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Amidst Uncertainty, Some Expect Home Prices to Fall

Fannie Mae's CEO, Daniel Mudd, knows that housing has been on a roll in recent years, but he thinks the market may be sliding backward this year.

Speaking at an investors conference sponsored by Citigroup, Mr. Mudd said that Fannie Mae's economists expect home prices to decline nationally by 1% to 2% this year. That would be the first time since World War II that the average housing price declined nationally.

"Our economists see more tough sledding this year for the housing and mortgage industries," Mr. Mudd said.

Fannie Mae expects to see home sales fall by 8% in 2007. The company also expects mortgage origination volume to decline by 7%.

"These figures are national averages, but I think the pain will not be felt equally or in any kind of national way," Mr. Mudd said, adding that some regions may continue to see price gains while others, such as the Gulf Coast and the Upper Midwest, will suffer from weak economies and credit losses.

He said "multifeatured," exotic and nontraditional loan products will likely experience the most default pressure, especially in areas that have seen substantial home price increases.

The downturn is not all that surprising, he suggested. The housing market has been extremely strong through two economic cycles without letting up, he said. Strong investor demand and the lowest mortgage rates in two generations helped fuel the housing boom. But those factors may have driven prices to unsustainable levels in some areas.

"In none of the top 10 U.S. markets can the average wage earner afford the average home, based on traditional underwriting ratios," Mr. Mudd said.

That has led consumers to choose mortgage products with low initial payments, ranging from simple adjustable-rate mortgages to more complicated negative amortization loans.

"I would look closely at any product underwritten at the upper margins - of LTV, credit, coverage, reset risk - and thus represent a de facto bet that increasing home prices would cover the bet. It may not happen," he said.

As a result, Mr. Mudd predicts that 2007 will be a year in which "marginal loans, marginal lenders and marginal products will get shaken out."

Fannie Mae's own exposure to a deteriorating market is manageable, he said. Currently, nontraditional mortgage products comprise 7% to 8% of the company's single-family credit exposure, he said. Properties owned by investors comprise 5% to 6% of the portfolio. The average FICO credit score on Fannie Mae's book of business is 721, he said. And the single-family delinquency rate stood at 61 basis points in the third quarter of 2006.

Credit losses amounted to about 1 basis point of the total portfolio last year. While Mr. Mudd suggested this is unsustainably low, he said Fannie Mae does not expect to see a jump in credit costs.

Mr. Mudd said that while Fannie Mae lost market share in its credit guarantee and securitization business to private-label securities in 2005, it began to regain some share last year.

In a separate conference call in late March, Freddie Mac CEO Richard Syron said that last year, home price gains slowed to a "low single digit" annual rate, with a sharp stalling of appreciation at the end of the year.

Recently, Freddie Mac economists reiterated their prediction that home prices will increase nationally this year, but at a rate of less than 3%. They also said that home price trends are difficult to predict.

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