INTERVIEW TRANSCRIPT

C-SPAN’S “NEWSMAKERS”

Guest: James Lockhart, Director, Federal Housing Finance Agency

Reporters: Zach Goldfarb, Washington Post &

Dawn Kopecki, Bloomberg News

TAPE DATE: Sunday, October 5, 2008

AIR DATE/TIME: SUNDAY, October 5, 2008 at 10 a.m. and 6 p.m. ET

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STEVE SCULLY: On “Newsmakers” on this Sunday, our guest, joining us from New York is James Lockhart, who is the director of the Federal Housing Finance Agency. Good morning to you, sir. Thanks very much for joining us.

JAMES LOCKHART: Good morning.

SCULLY: And joining us here for the questioning is Zach Goldfarb of “The Washington Post” and Dawn Kopecki of “Bloomberg News.” Mr. Lockhart, let me begin by asking you if you're trying to save yourself from foreclosure or are trying to refinance your house or are looking for that first mortgage loan, how do the events of this past week help you?

LOCKHART: It really helps a lot. The passage by the Senate and the House of the TARP bill will allow the Treasury to buy a lot of mortgages and will be able to rework those mortgages and get people into safer mortgages and that's really the most critical part of the bill to me is that people will be able to have their mortgages reworked and make them more affordable.

SCULLY: One of the lines that we've heard all week is that this will help get the toxic loans off the books. Can you explain - what are the toxic loans? What are they talking about?

LOCKHART: Well, that's a sort of a funny term, but what they're trying to say is some of the higher risk loans. Some of the loans that people are having trouble making their payments on that had teaser rates to begin with or had various options that didn't – you didn't pay all that you owed and delayed it for future and those kind of – that's an option arm, those kind of loans have really hurt people because they didn't understand them when they were taking them out and now as the payments have gone up, they're not being able to afford them. And so, the idea would be to take these off the balance sheets of banks and other financial institutions, bring them into the Treasury Department and hopefully rework them.

SCULLY: What kind of oversight will be involved by the Treasury Secretary and the Department itself as we now begin to manage these loans?

LOCKHART: Well, the Treasury Department, as I understand it, will be hiring investment managers and experts in the field and valuing assets and also how to service mortgages. And the Treasury Department will have a new group overseeing in that and then there will be a board, financial stability oversight board, which will be composed of the Treasury Secretary, the Fed Chairman, the SEC Chairman, the HUD Chairman and myself.

SCULLY: And will Fannie Mae and Freddie Mac change the way they do business?

LOCKHART: Fannie and Freddie are going to continue to do what they're doing and doing – and that's to buy conforming mortgages, mortgages that are primarily prime, but also they do do some non prime mortgages. But they basically will continue to fulfill their mission which is to provide stability, liquidity and affordability to the housing market.

SCULLY: Dawn Kopecki is a finance reporter for “Bloomberg News.”

DAWN KOPECKI: Director Lockhart, under the Treasury's plan, the Treasury secretary is able to buy a $100 billion a piece in Fannie Mae and Freddie Mac securities, but this new plan allows them to buy virtually any troubled assets. How much in Fannie and Freddie's portfolio would you consider troubled? And is there any discussion or any consideration for the Treasury to buy some of Fannie and Freddie's troubled assets out of their portfolios?

LOCKHART: Well, first of all, the $100 billion you're referring to as you know is part of the legislation that was passed last July that set up this new agency that oversees Fannie and Freddie and the Federal home loan banks. That has not been drawn down yet. The new facility will be looking at troubled loans and will certainly look at the possibility of potentially of buying some loans from Fannie and Freddie and as well as securities. It's not just loans, but it's also those private label securities as you know that Wall Street put out that have also a lot of sub prime and all paid (ph) problem mortgages.

KOPECKI: But how much in Fannie and Freddie's portfolios would you consider troubled or illiquid that don't have a market right now?

LOCKHART: Well, as you know, Freddie and Fannie's portfolios are giant. They're over $5 trillion of mortgages, almost 50 percent of the mortgage market in this country. Certainly, they have some troubled mortgages, much lower than the percent overall, but that's certainly in the low two, three, four percent in that range potentially, but it could be from their standpoint, they will just look at whether they want to keep them on their balance sheet or whether they want to sell them.

SCULLY: Also joining us on Newsmakers is Zach Goldfarb of the “Washington Post,” business reporter.

ZACH GOLDFARB: Good morning, director. It's been precisely one month since you announced the government would seize Fannie and Freddie. Can you tell us what you have been doing in that month to help the average borrower or homeowner out there and whether it's been successful or not?

LOCKHART: Morning, Zach. Well, first thing we did, even before we did the conservatorship, was to appoint two new CEOs and those CEOs have taken over the companies and we've been working very closely with them as they look at their mortgage book and decide what to do. One of the reasons that we took the action we did was because Fannie and Freddie were no longer able to fulfill their mission. They weren't being able to provide that stability of liquidity and affordability and hopefully, with the new Treasury facilities, they'll be able to do that. And so they've been looking at the options out there and just the end of last week they decided not to raise prices that they had previously talked about and certainly the idea there is to try to make mortgages more affordable.

GOLDFARB: Now, has there been any success in in fact making mortgages more affordable? What have we seen, for example, with mortgage interest rates on Fannie and Freddie loans and overall?

LOCKHART: Well, what we saw right after the conservatorship is mortgage rates came down actually very dramatically; they dropped almost half a percent and then they backed up a little bit with all of the turmoil that has happened in the last week or two. I'm hoping with the new TARP facility we may see rates start to ease down again and I think that will be very good for the mortgage market and certainly for the American people.

KOPECKI: Director Lockhart, with your decision as conservator to not increase rates again in November as Fannie and Freddie have done in the last couple of quarters, how does that impact their stability? Right now, their debt costs instead of going down with all of that Treasury has done over the last several months, they've actually gone up. Their debt costs are now hovering right around their highest levels ever, right around the Bear Stearns bailout. You're lowering costs to make mortgages more affordable for consumers, but at the same time, aren't the companies getting squeezed by this increase in debt funding, higher losses, higher loan delinquencies and yet at the same time, you're reducing their capacity to generate more income going forward? How can you manage that and how financially stable are they right now?

LOCKHART: Well, first of all, these were decisions and recommendations by the two CEOs. This was not a dictate by FHFA. The companies this year's book of business is profitable and one of the things I've said in the past is I didn't want this – them to raise prices so much to try to make up for all of the problems in the past. What we need to do now is to get people into new mortgages, we need to restructure some of those old mortgages and hopefully, that will help housing prices stabilize in this country and help the market stabilize. The two companies certainly had problems, that's why we put them in conservatorship and we're going to be watching them closely. But the good news is they do now have a backup through the senior preferred facility of the Treasury Department.

SCULLY: How long to sort through all of this and bring back more stability to the housing finance market? What kind of a timeframe do you think you're looking at ideally?

LOCKHART: Well, I think we all wish we knew. Certainly, the new facility just approved by Congress should speed the process up and hopefully, significantly. Most people talk about another year or so to run, could be longer, could be less. My view is that the steps have been put in place like the conservatorship of Fannie and Freddie, like the new TARP facility that the President signed on Friday, I think will help speed up the recovery. I think what we need to do is to rebuild confidence in the American economy and the American housing market and I think this will start to do that.

GOLDFARB: When the companies were taken over, I think a lot of people were confused; is this an experiment in the government owning private companies? Are these new government agencies? Who do the employees of these companies work for? Can you help clarify some of those questions?

LOCKHART: This was not an experiment. This was done out of necessity because as I said that they were having safety and soundness issues. The two companies were really created in a structure that didn't work in this market. They were very thinly capitalized, they were mandated to take on a lot of higher risk mortgages and the two didn't work. So it was definitely not an experiment and going forward, I think we'd have to rethink the structure of these two companies and hopefully, in the next year or so, congress will do that and we'll see a new structure going forward.

KOPECKI: Director Lockhart, at the hearing last week, the new CEOs, who you appointed and who I'm told don't make a decision without your approval to be honest and correct me if I'm wrong there, but they have to put all decisions through your agency now, but they had said that they are under taking a complete overhaul, a complete revaluation of their portfolios and that investors can expect those results in the third quarter. What are you seeing with that, with that revaluing of their assets? Are you seeing – are we talking that their assets are going to be dramatically altered by several billion dollars? A couple hundred million dollars? What are you seeing so far in that revaluation now that the quarter has closed?

LOCKHART: Well, certainly the quarter has just closed, but it's much too early to say what the results will be. And again, I – we are not making the day to day decisions. These are two very senior men that have extraordinary skills and they've – we've also appointed non executive chairman and we're going to build boards of directors for these two companies. So the idea will be that the agency will not be making the day to day decisions and certainly they are going to be working with their accountants as they close the books to look at the impact of the continuing problems in the housing market on their reserves.

KOPECKI: And the Securities and Exchange Commission recently eased up the accounting for – the fair value accounting rules for assets. How does that impact Fannie Mae and Freddie Mac? A lot of other people are saying that at banks across the country, it's going to increase their capital because the companies will be able to revalue their assets in a way that makes their balance sheets look a lot better. How do you think that will impact Fannie and Freddie?

LOCKHART: Well, the fair value accounting has become a hot button issue and it's hard to imagine that accounting issues become hot button issues, but what it is for people that don't understand it, it's simply marking all of the assets and liabilities to market and then looking at how much capital you have. Many companies do a variation of that, very few actually mark everything to market and so they choose some assets and choose some liabilities. In the case of Fannie and Freddie, they have relatively few assets and liabilities marked to market, so it won't have a dramatic impact on them. They do put out on a quarterly basis a full fair value, but that's not part of their normal accounting statements and that shows relatively large losses and certainly that number may change going forward.

KOPECKI: OK.

GOLDFARB: Director, as we look towards the future, what kind of goal posts should taxpayers be looking for to see if this intervention is working? In six months? Or 12 months? Or three months from now? What should we be looking for to find out if the conservatorship, if this decision was the right one?

LOCKHART: Good question, Zach and I think that's a very important question because we do want to make this intervention, as you put it, work. And to me the most important thing is getting the housing market back and functioning. These two companies now represent 70 to 80 percent of all new mortgages made in this country and we need to get people back into buying houses. We need to get people into getting mortgages. We need new home buyers to come back into the market. We need people to be able to refinance out of some of those toxic mortgages is the phrase was. And we need to – and Fannie and Freddie can play a very important role in that.

So a key thing will be Fannie and Freddie’s ability to borrow money, lend it out, and guarantee mortgaged-backed securities. And to me that would be the major test. Certainly we would hope that the – over the you know next year, two years they would return to profitability which also would be a very major step forward.

SCULLY: Mr. Lockhart, let me follow-up on that because as you know, the political geography and the regulations are different in Europe. But in Paris yesterday, the leaders of the largest European countries meeting to discuss kind of the ripple effect that they have been dealing with in their respective countries. Any advice you would give them as they deal with the situation.

LOCKHART: Well that is a tough one. There is a lot of different countries there and they each have some different issues. But you know I think the key thing is that we need a united front. And I know they have been working with the Fed and the treasury. And I think it is important to you know, stop this crisis. And I think you know certainly the action – the bold action taken by the president and Secretary Paulson should put forward the forward the (INAUDIBLE) proposal and Congress to pass it is the kind of thing that needs to be done.

We need a coordinated effort to stop the slowdown. And to start the – return stability to the world economy.

GOLDFARB: Just to clarify, director, will troubled assets on Fannie and Freddie’s books be sellable or to the new treasury program? Will the government be able to buy those troubled assets from Fannie and Freddie as they will other Wall Street banks?

LOCKHART: Well the definition of a financial institution as I read the act is very broad. And certainly to my reading of the act is they are financial institutions that could sell assets. Now whether they will or not is certainly the decision has not been made. Certainly you know it is very important for them because their customers are banks. Banks that have these mortgages on their books and other financial institutions.

So it is very important for them, the treasury will be able to buy those, free up capital in those banks to make new mortgages that hopefully Fannie and Freddie can buy. So I think it will help to really re-liquefy the system. And whether Fannie and Freddie decide to sell some I think will be up to the management team.

KOPECKI: Director Lockhart, on their accounting, the Securities & Exchange Commission is now investigating Fannie Mae and Freddie Mac’s accounting once again. The FBI, Department of Justice, I believe two field offices of the FBI are actually fighting over this case to prosecute whoever at Fannie and Freddie did whatever to their books. Can you tell me what it is that they are looking at? As conservator, I am sure you have seen the subpoenas. It has to do with their accounting.

They both just completed restatement and went through you know a white glove investigation by multiple federal agencies of their accounting two or three, maybe four years ago. So what has happened that has gotten them to this place again, and why couldn’t it have been prevented, and which accounting issues are they focusing on?

LOCKHART: That is a lot of questions, Dawn.

KOPECKI: Sorry.

LOCKHART: But I think the issue is they are one of – or they are two to be exact, of 20-some financial institutions that are being investigated. Virtually anybody that had any big player in the mortgage market over the last few years. And we have certainly met with them and are cooperating with them as they go through the process.

You are right. Both companies just finished major restatements. They just became finally in their financial statements just this February after three or four years. They had a major effort. Thousands of people potentially working on it.

Freddie Mac just in fact finished registering with the SEC for the first time in its history in June. So these books have been pretty well scrubbed. But certainly we welcome and will cooperate with the FBI and the SEC as they go through this process.

KOPECKI: Do you think they are being made examples of? Do you think that there is enough there to warrant criminal investigations, or do you think that because they are the largest mortgage companies in the United States, and because they were placed under a conservatorship that they are more or less an easy target?

LOCKHART: Well I think they are a big – they are you know two largest mortgage organizations in this country. And this as the Secretary Paulson quite often says, this all started in the housing market, all these problems. So I think it is a legitimate thing to look at the two largest players. You know my view is as to whether it is necessary or not I don’t think is important.

I think it is important to the American people to be sure that there weren’t problems at these two companies.

GOLDFARB: Director, you and Secretary Paulson have discussed this inhering conflict in the way the companies were set up. Serving dual masters, the public mission of housing and affordable housing and the private mission of serving shareholders.

Now taxpayers have replaced shareholders by large measure. What ways does this new set up under government control unravel that conflict, and what ways now and what ways in the future does that conflict have to be unraveled?

LOCKHART: Well we are only in a temporary conservatorship now. And it does have to be unraveled. There is a conflict, and the problem in my mind was that they were – congress allowed them to be very thinly capitalized. As you know, we put actually an extraordinary 30 percent additional charge on their capital because of their problems.

But even that was not enough. We actually also froze their portfolios. But that wasn’t enough. The model has to be re-looked. There is no doubt about it. And you know there is a range of possibilities going all the way from a pure privatization to a much stronger GSE model to you know some people are even talking a nationalization.

It has to be re-looked at. My view is that we – they should become able to come out of this situation with new investors and a much stronger capital structure.

KOPECKI: Director Lockhart, when do you think they might emerge from conservatorship? I believe at the hearing – correct me if I am wrong – you know said that it is at least going to take a year or more. Representative Jeb Hensarling introduced legislation last week that would require you, as Director of the FHFA to either place them into receivership, which is an effective bankruptcy and liquidate their assets, or completely bring them out of conservatorship within two years, and then eventually privatize them. How long do you think it will take you to bring them out of conservatorship, and what do you think about the Hensarling proposal?

LOCKHART: Well I haven’t been able to read it, although I have heard the description you just gave as well. I think it is a good start to the dialog of what needs to be done with the future of Fannie and Freddie. That is one set of proposals.

Certainly actually receivership doesn’t necessarily mean in bankruptcy. What can happen in a receivership is you leave the old assets and liabilities behind and you create a new company coming out. And that is one alternative. I don’t think these companies need to go into receivership. I think in the conservatorship we can do the kind of restructuring that needs to be done and we are going to be working with the two management teams and congress and the administration as we go forward to make sure that these two companies really do fulfill their mission which is you know so critical to the American economy now more than ever of providing stability, liquidity, and affordability to the mortgage markets.

GOLDFARB: Director, how will spending a year or more under government control affect how these companies and their employees think and operate? In other words, will a mortgage bankers, mortgage specialists, hired by the companies you know, with the hope of you know, making a lot of money in part in addition to the housing mission, want to stay if they are under government control or if making profits isn’t one of the top objectives? Will it be hard to retain employees? Will the cultures fundamentally change?

LOCKHART: Well certainly making profits on this year’s book of business is a critical goal. The employees are very important to us. And as you know, one of the things we did even before the conservativeship was to hire a personnel-consulting group to look at retention bonuses for these people to make sure that they stayed on board.

I don’t think there is going to be a culture change. I think you know maybe some of the culture needs to be changed. But I think what will happen is that people again really focus on the mission of the companies, and we are going to work with them to do that.

At the same time, we are not going to put in a government culture here. We are going to put in board of directors as I said. And we are going to reconstitute them. And they are going to meet monthly and they are going to be the oversight for the management.

KOPECKI: Director Lockhart, on – you have said twice now about this year’s book of business being profitable. But they are not bringing on a lot of new business right now. And it is only profitable if you can bring on a lot of new business, and yet congress or treasury has half their portfolio growth at 850 billion. In my estimate, that only gives them about $100 billion more worth of additional business to do this year.

How are you going to be able to make profits? I mean do you see the companies actually turning a profit any time in the next four quarters. And when do you see them turning profitable? Because they have not had profits in the last four quarters. It has been more than a year since either of them have shown a penny of profits. When do you see them becoming profitable?

LOCKHART: Well it is hard to predict when a company is going to become profitable in this market because a lot of it really does depend on the previous book of business. Not this year’s book of business. But the 2006 and 2007, some of those troubled mortgages. And you know, how people – will people continue to pay their mortgages? You know whether delinquencies will grow, whether foreclosures will grow.

Now hopefully the new TARP proposal will stop some of that and aggressive modifications that the two companies will do will stop some of that. The key thing to me is that they are continuing to grow in this market. Even though the mortgage market itself is shrinking, they have actually been positive suppliers and growing this year. Because it is not just their portfolios.

But they are also guaranteeing mortgages and selling them to investors worldwide. And so the idea really will be for them to continue to grow, and to continue to support this mortgage market.

GOLDFARB: Director Lockhart, can you give us some insight into what you call the new management of the companies about weighing the issue of whether we go for the highest profits possible, whether we put buying up mortgages, whatever their credit quality first, and a long (INAUDIBLE) spectrum, where you have instructed in this management to make decisions about pricing and mortgages?

LOCKHART: Well again, what I have told the two management teams is to re-look at their pricing and to re-look at their credit. I haven’t told them what to do and we are getting recommendations from them and decisions from them. Again, on Thursday and Friday they both announced that they weren’t going to be increasing their prices another 25 basis points.

I think that was good news from the mortgage market. But certainly they will be look also at the credit decisions. And you know we don’t want them to take on bad business. That makes no sense. On the other hand, they should continue to support the marketplace. And that may take serious credit decisions. And I think they are capable of doing that. And we encourage them you know to work with the lenders who they buy the mortgages from to try to create good programs for the American people.

SCULLY: And finally, is it also …

LOCKHART: We are also – we are also – and this is importantly encouraging to do a lot more in the foreclosure prevention area to modify those loans that need to be modified to get people into safer programs. Lower the interest rate, extend the maturity, even write down part of the principal if needed. We really do need to get people to be able to stay in their houses and prevent foreclosures.

Because you know, it not only hurts the individual, it hurts the whole neighborhood.

SCULLY: You may have answered the last question. But as a graduate of Harvard Business School, if you were to teach this next generation of business students some of the lessons learned in the housing finance market, what would it be?

LOCKHART: Well I think one lesson that we unfortunately learn too often is that bubbles happen. People you know get irrational about prices going up and you know whether it happens in internet stocks or housing. One needs to be prudent. One needs to be willing to put a brake on it. We tried with these two companies. Actually with our capital and extra capital requirements and constrained some of the portfolio.

But it is really very, very hard to fight that kind of exuberance if you will. Credit standards went out the door. And so one of the key lessons is you know keep to the fundamentals. Don’t forget that you know when you are making a credit decision, when you are you know making a loan, when you are managing a company, that a critical piece is to don’t forget the fundamentals. Don’t get carried away and managing the business for the long-term.

And it is not just for the shareholders. It is for the American people.

SCULLY: James Lockhart is the Director of the Federal Housing Finance Agency joining us from New York. Thanks very much for being with us.

LOCKHART: Thank you.

SCULLY: Continuing the conversation, Zack Goldfarb of the “Washington Post” and Dawn Kopecki of “Bloomberg News.”

One of the things that the director said is that the culture needs to be changed. What specifically do you think needs to happen?

GOLDFARB: Well in the past few years, before the housing downturn we saw the companies move aggressively into buying these risky securities, subprime loans, other securities that have now caused their pain and angst.

It is unclear what the companies have to do in terms of hiring people who have to be able to balance you know the need to make profits is to serve that goal, at the same time the need to support the housing market from employees talk you know with great lament now about how they work for Fannie and Freddie over two or three decades. And were able to make a steady living, but also were able to make a steady living, but also be able to support housing, they felt ideological, philosophically inclined towards that goal.

So now it is unclear you know. Do they work for a government agency, a government company so to speak? Do they work for a hedge fund, a private bank? It is very unclear. And so I don’t know how it could be changed. But it is certainly unclear and there’s a lot of ambiguity surrounding that now.

SCULLY: If you follow this story, how do you think we can measure whether or not this agency is fulfilling its objective?

KOPECKI: The FHFA? In turning around Fannie and Freddie?

SCULLY: And the overall housing finance market.

KOPECKI: Well I think it has been overshadowed by what the treasury is doing because Fannie Mae and Freddie Mac’s debt cost, which gets passed on almost directly to consumers, have continues to rise despite all of this liquidity, all of this extra money in cash that the federal reserve and treasury have put in and are putting into the system.

And I think what that signifies what I am told is that investors don’t have confidence that the treasury plan is going to work. Fannie Mae and Freddie Mac have a ton of losses on their books that are going to have to flow through earnings, that Director Lockhart himself said neither of these companies have really been marking their assets to market, meaning they haven’t been reflecting the actual – the real value of their assets.

That means that those losses are going to be coming through earnings in the next several quarters. I think the FHFA can be measured their effectiveness on this, on whether or not within the next three or four quarters you’ll start seeing profits at Fannie Mar and Freddie Mac.

You are not going to see an immediate – an immediate impact. Consumer mortgage rates are being affected by broader factors. Macroeconomic factors, and no matter that FHFA does, it is up to the markets whether or not the debt costs will lower, and whether or not you will see actual lower prices for consumers.

So far, you are not really seeing that. You were initially, the first couple of weeks, but they have since gone back up.

SCULLY: And to each of you, did anything surprise you? Did you learn anything from the director’s comments today?

GOLDFARB: Well I think what we have heard is that a lot still has to be worked out. And as Dawn said, that events really have been taken over by what we have seen in the last two weeks. It is funny you know, for reporters when this story broke four weeks ago to the day, we described this as the most sweeping government intervention or one of the most sweeping government interventions in American history of the private markets.

And we have just used that phrase you know five or six more times since then. And so I think that as Dawn said, events have really taken over. The recent events have really taken over the Fannie Freddie story. And a lot still has to be worked out. And their future is very much tied to the – and whether or not this succeeds is very much tied to what happens to the rest of the economy and the rest of the mortgage market.

SCULLY: And what did Mr. Lockhart bring to the table? What is his expertise?

KOPECKI: He was head of the Pension Benefits Guaranteed Corporation. And ran that during some very troubled times. So he is accustomed to trying to or at least working with troubled institutions.

On your previous question, I think – what I think is significant is he indicated that Fannie Mae and Fannie Mac’s assets are definitely eligible to purchase through this new treasury program. Which means the $200 billion figure that treasury initially put on it could be out the window completely. Could be a lot more than that direct assistance to Fannie Mae and Freddie Mac.

SCULLY: We will look for the stories in “Bloomberg News” and in the “Washington Post.” Thank you both for being with us. And thank you for joining us on this Sunday.

END