  And if they re cut off by the big mortgage banks, we have then decided as a nation that if you re in a small place where there s not a lot of banking competition, our national mortgage market is unavailable to you.  But I think people should be very careful about blanket.  You re a broker, right?  You re part of a third party origination channel.  No loan for you. Paul Miller:  I just want to -- we do track that and there is a lot of data on it.  And there s an order or magnitude of five to ten times default rate and losses coming out of the broker channels than it does come in through the self-origination channels.  When we go to banks that have these portfolios, especially in the hillock areas where it s almost a 20 to 30 percent loss rate versus two to three percent on self-originated, they now break everything up, broker versus traditional channels. And the other issue is Angelo Mozilo hated brokers up until about 2001-2002.  And then when he ramped up, he ramped up through the brokerage channel.  It s an easy way to ramp up your production is through the brokerage channel.  And that s when all these mortgage companies just light and fire, pouring gas on the fire by just loading up on these brokers. Ed Pinto:  The other involvements I have is I worked with The Independent Community Bankers Association, which represents 5,000 community banks.  And they are not -- you can t put them in the same category as brokers.  Almost all of them do their [indiscernible].  If they do, they sell their loans there as correspondents, they close the loans in their own name and then they sell them because they have a warehouse ability. Brokers are completely different.  They found themselves very -- it was very difficult to compete against brokers because the brokers are doing all the crazy stuff and they didn t do it.  As when I testified at Congress indicated that if you look at the performance of the loans of the community banks, of which there are 90 percent of the banks in this country are community banks, 95 percent of community banks, their default rate is a fraction of Fannie Mae and Freddie Mac s traditional default rate.  Forget the rest of the lenders.  It always ran half.  And so they didn t do any subprime, hardly.  They hardly did any Alt-A.  They stuck to their knitting and the biggest impact they had in the mortgage area is the regulators told them to buy preferred stock at Fannie and Freddie, which they then lost 100 percent of the dollar. Peter J. Wallison:  Where did the broker loans go? Ed Pinto:  Broker loans went directly from the brokers through the wholesale channels to the big originator, the big, the wholesale buyers, which were the banks and the independent mortgage companies, which mostly ended up being subsidiaries of the banks. Peter J. Wallison:  So the banks knew that this was coming from a broker channel but bought it anyway? Ed Pinto:  Yes.  [Cross-talking] broker channel. Peter J. Wallison:  And did it go then to Fannie and Freddie? Ed Pinto:  And then it was sold to Fannie and Freddie, yes. Peter J. Wallison:  Okay. Male Voice:  [indiscernible] some of it was kept on the books still. Peter J. Wallison:  Yes. Ed Pinto:  Yes, but a lot -- Peter J. Wallison:  Bill, can you identify [audio glitch] Male Voice:  When did HUD first start setting affordable housing goals for Fannie Mae and Freddie Mac and then under what authority? Alan Boyce:  Congress passed the Fannie-Freddie Stabilization Act.  You always have to get worried when they put a name like that.  And in 1992, and that, for the first time, set a fairly specific, without numbers, but it s a fairly specific requirement for affordable housing on Fannie and Freddie.  That then got turned into rule making by HUD in 1993.  There was no limit on the amount that they could set the percentages at.  And so HUD started out at a certain level and they just kept ratcheting them up over time until 2007, and I believe the number was 56 or 57 percent.  And then there were other categories that they also had to meet. That ended up being one of the driving forces of the whole business model of the Fannie and Freddie because that, in order to keep HUD happy, they had to keep meeting those goals, and they actually met them every year until last year when they cratered and that was the first year they didn t meet them. Peter J. Wallison:  And please identify yourself. Female Voice:  [indiscernible] Affordable Housing Lenders.  Ed, really, grateful for all the great [audio glitch].  We spent ten years as responsible banks and responsible Blue Chip nonprofit lend [audio glitch].  I m trying to figure out how Fannie and Freddie were meeting their affordable housing goals because they weren t buying responsible loans for low and moderate income people.  I came to find out a couple of things.  And this was documented in The Post in June. In the 90s, Fannie and Freddie didn t buy affordable housing loans from banks or any other source.  They invested in tax-exempt instruments and [audio glitch] Bill [indiscernible] of Harvard came to the Clinton administration and then set red line poll states, tax writing [audio glitch] committee members.  They [audio glitch] market, but then left HUD in 2005 [audio glitch] again documented in The Post in June.  Fannie and Freddie showed up at HUD, [audio glitch] a rule that said they weren t allowed to count anything below Alt-A for their goals, talked HUD into giving them credit with publishing, [audio glitch] they were doing this, [audio glitch] securities-backed by subprime loans.  It was that 04, 05 06 run-up of [audio glitch] new century option one, some countrywide, but frankly, an alternative network of originators and their brokers that Fannie and Freddie were fueling just as they were turning down their banks and nonprofit customers for the same [audio glitch] loan [audio glitch] prime.  And there are hundreds of [audio glitch]. Peter J. Wallison:  Anyone know anything about that?  That s quite interesting. Ed Pinto:  I could just say a couple of things.  One is the ability to buy the subprime securities, which was somewhat of a surprise, actually goes back to 19 -- Peter J. Wallison:  95, I think. Ed Pinto:  95, with a HUD determination that it was okay for them to buy subprime securities.  So there had to be something driving it this far back as that otherwise.  And the desire to buy them actually was twofold.  One, I believe, was they would help meet the affordable housing goals. But secondly, they were selling AAA paper and they were buying AAA paper but there was a spread difference.  And normally, they made their money on buying mortgages which are not AAA, putting their guarantee on it, and then funding it with AAA.  Here, they were buying AAA and selling AAA and the spread was about 40 to 50 basis points, I ve heard, and they just money on that and that was attractive. Regarding the issue of buying affordable housing loans from depository institutions, I met with -- I was there at the founding.  The National People s Action came into Fannie Mae s lobby in 1986 with a couple hundred people, as I recall, and Gale Cincotta was the leader.  She s the mother of CRA.  And I got a call from David Maxwell.  Ed, there s a couple of hundred people in the lobby.  You need to go deal with them.   And so I went down like an idiot.  What do you want?   And, We want to talk about affordable housing.   And so we talked.  And I got to know Gale very well and we spent a year putting together a program.  We didn t disagree on one thing.  She hated FHA.  She hated what they did to neighborhoods.  She hated that -- the term sustainable loans wasn t used back then, but that would have been the term today, and she said, We have to do these loans right. And I said, Well, the way to do them right is the bank has to -- we need to buy them from banks because it s got to be a depository institution.   It was the CRA.  She wanted liquefy CRA, provide liquidity.  We got to buy from banks, number one.  Number two, they ve got to keep a piece of the risk so that they have skin in the game.  And three, we have to use reasonable underwriting. And then she asked for some changes and I said, If I can show you data that that particular change leads to three times the default level -- she says, Don t do it.   And so we never disagreed on anything.  We put together the program.  I remember Boatman s National Bank in St. Louis.  I think it was the first one.  But it was a program that you had to do slowly.  What I also said, and she agreed, I said, Fannie Mae has no ability to run a national affordable housing program from Washington D.C.  If we have 500 or 1,000 banks doing it and then we have them as our eyes and ears setting these programs up and then they keep the risk and we provide the liquidity and provide some standards but work with them on each one, we can do that.  But we cannot set standards in Washington and then push them out.   As we have a hard enough time doing that with conventional conforming loans, much less affordable housing loans. And I was basing that on my experience in Michigan of eight years.  And that requirement that the banks keep on the risk through the CRA purchases was largely ended in 1989 after I left Fannie Mae.  And again, they really changed the approach to having to do affordable housing and they basically, because of this trillion-dollar proposal, had to do all kinds of things to meet it, none of which or a lot of which really got outside the realm of what they should have been doing, but they had these numbers to meet and they met them. Peter J. Wallison:  Ed, why, if the loans were available from the banks and they were reasonably sound loans, as this lady is suggesting, why is it that Fannie ignored them and went for the jump? Ed Pinto:  I can t really answer that. Female Voice:  You did.  [Indiscernible].  Why get a loan from Bank of America at six percent if you can get it [indiscernible] AAA [indiscernible] Ed Pinto:  Okay.  But they didn t start doing that until, in large numbers, until they did the Alt-A starting in 2000-2001 on the tranches.  The subprime, I ve been trying to figure out when they started, but it was a couple of years after that.  But I think if they had stuck to the banks keeping the risk, they then would have been able to price these loans, put their guarantee. My idea was we re going to put the guarantee on them and then let them be sold out as mortgage-backed securities.  And so the bank was taking the first loss.  Fannie Mae was putting and wrapping it with its guarantee and then they could go out as mortgage-backed securities and provide liquidity. And that, to this day, I believe would have worked and Fannie Mae could have done that and if they wouldn t have had to provide a particular subsidy, they would have made money on it, but the banks would have been happy because they were getting them off their balance sheet and then they could make more.  The idea was the banks needed to be able to make more.  So to do that, they need the liquidity and this was the vehicle to do it. Peter J. Wallison:  Other questions?  All right, we have time for one more question, I think. Tom LaMalfa:  Good afternoon.  I want to thank AEI first for putting up the time [cross-talking] -- Peter J. Wallison:  Can you identify yourself please? Tom LaMalfa:  I m Tom LaMalfa.  I m an analyst with Wholesale Access, a research company.  I have two questions, really.  My first question to the panelists other than Ed, Ed asserted in the latter part of his presentation that Fannie and Freddie were largely responsible for the housing bubble.  I wonder if the other three of you would concur with that assessment.  My second question has to do with the law of unintended consequences and specifically, I recall a conversation I had with the president of GMAC-RFC in 1999 when I called him to ask him why it was they were producing so many nonprime loans.  They were just getting into that marketplace. And the response from him was that we can t afford to compete with Fannie and Freddie any longer.  We have got to find niches because they are the dominant player in this sector of the market.  And I wonder if all of the panelists would concur with that assessment. Peter J. Wallison:  Alan, then Jay, if you want. Alan Boyce:  Let s go backwards.  I think that Fannie and Freddie really did monopolize the sort of prime conventional space, which forced the mortgage banking industry, and that also includes commercial banks because they are always big originators, to seek new margins.  But I d say overall, that if you want to assign a responsibility that basically, the U.S. financial system for the last 25 years has been run by the gas pedal guys, okay? Investment banks, commercial banks, non-depository institutions, the gas pedal guy was in charge.  The risk managers were paid lip service too but did not actually get to influence the final decisions.  And if you didn t have a gas pedal guy in charge, your company was either taken over or your stock performance was so bad that the top guys were replaced. Male Voice:  If you didn t have a gas pedal guy. Alan Boyce:  If you did not.  [Cross-talking] -- in every and all circumstances, you might be [audio glitch]. Paul Miller:  I think Fannie -- I agree with everything you said.  I think what Fannie and Freddie did was standardize the mortgage market and allow the big broker dealers to put the pedal to the metal.  I mean, without the standardization that took place over 20 years and leading up to loan prospect or desktop underwriter, which is probably the beginning of the end of what we re dealing with, where everything was just standardized down to the FICO score and you didn t really -- and then it got to the point where who cares about our W-2 form, right? And then that standardization was taken one step further by the broker dealers and the securitization market, and then you had the CDOs.  And the CDO is the ultimate culprit, but I do think the standardization was the first step that got us to the CDO structure.  And the CDO structure, I think, is the real reason why we re in the mess we re in today. Jay Brinkmann:  So Tom, your question was specifically on the bubble in California? Tom LaMalfa:  Yes, [indiscernible] to think that played a major role in creating. Jay Brinkmann:  Yes.  I think there are a number of culprits.  You d have to go back to all sorts of land use issues, what houses were kept off the market because of certain property tax issues in California.  So there are a number of contributing players.  I think the key point on some of this standardization is what happens if you standardize it and get it wrong?  And I think part of the problems that, with the credit models in place, it did not capture some of the macro factors that were behind some of the performance in that economy. So in terms of okay, just how many houses do we really need for the number of people here, what s really driving some of the buying, and I think there were some signs that politically would have been hard for someone then to put the brakes on this kind of stuff and said let s look rationally at what s going on here or do we keep feeding the system.  And I think that was the breakdown.  Peter J. Wallison:  This is quite a debate which will go on for quite a while.  And we don t have time to do it now but I do want to thank all of you for coming, and I do want to thank the panel for excellent work and Ed Pinto for an excellent presentation. [End of Session] [End of transcript]</body></html>