TCS Daily


James K. Glassman interviews Fannie Mae Vice Chair Jamie Gorelick

By James K. Glassman - July 17, 2000 12:00 AM

Fannie Mae, America's largest financier of mortgage loans, has been catching some heat on Capitol Hill for its government charter, which has allowed the company to borrow money at low rates. The stock has taken a beating lately, but when TCS Host James K. Glassman recently spoke to Fannie Mae Vice Chair Jamie Gorelick, the former Justice Department official said that the company's critics would fail and that Fannie is actually, believe it or not, a B2B technology company.

Glassman: Jamie, can you just tell us very briefly what it is that Fannie Mae does?

Gorelick: Fannie Mae is the country's largest source of housing finance. We essentially assist lenders who make loans to consumers -- to home buyers -- by replenishing their funds, either by buying the loans directly from them or by helping them securitize the loans by guaranteeing that the principal and interest will be repaid.

Glassman: So, if I go and take a mortgage from my friendly bank or other kind of mortgage lender, that bank might be getting the funds from you, one way or the other?
Gorelick: Yes.

Glassman: Okay, in what sense is Fannie Mae becoming a high-technology company? It sounds like kind of a low-tech business.

Gorelick: Well, actually since our product is virtual, that is, it has no physical reality, we are an ideal candidate for a business that can be revolutionized and is being revolutionized by the technology developments over the last decade. In addition to that, we basically deal in bits of information but millions of bits of information daily. And that is another reason why we are an excellent candidate for the technology revolution.

Glassman: Now, what we are seeing in the Internet is consumers buying directly from manufacturers, or at least trying anyway, basically cutting out the middleman. We see this in areas as diverse as buying cars or certainly buying books. Is Fannie Mae involved in that? In other words, why not simply cut out the mortgage lender and have consumers get their mortgages directly from Fannie Mae over the Internet?

Gorelick: The mortgage lender plays a very important role -- first of all with regard to a traditional mortgage file, if the mortgage lender needs to insure that the person who is applying for a loan really has the assets and the income that are fundamental to the loan transaction. Second, one of the effects of the technology revolution will be that consumers will be able to dictate what kind of mortgage they want. For example, when you got your last mortgage, you may well have gotten a fixed-rate mortgage for thirty years on which you put 20 percent down. That's the sort of bread and butter typical loan today.

We see gradually consumers being able to come in and say, "No, I want a loan that adjusts for five years and then becomes fixed. And then I want it to stop amortizing for four years while I pay for my kids' education and then I want to resume paying the loan and I want the entire obligation to end in 17 ½ years when I retire." In order for consumers to understand their options, to understand the different kinds of loans and to make educated purchases, they really need a lot of help at the front end, and therefore, we think there is a tremendous value to be delivered by a sophisticated lender who has at its fingertips great technology.

Glassman: But again, why can't you make direct loans to those consumers? Things such as credit checks are just as easy for you to do as for a bank to do.

Gorelick: Well, certainly, getting a credit report would be. But there's a lot more to it than that. We're a company of 4,000 people. The mortgage lending industry has hundreds of thousands of people working in it because it requires bricks and mortar. It requires a significant degree of counseling and hand-holding for the large number of consumers, particularly first-time home buyers. And there are, and will continue to be many, many loans which cannot be done solely in an automated fashion because human underwriting will still be required. So, if we were to change our business model - first of all, our charter does not permit us to do it - but if we were to change our business model, we would have to dramatically increase the number of our personnel. And one of the advantages that we have in the marketplace is our very low overhead, and we do not think that it would make a lot of sense. We are very good at doing small pieces of large numbers of transactions. We do not want to be in the origination business and very much value our lenders/partners and feel that they are a very important part of our approach to the marketplace.

Glassman: Origination means making the loan in the first place?

Gorelick: That's correct.

Glassman: Now in May, Franklin Raines, who is the CEO of Fannie Mae, spoke in London and talked about how e-commerce was going to be fueling the market for mortgages and that mortgage growth was going to increase very rapidly over the next five years and in fact, your earnings ought to double as a result of that. But why is he saying that e-commerce is going to lead to a growth in mortgage lending?

Gorelick: I think he's saying two things. One is that e-commerce is going to lead to growth in mortgage lending, which I can address, and second, that our ability to deliver value in that marketplace will increase as a result of e-commerce. So, it's both a growth in the market and the change in our role. The growth in the market comes from the ability that technology gives to analyze data from the housing finance in the past in a different way so as to extend credit to people who haven't been the recipients of credit in the past. And I will just give you one example.

I mentioned before that traditionally one put 20 percent down and borrowed 80 percent of the value of the property. And it was sort of a hard and fast rule up until about five years ago when we assessed the data and determined that someone with a good history in the management of their credit would be a better bet for lending than someone with a bad history and the ability to put 20 percent down. And we lowered dramatically our down payment requirements down to three percent for many loans, five percent for other loans, if one has compensating high credit. That has taken down the down payment barrier to home ownership for millions and millions of Americans and it's one of the critical factors responsible for the dramatic increase in the home ownership rate in this country over the last 45 years.

Glassman: And it's really through technology that you were even able to discover this.

Gorelick: Yes. The technology allows you to analyze the data and it has allowed us to develop automated underwriting, which instead of a rules-based system permits the sophisticated, instantaneous analysis of the overall credit picture presented by a borrower, that takes account not only of assets and income, but of credit behaviors and other important factors and again does it all instantaneously. In the old days, it took 30 days to build up a file on the potential borrower. And then that file was passed on to an underwriter, who had made a determination, perhaps sending the file back to the loan officer to have another conversation with the borrower. And this will go back and forth for a period of 90 days and you will hold your breath at the end and hope that everything was done so that a lender could get to the position where they can make a decision to make a loan. Now, you enter 35 pieces of information while sitting across from the borrower. That takes about 30 minutes and you get a decision in seconds. And then what the loan officer does is verify those key pieces of information. So we have taken a process that took at a minimum of 30 days and reduced it to 30 minutes.

Glassman: Now, the other thing that you were saying was that you, Fannie Mae, is in a position to profit from e-commerce.

Gorelick: Yes, and there are two ways in which we do that. If we can lower the cost of originating a loan through this process of streamlining the 30 days down to 30 minutes, then dramatically more people can get into homes. So it also broadens the marketplace. But in addition to that, we are now building an end-to-end platform in which a lender can instantaneously order title, order mortgage insurance, order an appraisal, order flood insurance. These are all things that we have done by fax and mail. An electronic loan file can be sent to the mortgage insurer, can be sent to the title company and can come back to the lender and to us in a matter of minutes. And by extracting that value from the process, you can pass on tremendous benefits to the consumer and you can lower our cost and the lender's costs... And we believe we can profit from that.
Glassman: So, when you say a platform, you mean essentially an electronic b-to-b network between you and the lender.

Gorelick: That's right. And we will be rolling that out in the year 2000.

Glassman: Now, you're doing a lot of things electronically and using high-technology and the Internet, and yet your stock price is not reflecting the market being very enthusiastic about the company. Even though your earnings are increasing, you're trading at a price earnings ratio of about 15. Why is that?

Gorelick: Well, for one thing, we are a financial services company and that PE-ratio is in line with other financial institutions and by and large, we have traded with the financial services industry. You can lay the two lines over each other and they pretty much track.

Glassman: Should you be?

Gorelick: Well, we hope to get ourselves into a higher PE ratio relative to the marketplace by showing that we are one of the real winners in the e-commerce revolution. We will have $700 billion a year in b-to-b commerce on the Net. And that is an extraordinary number. You know, we are just at a point as you know well from following the movement of traditional businesses into the Internet. We're just at the beginning of the marketplace understanding who the winners and losers will be. But it is very clear and our analysts have noted this, that we are very likely a winner in the movement unto the Internet. If you look at the most recent A.G. Edwards review of the Internet economy, the April issue headline is, "a permanent company well-positioned for the new economy." And if you look at the Morgan Stanley-Dean Witter report of a few months earlier, Ken Poser, probably the most well-regarded analyst in this area says that Fannie Mae is among their favorite stocks in a technology-driven marketplace.

Glassman: So, Fannie Mae could be a kind of sleeper tech stock at this point?

Gorelick: We believe so. And what you will end up with is, I think, people coming to that realization as the business migrates with incredible rapidity to the Internet. I described earlier what has already happened with automated underwriting technology. I told you that within the year 2000, we will have available to lenders literally an end-to-end platform. And by 2001 you can do the entire transaction in a day. I mean, literally from application to close in a day.

Glassman: Rather than in 90 days?

Gorelick: Yes. You know, with the passage of the [Electronic] Signature Bill, this will allow the transaction to be done entirely virtually, and it is entirely on the Internet and remotely.

Glassman: Let me ask you two more questions. One of the reasons why your stock may not be higher than it is, is concern that some of your critics may succeed in an effort they have been attempting for the last few years to get Fannie Mae to somehow pay for the use of the implicit government guarantee on its securities. That is to say, there is the implicit guarantee that if anything happens with debt that Fannie Mae issues, the government would step up. And that enables you to borrow at a lower rate than other commercial borrowers. Do you think that there's a chance that something like that could in fact happen?

Gorelick: No, first of all we don't have a guarantee. We explicitly state on our debt that it is not guaranteed. Nevertheless, we are an important part of the Housing Finance system and Congress made an excellent choice in 1968 in privatizing us and ratified that in 1992 to ensure our strength and our presence in the marketplace... Those who would like to change that system have gotten no legislative traction because they are unable to answer the question of, why in the world would you interfere with a great set of policies with choices that lowers the cost of home ownership and that broadens the base of home ownership in this country? And so in the end, I do not think that that will hurt.

Glassman: You said the government does not guarantee your debt.

Gorelick: That's right.

Glassman: But would you want an explicit renunciation by the Federal government that if Fannie Mae ever gets in trouble, [the taxpayers] will not pay one penny to borrowers?

Gorelick: No, we would not want that and nor would Citicorp, nor Bank America, nor would Chase. All of those institutions are very, very important to our economy. We believe that we are as important to our economy as they are and more so because of the important role that we play in housing finance. At the same time, we have and have welcomed the most stringent set of capital and safety and soundness standards in the entire financial service industry to ensure both our debt holders and policy makers that we are operating in a safe and sound manner.

Glassman: This is more of a low-tech question... the Federal government is now retiring debt on a net basis rather than issuing it. Fannie Mae seems to be stepping up to the plate to become the new benchmark borrower as the federal government gets out of the marketplace, or is less important in the marketplace. What would that mean to you?

Gorelick: Well, first of all, I don't know if we will become the benchmark or whether there will be several benchmarks. But we -

Glassman: By the way, you have a trademark on the name, "benchmark bonds."

Gorelick: Benchmark bonds, benchmark notes. We try to issue in large enough issuances and on a regular basis so that we can deliver to our debt investors the liquidity that they are looking for in the marketplace. They need to know that there is a highly liquid market in our debt. That has dramatically lowered our debt costs and we have been able to pass that advantage on to consumers. Similarly, we are very innovative using the Internet to lower our debt rate. We now auction our debt on the Net. We have auctioned $120 billion of debt this year over the Web, and that has broadened access to our debt and lowered our debt cost. This year, in total, we will auction $400 billion of debt on the Web.
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