    [Senate Hearing 109-1065]
    [From the U.S. Government Publishing Office]

                                                           S. Hrg. 109-1065

                           FHA: ISSUES FOR THE FUTURE

    =======================================================================

                                    HEARING

                                   before the

                   SUBCOMMITTEE ON HOUSING AND TRANSPORTATION

                                     of the

                                  COMMITTEE ON
                       BANKING,HOUSING,AND URBAN AFFAIRS
                              UNITED STATES SENATE

                           ONE HUNDRED NINTH CONGRESS

                                 SECOND SESSION

                                       ON

        PROPOSED CHANGES TO MODERNIZE FHA, ENABLING THE AGENCY TO MEET
        CHALLENGES WITHIN THE MORTGAGE-LENDING INDUSTRY AND TO CONTINUE
                     EFFECTIVELY SERVING LOW- AND MODERATE-
                               INCOME HOME BUYERS

                                   __________

                                 JUNE 20, 2006

                                   __________

      Printed for the use of the Committee on Banking, Housing, and Urban
                                    Affairs

    Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html

                                   ----------
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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      RICHARD C. SHELBY, Alabama, Chairman

    ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
    WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
    MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
    CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
    RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
    JIM BUNNING, Kentucky                EVAN BAYH, Indiana
    MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
    JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
    ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
    MEL MARTINEZ, Florida

                 Kathleen L. Casey, Staff Director and Counsel

         Steven B. Harris, Democratic Staff Director and Chief Counsel

                Mark Calabria, Senior Professional Staff Member

                 Jonathan Miller, Democratic Professional Staff

       Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                           George E. Whittle, Editor

                                     ______

                   Subcommittee on Housing and Transportation

                        WAYNE ALLARD, Colorado, Chairman

                    JACK REED, Rhode Island, Ranking Member

    RICK SANTORUM, Pennsylvania          DEBBIE STABENOW, Michigan
    ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
    MICHAEL B. ENZI, Wyoming             CHRISTOPHER J. DODD, Connecticut
    ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
    MEL MARTINEZ, Florida                CHARLES E. SCHUMER, New York
    RICHARD C. SHELBY, Alabama

                        Tewana Wilkerson, Staff Director

                       Kara Stein, Legislative Assistant

                                      (ii)

                                C O N T E N T S

                                  ----------

                             TUESDAY, JUNE 20, 2006

                                                                       Page

    Opening statement of Senator Allard..............................     1

    Opening statements, comments, or prepared statements of:
        Senator Reed.................................................     5
        Senator Martinez.............................................     7

                                   WITNESSES

    Rick Santorum, A U.S. Senator from the State of Pennsylvania.....    35
    Brian D. Montgomery, Assistant Secretary for Housing and Federal
      Housing Commissioner, Department of Housing and Urban
      Development....................................................     3
        Prepared statement...........................................    35
    William B. Shear, Director of the Financial Markets and Community
      Investment Team, Government Accountability Office..............     8
        Prepared statement...........................................    39
        Response to written questions of Senator Reed................    88
    Regina M. Lowrie, Chairman, Mortgage Bankers Association.........    14
        Prepared statement...........................................    58
    Tom Stevens, President, National Association of Realtors.........    16
        Prepared statement...........................................    67
    A.W. Pickel, III, President and Chief Executive Officer,
      LeaderOne Financial Corporation, on behalf of the National
      Association of Mortgage Brokers................................    18
        Prepared statement...........................................    72
    Ira Goldstein, Director of Policy and Information Services, The
      Reinvestment Fund..............................................    19
        Prepared statement...........................................    76
    Basil N. Petrou, Managing Partner, Federal Financial Analytics,
      Inc............................................................    21
        Prepared statement...........................................    78
        Response to a written question of Senator Reed...............    89

                  Additional Material Supplied for the Record

    Statement of the Mortgage Insurance Companies of America.........    89
    Statement of the National Association of Home Builders...........    96
    Letter submitted by the National Multi Housing Council and
      National Apartment Association.................................    99

                                     (iii)

                           FHA: ISSUES FOR THE FUTURE

                                  ----------

                             TUESDAY, JUNE 20, 2006

                                           U.S. Senate,
             Committee on Banking, Housing, and Urban Affairs,
                    Subcommittee on Housing and Transportation,
                                                        Washington, DC.
        The Subcommittee met at 2:32 p.m., in room 538, Dirksen
    Senate Office Building, Senator Wayne Allard, Chairman of the
    Subcommittee, presiding.

               OPENING STATEMENT OF SENATOR WAYNE ALLARD

        Senator Allard. Today the Subcommittee on Housing and
    Transportation will hold a hearing to examine the Federal
    Housing Administration, FHA. FHA has been an important source
    of home ownership for millions of Americans since its inception
    in 1943. It has been especially helpful in allowing low-income
    and first-time home buyers to achieve the American dream of
    home ownership.
        As we all know, though the financial markets have changed a
    great deal since 1934, in fact, the housing finance markets
    have changed a great deal in just the last decade and FHA's
    market share has declined. This leads to what I believe is one
    of the central questions of today's hearing: what is the role
    of FHA today and into the future?
        The answer to this question undoubtedly shapes the kind of
    reforms that Congress should be considering.
        I believe that the success of FHA and HUD is not determined
    solely by market share. After all, we have seen record-high
    levels of home ownership simultaneously with the declining FHA
    market share. Just because homeowners are not being served by
    FHA does not mean that they are not being served.
        So we return to the core question of what should be the
    role for FHA?
        A number of different people have attempted to answer that
    question through various reform proposals. FHA has offered its
    own proposal that would significantly reshape the Agency's
    mission. First, FHA has asked to institute risk-based pricing
    along with the ability to increase its maximum premiums.
        Second, the FHA proposal would raise loan limits both
    across the board and in high-cost areas.
        Third, HUD proposes a new zero down mortgage product. The
    package would also eliminate audit and net worth requirements
    for mortgage brokers, eliminate the current cap on reverse
    mortgages, authorize a 40-year mortgage product, restructure
    the manufacturing housing programs and streamline the
    condominium program.
        Many of these reforms are significant and merit close
    attention from Congress. Because FHA has been such an important
    program in promoting home ownership, changes of this magnitude
    should not be taken lightly. It is crucial that we make
    careful, responsible changes to ensure that FHA is available to
    home buyers for years to come.
        Today's hearing will give the Subcommittee an opportunity
    to better understand the changes being proposed, as well as the
    implications for FHA home buyers and the taxpayers.
        Before discussing reform, though, I believe that we must
    take a step backward. First and foremost, FHA must get its
    existing house in order, since it continues to be considered
    high risk by the GAO. It would be irresponsible to expand a
    seriously troubled program.
        I want to commend Commissioner Montgomery for his efforts
    on this point. He has undertaken a number of initiatives
    designed to improve the existing FHA programs, making them more
    efficient and less susceptible to waste, fraud, and abuse.
        We must also carefully consider the appropriate role for
    FHA relative to the private markets. Historically, the role of
    FHA has been to complement, not compete with, the private
    markets. FHA's proposal would begin to shift this role, while
    also moving FHA away from its traditional mission to serve low-
    income and first-time home buyers. Such a change must be
    carefully considered.
        I want to be absolutely clear that I do not oppose the FHA
    reform. I simply want to be certain that the reform is done
    right. While I believe that FHA is in need of reform, we must
    first ensure that FHA is on solid financial footing and has the
    capacity to implement and manage any changes.
        Our witnesses today will be helpful to the Subcommittee as
    we attempt to answer these questions. On the first panel I
    would like to welcome FHA Commissioner Brian Montgomery. During
    the time he has been at HUD, Commissioner Montgomery has moved
    vigorously to modernize and improve FHA.
        I would also like to welcome Mr. William Shear of the
    Government Accountability Office. GAO has completed a series of
    reports on FHA and Mr. Shear will provide key guidance as to
    HUD's capacity to implement various reforms.
        We also have a number of very distinguished witnesses on
    the second panel: Ms. Regina Lowrie, Chair of the Mortgage
    Bankers Association, will provide her group's recommendations
    for reform. As we all know, this is an issue that the Mortgage
    Bankers Association has been working on for some quite some
    time.
        Mr. Tom Stevens, president of the National Association of
    Realtors, will outline the Realtors priority within FHA.
        Mr. A.W. Pickel, president of LeaderOne Financial will
    testify on behalf of the National Association of Mortgage
    Brokers.
        Mr. Ira Goldstein of The Reinvestment Fund will share the
    perspective of an affordable housing developer.
        And finally, Mr. Basil Petrou, of Federal Financial
    Analytics, which share findings from his research.
        I would like to welcome all of you and thank you for taking
    the time to be here today. You are all leaders and experts
    within your field and your testimony will be helpful as the
    Subcommittee continues to consider this issue.
        Ranking member Reed and I have had the good fortune to work
    together on FHA issues in the past, such as downpayment
    simplification and increasing multifamily loan limits. I look
    forward to working closely with him as we find ways to define a
    modern FHA for the future.
        Senator Santorum, who has a couple people here from
    Pennsylvania, wanted to make sure that I got his statement in
    the record. He is unable to make it. I would ask that Senator
    Santorum's statement be put in the record behind Senator Reed,
    and also ask unanimous consent that Senator Reed's statement
    will be included behind my statement.
        I think we will start with you, Mr. Secretary, and then we
    will go to Mr. Shear. Proceed.

       STATEMENT OF BRIAN D. MONTGOMERY, ASSISTANT SECRETARY FOR
    HOUSING AND FEDERAL HOUSING COMMISSIONER, DEPARTMENT OF HOUSING
                    AND           URBAN DEVELOPMENT

        Mr. Montgomery. Thank you very much, Chairman Allard and
    ranking member Reed, for inviting me to testify on the
    Administration's proposed FHA Modernization Act.
        I also want to thank Senator Talent and Senator Martinez
    for their introduction yesterday of S. 3535, the Expanding
    American Home Ownership Act of 2006, as well as Senators
    Chambliss and Isakson for their support.
        I would like to begin the session by reminding everyone why
    FHA put forward this legislative proposal. It would have been
    very easy for us to sit back and continue to do what we have
    been doing for years and that would be the status quo. But we
    heard the concerns voiced by public policymakers, including
    members of this esteemed body, that many home buyers were
    putting themselves in harm's way. Hundreds of thousands of
    families, many of them low-income, were choosing, or worse
    being steered toward, risky high-cost loans. In good
    conscience, Mr. Chairman, we had to act.
        Senator Reed said at my confirmation hearing that FHA
    needed to raise the loan limits to better assist his
    constituents. We listened to Senator Reed and his idea is a
    part of this proposal. The bottom line is we decided that FHA
    should play the role it was intended to play. It just needed a
    long overdue modernization effort to do so. Because of limited
    time, I thought it would be beneficial for me to directly
    address three main reasons why this proposal is so important. I
    will start with reason number one. This proposal is good for
    American home buyers, for families that have worked hard to
    save for home ownership and who need a safe affordable
    financing option.
        Let me be very clear. Although FHA serves riskier
    borrowers, we serve families who are capable of becoming
    homeowners. Our underwriting standards are designed to
    determine which borrowers represent an appropriate level of
    risk and which of those do not. And that, Mr. Chairman, will
    not change.
        With a risk-based premium structure, FHA could reach more
    borrowers, borrowers who simply do not qualify for prime
    financing today. And FHA can do it at a substantially lower
    price than these borrowers would pay for a subprime loan.
        For example, each 1-percent increase in the upfront
    mortgage premium on a $200,000 home costs approximately $12 a
    month. For this low monthly payment, a borrower can get a
    market rate loan.
        Compare this $12, roughly the price of a pizza, to the
    additional cost of a loan with the interest rate priced for
    risk. On average, subprime borrowers pay an interest rate three
    points higher than conventional borrowers. That rate hike
    translates into an additional $255 a month, and that is
    $125,000 over the term of the loan.
        Reason number two, this proposal is good for FHA, improving
    the financial soundness of the fund and our ability to manage
    risk. While we are in a sound financial position today, this
    proposal brings FHA in line with the rest of the industry,
    where risk-based pricing is standard practice, and certainly in
    line with the way other insurance companies operate.
        Again, let us be clear about FHA's financial solvency. Our
    Mutual Mortgage Insurance Fund has never, I repeat never,
    operated in the red. As required by Congress, we annually
    reestimate the financial position of the total FHA portfolio.
    Sometimes the estimates indicate that we will do better than
    previously predicted. Sometimes they show that we will do
    worse. This is what happens when you are in the business of
    managing and predicting risk.
        In either case, there is no cost to the taxpayer. We either
    increase the estimated amount in FHA's capital reserve, which
    is now $22.6 billion, or we reduce that amount. Since 1990, we
    have generated more than $29 billion in potential income, which
    has been offset by $18.8 billion in reestimates of potential
    losses. That means that FHA's projected average annual net
    income over the past 16 years has been $670 million per year.
        Contrary to what some believe, FHA is not, nor has it ever
    been, losing money.
        Finally, the MMI Fund is not intended to provide a return
    on investment like a business. That is, FHA's main purpose is
    to serve a social need, not to make money.
        Reason number three--my final point--this proposal is good
    for the private sector, as it expands the borrower pool and
    provides the real estate financing industry with the
    appropriate products to reach higher-risk home buyers.
        Remember, FHA is not a lender. Our role is to provide home
    buyers access to market-rate financing by insuring lenders
    against loss. We are seeking to serve borrowers who do not
    qualify for prime loans but who do meet FHA's own eligibility
    criteria.
        Also, FHA will not encroach on the government-sponsored
    entities (GSEs), which have their own critical role to play,
    supporting prime conventional financing. A recent study showed
    there is very little overlap between GSEs and FHA, somewhere
    between 10 percent and 14 percent. In fact, approximately 90
    percent of FHA borrowers cannot even qualify for a prime
    conventional loan.
        Finally, a viable FHA will not take business from the
    private mortgage insurers. Private mortgage insurers (PMIs)
    serve a different client, namely less risky borrowers. Due to
    their profit-motivated business structure, PMIs simply cannot
    reach FHA-type borrowers at the same low price that we can.
        The PMIs did not serve the high-risk lower-income borrowers
    yesterday, they do not do so today, and they certainly will not
    tomorrow, even with the passage of S. 3535 because there is no
    money in it for them.
        If the PMIs are afraid that our proposal will hurt their
    business, then their fears are unfounded.
        Further, unlike the PMIs, FHA can and does stay in all
    markets all the time. Perhaps the best example of this
    difference can be seen in the oil-pad states during the 1980s.
    Data shows that the PMIs pulled out of several states while FHA
    business actually increased because they stuck it through. That
    is probably no more telling than in the State of Texas between
    1984 and 1987, when PMIs business dropped from 44 percent to
    less than 10 percent of the market.
        In summary, FHA has a very specific and very critical role
    to play. This legislative proposal is not intended to expand
    the reach of the Agency beyond what is appropriate and
    necessary in today's market. We are simply trying to serve
    those lower-income families who need the benefit of a
    Government insurance product to achieve home ownership at a
    fair price.
        Thank you for this opportunity to testify and I look
    forward to your questions.
        Senator Allard. Thank you for your testimony.
        We have had a couple of members show up, so I would like to
    now call on Senator Reed.
        I would like to inform the members that we have a vote that
    is scheduled now and we may have to break to go ahead. There
    are two votes so it might take us some time. So I am going to
    try and run this up to the last few minutes of this vote. Then
    we can go and catch the tail end of this vote and then catch
    the first on the other vote.
        Hopefully, we will keep our period of time where we disrupt
    the hearing to a minimum.
        Senator Reed.

                     STATEMENT OF SENATOR JACK REED

        Senator Reed. Thank you very much, Mr. Chairman. And thank
    you, gentleman, for your testimony today.
        It is not an overstatement to say that the FHA has played a
    critical role in the development of the U.S. housing market
    since its introduction during the Great Depression. Backed by
    the guarantee of FHA mortgage insurance, mortgage lenders were
    able to provide terms that made home ownership a possibility
    for a much larger share of America's families. Today's high
    ownership rates are a result of FHA activities over many, many
    years.
        Recently, FHA also pioneered the home-equity reverse
    mortgage, which has given seniors a new opportunity to realize
    the value of their homes.
        Despite earlier policies that made it difficult for many
    households to obtain FHA-insured loans, FHA has, for many
    decades, been recognized for its critical role in helping
    minority and low-income families become homeowners.
        Today we are here to begin a conversation about FHA's
    future. This conversation takes place in the context of a
    lending industry that is changing rapidly. Three developments
    are of particular note. First is the growth in the number of
    institutions and programs that serve low-income and first-time
    buyers.
        Second is the much broader use of mortgage products other
    than the additional 30-year fixed-rate loan, such as the ARM
    and the interest-only mortgage.
        And finally, the third is the growth of the subprime sector
    of the lending market.
        Over this same period of time, FHA's share of the lending
    market has fallen sharply from about 12 percent in the late
    1990s to about 3 percent today. This is not due simply to the
    growth in the private lending sector but also reflects a loss
    of borrowers who traditionally would have gotten FHA loans,
    particularly a loss to the subprime market. This is a source
    for concern.
        There are real reasons to believe that many of the new
    mortgage products decrease the likelihood that a family will be
    able to maintain home ownership over the long run. The cost of
    the subprime loan to the borrower is often unnecessarily high
    for the amount of risk entailed. The rate of foreclosure in the
    subprime sector is higher than in other parts of the lending
    sector. And predatory lenders, while only a very small part of
    the subprime market, destroy the dreams of home ownership and
    wealth accumulation for some of America's most vulnerable
    households.
        In proposing major changes to the FHA, HUD has stressed the
    goal of providing borrowers at the lower end of the market with
    better and safer alternatives. We have to look carefully
    because we do have to do more, I think, to serve these low-
    income and minority borrowers.
        We must also address serious issues about performance and
    perception with respect to FHA. FHA's foreclosure rate is well
    below that of the subprime market but is well above that of the
    private sector and the gap between the FHA and the prime sector
    has increased considerably in the last 5 years.
        While FHA still provides a net subsidy to the Treasury, the
    size of that subsidy has fallen markedly because of an increase
    in defaults.
        FHA procedural requirements are considered by many in the
    lending industry to be unduly cumbersome to meet. And in some
    cities a geographic concentration of FHA loans that have gone
    to foreclosure has raised the perception that FHA contributes
    to urban blight.
        But despite these problems, as history clearly shows, FHA's
    status as a public agency provides it not only with a special
    duty but also with a special ability to push the envelope so
    that American households have better housing choices.
        Today we are beginning a discussion that will consider not
    only the role FHA can and must play, but also the tools that it
    would need to carry this role forward.
        I look forward to the witnesses and, again, thank you, Mr.
    Chairman, for holding this hearing and your opportunity today.
        Senator Allard. Thank you for your statement.
        Senator Martinez, do you have a statement? girl are you
    kidding

                   STATEMENT OF SENATOR MEL MARTINEZ

        Senator Martinez. Mr. Chairman, thank you very much. I want
    to thank you and Senator Reed for holding this hearing.
        Senator Allard. Former Secretary of HUD, I might add.
        Senator Martinez. Yes, sir, and I welcome my former
    colleagues. It is always good to see friends.
        But I believe it is a very important and timely topic. Over
    the past 72 years, FHA has been an industry leader, helping
    more than 34 million Americans become homeowners at no cost to
    the taxpayers.
        In recent years, while the mortgage industry has adapted to
    changes in the marketplace, FHA has stayed the same, leaving
    many home buyers with no option but high-cost, high-risk
    mortgages. FHA has lost valuable market share over the recent
    years, falling from around 12 percent in the 1990s to
    approximately 3 percent today.
        In light of these developments, I appreciate the
    opportunity to be here this afternoon to examine current issues
    affecting FHA and to discuss the ideas for improving the
    Agency's role in providing home ownership.
        Yesterday, Senators Talent, Chambliss, Isakson, and I
    introduced reform legislation that would give FHA the needed
    flexibility to support sound lending in the 21st century. This
    bill incorporates a number of reforms aimed to increase market
    share, including risk-based premiums, eliminating downpayment
    requirements, increasing loan limits and terms, and removing
    the cap on reverse mortgages. This legislation is critical to
    the residents of my State.
        In fiscal year 2002, more than 58,000 Floridians used FHA
    to purchase their homes. In fiscal year 2005 that number
    plummeted to just under 18,000. The bill's loan limit increase
    alone could almost double the number to more than 32,000,
    resulting in a savings of $64 million to Florida homeowners who
    are now paying subprime prices.
        FHA is essential in order to protect consumers and
    encourage low-income and minority home ownership. I look
    forward to this hearing and the testimony from our witnesses
    and working with the Subcommittee on this important issue as we
    attempt to move it forward.
        Thank you, Mr. Chairman.
        Senator Allard. Thank you, Senator Martinez.
        We will now proceed with our second witness, Director Shear
    from the GAO. We are looking forward to your testimony.

       STATEMENT OF WILLIAM B. SHEAR, DIRECTOR OF THE FINANCIAL
                MARKETS AND COMMUNITY INVESTMENT TEAM,
                    GOVERNMENT ACCOUNTABILITY OFFICE

        Mr. Shear. Thank you very much.
        Mr. Chairman, Senator Reed, members of the Committee, it is
    a pleasure to be here this afternoon to discuss four of our
    recent reports on the Federal Housing Administration.
        My testimony focuses on FHA's actions to better evaluate
    and manage risk associated with its mortgage insurance
    operations.
        Today I will discuss: First, FHA's development and use of
    its mortgage scorecard, an automated underwriting tool that
    evaluates the default risk of borrowers.
        Second, FHA's annual estimation of program costs.
        Third, practices of other mortgage institutions for
    managing risk of new mortgage products that could be
    instructive to FHA.
        And fourth, FHA's management of risk related to loans with
    downpayment assistance.
        Our findings are particularly important as this Committee
    considers HUD's proposed legislative changes, especially those
    that would give the agency flexibility to set insurance
    premiums based on the credit risk of borrowers and to reduce
    downpayment requirements from the current 3 percent to
    potentially zero.
        To implement this legislative proposal, FHA would have to
    manage new risks and accurately estimate the costs of program
    changes. For example, to set risk-based insurance premiums, FHA
    would need to understand the relationships between borrower and
    loan characteristics and the likelihood of default, as well as
    how the premiums would affect the fund's financial condition.
        In summary, our past work identified a number of weaknesses
    in FHA's ability to manage risk and estimate program costs.
    First, while generally reasonable, the way that FHA developed
    and uses its mortgage scorecard limits the scorecard's
    effectiveness. FHA and its contractor used variables that
    reflected borrower and loan characteristics to create the
    scorecard, as well as an accepted modeling process to test the
    variables' accuracy in predicting mortgage default.
        However, the data used to develop the scorecard were 12
    years old by the time that FHA began using the scorecard in
    2004 and the mortgage market has changed significantly since
    then.
        Second, FHA's subsidy reestimates reflect a consistent
    underestimation of the cost of its single-family insurance
    program. For example, as of the end of fiscal year 2003, FHA
    submitted a $7 billion reestimate for the fund. Increases in
    the expected level of insurance claims was the major cause of
    the $7 billion reestimate.
        Third, some of the practices of other mortgage institutions
    offer a framework that could help FHA manage the risk
    associated with new products, such as no downpayment mortgages.
    For example, mortgage institutions may limit the volume of new
    products issued--that is, pilot a product--and sometimes
    require stricter underwriting on these products. FHA officials
    have questioned the circumstances under which pilot programs
    were needed and also said that they lack sufficient resources
    to appropriately manage a pilot.
        Fourth, FHA has not developed sufficient standards and
    controls to manage risk associated with the growing proportion
    of loans with downpayment assistance.
        We found that loans with downpayment assistance, especially
    from seller-funded sources, performed substantially worse than
    comparable loans without such assistance.
        In the four reports, we made several recommendations
    designed to improve FHA's risk management and cost estimates.
    FHA has taken actions in response to some of our
    recommendations. While FHA's actions represent improvements in
    its risk management, additional improvements will be important
    if FHA is to successfully implement some of the program changes
    HUD has proposed. Accordingly, consideration of this proposal
    should include serious deliberation of the associated risks and
    the capacity of FHA to mitigate them.
        Again, it is a pleasure to be here. I would be happy to
    answer any questions.
        Senator Allard. This is for you, Secretary Montgomery.
    HUD's proposal, particularly the zero down and the risk-based
    premiums, will require a strong ability to assess and manage
    risk. Yet a number of entities have questioned HUD's ability to
    do just that. And I would like to quote some of these agencies
    and then get a response from you in that regard.
        From GAO, they say this: ``The way that FHA developed and
    uses its mortgage scorecard, while generally reasonable, limits
    how effectively it assesses the default risk of borrowers.''
        From the Inspector General, they say ``FHA must incorporate
    better risk factors and monitoring tools into its single-family
    insured mortgage program risk analysis and liability estimation
    process.''
        And then it goes on to say that ``FHA cannot determine
    current risk trends in its active insured portfolio.''
        From the Congressional Budget Office, they say that ``risk-
    based pricing is complicated, requiring much precision in the
    underwriting process.''
        In the President's fiscal year 2007 budget, they say ``the
    program's credit model does not accurately predict losses to
    the insurance fund.''
        And yet, in your testimony you state that ``the FHA bill
    proposes to strengthen FHA's financial position, improving
    FHA's ability to mitigate and compensate for risk.''
        You go on to say, in your statement, that ``I want to
    reassure you that the changes we are proposing will not
    increase the overall risk of the MMI Fund.''
        Given the questions that have been raised regarding FHA's
    ability to assess risk, share with me how you feel that the
    proposal that you have suggested will not increase risk. And
    then what has FHA done to improve its ability to assess and
    manage risk in recent history?
        Mr. Montgomery. Thank you very much, Senator.
        On the first point, we firmly believe that actually pricing
    it to the risk, which is largely what the insurance industry
    does in this country, would actually help us better manage the
    fund by spreading it and pricing it commensurate with the risk.
    We can identify borrowers who would be less risky and identify
    those who would be more risky.
        Today we have a one-size-fits-all that is not fitting all.
    A lot of borrowers who might be better suited toward FHA have
    been steered toward other loans. Again, that is something we
    are trying to change.
        I will say this relative to the reestimate, I think it gets
    to the key of your question, is the $7 billion reestimate was
    done as the result of an error that HUD discovered. And that is
    at the time no one knew how risky these gift downpayment
    programs would be. That has actually been the largest
    reestimate to the MMI Fund in recent memory, again some $7
    billion.
        I actually use that as a point to point toward how HUD can
    manage the risk, that working with a contractor--we now have a
    new contractor, by the way, we got rid of the other one. That
    allowed us then to--again, we are constantly readjusting the
    risk. We have $29 billion in potential revenue out over the
    last 16 years. We have reestimated about $18 billion, which
    still leaves us $670 million a year in projected net income,
    despite the fact, sir, again that we have the more risky
    borrowers today and the fact that we had to do a $7 billion
    reestimate because nobody knew how popular and how more risky
    that these gift downpayment programs would be.
        So despite all of that, and also considering the fact that
    the gift downpayment programs are largely going away because of
    a revenue ruling by the IRS, I think that leaves us on
    excellent footing today, financial footing, to proceed forward
    with a risk-based premium structure.
        Senator Allard. I have seen some studies that indicated
    that the more that is paid down in the downpayment phase of the
    loan, the less your loan failures are. Have you seen those
    figures?
        Mr. Montgomery. It is no secret that higher LTV loans tend
    to have higher foreclosure rates. But I would also say, given
    the popularity of these gift downpayment programs, it just
    cries for the fact that some lower-income borrowers need some
    sort of assistance.
        Now sir, again, by pricing the risk accordingly, we can
    look at the family's individual portfolio, whether it is FICO
    scores, debt-to-income, any number of variables that now say
    that you may be a good candidate for a zero downpayment
    program.
        Or it can be a half percent. Or it could be that a family
    may have to pay even more than that. Again, sir, it now allows
    us to look at each family's individual portfolio. And even more
    importantly, allow us to reach deeper into the borrower pool.
        Senator Allard. Mr. Shear of GAO, do you believe that FHA
    currently has the risk assessment capacity to implement the
    proposed changes in a safe and sound manner?
        Mr. Shear. In the four reports I have discussed, we have
    raised the concerns noted in my statement with FHA's current
    ability to assess and manage risk and its historical record in
    doing so.
        We are pleased to see that they are implementing some of
    our recommendations. But, for example, when you look at FHA's
    TOTAL scorecard, we see an updating that might occur by the
    year 2007, but we are still looking for basically how that is
    going to be achieved.
        There are still a lot of open questions to us, in terms of
    where FHA is and what progress it will make. We call for
    continuous improvement. We think FHA is improving in the
    ability to assess and manage risk, but we think that FHA has a
    way to go. And for this proposal, it probably becomes more
    important for FHA to expand this capacity.
        Senator Allard. Let me recognize Senator Reed.
        Senator Reed. Thank you very much, Mr. Chairman. And thank
    you, gentlemen.
        Secretary Montgomery, the FHA qualifies the lenders and
    brokers that participate in the program. And I understand there
    are some that propose to lower the standard for brokers. Do you
    have any concerns about the standards with respect to brokers?
    And what is the status of the proposals in that regard?
        Mr. Montgomery. We are required by Congress to operate FHA
    in a financially sound manner. And for many years that gauge
    has been an audited financial statements if you are an
    independent broker.
        We also realize sir, on the other hand, and also hearing
    from SBA's Office of Advocacy, that a lot of brokers are small
    mom-and-pop, if you will, organizations. And many of those have
    expressed concerns that it is an expensive requirement for a
    small business.
        So we are trying to, on the one hand, make sure that we are
    offering the fund and with lenders, because it is the full
    faith and credit of the U.S. Government, to make sure that we
    are not left holding the bag, so to speak. But by the same
    token sort of recognizing that we are making it more difficult
    for small businesses to operate, especially considering the
    fact that brokers originate anywhere from 62 to 66 percent of
    loans today.
        I will say, sir, that we are still in consultation with
    them. They have been floating a proposal for a surety bond. On
    the one hand, that could be a good proposal in each individual
    State. But on the other hand, we need to make sure that the MMI
    Fund is protected.
        So we continue to meet with them. We continue to discuss
    with them ways that we can make it less onerous for some of
    their colleagues.
        Senator Reed. Do you maintain statistics on broker
    performance and lender performance, particularly with respect
    to defaults?
        Mr. Montgomery. Yes, sir, I believe we do but I do not have
    those with me
        Senator Reed. That would be something that you would also
    consider, in terms--
        Mr. Montgomery. We do that with every FHA-approved lender,
    whether it is a broker or a warehouse line or a large lender
    such as Countrywide or Wells Fargo. We maintain those
    statistics across the board.
        Senator Reed. A presentation given to the Committee staff
    by HUD suggested that many borrowers who could qualify for
    better terms are being steered to the nonprime mortgage market.
    We are proposing to give you enhanced power.
        But even today, if FHA terms are better, but still
    intermediaries are steering people away to the subprime market,
    what can we do? How can we work to avoid this adverse selection
    process where they are sent off to the subprime market?
        Mr. Montgomery. Sir, we are doing all we can on that front.
    I will say from the first day I took office, and we use the
    term market share because it is better descriptive, but we
    realize we are not a corporation. As we pored over the home
    mortgage disclosure data, it became very obvious to us that a
    lot of families, particularly lower-income families, were
    steered toward subprime products. You can only look at the
    explosion in that industry over the last 10 years to see that.
        Now if you want to believe a settlement involving a large
    subprime lender and 49 States Attorney Generals, the term
    steered is very appropriate in that case and a lot of families
    were taken advantage of.
        Now if a lot of those families had gone to a prime
    conventional product, I probably would not be sitting in front
    of you today. We want what is in the best interest of the
    family, particularly low-income families.
        But it did not sit well with us, sir, the fact that these
    families had been taken advantage of, especially the fact that
    some of them were lower down the income strata, or lower credit
    scores because of our requirements under the capital reserve
    and the MMI Fund that we could not reach them with our present
    structure.
        So I want everybody to fully understand, sir, and I am glad
    you brought up this point, that is the key reason we began this
    endeavor, was a way that we could reach those families either
    through a better marketing and public awareness campaign, but
    also improving FHA processes--which we have been doing--but
    more importantly, sir, improve the products to where we can
    provide low-income borrowers a better product at a much fairer
    price.
        Senator Reed. Thank you very much, Mr. Secretary.
        Let me direct a question to Mr. Shear. What do you believe
    the impact will be on the overall market, the lending industry,
    including entities such as GSEs, if the FHA changes are put in
    place, as suggested by Mr. Montgomery and others?
        Mr. Shear. We have not evaluated the interactions between
    FHA and the conventional market for close to a decade now,
    except for the one report I discussed where we looked at the
    expansion in low and no downpayment products offered by the
    conventional sector.
        So, I cannot directly answer your question but can say
    there are certain questions that we would want to look at that
    bear on this issue.
        In terms of FHA's decline in market share, the question is
    what are the causes of that decline in market share--that is,
    trying to get behind it in a more complete way, trying to
    become more current. Commissioner Montgomery just referred to a
    study about the overlap between FHA and the GSEs, which was
    based on data that went through the late 1990s. One could
    envision getting updates on that type of information.
        So these are the types of questions we would be looking to
    have answered to address the overall issue. Unfortunately, we
    have not done the work to address those questions.
        Senator Reed. Are you proposing to do the work, Director
    Shear?
        Mr. Shear. We do what is called upon by Congress. I would
    just say that--I would say that we would welcome it if we were
    called upon to do it.
        Senator Reed. Thank you.
        Senator Allard. Senator Martinez, we have got 15 minutes
    and the vote is running to an end here.
        Senator Martinez. I will go very quickly with just a couple
    of questions.
        Secretary Montgomery, I just wanted to ask you, to be sure
    I understand the purpose of your goal, which we have believed
    in enough to file us a bill.
        My understanding is that many, many people at the lower
    spectrum of home buying, in other words entry level into the
    market, are finding it necessary either to forgo home purchases
    or are financing it through what would be not predatory
    lending, but it would be high-cost lenders at an end of the
    market that does it for folks who do not have a good credit
    history, as a new home buyer often might now, or may not be
    able to put a downpayment on a home that is significant, and
    things of that nature.
        And what you are seeking to do, as I understand it, is to
    broaden your ability to serve that marketplace, to serve those
    people with a product that would be less costly, and would give
    them an opportunity to get into a home, where now they are
    either falling prey to very high-priced lending, or otherwise
    are just not in the market because they cannot get into the
    private market.
        Mr. Montgomery. That is absolutely correct, Senator.
        Senator Martinez. That is called a softball, by the way.
        Mr. Montgomery. Football was more my game.
        That is exactly right, Senator. And a lot of those were our
    traditional borrowers. And you are going to hear from a second
    panel here later, but in particular the Realtors and lenders,
    the mortgage brokers will tell you, I am talking about the
    process side of FHA which contributed to the percentage of
    people using FHA plummeting, is that they did not like doing
    business with us. Our IT system was antiquated. We required
    thick case binders of loan documents to go from our home
    ownership centers to lenders. If an I was not dotted and a T
    was not crossed, back they went. That cost time.
        If I was a Realtor or a broker or a lender, and I do not
    get paid until the loan closes, if FHA is stuck in the late
    1970s, then of course I am not going to do business with them.
        So before we even began to look at the product side, we
    knew we had to improve the process. And we have done a lot of
    changes over the last year to do that.
        I think, as evidenced by the support from the Realtors and
    others, they would say that we have made it less onerous to do
    business with FHA. Since we do not have the sales force, sir,
    we are not a retail operation, we require lenders and Realtors
    to, in effect, say if you are a borrower that might fit into
    FHA, to make them aware of it. I think we have made great
    strides now to where we have taken away some of the headache
    factor. So that was very important.
        The other thing is while we are trying to improve the
    products, we are also doing some consumer awareness, authority
    in minority publications. Because as you know, sir, the
    minority home ownership lags far behind those of Anglos. And
    that is where we think we can do the most good.
        Even though FHA is a good product, we want to make it a
    great product. With this marketing program in 44 markets
    nationwide, in African-American publications, Latino
    publications, it is already touting the many benefits, the here
    and now benefits of FHA.
        Senator Martinez. But if I understood it correctly, by your
    taking your market share, which has dropped from 12 to 3, back
    up to say 5, 8, 10, you are going to be serving a much broader
    and much larger number of first-time home buyers, which
    typically are going to be the least advantaged and the people
    that we are trying to get into ownership, and it will
    facilitate them doing so.
        Mr. Montgomery. Yes, sir, and those are exactly the
    borrowers we want to reach, the lower income, first-time home
    buyers.
        Senator Martinez. Thank you.
        Senator Allard. I am going to put the Subcommittee in
    recess and we will be back, I estimate, in about 10 or 15
    minutes.
        In the meantime, I think we will just let the first panel
    go. We have some more questions, we have had a first round of
    questions. We will send those to you in the mail and then if
    you could respond within 10 days, we would appreciate it.
        Thank you.
        [Recess.]
        Senator Allard. The Subcommittee will come back to order.
        I want to apologize to the panel that we had to depart for
    a vote, but we are ready and looking forward to your testimony.
    We will start with Ms. Lowrie, and then we will move to Mr.
    Stevens, Mr. Pickel, Mr. Goldstein, and Mr. Petrou.
        You are first, Ms. Lowrie.

       STATEMENT OF REGINA M. LOWRIE, CHAIRMAN, MORTGAGE BANKERS
                              ASSOCIATION

        Ms. Lowrie. Good afternoon, Mr. Chairman and members of the
    Committee. Thank you for holding this hearing and inviting me
    to share MBA's views on reforming the FHA.
        In 1994, I founded Gateway Funding Mortgage with seven
    employees and $1.5 million in capital. We now have over 800
    employees working in more than 58 offices and originating $3
    billion in loans. I am proud of our work at Gateway and of my
    entire industry in providing home ownership opportunities for
    American families.
        When I started Gateway, FHA programs helped us serve many
    borrowers who otherwise would not get a loan. Ten years ago,
    FHA comprised 40 percent of our volume. We worked hard to be a
    good partner with FHA and, together, FHA and Gateway served
    tens of thousands of home buyers.
        Today, however, the story is very different. While Gateway
    has grown significantly, our use of the FHA program has dropped
    precipitously. While Gateway has adapted to changes in the
    market, FHA has not. While the needs of low- and moderate-
    income home buyers, of first-time home buyers, and of senior
    homeowners have changed, FHA has not followed its historic path
    of adapting to meet borrowers' changing needs.
        MBA strongly supports FHA and believes that it still plays
    a critical role in today's marketplace. Most of FHA's business
    is directed toward low- and moderate-income and minority
    borrowers, the very strata that is most challenged to be part
    of our ownership society.
        At the same time, we have watched, with growing concern, as
    FHA has steadily lost market share over the past decade,
    potentially threatening its long-term ability to help
    underserved borrowers.
        FHA was founded in 1934. Many of the laws, regulations,
    traditions that governed its operations have not kept pace with
    a rapidly changing and dynamic marketplace. As the market
    continues to innovate around FHA, the great fear is that many
    aspiring homeowners will either be left behind or forced into
    higher-cost alternatives.
        We believe Congress should empower FHA to incorporate
    private sector efficiencies that will allow it to meet today's
    needs, and anticipate tomorrow's. MBA believes changes should
    be made in three areas. FHA needs more flexibility to introduce
    innovative new products, invest in new technology, and manage
    their human resources. MBA supports the Administration's
    proposals and the bills recently introduced by Senators Talent
    and Clinton to help FHA achieve these goals.
        MBA supports changes to FHA's downpayment requirements,
    including the elimination of the complicated downpayment
    formula and rigid cash investment requirements. The downpayment
    is one of the primary obstacles for first-time minority and
    low-income home buyers.
        FHA may be able to better serve borrowers and to do so with
    lower risk to their funds if they are able to adjust premiums
    based on the risk of each mortgage insured. We believe that FHA
    can develop a sound and simple premium structure that will be
    transparent to borrowers and insure that FHA is better matching
    the risk it is taking on with the premiums it is charging.
        Finally, MBA supports all of the proposed changes to the
    home equity conversion mortgage program. MBA surveys show that
    FHA's HECM product comprises 95 percent of all reverse
    mortgages, and is thus tremendously important for our senior
    homeowners.
        In conclusion, FHA has an important role to play in the
    market in expanding affordable home ownership opportunities for
    the underserved in addressing the home ownership gap. But the
    loss of market presence means we are losing FHA's impact. The
    result is that some families are either turning to more
    expensive financing or giving up.
        MBA applauds the leadership and commitment of HUD Secretary
    Jackson, FHA Commissioner Montgomery, Senator Talent and
    Senator Clinton in calling for FHA reform. I urge Congress to
    enact legislation to reform FHA to increase its availability to
    home buyers, promote consumer choice, and insure its ability to
    continue serving American families.
        Thank you for the opportunity to testify here today. We
    look forward to working with you on this important issue. Mr.
    Chairman.
        Senator Allard. Thank you, Ms. Lowrie. Your timing was just
    perfect, you stayed within the 5-minute limit.
        Mr. Stevens.

     STATEMENT OF TOM STEVENS, PRESIDENT, NATIONAL ASSOCIATION OF
                                REALTORS

        Mr. Stevens. Good afternoon, Chairman Allard and Senator
    Reed and other Subcommittee members. My name is Tom Stevens,
    and I am the former president of Coldwell Banker Stevens,
    headquartered in Vienna, Virginia, serving the Washington-to-
    Baltimore market. And I am currently the 2006 president of the
    National Association of Realtors. I appreciate the opportunity
    to present the views of NAR's 1.3 million realtor members on
    the need to reform the FHA program.
        As you know, FHA was established in 1934 to provide an
    alternative to the private market. From its inception, this
    program has played a vital role in the success and growth of
    home ownership in America. For more than 70 years, FHA has made
    mortgage insurance available to individuals regardless of their
    racial, ethnic, or social characteristics during periods of
    economic prosperity and economic depression.
        Yet, despite its evident value, FHA's market share has
    dropped significantly in recent years. In the 1990s, FHA loans
    accounted for about 12 percent of the market. Today, that rate
    is closer to 3 percent. The decline in FHA mortgages has had a
    significant impact on America's home buyers. With FHA shrinking
    out of view, many home buyers have been left to consider more
    costly mortgage alternatives.
        It is no coincidence that the market share of subprime
    loans has grown from 8.5 percent in 2002 to 20 percent just
    this past year. While such loans have a very important role to
    play for certain borrowers, there are many consumers who have
    taken out subprime loans when they would have qualified for FHA
    for a lower, overall cost.
        Home buyers have also turned their attention to new types
    of specialty mortgages. Such mortgages include interest-only
    and option ARMs, which can be risky propositions to borrowers.
    These loans allow them to stretch their income so they can
    qualify for larger loans.
        According to Moody's, more than a quarter of all existing
    mortgages come up for interest rate resets in 2006 and 2007.
    While some homeowners may be prepared to make the new higher
    payments, many will find it difficult, if not impossible.
        NAR recently developed a specialty mortgage brochure to
    help Realtors discuss the risks and benefits of these mortgages
    with clients. And at this time, Mr. Chairman, I would like for
    permission to insert a copy of this into the record.
        Senator Allard. Would you identify what this is?
        Mr. Stevens. This is a brochure that NAR has produced.
        Senator Allard. So, it is a brochure from the National
    Association of Realtors?
        Mr. Stevens. Right.
        Senator Allard. Without objection, so ordered.
        What we need now is a viable alternative to these products.
    Minority home buyers are particularly vulnerable to high-cost
    loans. According to a recent study by the Center for
    Responsible Lending, minorities are 30 percent more likely to
    receive a higher-priced loan than white borrowers, even after
    accounting for risk. If made competitive, FHA could once again
    provide an affordable alternative to predatory or
    discriminatory loans and help bridge the gap in minority home
    ownership.
        To reform this program, we must address what caused the
    decline. Simply put, FHA's market share has dwindled because
    its loan limits, downpayments, and fee structure have not kept
    pace with the current mortgage marketplace. The Administration
    is proposing a number of important reforms to the FHA single-
    family insurance program that will greatly benefit home buyers
    nationwide.
        First, FHA proposes eliminating the statutory 3 percent
    minimum cash investment and downpayment calculation. In 2005,
    43 percent of the first-time home buyers financed 100 percent
    of their home. NAR research indicates that if FHA were allowed
    to offer this option, 1.6 million families would benefit.
        By allowing both flexible downpayments and the flexibility
    pricing proposal, FHA could price such a product according to
    risk, as is done in the conventional market. Differentiating
    premiums based on the risk of the borrowers would permit FHA to
    reach higher-risk borrowers and charge borrowers with better
    credit risk less. Risk-based pricing is accepted practice in
    the private market. It should be for FHA, as well.
        The Administration also proposed combining all single-
    family programs into the mutual mortgage insurance fund. In
    addition to combining the 203(k) and condominium programs under
    the MMIF, NAR also recommends that HUD be directed to restore
    investor participation in the 203(k) program. We also recommend
    that HUD lift the current owner-occupied requirement of 51
    percent before individual condominium units can qualify for
    FHA-insured mortgages. The policy limits sales and home
    ownership opportunities, particularly in market areas with
    significant condominium developments and first-time home
    buyers.
        Finally the Administration proposes increasing the FHA
    limits. The limits for single-family unit homes in high-cost
    areas would increase from $362,790 to the 2006 conforming loan
    limit of $417,000. In non-high-cost areas, the FHA limit, or
    floor, would increase from $200,160 to $271,050 for single unit
    homes.
        Such increases are critical for FHA to assist home buyers
    in areas where home prices exceed the current maximum of
    $200,160, but are not defined as high-cost, such as Colorado,
    Florida, Pennsylvania, North Carolina, to mention a few.
        Without such reforms to the FHA program, first-time home
    buyers, minorities, and home buyers with less than perfect
    credit, will continue to see fewer and fewer safe, affordable
    mortgage options. As we sit here today, interest rates are
    relatively low, home prices are rising, and lenders have
    expanded their pool of tools to offer borrowers. We must
    consider whether these options will still be available during
    periods of economic uncertainty.
        FHA is the only national mortgage insurance program that
    provides financing to all markets at all times. NAR stands
    ready to work with you to craft legislation that furthers the
    mission of the FHA single-family mortgage insurance program,
    and make the dream of home ownership possible for even more
    families in the years to come. I thank you for the opportunity
    to testify.
        Senator Allard. Mr. Pickel.

     STATEMENT OF A.W. PICKEL, III, PRESIDENT AND CHIEF EXECUTIVE
      OFFICER, LeaderOne FINANCIAL CORPORATION, ON BEHALF OF THE
                NATIONAL ASSOCIATION OF MORTGAGE BROKERS

        Mr. Pickel. Good afternoon, Chairman Allard and members of
    the Subcommittee. My name is A.W. Pickel, III. I am past
    president of the National Association of Mortgage Brokers
    (NAMB), and I am currently president of LeaderOne Financial
    Corporation in Kansas City. I am both a mortgage banker and a
    mortgage broker.
        Thank you for inviting NAMB to testify today on FHA, issues
    for the future. As a voice of the mortgage brokers, NAMB speaks
    on behalf of more than 25,000 members in all 50 States and the
    District of Columbia. I want to commend this Subcommittee for
    its leadership on addressing the much needed reforms to the FHA
    program.
        NAMB appreciates the opportunity to address the need to
    reform the FHA program to reduce the barriers to mortgage
    broker participation. And, two, increase FHA loan amounts for
    high-cost areas. We support many of the proposed reforms to the
    FHA program, but we believe the Administration should first
    make certain that the FHA loan program is a real choice for all
    prospective borrowers.
        Regardless of how beneficial a loan product may be, it
    requires an effective distribution channel to deliver it to the
    marketplace. Unfortunately, many prospective borrowers are
    denied the benefits offered by FHA because mortgage brokers,
    the most widely used distribution channel in the mortgage
    industry, are limited in their ability to offer such products.
    Current FHA requirements impose cost-prohibitive, time-
    consuming, and unnecessary annual audit and net worth
    requirements on mortgage brokers who want to originate FHA
    loans. These requirements seriously impede mortgage brokers'
    ability to bring FHA loans to the marketplace.
        A stated objective of both HUD and FHA is to increase
    origination of FHA loan products and expand home ownership
    opportunities for first-time, minority, and low- to moderate-
    income families. NAMB supports increased access to FHA loans so
    that prospective borrowers who may have blemished or almost
    nonexistent credit histories, or who can only afford minimum
    downpayments, have increased choice of affordable loan
    products, and are not forced by default to the subprime loan
    market.
        The solution to increasing FHA loan production is
    relatively simple. Allow more mortgage brokers to offer FHA
    loan products directly to consumers. This could be accomplished
    by eliminating the audit and net worth requirements for
    mortgage brokers that want to offer these products to
    consumers. At a minimum, annual bonding requirements offer a
    better way to insure the safety and soundness of the FHA
    program than requiring originators to submit audited financial
    statements.
        Congress and this Administration have made home ownership a
    priority in this country. Unfortunately, today, the demand for
    homes continues to outpace new housing development and sales of
    existing homes, causing escalation of home prices. In an
    environment of rising interest rates, many first-time,
    minority, and low- to moderate-income home buyers need the
    safer and less expensive financing options that the FHA program
    can provide.
        For this reason, NAMB uniformly and unequivocally supports
    increasing FHA loan limits in high-cost areas. Congress should
    create the ability for FHA loan limits to be adjusted up to 100
    percent of the local area median home price in all communities,
    thereby providing a logical loan limit that will benefit both
    the housing industry and the consumer. This approach allows the
    FHA loan limits to respond to changes in home prices and
    reflect a true home market economy. The benefits of the FHA
    program should belong equally to all taxpayers, especially
    those residing in high-cost areas that often are most in need
    for affordable financing options.
        NAMB also supports eliminating the downpayment requirement
    and granting FHA the flexibility to offer 100 percent financing
    to aid in the effort to increase home ownership for first-time,
    minority, and low- to moderate-income families. This proposed
    reform will help significantly in achieving the
    Administration's stated goal of increasing minority home
    ownership by 5.5 million by 2010.
        Congress should seize this opportunity to address these
    issues and revitalize the FHA program with this proposal.
    Borrowers will receive better loan programs and at lower
    interest rates. We strongly urge the Subcommittee to support
    these FHA reforms. NAMB appreciates the opportunity to offer
    you our views. I am happy to answer any questions and thank you
    very much.
        Senator Allard. Mr. Goldstein.

    STATEMENT OF IRA GOLDSTEIN, DIRECTOR OF POLICY AND INFORMATION
                    SERVICES, THE REINVESTMENT FUND

        Mr. Goldstein. Good afternoon, Senator, and thank you for
    the opportunity to offer my views today. My name is Ira
    Goldstein, and I am here from The Reinvestment Fund. The
    Reinvestment Fund is a national leader in the financing of
    neighborhood revitalization. Founded in 1985, TRF has invested
    $500 million for the creation and preservation of affordable
    housing, community facilities, commercial real estate, and
    renewable energy.
        Our research in the areas of mortgage lending, foreclosure,
    and predatory lending has both a strong data base component, as
    well as a qualitative component that brings us personally in
    touch with the people from all quarters of the mortgage-lending
    process.
        I speak today from what we have learned through those
    research endeavors. Home ownership is undeniably a critical
    component in the accumulation of wealth for most American
    families. Going forward, the demographic groups available to
    become homeowners are younger, lower income, and minority
    households. Those are the groups currently with the lowest home
    ownership rates. These are also the households that,
    statistically, have the least net worth.
        So, many who have recently, and will in the future, become
    owners, are least able to weather the financial impact of the
    kinds of significant financial events that often occur with new
    homeowners. I think that it is worth considering the proposed
    changes to the FHA in the larger social context of whether we
    are approaching or have passed the peak societal benefit of
    home ownership.
        As former Federal Reserve Governor Gramlich stated, and I
    quote, ``there is a valid debate as to whether continuing to
    increase overall home ownership much further is feasible or
    even desirable.'' Legislation under consideration would seek to
    raise the home ownership rate through a variety of products and
    processes, essentially leveling the playing field so that FHA
    can effectively compete with the subprime mortgage market.
        One such change is the zero downpayment mortgages. That is
    important because so few Americans are saving and household
    debt service ratios are currently at such high levels. The
    downpayment is a barrier to owning a home. The evidence seems
    to be fairly clear that those zero downpayment loans have a
    much higher probability of failure. Our review of foreclosures
    in the cities of Philadelphia and Baltimore and in the State of
    Delaware, suggests that people who purchased homes with two
    mortgages, one covering downpayment, were prominently
    represented among those in foreclosures.
        According to reports from Fitch ratings, those products
    that we now call the exotic mortgages work well for higher net
    worth individuals seeking to manage their finances more
    advantageously. They are very risky for a person who is trying
    to afford a home for which they are only marginally qualified.
        With respect to the proposal that FHA adopts a risk-based
    pricing approach, that is an idea that I think is certainly
    supportable, assuming that the models are properly conceived,
    developed, and monitored. The problematic part of the risk-
    based pricing model is that the price only compensates the
    lender for the risk the borrowers presents. In the end,
    assuming the model is correct, the lender and FHA can make
    money, even if some calculable percentage of borrowers default.
        But that assumes that no one other than the borrowers and
    the lender matter. Research conducted by The Reinvestment Fund
    and Econsult Corporation that was commissioned by the Federal
    Reserve Bank of Philadelphia shows that there is a
    statistically demonstrable adverse effect of mortgage
    foreclosures on local property markets. In fact, after applying
    an appropriate set of statistical controls, we found that each
    foreclosure within an eighth of a mile of a sale, and 1 to 2
    years prior to that sale, reduces the value of a home by 1
    percent, at least.
        In Philadelphia, the typical home has four to five
    foreclosures within the specified time and distance, so it is
    reduced by more than 5 percent. The implications of this is
    that everyone within the area has lost some wealth. This is not
    an argument against risk-based pricing. It is simply an
    argument to consider the social costs beyond those of the
    transaction.
        My final points have to do with selling and servicing of
    loans. With respect to servicing, it is a well-settled fact
    that certain servicing and loss mitigation techniques increase
    the likelihood that a delinquent loan returns to paying status.
    For example, early intervention and reasonable access of the
    borrower to their servicer increases the chances that the loss
    to the investor is minimized.
        The servicing and loss mitigation efforts on FHA loans are
    not the best. TRF's work with practitioners suggests that HUD
    has not enforced compliance with its current procedures. Even
    assuming they were complied with, the rules themselves have
    flaws.
        Pennsylvania's Homeowners Emergency Mortgage Assistance
    Program, not currently available to people with FHA loans is a
    remarkably successful example of a loss mitigation strategy
    that in the case of the FHA could reduce claims against the
    insurance pool. Servicing and loss mitigation take on added
    importance if FHA expands its current customer base as it has
    proposed.
        There will be an added cost and added servicing burden
    undoubtedly passed on to the consumer, but that cost would
    likely be justified by increasing the likelihood that
    homeowners can keep their homes through financial hardships.
        With respect to selling loans, our experience suggests
    strongly that changes that lower the threshold of entry or
    loosen the monitoring or accountability of mortgage brokers
    would be problematic. Brokers have, in most states, no
    fiduciary obligation to the borrower and their incentive
    structure is both unclear to borrowers, promotive of larger
    transactions, and does not necessarily incent locating the best
    transaction for borrowers.
        First-time home buyers are oftentimes not equipped to
    understand that the broker, although paid by them, does not
    work for them the way you and I would use that phrase.
        In closing, success for most American families is not just
    changing the rules so that FHA can originate more loans or
    compete with subprime lenders. Success would be that FHA
    replaces those products within the subprime mortgage market
    that disadvantage home buyers and homeowners with products and
    processes that enhance the likelihood of sustainable home
    ownership. Thank you.
        Senator Allard. Mr. Petrou.

        STATEMENT OF BASIL N. PETROU, MANAGING PARTNER, FEDERAL
                       FINANCIAL ANALYTICS, INC.

        Mr. Petrou. Thank you, Mr. Chairman. It is an honor to
    appear today before the Subcommittee to discuss the reform of
    the FHA single-family insurance program. I am managing partner
    of Federal Financial Analytics, a consulting firm that advises
    on U.S. legislative, regulatory, and policy issues affecting
    financial institutions and strategic planning.
        I believe FHA needs reform, but the proposals currently
    under consideration by Congress would undermine FHA's mission
    and increase the risk to the insurance fund. As a Government
    program, FHA should serve its targeted borrowers if they are
    not already being adequately served by the private sector. It
    is not appropriate for FHA as a Government program to launch
    initiatives to expand its market share, per se.
        FHA's market share has fallen along with for the
    traditional, privately insured mortgage market. But markets
    change. Recent TAO and HUD Inspector General reports, as well
    as the Presidents fiscal year 2007 budget raise serious
    questions about the mutual mortgage insurance funds financial
    soundness. We heard that this morning from GAO.
        The most recent available MMI fund data show a serious
    reduction in the economic value of the fund. Mortgage market
    trends since then have shown significant weakening, as
    evidenced by recent guidance from the Federal Bank Regulatory
    Agency designed to protect insured depository institutions.
        The FHA should not seek to grow its way out of its current
    financial problems. Doing so is reminiscent of the actions
    taken by distressed Savings and Loans during the 1980s. The MMI
    fund is already taking financial risks. For example, 50 percent
    of all FHA loans insured in 2004 had downpayment assistance
    with nonprofit organizations that received seller funding
    accounting for 30 percent of these loans. GAO analysis
    indicates that these sellers raised the price of their
    properties to recover their contribution to the seller funded
    nonprofit, placing the FHA buyers and mortgages that were above
    the true market value of the home.
        The IRS is curtailing these programs, but the significantly
    higher claim rates FHA has experienced from these loans will
    continue for those remaining on its books. Indicative of FHA's
    problems is that its delinquency rates are higher than those
    associated with prime loans and private subprime loans, adding
    yet more risk for chasing subprime borrowers with riskier
    products at this point in the mortgage market cycle could mean
    potentially profound losses for the FHA fund that will heighten
    the risk of calls upon the taxpayer.
        From a budgetary perspective, the MMI fund now is only
    breaking even. Any shift in the MMI fund's financial condition
    will convert the program into a net cost to taxpayers,
    increasing the Federal budget deficit.
        Raising FHA area loan limits, both the base limit and the
    high-cost area limit, will not help low- and moderate-income
    families to become homeowners. Raising the base limit would
    push the FHA-insured loan amount in low-cost areas to $271,000.
    And the income of borrowers qualifying for a mortgage of this
    size is over $86,000. Raising the high-cost limit would push
    the mortgage amount that could be insured by the FHA to
    $417,000, which could only be reached by borrowers with incomes
    over $132,000.
        In key markets, raising the base limit would mean that the
    FHA not only would be targeting the higher-income borrowers in
    an area, but would also insure homes well above the median
    house price in an entire State.
        Entire areas would become vulnerable to underwriting errors
    in the FHA program, potentially putting communities at serious
    risk of foreclosure. Raising the base limit to 65 percent of
    the GSE loan limit would set the base limit at a higher level
    than the current median existing house price for over 80
    percent of the metropolitan areas reported by the Realtors.
        This would further distance the FHA from its mission, as
    well as expose the MMI fund to increased risk from regional
    economic downturns. Giving FHA authority to replace its current
    premium structure with a risk-based premium is a very risky
    proposition. It raises serious questions about whether some
    low- and moderate-income borrowers and minorities will be
    priced out of the entire mortgage market. Further, GAO and HUD
    reports indicate that FHA does not have the necessary data or
    analytical capability to establish a successful risk-based
    premium.
        A mispriced FHA premium structure would be devastating to
    the MMI fund and the borrowers it was meant to serve.
    Eliminating 3 percent minimum downpayment requirement must be
    carefully structured to prevent risk to borrowers, communities,
    and the rest of the MMI fund. Careful underwriting is critical
    for a pilot program.
        The 100 percent Federal guarantee behind--these are my
    recommendations, now, for reform. They are not in the bill. The
    100 percent FHA guarantee undercuts the financial health of the
    MMI fund, provides incentives for lax underwriting, and is not
    needed to make FHA insurance useful for most of its targeted
    borrowers.
        It is time that FHA became an income-targeted rather than a
    loan amount targeted housing program. The current system for
    setting FHA area limits is skewed toward raising these limits
    above the true median house price for an area, never lowering
    them, even if house prices fall. Income targeting FHA single-
    family program will assure that low- and moderate-income
    borrowers become the primary focus of the program. It should
    also make housing more affordable for these targeted borrowers.
    Thank you.
        Senator Allard. Thank you for your testimony.
        Now, let us see, we will have some time here for some
    questions from both Senator Reed and myself.
        I understand that, Mr. Stevens, you need to get going here
    within a short period of time. So, Senator Reed is indicating
    that he does not have any specific questions for you, and I do
    not have any specific questions, although we do have questions
    that we will ask of the whole panel. And we will submit those
    to you, and if you could get the responses back to us within a
    10-day period, I would appreciate it.
        So, you were planning on leaving about 4:15 or so; is that
    correct?
        Mr. Stevens. I am supposed to be at another location at
    4:15, so anytime that you will dismiss me, I would appreciate
    it.
        Senator Allard. OK.
        Do you have any questions, Senator for----
        Senator Carper. Not for Mr. Stevens.
        Senator Allard. OK.
        Very good, Mr. Stevens, just get a response in to us, if
    you would.
        Mr. Stevens. I will.
        Senator Allard. Go ahead.
        Mr. Stevens. Thank you for your consideration.
        Senator Allard. You are welcome.
        OK. The first question I have is for all of the witnesses.
    As I indicated in my opening statement, we believe that one of
    the central questions that must be answered as a part of
    reforming FHA is, what is the role of the FHA, particularly
    vis-a-vis the private sector and low-income and first-time home
    buyers.
        Ms. Lowrie, why don't you respond first, and we will give
    everybody else on the panel a chance to respond.
        Ms. Lowrie. Thank you, Mr. Chairman. Well, to speak to your
    question of the role of FHA, I think we can look at
    historically what FHA has done in consistently serving
    borrowers that were traditionally under-represented in the
    single-family mortgage market, particularly in the private
    sector.
        I have been in the lending industry for 29 years and, up
    until about 15 years ago, FHA was the sole source of serving
    low- and moderate-income borrowers, first-time home buyers,
    minorities. When we look at statistics in 2004, 14.2 percent of
    FHA borrowers were African-Americans, compared with 5.4 percent
    of conventional borrowers. Hispanic borrowers made up about
    15.3 percent of FHA loans, while they were only 8.9 percent of
    the conventional market.
        And if we look at the overall home ownership rate being
    close to 70 percent--and I am not going to get into specifics
    to take up time, but for Hispanics, African-Americans, low- and
    moderate-income borrowers, those numbers fall more in the line
    of the 50 percent range, 48-50 percent range.
        So, there is definitely a need and we have definitely seen
    where FHA has served that market over the years. I think MBA
    has been calling for FHA reform for a number of years. To point
    out Mr. Petrou's concerns about the ability for FHA to manage
    risk-based pricing, that is one of the reasons why we think
    this reform is so critical, to improve their technology,
    improve their human resources, and improve their ability to be
    able to innovate new products to diversify their product line.
        Senator Allard. Mr. Pickel.
        Mr. Pickel. Yes. Thank you, Chairman. I would say that if
    we do not change FHA, we are going to be hurting the very
    people that FHA should be serving.
        When I started in the mortgage business in 1988, you had to
    have perfect credit and you had to have 5 percent down.
    Otherwise, you did not get a 5-percent down loan. With the
    advent of credit scoring, that changed. FHA, at that time, was
    the only one who allowed 3 percent down, was the only one who
    allowed gifts, and was the only one who took marginal credit.
        If you want to know why FHA went from 12 percent to 3, it
    is because the GSEs started allowing gifts and doing 3 percent
    down, and subprime started taking over the marginal credit.
    That is not a bad thing. Those are good things. But we need to
    give FHA the freedom to adjust to the marketplace so they can
    help those people and give them 30-year fixed-rate mortgage
    loans so they can be there and they can be in the house. I have
    seen it.
        The other thing is mortgage brokers today, if it is a one
    and two-person shop, they cannot afford an audit by a CPA for
    $15,000 to prove that they have $75,000 of net worth. So, if
    you go into a mortgage broker shop who cannot afford it, he or
    she is simply going to offer what they can, which is
    conventional or subprime. The lenders are still on the hook.
        Some of the points--Regina and I talked about this
    earlier--FHA still holds that lender accountable for the
    underwriting of the file. The broker does not underwrite it.
    They simply are a distribution channel. Brokers need lenders as
    much as lenders need brokers.
        Senator Allard. Mr. Goldstein.
        Mr. Goldstein. Yes, Sir. Briefly, I would say that the role
    of the FHA has to be something more than just putting another
    product in the marketplace. There is plenty of product in the
    marketplace. It does not feel to me, nor does the research
    suggest, that there is a dearth of mortgage products, even in
    lower-income communities and in minority communities.
        What there is a dearth of is good, safe products that
    people can use to purchase and refinance their mortgages so
    that they do not find themselves in a position of enhanced
    risk. The FHA could take a leadership role in that. But it is
    not by just putting out more product and becoming, essentially,
    some competitor with subprime lenders. It needs to be a market
    leader in terms of the best practices with respect to servicing
    loans, the best practices with respect to the selling channels
    of those loans, et cetera.
        So again, it should not be just another product, it needs
    to be a good product. It needs a product leader in those
    markets.
        Senator Allard. Mr. Petrou, do you have a response?
        Mr. Petrou. I agree with Mr. Goldstein. The systems of the
    FHA at the current time really have to be improved. The
    servicing has to be improved. Just expanding to reach people at
    the very highest incomes is not going to do anything to bring
    in first-time home buyers or minorities into the program who
    are not otherwise going to be there.
        The real issue, I think, is addressed by GAO. They have
    structural problems. They have systems problems. And if they
    expand without thinking about this--they are not qualified now
    to do a risk-based premium, according to the work the GAO and
    HUD IG have shown.
        If they were to do that now, it could be devastating to the
    minorities in this country who would need FHA for their homes.
        Senator Allard. Thank you for your responses.
        Now I will call on Senator Reed for a question or two.
        Senator Reed. Thank you, Mr. Chairman.
        Mr. Pickel, let me follow up an issue that I raised with
    Secretary Montgomery and that you alluded to, also, that is the
    notion of the impediments to an audit's financial statement.
    And this is the information received from HUD, their words, a
    submission of an audited financial statement that meets FHA's
    requirements effectively minimizes the insurance risk to FHA.
    Without this insurance, the risk to the FHA funds increases
    significantly because the financial viability of the approved
    lenders is undermined. This financial statement is also
    required by over half the states as a condition of obtaining a
    mortgage-broker license.
        Furthermore, we have not found the cost of a financial
    audit to be a barrier for financially sound brokers to
    participate in our programs. For the past several years we
    continue to approve new brokers at a record rate. The
    percentage of brokers participating in our program have doubled
    from 30 percent in 1995, to 60 percent in 2005.
        So, is this really a difficult issue for most brokers?
        Mr. Pickel. I believe it is. I cannot speak to their
    statistics because they are the ones who put those out. I
    cannot say that they are wrong or right. What I can tell you is
    that the brokers that I talk to, in response to the first
    thing, the audited net worth requirement is for $75,000. That
    may speak somewhat to the viability, but I would tell you that
    a bond, whereby there could be a pool of money that could be
    tapped upon, should there be something that occurs would be a
    much better deal than a financial statement.
        In that audited financial they also allow furniture and
    fixtures. So, if you take about half of that out, really you
    are auditing someone for $15,000 to prove that they have about
    $40,000 in cash. That is never going to buy back a loan, even
    at the lower rates.
        Second, brokers are only held accountable for fraud. We do
    not want the bad actors in the business, either. We want good
    actors. I am sure Regina can tell you, as a lender, she
    approves brokers and she does all the underwriting. All of the
    accountability, in terms of that loan buyback is held upon the
    lender and not the broker. What we are asking is to get the
    broker channel out there so that more brokers can do that. We
    would suggest a bond, which would allow a better source of
    funds to go back against, if there is that need to go back
    against it.
        Senator Reed. Is Missouri one of those states that requires
    audit financial statements for a license?
        Mr. Pickel. You know, I am a mortgage lender and so I have
    audited financials, but I do not remember if they do for a
    broker. I do not think they do, at this point in time.
        Senator Reed. Mr. Goldstein.
        Mr. Goldstein. Yes, Sir.
        Senator Reed. One of the issues that comes up is why,
    particularly low-income borrowers find themselves in the
    subprime market rather than with a competing and maybe a better
    product that the FHA market has--issues of advertising,
    steering, can you comment on that, based upon your research?
        Mr. Goldstein. The research that we have done and that we
    have seen suggests that the way that this happens is the
    subprime products are actually just marketed much more
    aggressively than are the prime products or the FHA products.
        And so, when there is a vacuum, that vacuum is taken up by
    that subprime market. The distribution channels are quite
    efficient and they make their way into the markets in a way
    that the FHA has not.
        Senator Reed. So, one thing that the FHA should think about
    is a more aggressive and effective marketing plan. Is that
    accurate?
        Mr. Goldstein. Right. I would say that the lenders
    originating those FHA loans could consider that. And to be both
    appropriate and aggressive. I mean, one of the things that
    people complain about with respect to the subprime mortgages is
    that they are often marketed to people who are not, in fact, in
    search of money. And so they end up with a loan that they did
    not necessarily want or need.
        Senator Reed. Mr. Petrou, your comments on this issue of
    directing people to the FHA market versus the subprime market?
        Mr. Petrou. Yes. I think that, you know, predatory lending,
    per se, is just wrong and that the bank regulators are doing
    what they can to try to go after it, and FHA should, as well.
    The traditional FHA product, properly underwritten has
    absolutely no problems if it is properly underwritten and
    properly priced.
        So, the issue about marketing it, I can fully support that.
    The problem I have is that FHA does not know the risk it has on
    its books today.
        Senator Reed. But, just for clarification, there is a
    category of loans that are not predatory?
        Mr. Petrou. Yes.
        Senator Reed. But there is a situation where a borrower
    could have done much better in an FHA versus a predatory
    product. And the presumption--at least, I think what FHA would
    like to see, is more of those people being aware of those
    products and taking advantage of it. Is that fair?
        Mr. Petrou. Definitely. And our marketing program would be
    quite appropriate in that case.
        Senator Reed. Thank you very much.
        Ms. Lowrie, there has been some discussion today, also,
    about the zero downpayment loans and other non-traditional
    loans. Can you give us your perspective on these products, when
    they are appropriate, should the FHA have these types of tools
    at their disposal?
        Ms. Lowrie. Yes, Senator, I can.
        When we look at the demographics over the next decade and
    we look at the buyers that will be out there in the
    marketplace. A large percentage of those will be first-time
    home buyers. Some of them will be the first in their families
    to ever own a home. And we also know, through years of study
    and evidence, that the biggest obstacle is making a
    downpayment.
        So, when we look at FHA competing in a marketplace, not to
    compete against the private sector, but to provide an
    opportunity to those first-time home buyers, the low- to
    moderate-income borrowers, minorities, the zero downpayment
    would afford them the opportunity to be able to get an FHA loan
    at a lower price than they would in the private sector.
        In 2005, 43 percent of first-time home buyers used the zero
    downpayment. And I think when we look--and I cannot disagree
    that FHA needs reform in a lot of different areas, and we
    support that wholly. But we also, in addition to upgrading
    their technology and their human resources, they have to have
    the ability--and it is not just to introduce any new product.
    The zero downpayment product has been out in the marketplace
    for almost a decade now.
        And we look at the need for FHA reform, a perfect example
    is the fact that it took almost 5 years for FHA to introduce a
    hybrid ARM because of the legislation and regulatory obstacles,
    that they operate within, almost, a strait jacket.
        So I think, number one, the demographics, just to emphasize
    it again, the demographics show clearly that there is a need
    for a zero downpayment because of the increase in first-time
    home buyers over the next decade that we will be seeing.
        And FHA has served the market of first-time home buyers and
    has had a history of serving that market for many, many years.
        Senator Reed. Thank you.
        Thank you, Mr. Chairman.
        Senator Allard. Senator Reed, I think I will do another
    round, if it is OK with you.
        Senator Reed. Sure.
        Senator Allard. I think Senator Carper is coming back.
        OK. This is for Ms. Lowrie, Mr. Pickel, and Mr. Petrou.
        In your testimony, each of you mentioned FHA in the context
    of its mission to serve low-income and first-time home buyers.
    Raising the FHA loan limit to 100 percent of the conforming
    loan limit would currently increase the loan limit to $417,000.
    A mortgage at this level would require an income of
    approximately $132,000 in order to qualify. Do you think
    someone of this income should be considered a low-income home
    buyer?
        Ms. Lowrie. Unfortunately, I never thought that I would sit
    here in the United States and call that a low-income home
    buyer. But when we look in so many markets throughout this
    country--I had the opportunity last year to participate in a
    Habitat for Humanity build in San Francisco in a townhouse in a
    low- to moderate-income neighborhood that Habitat said those
    townhomes--and these are skinny, 1,500-square-foot townhomes
    that are going for $700,000.
        There are so many areas in the country where unfortunately,
    because of the limits that FHA operates under, that first-time
    home buyers, whether they are policemen, firemen, teachers in
    the inner cities that cannot afford, that do not have the
    ability to get FHA financing because of FHA's loan limits.
        It is a circumstance that I think we are all dealing with
    throughout this country in a lot of different areas.
        Senator Allard. Mr. Pickel.
        Mr. Pickel. Well, while I wish everyone lived in Kansas
    City because our housing is much more affordable, that is not
    the case.
        Senator Allard. What is the average home in Kansas City?
        Mr. Pickel. Actually, my average loan is about $130,000.
        Senator Allard. And the average home in California must be
    around the $700,000, is that what you said?
        Ms. Lowrie. $700,000, yes. $500,000.
        Senator Allard. Go ahead, Mr. Pickel.
        Mr. Pickel. I think our average sale price is about
    $190,000 but our average loan is $130,000.
        I do not know if it is low income or not. All I do know is
    that in the high-cost markets, the only way for these people to
    buy a home that gets them a good interest rate, one that is
    fixed, that is not going to adjust, where the taxes and
    insurance are also put in the payment, is going to be through
    FHA.
        And even when I spoke before the House, when they brought
    this up, one of the representatives stood up and said that
    $417,000 still would not touch what the cost of the homes were
    in that area.
        So I think it only makes sense to me to go to that point
    and then give FHA the freedom to come up with products that are
    not risky, but allow people to get into homes. Because
    otherwise, they are going to get into a home with a 1-month ARM
    or a 228 that is going to adjust by seven points when it comes
    due. And then they are going to be out of that house.
        So I think we have to let FHA go to that point and come up
    with some type of program that allows those people to get in.
        Senator Allard. Mr. Petrou.
        Mr. Petrou. The IRS data that is recently available for
    2003 shows that roughly 79 percent of the people who filed tax
    returns with incomes over $100,000 showed that they took the
    mortgage interest deduction, which means that they had a house
    with a mortgage already, so they are not first-time home
    buyers, 85 percent paid State and local real estate taxes,
    which showed they had a home and probably some of them did not
    even have a mortgage.
        So the same thing when you raise the base. If you raise the
    base to $270,000, you are talking about $86,000 mortgages, you
    are talking about 75 percent home ownership rates, according to
    what the IRS data shows.
        You may be helping some people but you are not helping
    first-time home buyers.
        Senator Allard. Thank you, and I will now go to Senator
    Carper.
        Senator Carper. Thank you, Mr. Chairman. Welcome. We are
    glad you are here. Thank you for joining us today and for your
    testimony in responding to our questions.
        Is it Mr. Petrou?
        Mr. Petrou. Petrou, yes.
        Senator Carper. Mr. Petrou, in your testimony, I think you
    mentioned a couple of reforms that you thought were
    appropriate. Could you just very briefly mention them again.
    And then I am going to ask, maybe starting with Ms. Lowrie and
    is it Mr. Pickel?
        Mr. Pickel. Just like sweet or dill.
        Senator Carper. There used to be a congressman named Jake
    Pickle. He spelled it wrong.
        Mr. Pickel. I am sure he did not, sir. He was out of Texas.
        Senator Carper. And Mr. Goldstein, I am going to just
    briefly ask you to just briefly respond to the reform proposals
    that Mr. Petrou has shared.
        Mr. Petrou. Thank you, Senator.
        I suggested that FHA become an income-targeted program
    instead of a loan price targeted program. And that way you
    could be assured that it was focused on people making--and I am
    not setting it at 100 percent of area median, 110, 95. That is
    for Congress to decide.
        But the issue is once you target it to the median income of
    an area, you take into consideration the varying incomes across
    the country and make sure FHA is focused on those people,
    rather than, as for example in Mr. Pickel's case in Kansas
    City, where the $130,000 house, raising the base limit to
    $271,000 will be double the price of the median house prices in
    Kansas City. That is upper income people in that city. It is
    just the way it is.
        The other thing I talked about was----
        Senator Carper. Would you all take a minute and just
    respond briefly to that idea. Ms. Lowrie.
        Ms. Lowrie. I guess my initial reaction to that, Senator,
    is that income limits will not improve the performance of the
    fund for FHA. I do not see how that would help that, at all. It
    would make it harder to actually improve the performance of the
    fund.
        Senator Carper. Mr. Pickel.
        Mr. Pickel. That was $130,000 loan amount, sales price
    $190,000, but close enough.
        I think the issue I guess I would have is it makes FHA that
    much more cumbersome and FHA is cumbersome now.
        And I do not think it also solves the problem.
        Senator Carper. Thanks. Mr. Goldstein.
        Mr. Goldstein. I do not know if it is better or not, but I
    will say the one thing that I think that is interesting about
    it is what it does is it takes the emphasis away from allowing
    somebody to become essentially increasingly house poor and
    capping that.
        So again, I do not know that it is better.
        Senator Carper. Mr. Petrou, you had a second----
        Mr. Petrou. Yes, and that is to eliminate the 100 percent
    Federal insurance coverage on FHA loans. I mean, there is
    supposed to be a house and property behind these loans. The
    idea that the Federal Government has to insure 100 percent of
    the loan amount, assuming that there is a house and some
    property there, makes no sense. It sends all the wrong
    incentives out to people.
        As you know, FHA is plagued with fraud. It continues to
    have fraud. In my view, 100 percent insurance is one of the
    reasons it is prevalent with fraud.
        Senator Carper. And so your recommendation was?
        Mr. Petrou. I want to have it reduced, tied to income. For
    example, and I will give you an example, the VA program does
    not have 100 percent Federal insurance. The VA program has
    insurance coverage which falls as the loan amount increases. It
    begins, I think, about 50 percent and then it goes down to 25
    percent.
        Senator Carper. Again Ms. Lowrie, would you and Mr. Pickel
    and Mr. Goldstein just briefly respond to that recommendation?
        Ms. Lowrie. Yes, Senator.
        First of all, I think that FHA has been in existence since
    1934. We heard Commissioner Montgomery talk about today the
    revenue that it has brought to the U.S. Treasury. But also,
    when we look at what FHA has done to open doors for the
    American dream of home ownership to so many Americans, it has
    worked.
        That, to me, is a much bigger broader discussion about
    Federal subsidies. We could talk about a lot of different
    Federal subsidies. But this is a program that has worked for
    years.
        I will not disagree with Mr. Petrou that there has been an
    increase in fraud in the FHA program. But I will also say that
    there has been an increase of fraud against mortgage lenders
    across every segment of the market. In the private sector, in
    the GSE programs, in the subprime, in the Alt A, that fraud is
    an issue that we, as an industry, have to deal with. I have had
    meetings with the inspector general about it.
        I do not necessarily think that by changing and lowering
    the amount of the insurance of the FHA program, that is going
    to decrease the fraud.
        Senator Carper. Thank you, ma'am.
        Mr. Pickel, just a brief comment, please.
        Mr. Pickel. I think FHA was one of the most innovative
    programs that the Government came up with when they decided to
    do 100 percent insurance on the loan amount. It was the first
    time that any lender would ever decide to go and loan people
    money because they knew their risk was covered.
        So I think, in taking that away, we are actually deciding
    that we are going to say FHA should not be innovative. Now they
    have not been innovative for 15 years. But by golly, in the
    beginning, they were.
        So I think we should allow them to be innovative again. And
    I would not take it away.
        Senator Carper. Mr. Goldstein, could you briefly comment,
    please?
        Mr. Goldstein. Briefly, I would say that what Mr. Petrou
    raised is an empirical question that we could figure out the
    answer to. And that is, econometrically, if you were to remove
    that 100 percent guarantee, would you adversely affect the
    market?
        I do not think any of us here knows the answer to that
    question but it is a question that could be answered.
        Senator Carper. Mr. Chairman, my time is expired. Can I
    just ask----
        Senator Allard. Go ahead and speak more. You missed the
    first round, so if you would like to speak more, that is fine.
        Senator Carper. Thanks very much.
        This will probably be just for Mr. Goldstein, and if others
    feel really encouraged you can jump in, but this is really for
    Mr. Goldstein.
        I think over the past decade or so homes have been really
    the primary method that a lot of families use to save money, as
    you know. Today, with interest rates starting to rise again and
    the threat of job losses, homeowners are in a somewhat more
    precarious situation, at least a lot of them are. If they lose
    their jobs and are unable to pay their mortgage they will maybe
    lose their homes which is, for a lot of folks, as I said, the
    primary source of their savings. And with the high interest
    rates, they may find it more difficult to get another home.
        I think in your testimony, Mr. Goldstein, you may have
    mentioned that there are inadequacies in FHA's mitigation
    plans. I just want to ask if you can maybe comment a little bit
    more on what you believe those inadequacies to be.
        Mr. Goldstein. Yes, sir. I was talking about the loss
    mitigation programs.
        And there, what we have learned from our work with
    consumers and the like is the general rules that exist for loss
    mitigation, for servicing of the loans, have not been
    essentially complied with between the FHA borrowers and the FHA
    servicers. So that, for example, it is rare--in fact, I do not
    think I can ever remember an example of meeting with a borrower
    who said that they ever had their face-to-face meeting with
    their servicer when they got in trouble with their loan, which
    is a requirement.
        I would also say that there were other such things in terms
    of the loss mitigation being made available only to those
    people who show immediately that they are able to again repay,
    rather than perhaps again repay within 30 or 60 or 90 days when
    they are reemployed.
        So that there are certain aspects of the loss mitigation
    and the servicing, those two that are mentioned, that are
    frequently mentioned among borrowers.
        Senator Carper. Anything else you want to mention with
    respect to how to improve mitigation practices at FHA?
        Mr. Goldstein. I would say that Pennsylvania, and I
    understand Delaware is contemplating something along these
    lines, has this homeowner's emergency mortgage assistance
    program, which was put in place back in the 1970s and was
    designed to ease that gap between the period of time when
    somebody, for example, lost a job as a result of a plant
    closing or a dramatic illness or something in that nature.
        And under certain circumstances, the State of Pennsylvania
    will take a look at their circumstance. And if they consider
    that the circumstance that they are in is not of their own
    making and they are likely to come out of it, they will bring
    the mortgage current, put a silent second loan against their
    property, and at such time as they are required to pay back the
    State of Pennsylvania.
        That program helps thousands of people a year. It is not a
    huge cost item to the State. In fact, in most ways, it is a
    revolving loan product.
        Other states, like North Carolina, are taking a look at it.
    I understand there has been Federal legislation looking at
    something of that nature, and Delaware is looking at it, as
    well.
        Senator Carper. Let me just build on that, and this will be
    my last question.
        There is a fellow in Delaware. His name is Henry Topel, T-
    o-p-e-l, who has probably reached the age a lot of people are
    thinking about slowing down, but he has no interest in that. He
    is a widower and in the past he has been involved in real
    estate and chaired a bank board.
        But he is still active and thinks a lot about issues. He is
    one of those people who is not at all shy about sharing those
    ideas with guys like me, which I appreciate very much.
        What he asked us to consider, and I will not do justice to
    what he suggested, but the plan would involve the creation of a
    fund modeled after the FHA program. And under the FHA program,
    home buyers would pay an additional, maybe half, percentage
    point for the FHA to insure their mortgage to private lenders.
        Under his proposal, home buyers using the FHA program could
    elect to contribute another one-half percent to what he calls a
    reserve fund. And if the home buyer lost their job, they could
    draw down on this fund to cover mortgage payments until they
    were able to become gainfully employed. That is kind of a rough
    outline, maybe does not even do justice to what he suggests,
    but I think it does.
        Do you have any initial thoughts or reactions to what he
    has shared? I would ask that you feel free to share any other
    programs you know that might serve to accomplish the same kind
    of goal, and that is to enable Americans--especially when they
    lose their jobs--to stay in their homes. Anybody?
        Ms. Lowrie. Senator, I will kind of jump in here.
        I would be very interested to have MBA do a study and some
    research to look at how that might impact overall
    delinquencies. I would also like to submit MBA's most recent
    delinquency survey which was issued yesterday.
        But I think there are insurance programs out there now for
    loss of job, medical illness, where maybe that is something
    that we might want to look at incorporating into the FHA
    programs, mandatory insurance. I am not sure that setting up a
    reserve fund, I would kind of put that in the same category as
    us talking about catastrophic insurance.
        But I will, I do want to comment, back on the previous
    comments, about loss mitigation.
        Senator Carper. If you could do so just briefly because of
    the time.
        Ms. Lowrie. Real brief. And that is that FHA has been
    working very closely with all of the servicers to ensure active
    loss mitigation. And we have seen a decrease in delinquencies
    as a result of that strong enforcement of their loss
    mitigation.
        Senator Allard. Ms. Lowrie, I am going to ask unanimous
    consent that your request be part of the record. Would you
    repeat it, what it is that you wanted? It was a survey----
        Ms. Lowrie. A survey of the impact of collecting a half
    percent for a reserve, for a loss reserve for loss of job.
        Senator Allard. If you could submit that to the Committee,
    I will make that part of the record.
        Senator Carper. Thank you. Thanks, Mr. Chairman.
        Mr. Pickel, any initial reaction to what Mr. Topel has
    raised?
        Mr. Pickel. I think loss mitigation and early intervention
    are one of the best things we can do, especially for people
    with low-to-moderate income who are new at buying a house. They
    are used to renting. It is a whole new ball game.
        There are a couple of ideas that come to mind, and I do not
    know how you would implement these. But one would be where you
    would allow them to skip a payment. Part of that some lenders
    already do now, where they put it onto the end of the mortgage.
        But other things like that, to gradually build people in.
    If you can get people into that home for a year and help them
    for that first year, which is the most crucial period, I think
    that would be the best.
        In my own shop, we actually call people, and it is not a
    threatening call. We simply call and say hey, how is it going?
    We want to know. We actually call every single month the first
    year on all FHA loans.
        Senator Carper. Do you really? Wow. Thank you.
        Mr. Goldstein.
        Mr. Goldstein. What Mr. Pickel just mentioned I think is a
    very interesting thing because the data does very clearly show
    that the earlier that you intervene with somebody who is in
    difficulty with their loan, there is a much greater likelihood
    in terms of them becoming current again.
        With respect to Mr. Topel's idea, it is an interesting
    concept because generally speaking the people that we are
    talking about are people who have made a zero downpayment, or
    very close to a zero downpayment. And the reason they did it
    was not to save their savings, but because they did not have
    savings.
        And so, the ability to be able to have something to draw
    upon, I think represents quite an interesting idea.
        Senator Carper. Thank you. Mr. Petrou.
        Mr. Petrou. It could be changed a bit, I think, to focus it
    on a rather narrow target, which is a group of very low- and
    moderate-income in the area.
        My concern is with the FHA because I am not sure that they
    have the financial wherewithal at this time to start expanding
    into an area like that, which is actually a separate risk
    category for them. So that is my only reserve. But the pricing
    might also be an issue.
        Senator Carper. My thanks to each of you.
        Mr. Chairman, you have been very generous with the time.
    Thank you so much.
        Senator Allard. Thank you, Senator Carper.
        I do have more questions, and perhaps other members on the
    Committee have more questions. I would ask that you respond to
    those within 10 days after we submit them to you, if you would,
    please.
        In the meantime, I have a closing statement that I am going
    to make here.
        Once again, I would like to thank all of our witnesses for
    being here today. Your testimony touched on a number of
    important points and we had a productive question and answer
    period.
        I appreciate this opportunity to hear these perspectives as
    the Subcommittee considers the future of a program that has
    been so helpful in allowing low-income and first-time home
    buyers to experience the American dream of home ownership.
        Because there are still so many unanswered questions
    regarding the role of FHA and the effect of the proposed
    reforms, along with Senator Shelby I plan to commission a GAO
    study. We will ask GAO to examine the major factors underlying
    the decline in FHA's market share, the financial and public
    policy implications of the decline in market share, the extent
    and areas of overlap between types of borrowers served by FHA
    and other markets, the most viable options FHA could pursue to
    serve additional low-income and first-time home buyers, the
    implications of the reform proposal before us.
        This study will provide the fact that we need to reform FHA
    in an informed, responsible manner that will ensure it
    continues to be viable for years to come.
        The record will remain open for 10 days should members wish
    to submit any additional questions to the witnesses. Witnesses,
    we would appreciate your prompt response to the questions, and
    would ask you to please respond to them within 10 days.
        Thank you to everyone for attending this hearing of the
    HousING and Transportation Subcommittee.
        The hearing is adjourned.
        [Whereupon, at 4:45 p.m., the hearing was adjourned.]
        [Prepared statements, responses to written questions, and
    additional material supplied for the record follow:]
                      PREPARED STATEMENT OF RICK SANTORUM
                    A Senator from the State of Pennsylvania
                                 June 20, 2006
        Mr. Chairman, I appreciate you holding this hearing today on the
    important subject of reform of the Federal Housing Administration
    (FHA). FHA has enabled many Americans to become homeowners who may
    otherwise not have been able to buy homes. FHA does this by providing
    Federal insurance on the loans made by private lenders. Because lenders
    are protected against borrowers defaulting, FHA has made mortgages
    available to more Americans, particularly for low-income borrowers.
        In recent years, the FHA market share has dropped significantly.
    This hearing will examine some proposals that have been put forward to
    address this drop in market share.
        I am particularly pleased that we have two witnesses from
    Pennsylvania testifying.
        Ms. Regina Lowrie is the Chairman of the Mortgage Bankers
    Association and brings her expertise in the mortgage market and in
    working with FHA to bear on this important topic. Her company, Gateway
    Funding Diversified Mortgage Services, has seen their ability to use
    the FHA programs drop markedly. I appreciate her insight into what
    changes her organization thinks are necessary for FHA to regain some of
    their market share and positively impact home ownership rates.
        Mr. Ira Goldstein is the Director of Policy and Information
    Services for The Reinvestment Fund (TRF) in Philadelphia. I have worked
    with TRF for several years now and am proud of their thoughtful and
    data-based contribution to neighborhood revitalization. TRF has done a
    lot of work looking at the factors that lead to mortgage foreclosures
    and the lasting impact of such foreclosures on neighborhoods. I believe
    Mr. Goldstein provides a proper cautionary note that while we seek to
    increase our home ownership rates, we should do so in ways that lead to
    sustainable home ownership for people who are truly ready to own and
    maintain their homes over the long-term, even through the financial
    hardships that may come their way.
        I welcome them both to the Committee, and look forward to hearing
    their testimony.
                                     ______

                   PREPARED STATEMENT OF BRIAN D. MONTGOMERY
        Assistant Secretary for Housing and Federal Housing Commissioner
                  Department of Housing and Urban Development
                                 June 20, 2006
        Thank you Chairman Allard and Ranking Member Reed for inviting me
    to be here today to testify on the Administration's proposed FHA
    Modernization Act.
         As you are all aware, the Federal Housing Administration (FHA) was
    created in 1934 to serve as an innovator in the mortgage market, to
    meet the needs of citizens otherwise underserved by the private sector,
    to stabilize local and regional housing markets, and to support the
    national economy. This mission is still very relevant, perhaps now more
    so than ever.
        Moreover, the FHA model represents the very best of what government
    can and should do. Since its inception, FHA has helped more than 34
    million Americans become homeowners. By operating through a private
    distribution network, FHA efficiently reaches families in need of safe
    and affordable home financing. Simply put, FHA insurance protects
    lenders against loss, enabling these private sector partners to offer
    market-rate mortgages to home buyers who would otherwise remain
    unserved or underserved. FHA provides a substantial benefit to
    families, communities, and the entire national economy.
        We believe that FHA should continue to play a key role in the
    national mortgage market and I'm here today to make the case for
    changes to the National Housing Act that will permit us to continue to
    fulfill our critical mission.
        Let me explain. In recent years, FHA's outdated statutory authority
    has left the agency out of synch with the rest of the lending industry.
    Over the last decade, the mortgage industry transformed itself,
    offering innovative new products, risk-based pricing, and faster
    processing with automated systems. Meanwhile, FHA continued to offer
    the same types of products with the same kinds of pricing, becoming
    less attractive to lenders and borrowers alike.
        As a result, FHA's business has dropped precipitously in housing
    markets all across the nation. For example, in Chairman Allard's home
    State of Colorado, FHA's volume has dropped from 42,609 loans in 1999
    to 18,543 loans in 2005. For Ranking Member Sarbanes, during that same
    time period, FHA's volume in Maryland dropped from 61,201 to 11,824
    loans. And for Ranking Member Reed, FHA's volume in Rhode Island is
    down from 4,695 loans in 1999 to just 906 loans in 2005.
        FHA has fallen behind for a variety of reasons, from outdated
    business practices to cumbersome program requirements. Over the last 9
    months, we have made significant changes, streamlining and realigning
    FHA's operating procedures. While these changes are good and long
    overdue, they are not enough, a point that FHA's industry partners have
    clearly conveyed. Therefore, FHA is now requesting that we amend the
    law to give FHA the flexibility it needs to fulfill its original
    mission in today's marketplace.
        As the dynamic mortgage market passed FHA by, many home buyers--
    first-time home buyers, minority home buyers and home buyers with less-
    than-perfect credit--were left with fewer safe and affordable options.
    Many of them became home buyers, but paid a steep price to do so,
    especially those living in higher-cost states, such as California, New
    York, Rhode Island, and Massachusetts, to name a few.
        Without a viable FHA alternative, many home buyers turned to high-
    cost financing and nontraditional loan products to afford their first
    homes. While low initial monthly payments seemed like a good thing, the
    reset rates on some interest-only loans are substantial and many
    families are unable to keep pace when the payments increase. In
    addition, prepayment penalties make refinancing cost-prohibitive.
    According to Moody's Economy.com, more than $2 trillion of U.S.
    mortgage debt, or about a quarter of all mortgage loans outstanding,
    comes up for interest rate resets in 2006 and 2007. While some
    borrowers will make the higher payments, many will struggle. Some will
    be forced to sell or lose their homes to foreclosure. The foreclosure
    rate for subprime loans is twice that of prime loans. And I think we
    can all agree that foreclosures are bad for families, bad for
    neighborhoods, and bad for the economy as a whole.
        That said, the FHA Modernization Act is part of the solution. FHA
    reform is designed to give home buyers who can't qualify for prime
    financing a choice again.
        Moreover, the FHA bill proposes changes that will strengthen FHA's
    financial position, improving FHA's ability to mitigate and compensate
    for risk. The proposed changes would permit FHA to operate like every
    other insurance company in the nation, pricing its products
    commensurate with the risk, as opposed to having some clients pay too
    much and some too little. Imagine if a car insurance company charged
    all clients the same premium--the 17-year-old teenager and a 40-year-
    old adult would pay the same rate. Is that fair? With a blended rate,
    those who know they're paying too much find themselves another
    insurance company. That leads to a portfolio that is increasingly
    lopsided: too many riskier borrowers, too few safer borrowers, and an
    insurance fund that poses a risk of default. This type of adverse
    selection is exactly what happened to FHA over the last decade. Those
    who were lower credit risks went elsewhere. The premium changes
    proposed in the bill will restore balance to the FHA funds, providing
    appropriate levels of revenue to operate in a more fiscally sound
    manner.
        I know my introduction was lengthy, but I want you to understand
    how important FHA reform really is--for FHA, for the home buyers we
    serve, and for the industry as a whole. FHA's private sector partners--
    the brokers, the realtors, the lenders, the home builders--want to tell
    their clients about the FHA alternative. They want low- to moderate-
    income home buyers to have a safer, more affordable financing option.
    They want FHA to be a viable player again.
        Now let me explain a little bit about the simple changes we're
    proposing. For one, we're proposing to eliminate FHA's complicated
    downpayment calculation and 3 percent cash investment requirement.
    Before the rest of the market began offering low downpayment loans, FHA
    was often the best option for first-time home buyers because it
    required only a minimal downpayment. But, as I said before, the market
    passed FHA by. Last year, 43 percent of first-time home buyers
    purchased their homes with no downpayment. Of those who did put money
    down, the majority put down 2 percent or less.
        The downpayment is the biggest barrier to home ownership in this
    country, but FHA has no way to address the barrier without changes to
    its statute. The FHA Modernization Act proposes to permit borrowers to
    choose how much to invest, from no money down to one or two or even 10
    percent.
        The bill also proposes to provide FHA the flexibility to set the
    FHA insurance premiums commensurate with the risk of the loans. For
    example, no downpayment loans would be priced slightly higher, yet
    appropriately, to give home buyers a fairly priced option and to ensure
    that FHA's insurance fund is compensated for taking on the additional
    risk. FHA would also consider the borrower's credit profile when
    setting the insurance premium. FHA would charge lower-credit risk
    borrowers a lower insurance premium than it does today, and higher-
    credit risk borrowers would be charged a slightly higher premium. In so
    doing, FHA could reach deeper into the pool of prospective borrowers,
    while protecting the financial soundness of the FHA Fund.
        A slightly higher premium would increase a borrower's monthly
    payment only minimally. For example, on a $200,000 loan, a 1 percent
    upfront premium financed into the loan would cost the borrower $12.64
    per month; a 2 percent premium would cost $25.28 and a 3 percent
    premium, $37.92. Clearly, this higher premium is still affordable.
    Moreover, it's a smart investment, because the borrower is paying for
    the FHA insurance to obtain a market rate loan.
        The primary concerns with a risk-based pricing approach are that
    FHA will target people who shouldn't be home buyers and charge them
    more than they should pay. I want to address these concerns directly.
    Our goal is to reach families who are capable of becoming homeowners
    and to offer them a safe and fairly priced loan option.
        With a risk-based premium structure, FHA can reach hard-working,
    credit-worthy borrowers--such as store clerks, bus drivers, librarians,
    and social workers--who, for a variety of reasons, do not qualify for
    prime financing. Some have poor credit scores due to circumstances
    beyond their control, but have put their lives back together and need a
    second chance. For some, the rapid appreciation in housing prices has
    simply outpaced their incomes. Many renters find it difficult to save
    for a downpayment, but have adequate incomes to make monthly mortgage
    payments and do not pose a significant credit risk. They simply need an
    affordable financing vehicle to get them in the door. FHA can and
    should be there for these families.
        The higher premiums that FHA will charge some types of borrowers
    are still substantially lower than they would pay for subprime
    financing. Let me repeat that point: the higher premiums that FHA will
    charge some types of borrowers are still substantially lower than they
    would pay for subprime financing. The cost of a loan with a higher FHA
    insurance premium is still substantially lower than the cost of a loan
    with a higher interest rate. For example, if FHA charged a 3 percent
    upfront insurance premium for a $200,000 loan to a credit-impaired
    borrower versus that same borrower obtaining a subprime loan with an
    interest rate 3 percent above par, the borrower would pay over $255
    more in monthly mortgage payments with the subprime loan and over
    $125,000 more over the life of the loan, if they kept it for a full 30-
    year term.
        Moreover, as I stated earlier, FHA intends to lower the insurance
    premium for many borrowers. FHA will charge lower-risk borrowers a
    substantially lower premium than these types of borrowers pay today.
    For example, home buyers with higher credit scores who choose to invest
    at least 3 percent in a downpayment may pay as little as half a percent
    upfront premium.
        So, while FHA may charge riskier borrowers more (and less risky
    borrowers less) than it does today, the benefit is three-fold. First,
    FHA will be able to reach additional borrowers the agency can't serve
    today. There is nothing that upsets us more than to see people taken to
    the cleaners when they would have fared better with an FHA-insured
    product. Second, these borrowers will pay less with FHA than with a
    subprime loan. And finally, the FHA Fund will be managed in a
    financially sound manner, with adequate premium income to cover any
    losses.
        Another change proposed in the FHA Modernization Act is to increase
    FHA's loan limits. Members of Congress from high-cost states have
    repeatedly asked FHA to do something about our antiquated loan limits.
    This bill finally answers their concerns. FHA's loan limit in high-cost
    areas would rise from 87 to 100 percent of the GSE conforming loan
    limit and in lower-cost areas from 48 to 65 percent of the conforming
    loan limit. In between high- and lower-cost areas, FHA's loan limit
    will increase from 95 to 100 percent of the local median home price.
    This change is extremely important and crucial in today's housing
    market. In many areas of the country, the existing FHA limits are lower
    than the cost of new construction. Buyers of new homes can't choose FHA
    financing in these markets. In other areas, FHA has simply been priced
    out of the market. For example, in 1999, FHA insured 127,000 loans in
    the State of California; in 2005, FHA-insured only 5,000.
        FHA is also proposing some changes to specific FHA products. For
    example, the bill proposes to permit FHA to insure mortgages on
    condominiums under its standard single-family product. The existing
    condo program is very specialized and burdensome, as a result of
    outdated statutory provisions that were written at a time when
    condominiums were an unfamiliar form of ownership. Condos represent 25
    percent of the new, and 12 percent of the existing, home market today
    and serve as one of the primary forms of affordable housing for first-
    time home buyers. In fact, condos tend to be closer to city centers and
    offer lower-income borrowers an opportunity to buy an affordable home
    without moving far from their jobs and away from the public
    transportation that gets them to those jobs. Therefore, FHA should be
    able to serve condo buyers, just like any other home buyers, under its
    standard single-family program.
        Our reform bill also proposes to modernize the Title I manufactured
    housing program, eliminating the portfolio insurance feature from the
    program and increasing the loan limits to reflect the real cost of
    manufactured housing today. The existing statute restricts FHA claim
    payments to 10 percent of the value of a lender's loan portfolio. With
    portfolio insurance, lenders are not guaranteed coverage against loss
    and subsequently price their loans for additional risk. The higher loan
    costs, in turn, increase the likelihood of borrower default. With
    additional default risk, but insufficient coverage, the losses grew to
    unsustainable levels in the 1990s and Ginnie Mae pulled out of the
    program. Ginnie Mae has testified that with the elimination of this
    outdated insurance model it would reconsider participation in the Title
    I securities market, which will bring in more lenders and drive down
    the costs of manufactured home financing.
        Finally, the FHA Modernization Act offers some changes to the Home
    Equity Conversion Mortgage (HECM) program, which enables senior
    homeowners, aged 62 years or older, to tap into their home equity to
    live comfortably in their golden years. The bill proposes elimination
    of the cap on the number of loans FHA can insure; a single, national
    loan limit set at conforming; and a new HECM for Home Purchase product
    to permit seniors to move from the family home to more suitable senior
    housing and convert the purchase loan into a HECM in a single
    transaction. Today, seniors who want to move, but need additional cash-
    flow to pay their living expenses, must purchase a new home and take
    out a HECM in two distinct transactions, resulting in two sets of loan
    fees and charges.
        Let me repeat a point I made earlier in the testimony. I want to
    assure you that the changes we are proposing will not increase the
    overall risk of the MMI Fund or impose a potential cost on taxpayers.
    We are proposing to manage the Fund in a financially prudent way,
    beginning with the change in FHA pricing to match premiums with risk.
    This will avoid FHA being exposed to excessive risk, as it is today,
    because some borrowers who use FHA are under-charged for their risk to
    the Fund while others are overcharged. Of course, we will continue to
    monitor the performance of our borrowers very closely, and make
    adjustments to underwriting policies and/or premiums as needed.
        I know I've talked a lot here today, but I want to convey to you
    how passionate I am about the proposed changes. I believe we have an
    opportunity to make a difference in the lives of millions of low- and
    moderate-income Americans. We have a chance to bring FHA back into
    business, to restore the FHA product to its traditional market
    position. To all those families who can buy a home with prime
    conventional financing, I say, ``Go for it!'' They're fortunate and
    they should take full advantage of that benefit. But for those who
    can't, FHA needs to be a viable option. And when people ask me why are
    we proposing these changes, I tell them these exact words: ``Families
    need a safe deal, at a fair price. Families need a way to take part in
    the American Dream without putting themselves at risk. Families need
    FHA.''
        I want to thank you again for providing me the opportunity to
    testify here today on the FHA Modernization Act. I look forward to
    working with all of you to make these reforms a reality.
                                     ______

                     PREPARED STATEMENT OF WILLIAM B. SHEAR
       Director of the Financial Markets and Community Investment Team,
                        Government Accountability Office
                                 June 20, 2006

                                     ______

                     PREPARED STATEMENT OF REGINA M. LOWRIE
                     Chairman, Mortgage Bankers Association
                                 June 20, 2006
        Thank you for holding this hearing and inviting the Mortgage
    Bankers Association (MBA)\1\ to share its views with the Subcommittee
    on ``FHA: Issues for the Future.'' My name is Regina M. Lowrie and I am
    the President of Gateway Funding Diversified Mortgage Services, LP in
    Horsham, Pennsylvania and Chairman of the Mortgage Bankers Association.
    I am here today because MBA believes that the Senate must act to make
    important legislative changes to the National Housing Act if the
    Federal Housing Administration (FHA) is to continue to be a financially
    sound tool for lenders to use in serving the housing needs of American
    families who are unserved or underserved by conventional markets.
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        \1\ The Mortgage Bankers Association (MBA) is the national
    association representing the real estate finance industry, an industry
    that employs more than 500,000 people in virtually every community in
    the country. Headquartered in Washington, D.C., the association works
    to ensure the continued strength of the nation's residential and
    commercial real estate markets; to expand home ownership and extend
    access to affordable housing to all Americans. MBA promotes fair and
    ethical lending practices and fosters professional excellence among
    real estate finance employees through a wide range of educational
    programs and a variety of publications. Its membership of over 3,000
    companies includes all elements of real estate finance: mortgage
    companies, mortgage brokers, commercial banks, thrifts, Wall Street
    conduits, life insurance companies and others in the mortgage lending
    field. For additional information, visit MBA's web site: http://
    www.mortgagebankers.org.
    ---------------------------------------------------------------------------
        In 1994, I founded Gateway with only seven employees and $1.5
    million in startup capital. Over the past 12 years, I have grown the
    company to over 800 employees working in more than 58 offices,
    originating $3 billion in loans annually throughout Pennsylvania,
    Delaware, New Jersey, and Maryland. I am proud of the work of Gateway,
    and of the mortgage industry itself, in providing opportunities for
    home ownership for families of this great land.
        When I started Gateway, the programs of FHA were invaluable in
    enabling us to serve families who otherwise would have no other
    affordable alternative for financing their home. Ten years ago, FHA
    loans comprised 40 percent of Gateway's volume. We worked hard to be a
    good partner with FHA in administering its programs and, together, FHA
    and Gateway enabled tens of thousands of families to purchase their
    first homes.
        Today, though, the story is very different. While Gateway has grown
    significantly, our ability to use the FHA program has declined
    precipitously. Gateway has been able to adapt to changes in the
    mortgage markets, but FHA has been prevented from doing so. The needs
    of low- and moderate-income home buyers, of first-time home buyers, of
    minority home buyers, and of senior homeowners have changed. FHA's
    programs though, have not followed their historic path of adaptation to
    meet these borrowers' changing needs.
        The numbers are troublesome. In 1990, 13 percent of total
    originations in the United States were FHA-insured mortgages. In 2004,
    that number dropped to near 3.5 percent. More importantly, in 1990, 28
    percent of new home sales (which are typically a large first-time home
    buyer market) were financed through programs at FHA or the Department
    of Veterans Affairs (VA); today that number has dropped to under 12
    percent.
        MBA cites these numbers not because we believe that there is a
    certain market share that FHA should retain, but rather because these
    numbers are consistent with many lenders' views that FHA has not kept
    up with changes in the market. These numbers point to a decline, not
    just in marketshare, but in FHA's potential to positively impact home
    ownership. This loss of impact does not stem from the fact that FHA is
    no longer relevant, but rather that statutory constraints prohibit FHA
    from adapting its relevance to consumer needs today.
        A recent anecdote illustrates this point very well. A story ran in
    RealtyTimes 1 year ago, on June 21, 2005, in which a Baltimore, MD,
    real estate agent unabashedly advises home buyers to avoid FHA
    financing. The agent states: ``Approved FHA loan recipients, same
    notice to you, don't bother bringing it to the table during a sellers
    market. More times than not, your offer will be rejected. We know that
    VA and FHA loans allow you the means of purchasing more home for the
    mortgage, but it only works if you are the only game in town.'' His
    advice was based on the often true notion that FHA-insured financing is
    slower and more laborious than conventional financing.
        This is a very unfortunate perspective, especially because FHA is
    vitally needed today. Thus, MBA is not focused on FHA marketshare in
    and of itself, but rather because it signals whether or not FHA's
    valuable programs are reaching the people they should.
        MBA is committed to supporting FHA. Nowhere in Washington will you
    find a stronger supporter of the FHA and the programs it offers.
    Mortgage lenders are the private delivery system that allows FHA to
    reach borrowers with affordable home ownership financing and rental
    housing opportunities, especially low- and moderate-income families,
    first-time home buyers, minorities, and the elderly. Every day,
    mortgage lenders sit down with the very families FHA seeks to serve to
    discuss how we can help them realize their dreams. Maybe we understand
    better than most that without FHA, many American families simply would
    not have had and will not have the opportunity to own their own home.
    FHA Background
        FHA was created as an independent entity by the National Housing
    Act on June 27, 1934 to encourage improvement in housing standards and
    conditions, to provide an adequate home-financing system by insurance
    of housing mortgages and credit, and to exert a stabilizing influence
    on the mortgage market. FHA was incorporated into the newly formed U.S.
    Department of Housing and Urban Development (HUD) in 1965. Over the
    years, FHA has facilitated the availability of capital for the nation's
    multifamily and single-family housing market by providing government-
    insured financing on a loan-by-loan basis.
        FHA offers multifamily and single-family insurance programs that
    work through private lenders to extend financing for homes. FHA has
    historically been an innovator. Over the past several decades, the
    mission of FHA's single-family programs have increasingly focused on
    expanding home ownership for those families who would otherwise either
    be unable to obtain financing or obtain financing with affordable
    terms. FHA's multifamily programs have allowed projects to be developed
    in areas that otherwise would be difficult to finance and provides
    needed rental housing to families that might otherwise be priced out of
    a community.
        Additionally, the FHA program has been a stabilizing influence on
    the nation's housing markets due to the fact that it is consistently
    available under the same terms at all times and in all places. FHA does
    not withdraw from markets.
    FHA Single-family Programs
        Single-family FHA-insured mortgages are made by private lenders,
    such as mortgage companies, banks, and thrifts. FHA insures single-
    family mortgages with more flexible underwriting requirements than
    might otherwise be available. Approved FHA mortgage lenders process,
    underwrite and close FHA-insured mortgages without prior FHA approval.
    As an incentive to reach into harder to serve populations, FHA insures
    100 percent of the loan balance as long as the loan is properly
    underwritten.
        FHA has a strong history of innovating mortgage products to serve
    an increasing number of home buyers. FHA was the first nationwide
    mortgage program; the first to offer 20-year, 25-year, and finally 30-
    year amortizing mortgages; and the first to lower downpayment
    requirements from 20 percent to 10 percent to 5 percent to 3 percent.
    FHA has always performed a market stabilizing function by ensuring that
    mortgage lending continued after local economic collapses or regional
    natural disasters when many other lenders and mortgage insurers pulled
    out of these markets.
        FHA's primary single-family program is funded through the Mutual
    Mortgage Insurance Fund (MMIF), which operates similar to a trust fund
    and has been completely self-sufficient. This allows FHA to accomplish
    its mission at little or no cost to the government. In fact, FHA's
    operations transfer funds to the U.S. Treasury each year, thereby
    reducing the Federal deficit. FHA has always accomplished its mission
    without cost to the taxpayer. At no time in FHA's history has the U.S.
    Treasury ever had to ``bail out'' the MMIF or the FHA.
    FHA Multifamily Programs
        While much focus over the past several months has been on FHA's
    single-family programs, it is important to underscore the critical role
    of FHA's multifamily programs in providing decent, affordable rental
    housing to many Americans. There are a number of families and elderly
    citizens who either prefer to rent or who cannot afford to own their
    own homes. FHA's insurance of multifamily mortgages provides a cost-
    effective means of generating new construction or rehabilitation of
    rental housing across the nation. As well, FHA is one of the primary
    generators of capital for healthcare facilities, particularly nursing
    homes.
        While the FHA has implemented a number of significant improvements
    to its single-family program over the last year, the same focus needs
    to be applied to improving the multifamily programs. MBA hopes that
    process improvements on the multifamily side of FHA will soon be
    discussed and implemented.
    The Need for FHA Today and Tomorrow
        The FHA single-family programs are vital to many home buyers who
    desire to own a home but cannot find affordable financing to realize
    this dream. While the FHA has had a number of roles throughout its
    history, its most important role today is to give first-time home
    buyers the ability to climb onto the first rung of the home ownership
    ladder and to act as a vehicle for closing the home ownership gap for
    minorities and low- and moderate-income families.
        Despite this country's recent record high levels of home ownership,
    not all families share in this dream equally. As of the first quarter
    of 2006, the national home ownership rate stood at 68.5 percent, but
    only 51 percent of minorities owned their own home. Only 48 percent of
    African-Americans and 49.4 percent of Latinos owned their own homes.
    This compares with 75.5 percent of non-Hispanic white households.
        By the end of 2005, 84.3 percent of families earning more than the
    median income owned their own home, while only 53.1 percent of families
    below the median income owned their own home.
        These discrepancies are tragic because home ownership remains the
    most important wealth-building tool the average American family has.
    FHA's Record
        More than any other nationally available program, during the 1990s,
    FHA's impact focused on the needs of first-time, minority, and/or low-
    and moderate-income borrowers.
        In 1990, 64 percent of FHA borrowers using FHA to purchase a home
    were first-time home buyers. Today, that rate has climbed to about 80
    percent. In 1992, about one in five FHA-insured purchase loans went to
    minority home buyers. That number in recent years has grown to more
    than one in three. Minorities make up a greater percentage of FHA
    borrowers than they do conventional market borrowers.
        FHA is particularly important to those minority populations
    experiencing the largest home ownership gaps. Home Mortgage Disclosure
    Act (HMDA) data reveal that in 2004, 14.2 percent of FHA borrowers were
    African-Americans, compared with 5.4 percent of conventional borrowers.
    Hispanic borrowers made up 15.3 percent of FHA loans, while they were
    only 8.9 percent of the conventional market. Combined, African-American
    and Hispanic borrowers constituted 29.5 percent of FHA loans, doubling
    the conventional market's rate of 14.3 percent. In fact, in 2004, FHA
    insured nearly as many purchase loans to African-American and Hispanic
    families as were purchased by Fannie Mae and Freddie Mac combined.
        The same data demonstrates FHA's tremendous service to those
    American families earning near or below the national median income.
    Over 57 percent of FHA borrowers earned less than $50,000, which is
    more than double the rate of the conventional market, where fewer than
    28 percent of borrowers earned less than $50,000.
        Ironically, as the above numbers reveal, FHA's mission to serve
    underserved populations has become increasingly focused during the same
    period as the decline in FHA's presence in the market. FHA's impact is
    being lost at the very time when it is needed most. The result is that
    American families are either turning to more expensive financing or
    giving up.
        It is crucial that FHA keep pace with changes in the U.S. mortgage
    markets. While FHA programs can be the best and most cost-effective way
    of expanding lending to underserved communities, we have yet to unleash
    the full potential of these programs to help this country achieve
    important societal goals.
        To be effective in the 21st century, FHA should be empowered to
    incorporate private sector efficiencies that allow it to develop
    products and programs to meet the needs of today's home buyers and
    anticipate the needs of tomorrow's mortgage markets, while at the same
    time being fully accountable for the results it achieves and the impact
    of its programs.
        Under the strong leadership of its current Commissioner, Brian
    Montgomery, FHA has undertaken significant changes to its regulations
    and operations in a very short time. In just 1 year, FHA has
    streamlined the insurance endorsement process, improved appraisal
    requirements, and removed some unnecessary regulations. By doing so,
    Commissioner Montgomery has also instilled a spirit of change and a
    bias for action within FHA.
        MBA compliments the Commissioner on his significant accomplishments
    to date, though we recognize that more work lies ahead. Lenders still
    report that FHA is difficult to work with and that oversight activities
    often focus on minor compliance deficiencies in a loan file rather than
    focusing on issues of true risk to FHA's insurance funds. FHA is
    designed to serve higher-risk borrowers and MBA believes that those
    auditing FHA lenders must understand this and be able to differentiate
    this aspect of the program from intentional abuse.
        MBA is confident in the Commissioner's ability to address these and
    other issues that are within his control. There is much though, that is
    beyond FHA's control and needs Congressional action.
    FHA Reform is Urgent
        MBA is concerned that while FHA is currently sound and under the
    strong leadership of Commissioner Montgomery, without imbuing FHA with
    the flexibility to adapt to 21st century mortgage markets, the health
    of FHA operations will be at risk in the future. While the annual audit
    of the MMIF has consistently found over the past 10 years that the fund
    is operating soundly and well in excess of capital ratios established
    by Congress, there have also been signs that statutory constraints are
    causing FHA to be adversely selected.
    Unleashing FHA's Potential
        In reviewing the status of FHA over the past decade, MBA has come
    to the conclusion that FHA faces severe challenges in managing its
    resources and programs in a quickly changing mortgage market. These
    challenges have already diminished FHA's ability to serve its public
    purposes and have also made it susceptible to fraud, waste, and abuse.
    Unaddressed, these issues will cause FHA to become less relevant, and
    will leave families served by its programs with no alternative for home
    ownership or affordable rental housing.
        In the Fall of 2004, MBA formed a FHA Empowerment Task Force
    comprising of MBA member companies experienced in originating single-
    family and multifamily FHA loans. The Task Force discussed the long-
    term issues confronting FHA with the goal of developing legislative
    proposals that would empower it to manage its programs and policies
    more effectively.
        The Task Force identified FHA's higher costs of originations,
    lessening prominence in the market, out-dated technology, adverse
    selection, and the inability to efficiently develop products as
    problems for FHA. Per the Task Force's recommendations, MBA proposed
    the following three steps to unleash FHA from overly burdensome
    statutory processes and restrictions, and to empower FHA to adopt
    important private sector efficiencies:
        1. FHA needs the ability to use a portion of the revenues generated
    by its operations to invest in the upgrade and maintenance of
    technology to adequately manage its portfolios and interface with
    lenders.
        2. FHA needs greater flexibility to recruit, manage, and compensate
    employees if it is to keep pace with a changing financial landscape and
    ensure appropriate staffing to the task of managing $450+ billion
    insurance funds.
        3. FHA needs greater autonomy to make changes to their programs and
    to develop new products that will better serve those who are not being
    adequately served by others in the mortgage market.
    Ability To Invest Revenues in Technology
        Technology's impact on U.S. mortgage markets over the past 15 years
    cannot be overstated. Technology has allowed the mortgage industry to
    lower the cost of home ownership, streamline the origination process,
    and has allowed more borrowers to qualify for financing. The creation
    of automated underwriting systems, sophisticated credit-score modeling,
    and business-to-business electronic commerce are but a few examples of
    technology's impact.
        FHA has been detrimentally slow to move from a paper-based process
    and it cannot electronically interface with its business customers in
    the same manner as the private sector. During 2004 and 2005, over 1.5
    million paper loan files were mailed back and forth between FHA and its
    approved lenders and manually reviewed during the endorsement process.
    Despite the fact that FHA published regulations in 1997 authorizing
    electronic endorsement of loans, FHA was not able to implement this
    regulation until this past January, 8 years after the fact. This delay
    occurred despite the fact that over the same 8 years, FHA's operations
    generated billions of dollars in excess of program costs that was
    transferred to the U.S. Treasury.
        MBA believes FHA cannot create and implement technological
    improvements because it lacks sufficient authority to use the revenues
    it generates to invest in technology.
        MBA proposes the creation of a separate fund specifically for FHA
    technology, funded by revenues generated by the operation of the MMIF.
    MBA suggests the establishment of a revenue and a capital ratio
    benchmark for FHA, wherein, if both are exceeded, FHA be authorized by
    Congress to use a portion of the excess revenue generated to invest in
    its technology. Such a mechanism would allow FHA to invest in
    technology upgrades, without requiring additional appropriations from
    Congress.
        Improvements to FHA's technology will allow it to improve
    management of its portfolio, garner efficiencies, and lower operational
    costs, which will allow it to reach farther down the risk spectrum to
    borrowers currently unable to achieve home ownership. MBA believes that
    such an investment would yield cost-savings to FHA operations far in
    excess of the dollar investment amount.
    Greater Control in Managing Human Resources
        FHA is restricted in its ability to effectively manage its human
    resources at a time when the sophistication of the U.S. mortgage
    markets demand market participants to be experienced, knowledgeable,
    flexible, and innovative. To fulfill its mission, FHA needs to be able
    to attract the best and brightest. Other Federal agencies, such as the
    Federal Deposit Insurance Corporation (FDIC), that interface with and
    oversee the financial services sector are given greater authority to
    manage and incentivize their human resources. MBA believes that FHA
    should have similar authority if it is to remain relevant in providing
    home ownership opportunities to those families underserved by the
    private markets.
        FHA should have more flexibility in its personnel structure than
    that which is provided under the regular Federal civil service rules.
    With greater freedom, FHA could operate more efficiently and
    effectively at a lower cost. Further, improvements to FHA's ability to
    manage its human capital will allow FHA to attract and manage the
    talent necessary to develop and implement the strategies that will
    provide opportunities for home ownership to underserved segments of the
    market.
    Flexibility To Create Products and Make Program Changes
        FHA programs are slow to adapt to changing needs within the
    mortgage markets. Whether it is small technical issues or larger
    program needs, it often takes many years and the expenditure of great
    resources to implement changes. This process overly burdens FHA from
    efficiently making changes that will serve home buyers and renters
    better and protect FHA's insurance funds.
        Today's mortgage markets require agencies that are empowered to
    implement changes quickly and to roll-out or test new programs to
    address underserved segments of the market.
        A prime example of this problem can be found in the recent
    experience of FHA in offering hybrid Adjustable-Rate Mortgage (ARM)
    products. A hybrid ARM is a mortgage product which offers borrowers a
    fixed-interest rate for a specified period of time, after which the
    rate adjusts periodically at a certain margin over an agreed upon
    index. Lenders are typically able to offer a lower initial interest
    rate on a 30-year hybrid ARM than on a 30-year fixed-rate mortgage.
    During the late 1990s, hybrid ARMs grew in popularity in the
    conventional market due to the fact that they offer borrowers a
    compromise between the lower rates associated with ARM products and the
    benefits of a fixed-rate period.
        In order for FHA to offer this product to the home buyers it
    serves, legislative approval was required. After several years of
    advocacy efforts, such approval was granted with the passage of Public
    Law 107-73 in November 2001. Unfortunately, this authority was not
    fully implemented until the Spring of 2005.
        The problem began when Public Law 107-73 included an interest-rate
    cap structure for the 5/1 hybrid ARMs that was not viable in the
    marketplace. The 5/1 hybrid ARM has been the most popular hybrid ARM in
    the conventional market. As FHA began the rulemaking process for
    implementing the new program, they had no choice but to issue a
    proposed rule for comment with a 5/1 cap structure as dictated in
    legislation. By the time MBA submitted its comment letter on the
    proposed rule to FHA, we had already supported efforts within Congress
    to have legislation introduced that would amend the statute to change
    the cap structure. MBA's comments urged that, if passed prior to final
    rulemaking, the 5/1 cap fix be included in the final rule.
        On December 16, 2003, Public Law 108-186 was signed into law
    amending the hybrid ARM statutes to make the required technical fix to
    the interest rate cap structure affecting the 5/1 hybrid ARM product.
    At this point, FHA was ready to publish a final rule. Regardless of the
    passage of Public Law 108-186, FHA was forced to go through additional
    rulemaking in order to incorporate the fix into regulation. Thus on
    March 10, 2004, FHA issued a Final Rule authorizing the hybrid ARM
    program, with a cap structure that made FHA's 5/1 hybrid ARM unworkable
    in the marketplace. It was not until March 29, 2005 that FHA was able
    to complete rulemaking on the amendment and implement the new cap
    structure for the 5/1 hybrid ARM product.
        The hybrid ARM story demonstrates well the statutory straitjacket
    under which the FHA operates. A 4 to 6 year lag in introducing program
    changes is simply unacceptable in today's market. Each year that a new
    program is delayed or a rule is held-up, means that families who could
    otherwise be served by the program are prevented from realizing the
    dream of home ownership or securing affordable rental housing. MBA
    believes the above three changes will allow FHA to become an
    organization that can effectively manage risk and self-adapt to
    shifting mortgage market conditions while meeting the housing needs of
    those families who continue to be unserved or underserved today.
    Legislative Activity
        MBA is supportive of much of the legislation that is currently
    before Congress, and I would like to take a moment to offer our
    perspective on various provisions.
        On April 4, 2005, Representatives Bob Ney and Maxine Waters
    introduced the Expanding American Home Ownership Act of 2006, H.R.
    5121. This bi-partisan bill, which has over 67 co-sponsors, marks the
    first time FHA is being looked at by Congress in a comprehensive way in
    over 10 years.
        In general, H.R. 5121 significantly streamlines and modernizes the
    National Housing Act and seeks to unleash FHA from a 74 year-old
    statutory regime that constricts its effectiveness. Among other things,
    H.R. 5121 would provide for flexible downpayments, flexible risk-based
    premiums, an increase in mortgage limits, an extension of mortgage
    terms, reform of FHA's condominium program, and changes to the Home
    Equity Conversion Mortgage (HECM) program.
        MBA would note that the Congressional Budget Office (CBO) has
    recently reported that H.R. 5121 would generate $247 million in
    revenues for the U.S. Treasury in 2007 and $2.3 billion in revenues
    during fiscal years 2007-2011. This report makes it obvious that the
    reforms proposed in H.R. 5121 are not only beneficial to FHA and to the
    home buyers it serves, but it is beneficial to the U.S. government's
    bottom line.
        More importantly to this Subcommittee is legislation that has been
    discussed or introduced in the Senate. Currently, MBA is aware of three
    bills that affect FHA that have been introduced and one that may be
    introduced. MBA would like to briefly comment on each one.
        MBA would like to review a number of provisions that we understand
    may be part of legislation introduced in the Senate as a companion bill
    to H.R. 5121.
    Downpayment Requirements
        MBA supports the elimination of the complicated formula for
    determining the downpayment that is currently detailed in the statute.
    The calculation is outdated and unnecessarily complex. The calculation
    of the downpayment alone is often cited by loan officers as a reason
    for not offering the FHA product. MBA supports the elimination of the
    statutory requirement that the borrower provide a minimum cash
    investment. Improving FHA's products with such downpayment flexibility
    is one of the most important innovations FHA can be empowered to make.
    Independent studies have demonstrated two important facts: first, the
    downpayment is one of the primary obstacles for first-time home buyers,
    minorities, and low- and moderate-income home buyers. Second, the
    downpayment itself, in many cases, is not as important a factor in
    determining risk as are other factors.
        The private market has already demonstrated that the downpayment
    can be replaced with other risk-mitigating features without
    significantly hurting performance. Many borrowers will be in a better
    financial position if they keep the funds they would have expended for
    the downpayment as a cash reserve for unexpected home ownership costs
    or life events.
        We believe that FHA should be empowered to establish policies that
    would allow borrowers to qualify for FHA insurance with flexible
    downpayment requirements and decide the amount of the cash investment
    they would like to make in purchasing a home.
    Adjusting Mortgage Insurance Premiums for Loan Level Risk
        MBA believes that FHA would be able to serve more borrowers, and do
    so with lower risk to the MMIF, if they are able to adjust premiums
    based on the risk of each mortgage they insure. A flexible premium
    structure could also give borrowers greater choice in how they utilize
    the FHA program.
        It is a fact that some borrowers and loans will pose a greater risk
    to FHA than others. At some level, FHA should have the authority to
    adjust premiums based upon some borrower or loan factors that add risk.
    Such adjustment for risk need not be a complicated formula. MBA
    believes FHA could significantly mitigate the risk to the MMIF by
    selecting a small number of risk factors that would cause an adjustment
    from a base mortgage insurance premium (MIP).
        A current example of this would be the fact that borrowers
    receiving a gift of the downpayment on a FHA-insured mortgage is
    charged the same premium as a borrower who puts down 3 percent of their
    own funds, despite the fact that the former represents a higher risk
    loan. FHA could better address such a risk in the MMIF by charging a
    higher MIP to offset some of the additional risk that such a borrower
    poses. In this manner, while a borrower receiving a gift of funds for
    the downpayment will still receive the benefits of FHA financing, they
    themselves would share some of the risk, rather than having the risk
    born solely by those making a 3 percent downpayment.
        Creating a risk-based premium structure will only be beneficial to
    consumers, though, if FHA considers lowering of current premiums to
    less risky loans. We would not support simply raising current premiums
    for higher-risk borrowers.
        In December 2004, FHA eliminated the practice of refunding the
    unearned portion of the Up-front Mortgage Insurance Premium (UfMIP) to
    borrowers who prepay their FHA-insured mortgage early and go to another
    product. MBA was hopeful that the removal of the refund (which
    admittedly was an administrative cost for FHA and servicers) would have
    been followed by a correlated lowering of the UfMIP. This did not
    happen. The net effect was to actually raise the cost of the FHA
    program. MBA would not want to see the same thing happen under a risk-
    based premium structure.
    Raising Maximum Mortgage Limits for High-Cost Areas
        MBA supports the proposal to raise FHA's maximum mortgage limits to
    100 percent of an area's median home price (currently pegged at 95
    percent) and to raise the ceiling to 100 percent of the conforming loan
    limit (currently limited to 87 percent) and the floor to 65 percent
    (currently 48 percent).
        There is a strong need for FHA financing to be relevant in areas
    with high home prices. MBA believes raising the limits to conforming
    limits in these areas strikes a good balance between allowing FHA to
    serve a greater number of borrowers without taking on additional risk.
    The CBO scored this provision in H.R. 5121 as a net revenue generator
    for the Treasury, indicating that it will improve FHA's performance.
        Additionally, in many low-cost areas, FHA's loan limits are not
    sufficient to cover the costs of new construction. New construction
    targeted to first-time home buyers has historically been a part of the
    market in which FHA has had a large presence. MBA believes raising the
    floor will improve the ability of first-time home buyers to purchase
    modest newly constructed homes in low-cost areas since they will be
    able to use FHA-insured financing.
    Lengthening Mortgage Term
        MBA supports authorizing FHA to develop products with mortgage
    terms up to 40 years. Currently, FHA is generally limited to products
    with terms of no more than 30 years. Stretching out the term will lower
    the monthly mortgage payment and allow more borrowers to qualify for a
    loan while remaining in a product that continues to amortize. We
    believe FHA should have the ability to test products with these
    features, and then, based on performance and home buyer needs, to
    improve or remove such a product.
    Improvements to FHA Condominium Financing
        MBA supports changes to FHA's condominium program that will
    streamline the process for obtaining project approval and allow for
    greater use of this program. It is unfortunate to note that FHA
    insurance on condominium units has dropped at a higher rate than the
    overall decline in FHA's originations. This decline contradicts the
    fact that in costly markets, condominium units are typically the
    primary type of housing for first-time home buyers. FHA should have a
    much bigger presence in the condominium market.
    Improvements to the Reverse Mortgage Program
        MBA unequivocally supports all of the following proposed changes to
    FHA's Home Equity Conversion Mortgage (HECM) program: the removal of
    the current 250,000 loan cap, the authorization of HECMs for home
    purchase and on properties less than 1-year old, and the creation of a
    single, national loan limit for the HECM program.
        The HECM program has proven itself to be an important financing
    product for this country's senior homeowners, allowing them to access
    the equity in their homes without having to worry about making mortgage
    payments until they move out. The program has allowed tens of thousands
    of senior homeowners to pay for items that have given them greater
    freedom, such as improvements to their homes that have allowed them to
    age in place, or to meet monthly living expenses without having to move
    out of the family home.
        MBA believes it is time to remove the program's cap because the cap
    threatens to limit the HECM program at a time when more and more
    seniors are turning to reverse mortgages as a means to provide
    necessary funds for their daily lives. MBA further believes that the
    HECM program has earned the right to be on par with other FHA programs
    that are subject only to FHA's overall insurance fund caps.
    Additionally, removing the program cap will serve to lower costs as
    more lenders will be encouraged to enter the reverse mortgage market.
        Additionally, authorizing the HECM program for home purchase will
    improve housing options for seniors. In a HECM for purchase
    transaction, a senior homeowner might sell a property they own to move
    to be near family. The proceeds of the sale could be combined with a
    reverse mortgage, originated at closing and paid in a lump sum, to
    allow a senior to purchase the home without the future responsibility
    of monthly mortgage payments. Alternatively, a senior homeowner may
    wish to take out a reverse mortgage on a property that is less than 1-
    year old, defined as ``new construction'' by FHA.
        Finally, the HECM program should have a single, national loan limit
    equal to the conforming loan limit. Currently, the HECM program is
    subject to the same county-by-county loan limits as FHA's forward
    programs. HECM borrowers are disadvantaged under this system because
    they are not able to access the full value of the equity they have
    built up over the years by making their mortgage payments. A senior
    homeowner living in a high-cost area will be able to access more equity
    than a senior living in a lower-cost area, despite the fact that their
    homes may be worth the same and they have the same amount of equity
    built up. Reverse mortgages are different than forward mortgages and
    the reasons for loan limits are different, too. FHA needs the
    flexibility to implement different policies, especially concerning loan
    limits.
        In addition to the above proposed legislation, MBA is aware of
    three pieces of legislation which have been introduced in the Senate
    that would positively affect FHA. These are S. 2123 the ``FHA
    Manufactured Housing Loan Modernization Act of 2005,'' S. 2597 ``The
    Federal Housing Fairness Act of 2006,'' and S. 3173 the ``21st Century
    Housing Act.'' MBA would like to highlight each of these bills.
    The FHA Manufactured Housing Loan Modernization Act of 2005--S. 2123
        On December 16, 2005, Senator Allard (R-CO) introduced S. 2123, the
    FHA Manufactured Housing Loan Modernization Act of 2005. The proposals
    outlined in S. 2123 would help make FHA a leader in promoting sound
    financing of manufactured housing. MBA understands that the provisions
    of S. 2123 will be included in the proposed Senate companion
    legislation to H.R. 5121.
        MBA supports revitalizing FHA's Title I manufactured housing
    mortgage insurance program. Manufactured housing is an important source
    of affordable housing but FHA's current program to insure mortgages of
    manufactured housing needs to be updated in order to be relevant to
    this market.
    The Federal Housing Fairness Act of 2006--S. 2597
        On April 7, 2006, Senator Hillary Clinton (D-NY) introduced S. 2597
    ``The Federal Housing Fairness Act of 2006.'' MBA strongly supports S.
    2597, which would facilitate home ownership in high-cost areas.
        The sole provision of this bill would amend the National Housing
    Act by raising FHA loan limits to 100 percent of an area's median home
    price, not to exceed the conforming loan limit. Currently, FHA loan
    limits are set at 95 percent of an area's median home price not to
    exceed 87 percent of the conforming loan limit.
    21st Century Housing Act--S. 3173
        On May 25, 2006, Senator Clinton introduced S. 3173, the ``21st
    Century Housing Act.'' MBA supports S. 3173 which has a number of
    provisions that would significantly modernize FHA and its programs. The
    bill contains the following positive provisions:
    Investment in FHA Infrastructure--Human Resources
        MBA supports authorizing the Secretary of HUD to appoint and fix
    the compensation of FHA employees and officers. The bill calls on the
    Secretary to consult with, and maintain comparability with, the
    compensation of officers and employees of the Federal Deposit Insurance
    Corporation. This provision can be carried out by excess revenue
    derived from the operation of FHA's insurance funds, beyond that which
    was estimated in the Federal budget for any given year.
        While MBA has some questions as to the funding mechanism detailed
    in the bill for this provision, we firmly believe that giving FHA
    greater flexibility in investing in its human capital is critical if it
    is to attract and retain the talent it needs to become a stronger and
    more effective program serving the needs of our nation's homeowners and
    renters.
    Investment in FHA Infrastructure--Information Technology
        MBA strongly supports this provision of S. 3173, which would fund
    investment in FHA's information technology. This provision contemplates
    that excess funding derived from the operation of FHA's insurance
    funds, beyond that which was estimated in the Federal budget for any
    given year, would be used to carry out this provision.
        While MBA has some questions as to the funding mechanism detailed
    in the bill for this provision MBA believes that upgrading FHA's
    technology is critical to improving FHA's management of its portfolio
    and lowering its operational costs. MBA also believes that such an
    investment will allow FHA to reach farther down the risk spectrum to
    borrowers currently unable to achieve home ownership.
    Extension of Mortgage Term Authority
        MBA supports an extension of FHA's mortgage term authority. S. 3173
    would amend the National Housing Act by extending FHA's mortgage term
    authority to 50 years. MBA believes this flexibility would allow FHA to
    develop products that lower monthly costs and make home ownership a
    more viable option for many families.
    Downpayment Flexibility
        Since the downpayment is one of the primary obstacles for first-
    time home buyers, minorities, and low- and moderate-income home buyers,
    MBA supports this provision that would allow for flexible downpayments.
    In many cases, the downpayment itself is not as important a factor in
    determining risk as are other factors, such as credit scores.
        MBA believes that a flexible downpayment will allow borrowers to
    have a cash reserve that may be necessary for the upkeep and
    maintenance of their homes, as well as for other unforeseen life
    events.
    Mortgage Insurance Flexibility
        S. 3173 would allow the Secretary of HUD to establish the cost of a
    mortgage insurance premium payment, based on factors determined by the
    Secretary and commensurate with the likelihood of default of the
    borrower.
        MBA supports this provision, as we recognize that FHA may be able
    to serve more borrowers and do so with lower risk if they are able to
    adjust premiums based on the risk of each mortgage it insures.
    Increasing Maximum Mortgage Limits for Multifamily Housing in High Cost
            Areas
        MBA supports the provision in S. 3173 that would increase loan
    limits from 140 percent to 170 percent of the basic statutory limits in
    high-cost areas, and from 170 percent to 215 percent of the basic
    statutory limits to allow for higher than typical costs for individual
    projects. MBA recognizes that home ownership is not necessarily
    appropriate for every American, and it is important that there are
    affordable rental housing options as well as adequate healthcare
    facilities in communities.
    Multifamily concerns
        Additionally, I must voice MBA's strong opposition to the proposal
    in the Administration's budget to increase the insurance premiums on
    multifamily projects far above that necessary to operate a financially
    sound program. The net effect of this proposal will be to cause many
    affordable rental properties not to be built or rehabilitated and to
    raise rents on those families and elderly households on the projects
    that still go through.
        There is no rationale for this fee increase except to generate
    additional revenue for the Federal Government as these programs are
    already priced to cover their costs. We urge the committee to prohibit
    FHA from implementing this fee increase.
    Conclusion
        FHA's presence in the single-family marketplace is smaller than it
    has been in the past and its impact is diminishing. Many MBA members,
    who have been traditionally strong FHA lenders, have seen their
    production of FHA loans drop significantly. This belies the fact that
    FHA's purposes are still relevant and its potential to help borrowers
    is still necessary.
        I would like to conclude my testimony highlighting two issues which
    make passing FHA legislation particularly urgent this year.
        First, hurricane season is upon us. The disasters of Hurricanes
    Katrina and Rita point to the need for a financially solvent FHA that
    is not restricted by onerous processes and procedures. The FHA program
    must be ready to assist homeowners and renters who lost everything amid
    the destruction of the hurricanes. It must have the necessary
    wherewithal to step in and help work out the existing mortgages in
    disaster areas. FHA must have the programs necessary to meaningfully
    assist in the rebuilding effort. Giving FHA the mechanisms to fund
    adequate technology improvements, flexibilities in managing human
    resources, and greater authority to introduce products will ensure FHA
    can step in to help communities when disasters occur.
        Second, without Congressional action this year, many families face
    a serious risk of being unable to access FHA financing due to a recent
    ruling passed down by the Internal Revenue Service (IRS). On May 4,
    2006, the IRS released Revenue Ruling 2006-27, which will likely lead
    the IRS to rescind the nonprofit status of a large number of nonprofits
    who receive funding from property sellers in providing downpayment
    assistance to FHA borrowers. FHA regulations require that nonprofits
    providing a downpayment gift have an IRS nonprofit exempt status. Due
    to the ruling, the IRS has indicated that it is investigating 185
    organizations which provide downpayment assistance.
        MBA expects this ruling to have a dramatic effect on FHA's purchase
    production. Currently, more than one-third of FHA purchase loans have
    the type of downpayment assistance that will be affected by the IRS
    ruling. Such programs currently serve tens of thousands of FHA's
    primary clientele: first-time home buyers, low- and moderate-income
    families and minorities.
        MBA does not dispute the ruling by the IRS but we are concerned
    about the families that will find affordable financing unavailable to
    them and implore Congress to give FHA the authority to serve these
    families through a flexible downpayment program this year.
        MBA has taken great efforts to inform our membership about the
    impact of the IRS ruling, and the responses of our members have been
    strong. Mortgage lenders want to be able to serve these families
    directly with an FHA product that allows for flexible downpayments. On
    May 15, 2006, MBA, along with nine other trade associations, sent a
    coalition letter to members of the House, urging them to co-sponsor
    H.R. 5121. We have heard that over 12,000 mortgage industry
    professionals contacted their representatives during May urging them to
    support H.R. 5121. Clearly, Congressional action on FHA reform this
    year is vital.
        On behalf of MBA, I would like to thank the Subcommittee for the
    opportunity to present MBA's views on the important programs offered by
    FHA. MBA looks forward to working with Congress and HUD to improve
    FHA's ability to serve aspiring homeowners and those seeking affordable
    rental housing.
                                     ______

                       PREPARED STATEMENT OF TOM STEVENS
                  President, National Association of Realtors
                                 June 20, 2006
         Senator Allard, Senator Reed and the Members of the Subcommittee,
    My name is Tom Stevens, and I am the former President of Coldwell
    Banker Stevens (now known as Coldwell Banker Residential Brokerage Mid-
    Atlantic)--a full-service realty firm specializing in residential sales
    and brokerage. Since 2004, I have served as Senior Vice President for
    NRT Inc., the largest residential real estate brokerage company in the
    nation.
         As the 2006 President of the National Association of REALTORS, I
    am here to testify on behalf of our nearly 1.3 million REALTOR
    members. We thank you for the opportunity to present our view of the
    FHA program and the need for reform. NAR represents a wide variety of
    housing industry professionals committed to the development and
    preservation of the nation's housing stock and making it available to
    the widest range of potential home buyers. The Association has a long
    tradition of support for innovative and effective Federal housing
    programs and we work diligently with the Subcommittee and the Congress
    to fashion housing policies that ensure Federal housing programs meet
    their mission responsibly and efficiently.
        FHA's single-family mortgage insurance program is a valuable
    government program that has proved highly beneficial in helping low-,
    moderate-, and middle-income people achieve the dream of home
    ownership. FHA insurance is available to individuals regardless of
    their racial, ethnic, or social characteristics and its universal
    availability helps stabilize housing markets when private mortgage
    insurance is nonexistent or regional economies encounter disruptions.
    FHA's underwriting standards are more flexible than the conventional
    market, allowing more borrowers to qualify for mortgages. We believe
    that the FHA program can be empowered with tools to close the minority
    home ownership gap and provide home buyers with alternatives to risky
    loan products currently being provided by the conventional and subprime
    markets.
         FHA was established in 1934 to provide an alternative to home
    buyers. At that time in our history short-term, interest-only and
    balloon loans were prevalent. FHA was created to provide long-term,
    fixed-rate financing. These same conditions exist today, warranting the
    continued existence and viability of FHA.
         FHA's market share has dwindled because its loan limits,
    inflexible downpayment requirement, and fee structure have not kept
    pace with the current mortgage marketplace. As a result, a growing
    number of home buyers are deciding to use one of several new types of
    specialty mortgages that let them ``stretch'' their income so they can
    qualify for a larger loan. Specialty mortgages often begin with a low
    introductory interest rate or payment plan a ``teaser''--but the
    monthly mortgage payments are likely to increase significantly in the
    future. Some are ``low documentation'' mortgages that provide easier
    standards for qualifying, but also feature higher interest rates or
    higher fees. Mortgages such as interest-only and option ARMs can often
    be risky propositions to borrowers. These pose severe risk burdens to
    consumers who may be unable to afford the mortgage payment in the
    future because monthly payments may increase by as much as 50 percent
    or more when the introductory period ends, or cause their loan balance
    (the amount you still owe) to get larger each month instead of smaller.
    According to Moody's, more than a quarter of all existing mortgages
    come up for interest-rate resets in 2006 and 2007.\1\ While some
    borrowers may be able to make the new higher payments, many will find
    it difficult, if not impossible.
    ---------------------------------------------------------------------------
        \1\ ``Millions are Facing Monthly Squeeze on House Payments,'' Wall
    Street Journal, March 11, 2006, page 1.
    ---------------------------------------------------------------------------
         For many of these potential home buyers, FHA can play a major role
    in meeting their home ownership aspirations without adverse
    consequences. FHA typically serves borrowers who have lower annual
    incomes, make smaller downpayments, and purchase less expensive homes.
    However, FHA's market share has been dropping in recent years. In the
    1990s FHA loans were about 12 percent of the market. Today, that rate
    is closer to 3 percent. As the market has changed, FHA must also change
    to reflect consumer needs and demands. Conventional and subprime
    lenders have been expanding their products and offering more types of
    loans to more types of borrowers. However, not all of these loans are
    in the best interest of the borrower. If FHA is enhanced to conform to
    today's mortgage environment, many borrowers would have available to
    them a viable alternative to the riskier products that are marketed to
    them.
         In recent years the subprime mortgage market has exploded. In
    2003, subprime loans accounted for 8.5 percent of the market. In 2005,
    their share was 20 percent. Subprime loans are not inherently bad. The
    subprime market has a very important role to play for many borrowers.
    Subprime loans allow many home buyers who could not otherwise get into
    a home achieve the dream of home ownership. But, as FHA has declined to
    be a player in the mortgage market, more and more borrowers have taken
    out subprime loans, when they would have qualified for FHA at a lower
    overall cost. In the first quarter of this year, FHA lost almost 38
    percent of its market share, the conventional market lost almost 10
    percent, while the subprime market gained nearly 16 percent. American
    home buyers need to have affordable alternatives, such as FHA available
    to them.
         While the home ownership rate continues to rise, there are still
    many hard-working families that simply cannot qualify for a
    conventional mortgage. Minority home ownership rates are significantly
    lower than the national average--around 50 percent, compared with
    nearly 70 percent for the Nation as a whole. The home ownership rate
    for African-American households in the first quarter of 2005 was 48.8
    percent, while Hispanic households were at 49.7 percent. The home
    ownership rate for Asian, Native Americans, and Pacific Islanders was
    59.4 percent. By comparison, 76.0 percent of non-Hispanic whites were
    homeowners.
         Recently the Center for Responsible Lending released a study \2\
    that demonstrated that minorities are 30 percent more likely to receive
    a higher-priced loan than white borrowers, even after accounting for
    risk. African-Americans were more likely to receive higher-rate home
    purchase and refinance loans than similarly situated white borrowers,
    particularly for loans with prepayment penalties. For Latinos it was
    even worse. According to the study, Latinos were 29 to 142 percent more
    likely to receive a higher-cost loan than whites of similar risk.
    ---------------------------------------------------------------------------
        \2\ Unfair Lending: The Effect of Race and Ethnicity on the Price
    of Subprime Mortgages, Center for Responsible Lending, May 31, 2006.
    ---------------------------------------------------------------------------
         A study by the National Community Reinvestment Coalition \3\ found
    similar results. Its study found that of all the conventional loans
    made to African-Americans, 54.5 percent were high-cost loans, while
    only 23.3 percent of whites had high-cost loans. FHA insurance is
    available to individuals regardless of their racial, ethnic or social
    characteristics. Nearly 30 percent of FHA's market is minority home
    buyers, compared to only 17 percent of the conventional market.
    ---------------------------------------------------------------------------
        \3\ The 2005 Fair Lending Disparities: Stubborn and Persistent II,
    National Community Reinvestment Coalition, May 23, 2006.
    ---------------------------------------------------------------------------
        Finally, a report by the Consumer Federation of America \4\
    determined that African-American and Latinos are more likely to obtain
    payment option mortgages. Latinos were twice as likely to obtain
    payment option mortgages as non-Latinos and African-Americans were 30
    percent more likely to obtain payment option mortgages than non-
    African-Americans. With regard to borrower income levels, CFA
    discovered that 37 percent of interest only borrowers and 35 percent of
    option payment borrowers had incomes below $70,000. If revitalized, FHA
    can help bridge the gap in minority home ownership and provide
    alternative options that help fight against predatory or discriminatory
    loans.
    ---------------------------------------------------------------------------
        \4\ Exotic or Toxic? An Examination of the Non-traditional Mortgage
    Market for Consumers and Lenders, Consumer Federation of America, May,
    2006.
    ---------------------------------------------------------------------------
         To enhance FHA's viability, the Administration is proposing a
    number of important reforms to the FHA single-family insurance program
    that will greatly benefit home buyers nationwide. FHA is proposing to
    eliminate the statutory 3 percent minimum cash investment and
    downpayment calculation, allow for extended loan terms from 30 to 40
    years, allowing FHA flexibility to provide risk-based pricing, move the
    condo program into the 203(b) fund, and increase the loan limits. The
    National Association of REALTORS strongly supports these reform
    provisions.
         The ability to afford the downpayment and settlement costs
    associated with buying a home remains the most challenging hurdle for
    many home buyers. Eliminating the statutory 3-percent minimum
    downpayment will provide FHA flexibility to offer varying downpayment
    terms to different borrowers. Although housing remains strong in our
    nation's economy and has helped to increase our nation's home ownership
    rate to a record 69 percent, many deserving American families continue
    to face obstacles in their quest for the American dream of owning a
    home. Providing flexible downpayment products for FHA will go a long
    way to addressing this problem.
         In 2005, 43 percent of first-time home buyers financed 100 percent
    of their homes. NAR research indicates that if FHA were allowed to
    offer this option, 1.6 million families could benefit. According to
    NAR's Profile of Home buyers, 55 percent of home buyers who financed
    with a zero-downpayment loan in 2005, had incomes less than $65,000; 24
    percent of those who used a zero-downpayment product were minorities;
    and 52 percent of people who financed 100 percent of their home
    purchased homes priced at less than $150,000.
         FHA has allowed borrowers to receive their downpayment assistance
    through an approved gifting source. However, the IRS recently ruled
    that many seller-funded downpayment programs would lose their
    charitable tax status, making them ineligible for FHA usage. It has
    been estimated that 29 percent of FHA borrowers in 2005 used seller-
    funded downpayment assistance. Studies done by Government
    Accountability Office and others determined that this form of
    downpayment assistance in fact drove up the costs of home ownership,
    and generally made the loan a bigger risk. Instead, by providing FHA
    the ability to offer flexible downpayments, homeowners won't bear this
    increased cost, and, along with the flexibly pricing proposal, FHA
    could price such a product according to risk, as is done in the
    conventional market.
         FHA mortgages are used most often by first-time home buyers,
    minority buyers, low- and moderate-income buyers, and other buyers who
    cannot qualify for conventional mortgages because they are unable to
    meet the lender's stringent underwriting standards. Despite its
    successes as a home ownership tool, FHA is not a useful product in
    high-cost areas of the country because its maximum mortgage limits have
    lagged far behind the median home price in many communities. As a
    result, working families such as teachers, police officers and
    firefighters are unable to buy a home in the communities where they
    work.
         Under the Administration's proposal, FHA's limits for single unit
    homes in high-cost areas would increase from $362,790 to the 2006
    conforming loan limit of $417,000. Research conducted by the National
    Association of REALTORS indicates that this will result in 28 percent
    more FHA originations in California and 19 percent more originations in
    Massachusetts.
         In non-high-cost areas, the FHA limit (floor) would increase from
    $200,160 to $271,050 for single unit homes. This increase will enhance
    FHA's ability to assist home buyers in areas not defined as high-cost,
    but where home prices still exceed the current maximum of $200,160.
    This includes the states of Arizona, Colorado, Florida, Georgia,
    Illinois, Maine, Minnesota, Nevada, North Carolina, Ohio, Oregon,
    Pennsylvania, Utah, Vermont, and Washington. While none of these states
    is generally considered ``high cost'', all have median home prices
    higher than the current FHA loan limit.
         Another key component of the Administration's proposal is to
    provide FHA with the ability to charge borrowers different premiums
    based on differing credit scores and payment histories. Risk-based
    pricing of the interest rate and fees and/or mortgage insurance is used
    in the conventional and subprime markets to manage risk and
    appropriately price products based on an individual's financial
    circumstances. Currently, all FHA borrowers, regardless of risk, pay
    virtually the same premiums and receive the same interest rate.
         The legislation will allow FHA to differentiate premiums based on
    the risk of the product (e.g., amount of cash investment) and the
    credit profile of the borrower. These changes will enable FHA to offer
    all borrowers choices in the type of premium charged (e.g., annual,
    upfront, or a hybrid that includes both an upfront and annual premium
    structure) and will permit FHA to reach higher-risk borrowers (by
    charging them a premium amount commensurate with risk), and continue to
    accommodate the better credit risks, by charging them less. FHA
    financing, with risk-based premium pricing, will still be a much better
    deal for borrowers with higher risk characteristics than is currently
    available in the ``near prime'' or subprime markets. Risk-based pricing
    makes total sense to the private market, and should for FHA as well.
         It is also important to note that, while FHA has had the authority
    to charge premiums up to 2.25 percent, they have not done so. FHA
    currently charges 1.5 percent. The FHA Fund is strong and has continued
    to have excess revenue, so there has not been a need to increase the
    premiums. Opponents argue that FHA is seeking to increase premiums to
    make money, gouging lower-income borrowers. Giving FHA the flexibility
    to charge different borrowers different premiums based on risk will
    simply allow FHA to increase their pool of borrowers. If FHA is also
    given authority to provide lower downpayment mortgages, premium levels
    will need to reflect the added risk of such loans (as is done in the
    private market) to protect the FHA fund.
         The Administration also proposes to combine all single-family
    programs into the Mutual Mortgage Insurance (MMI) Fund. The FHA program
    has four funds with which it insures its mortgages. The MMI Fund is the
    principal funding account that insures traditional 203(b) single-family
    mortgages. The Fund receives upfront and annual premiums collected from
    borrowers as well as net proceeds from the sale of foreclosed homes. It
    is self-sufficient and has not required taxpayer bailouts.
        For accounting purposes, the MMI Fund is linked with the
    Cooperative Management Housing Insurance Fund (CMHI). The CMHI finances
    the Cooperative Housing Insurance program (Section 213) which provides
    mortgage insurance for cooperative housing projects of more than five
    units that are occupied by members of a cooperative housing
    corporation. FHA also operates Special Risk Insurance (SRI) and General
    Insurance (GI) Funds, insuring loans used for the development,
    construction, rehabilitation, purchase, and refinancing of multifamily
    housing and healthcare facilities as well as loans for disaster
    victims, cooperatives and seniors housing.
        Currently, the FHA condominium loan guarantee program and 203(k)
    purchase/rehabilitation loan guarantee program are operated under the
    GI/SRI Fund. NAR strongly supports inclusion of these programs in the
    MMIF. In recent years programs operating under the GI/SRI funds have
    experienced disruptions and suspensions due to funding commitment
    limitations. Because the multifamily housing programs are under the GI/
    SRI funds and thus susceptible to future funding expirations,
    maintaining the single-family programs under the GI/SRI funds would
    expose these programs to possible future disruptions. Thus, from an
    accounting standpoint, it makes sound business sense to place all the
    single-family programs under the MMIF.
        Besides combining the 203(k) and condominium programs under the
    MMIF, NAR also recommends key enhancements to increase the programs'
    appeal and viability. Specifically, NAR recommends that HUD be directed
    to restore investor participation in the 203(k) program. In blighted
    areas, homeowners are often wary of the burdens associated with buying
    and rehabilitating a home themselves. However, investors are often
    better equipped and prepared to handle the responsibilities related to
    renovating and repairing homes. Investors can be very helpful in
    revitalizing areas where homeowners are nervous about taking on such a
    project.
         We also recommend that HUD lift the current owner-occupied
    requirement of 51 percent before individual condominium units can
    qualify for FHA-insured
    mortgages. The policy is too restrictive because it limits sales and
    home ownership opportunities, particularly in market areas comprised of
    significant condominium developments and first-time home buyers. In
    addition, the inspection requirements on condominiums are burdensome.
    HUD has indicated that it would provide more flexibility to the condo
    program under the MMIF. We strongly support loosening restrictions on
    FHA condo sales and 203(k) loans to provide more housing opportunities
    to home buyers nationwide.
         In today's market, interest rates are low, home prices are rising,
    and lenders have expanded their pool of tools to offer borrowers. But
    will these options still be available during periods of economic
    uncertainty? FHA has been there for borrowers. When the housing market
    was in turmoil during the 1980s, FHA continued to insure loans when
    other left the market. Following Hurricanes Katrina and Rita, FHA
    provided a foreclosure moratorium for borrowers who were unable to pay
    their mortgages while they recover from the disaster.
         The universal and consistent availability of FHA is the principal
    hallmark of the program that has made mortgage insurance available to
    individuals regardless of their racial, ethnic, or social
    characteristics during periods of economic prosperity and economic
    depression. FHA's universal availability helps stabilize housing
    markets when private mortgage insurance is nonexistent or regional
    economies encounter disruptions. FHA is the only national mortgage
    insurance program that provides financing to all markets at all times.
         FHA also works to protect borrowers against foreclosure. FHA
    provides financial incentives to lenders who use HUD's loss mitigation
    program to help homeowners keep their homes. FHA's loss mitigation
    program authorizes lenders to assist borrowers in default and reduce
    losses to the FHA fund. These programs include mortgage modification
    and partial claim. Mortgage modification allows borrowers to change the
    terms of their mortgage so that they can afford to stay in the home.
    Changes include extension of the length of the mortgage or changes in
    the interest rate. Under the partial claim program, FHA lends the
    borrower money to cure the loan default. This no-interest loan is not
    due until the property is sold or paid off. In the year 2004 alone,
    more than 78,000 borrowers were able to retain their home through FHA's
    loss mitigation program.
         The NATIONAL ASSOCIATION OF REALTORS recognizes that home
    ownership is a primary goal of American families. Housing has always
    been and continues to be one of the highest personal and social
    priorities in America with study after study affirming that a large
    proportion of Americans would rather own than rent a home. Home
    ownership directly benefits society by fostering pride and
    participation in one's community, encouraging savings, and promoting
    social and political stability. Home ownership has been emulated on
    television, romanticized in literature, and coveted in the popular
    social consciousness. It is advocated by private enterprise and
    encouraged by government policy. Clearly, it is the proud achievement
    of most American families, the ultimate assimilation for generations of
    immigrants to this country, and the pinnacle for Americans generally as
    they climb the ladder of economic success.
         The NATIONAL ASSOCIATION OF REALTORS applauds the private sector
    for the recent development of innovative and affordable housing
    products that are providing housing opportunities for many deserving
    families. However, not all needs are being met, and some homeowners may
    not be in a loan that is appropriate for them. Consequently, the
    NATIONAL ASSOCIATION OF REALTORS steadfastly maintains that government
    mortgage programs in general and the FHA in particular represent the
    most important source of home ownership for many American families. FHA
    is currently a lender of last resort. Without reforms to the program,
    first-time home buyers, minorities, and home buyers with less than
    perfect credit are left with fewer and fewer safe, affordable options.
    FHA is a safe product at a fair price. We need reforms to the program
    that make FHA a viable mortgage product for today's home buyers. We
    urge you to seriously consider these reforms to the FHA single-family
    home loan guarantee program to ensure all homeowners are afforded the
    true dream of home ownership.
         In conclusion, the National Association of REALTORS commends you,
    Ranking Member Reed, Chairman Allard, and the Subcommittee for its
    leadership in fashioning housing policies that stimulate housing
    opportunities for deserving families. The NAR stands ready to work with
    you in crafting legislation that furthers the mission of the FHA
    single-family mortgage insurance program.
                                     ______

                     PREPARED STATEMENT OF A.W. PICKEL, III
    President and Chief Executive Officer, LeaderOne Financial Corporation,
           on behalf of the National Association of Mortgage Brokers
                                 June 20, 2006
        Good afternoon Chairman Allard and members of the Subcommittee, I
    am A.W. Pickel, III, past President of the National Association of
    Mortgage Brokers (NAMB). Thank you for inviting NAMB to testify today
    on the Federal Housing Administration: Issues for the Future. In
    particular, we appreciate the opportunity to address the need to: (1)
    increase Federal Housing Administration (FHA) loan amounts for high-
    cost areas, (2) develop risk-based pricing for mortgage insurance on
    FHA loans, and (3) reform the FHA program to reduce the barriers to
    mortgage broker participation.
        NAMB is the only national trade association exclusively devoted to
    representing the mortgage brokerage industry. As the voice of the
    mortgage brokers, NAMB speaks on behalf of more than 25,000 members in
    all 50 states and the District of Columbia.
        America enjoys an all-time record rate of home ownership today.
    Mortgage brokers have contributed to this achievement as we work with a
    large array of home buyers and capital sources to originate the
    majority of residential loans in the United States. At the end of last
    year, the overall home ownership rate neared 70 percent. This is an
    astounding number until one realizes that the home-ownership rate for
    Hispanics is just over 50 percent and for African-Americans, is only 48
    percent. Many families still need assistance in obtaining home
    ownership and NAMB believes that the proposed reforms to the FHA
    program are critical to expanding home ownership opportunities for
    prospective first-time, minority, and low- to moderate-income home
    buyers.
    FHA Utilization of Mortgage Brokers
        NAMB supports the U.S. Department of Housing and Urban
    Development's (HUD) proposed reforms to the FHA program (Proposal), but
    believes that the FHA program must first be a viable option for
    prospective borrowers. Regardless of how beneficial a loan product may
    be, it requires an effective distribution channel to deliver it to the
    marketplace. Unfortunately, many prospective borrowers are denied the
    benefits offered by the FHA program because mortgage brokers--the most
    widely used distribution channel in the mortgage industry--are limited
    in offering FHA loan products.
        According to Wholesale Access, mortgage brokers originated 38.6
    percent of all FHA loans for a total of $110 billion in 2003. Mortgage
    brokers want to further increase origination of FHA loan products for
    first-time, minority and low- to moderate-income home buyers. However,
    current financial audit and net worth requirements create a formidable
    barrier to mortgage broker participation in the FHA program. This
    barrier makes it difficult for mortgage brokers to offer FHA loan
    products to those borrowers that could clearly benefit by participating
    in the FHA program.
        NAMB supports increased access to FHA loans so that prospective
    borrowers who may have blemished or almost non-existent credit
    histories, or who can afford only minimal downpayments, have increased
    choice of affordable loan products and are not forced by default to the
    subprime loan market. In this spirit, NAMB believes the audit and net
    worth requirements should be eliminated for mortgage brokers that want
    to offer FHA loan products to consumers.
        First, current FHA requirements impose cost prohibitive and time
    consuming annual audit and net worth requirements on mortgage brokers
    that want to originate FHA loans. These requirements place serious
    impediments in the origination process that functionally bar mortgage
    brokers from distributing FHA loans to the marketplace, leaving
    subprime loan products as the only other option for many borrowers.
        Most small businesses find the cost to produce audited financial
    statements a significant burden. An audit must meet government
    accounting standards and only a small percentage of certified public
    accountants (CPAs) are qualified to do these audits. Moreover, because
    many auditors do not find it feasible to audit such small entities to
    government standards, even qualified CPA firms are reluctant to audit
    mortgage brokers. Cost is not the only factor. A mortgage broker can
    also lose valuable time--up to several weeks--preparing for and
    assisting in the audit. Between the cost of hiring an accountant who
    meets government auditing standards and is willing to conduct the audit
    and the hours needed to compile and report the needed data, it is
    simply impractical for a small business to conduct this type of
    financial audit.
        The net worth requirement for mortgage brokers is also limited to
    liquid assets because equipment and fixtures depreciate rapidly and
    loans to officers and goodwill are not permitted assets. To compound
    this, a broker who greatly exceeds the net worth requirement is forced
    to keep cash or equivalents of 20 percent of net worth up to $100,000.
    There has been no evidence presented by FHA that loans originated by
    high net worth originators perform better than those with a lower net
    worth.
        Moreover, annual audit and net worth requirements are unnecessary.
    Originators are already governed by contract agreements with their
    respective FHA-approved lenders, affording HUD adequate protection
    against loss. FHA-approved lenders already submit to audits, thereby
    ensuring that customers are protected and can seek relief from
    dishonest originators.
        In sum, the audit and net worth requirements are prohibitively
    expensive for a large majority of mortgage brokers and as a direct
    result, many brokers have been left with little choice but to originate
    loans other than FHA. As a result, the audit and net worth requirements
    actually limit the utility and effectiveness of the FHA program and
    seriously restrict the range of choice available for prospective
    borrowers who can afford only a minimal downpayment. At a minimum, NAMB
    believes annual bonding requirements offer a better way to ensure the
    safety and soundness of the FHA program than requiring originators to
    submit audited financial statements.
        Second, FHA's formal position is that it only approves lenders to
    originate FHA loans. FHA does not even acknowledge the term ``mortgage
    broker'' in its guidelines and therefore, no provision currently exists
    that would explicitly permit mortgage brokers to originate FHA loans.
    In fact, until several years ago, FHA required all loans to be closed
    in the name of the originating party. Fortunately, this prohibition was
    somewhat alleviated when FHA allowed the loan to close in the name of
    the actual source of the funds. Today, anyone who originates, but is
    not the ultimate source of funds, is referred to as a ``Correspondent
    Lender''--a term normally only used for mortgage bankers.
        A stated objective of HUD, and the FHA program, is to increase
    origination of FHA-loan products and expand home ownership
    opportunities for first-time, minority, and low- to moderate-income
    families. NAMB believes the solution to increase FHA loan production is
    simple--allow more stores, such as mortgage brokers, to offer FHA loan
    products directly to consumers. As stated previously, mortgage brokers
    originate the majority of all residential loans and therefore, would
    provide HUD with the most viable and efficient distribution channel to
    bring FHA loan products to the marketplace.
    FHA Risk-Based Premiums are Relevant to the Market
        The ability to match borrower characteristics with an appropriate
    mortgage insurance premium has been recognized as essential by every
    private mortgage insurer (PMI). PMI companies have established levels
    of credit quality, loan-to-value, and protection coverage to aid in
    this matching process. They also offer various programs that allow for
    upfront mortgage insurance premiums, monthly premiums or combinations
    of both. This program flexibility has enabled lenders to make
    conventional loans in the private marketplace that either are not
    allowable under FHA or that present a risk level that is currently
    unacceptable to FHA.
        Unfortunately, where FHA is not available as a viable competitor,
    PMI premiums are quite expensive. Should FHA decide to enter this
    market, it will increase competition for these programs and ultimately,
    drive down costs for borrowers.
        For example, many mortgage products that require minimal or no
    downpayment or equity do not use PMI insurance. Rather, these loans are
    split into two--a first mortgage, which is offered at a lower interest
    rate, and then a second mortgage offered at a considerably higher
    interest rate. This ``combo'' or ``80/20'' type of mortgage product is
    commonly offered to borrowers with less than perfect credit. Borrowers
    who are unable to adequately prove their income also commonly utilize
    ``combo'' mortgages. In this market, PMI may not be offered or is
    offered at a prohibitively high premium. Again, FHA could act as a
    competitor to drive down costs for these types of products.
        PMIs have demonstrated the ability to balance risk with the
    premiums charged and the FHA program should be afforded the same
    opportunity. If the risks are assessed appropriately, the premiums
    charged should ensure that the Mutual Mortgage Insurance Fund (MMIF)
    will not be adversely affected. FHA is not required to make a suitable
    profit or demonstrate market growth to shareholders; therefore, it is
    likely that FHA can afford to assume even greater risk levels than PMIs
    can currently absorb. This increased capacity to assume and manage risk
    will allow FHA to serve even those borrowers who presently do not have
    PMI available as a choice.
        This Proposal also allows FHA to offer lower premiums to lower-
    credit-risk home buyers, which will have the net effect of reducing the
    overall default rates at FHA. Recent changes made by HUD such as
    permitting formerly non-allowable fees to be charged and utilizing
    Fannie Mae appraisal guidelines have had the effect of modernizing the
    FHA program. These advances make the FHA program easier to use, which
    in turn attracts more borrowers who would not otherwise tolerate the
    red-tape long-associated with origination of FHA loans. Real estate
    agents, sellers and mortgage companies who have not viewed FHA
    financing as a viable alternative to the private marketplace would also
    return to the program, bringing with them suitable borrowers that would
    make FHA's default rate comparable to that of conventional loans.
        Because a substantial body of data for risk-based lending is
    available, this Proposal is not a leap into the unknown. Rather, it
    creates a venue to bring FHA into parity with what has already proven
    to be reasonable assumption of risk for the marketplace.
        This Proposal is not intended to be a change to the FHA program
    that will create losses. Rather, it is designed to avoid losses to the
    MMIF. The Proposal contains needed reforms that will help FHA meet its
    chartered mandate of increasing home ownership opportunities for first-
    time, minority, and low- to moderate-income home buyers, and which may
    actually have the side effect of improving the solvency of the MMIF.
        All insurance constructs involve assumption of risk. When an
    insurer can use sound actuarial data and price in a manner that is
    responsive to trends revealed by such data, the risk is spread over a
    sufficiently large base to minimize the chance of loss. Because FHA's
    share of the market is approaching marginal levels, the risks to the
    program are likely to be greater under the status quo than with the
    Proposal.
    Benefits to Consumers, Particularly First-Time Home Buyers, Minority,
            and Low- to Moderate-Income Families
        Lenders and insurers tend to demand a higher proportional return
    when they enter a riskier market. It has been demonstrated that the
    return demanded is considerably higher for subprime loan products than
    for prime loans because of the inherent risks presented by the subprime
    market. At the same time, consumer advocates have claimed that fees and
    rates for many subprime borrowers are too high. FHA has the ability to
    enter into the subprime market safely and still offer significant
    savings to prospective borrowers. The benefits received by expanded FHA
    entry into the subprime market would be particularly useful for first-
    time, minority and low- to moderate-income home buyers who could
    receive prime interest rates on their loans by using FHA insurance.
        The FHA program also possesses many attributes that are
    particularly friendly to prospective borrowers who may have less money
    available for closing costs, temporary income, or a limited credit
    history. For example, FHA Direct Endorsement Underwriters are given
    considerable latitude to make loans that they believe should be made,
    but may not have all of the requisite attributes conventional
    guidelines require. FHA servicing is far less likely to quickly send a
    loan to foreclosure and must follow borrower-friendly practices whereas
    some conventional lenders have been cited for questionable loan
    servicing practices. FHA loans usually offer fixed-interest rates
    compared to the adjustable rates offered on most subprime mortgages.
    Complements the Private Sector
        As discussed earlier, America is built on the concept that
    competition is healthy for the market. It improves efficiency and
    quality while offering more competitively priced products to consumers.
    Making FHA more competitive will improve the services and products
    provided by other lenders and insurers in the industry. Consumers will
    be offered FHA programs that serve a similar purpose but are certainly
    not identical to conventional programs now available. This healthy
    level of competition should drive down the cost of programs that serve
    those with minimal downpayments or who need flexible underwriting to
    obtain home financing.
        Borrowers who can afford larger downpayments or who have reasonable
    equity levels do not find the FHA program to be a reasonable
    alternative to conventional financing. Nearly all FHA borrowers have a
    loan-to-value ratio in excess of ninety percent. Since 1980, FHA has
    never served more than fifteen percent of the total housing market but,
    at times, it insured nearly fifty percent of urban mortgages. Clearly,
    the Proposal will not make the FHA program a threat to the overall
    mortgage market. At most, this Proposal will help to restore FHA loan
    product origination to levels of previous years.
        Nevertheless, the possibility that FHA could supplant certain
    conventional loans does exist. Such a result is inevitable if FHA
    regains market share. However, the conventional loans most likely to be
    supplanted are those made to borrowers who fall just short of receiving
    A-grade conventional loans. Many first-time, minority, and low- to
    moderate-income home buyers find themselves in this situation but are
    forced to turn to the subprime market to achieve home ownership. This
    Proposal makes FHA loan products a viable alternative for these
    prospective borrowers.
    The Elimination of the Down Payment Requirement
        NAMB supports eliminating the downpayment requirement and granting
    FHA the flexibility to offer 100 percent financing to aid in the effort
    to increase home ownership for first-time, minority, and low- to
    moderate-income families.
        Home ownership is a dream that many wish to experience, but for
    years barriers have existed that prevent many low-income and minority
    families from purchasing a home. In fact, a recent study published in
    March 2006 by the Center for Housing Policy \1\ reveals that many
    working minority families with children are less likely to achieve the
    dream of home ownership today than in the 1970s. A principal barrier to
    achieving home ownership for these families is financial--the lack of
    money for a downpayment and closing costs. The Proposal to eliminate
    the downpayment requirement will help break down this financial barrier
    for many low- to moderate-income and minority families. This Proposal
    will help significantly to achieve the Administration's stated goal of
    increasing minority home ownership by 5.5 million by 2010.
    ---------------------------------------------------------------------------
        \1\ The Center for Housing Policy recently released a study
    entitled ``Locked Out: Keys to Home Ownership Elude Many Working
    Families with Children,'' in March 2006 which showed that the cost of
    home ownership outpaced income growth for many low- to moderate-income
    working families with children.
    ---------------------------------------------------------------------------
    Future of the FHA Program If Proposal Is Enacted or Not Enacted
        Proposed changes are needed to the FHA program to meet its
    chartered mandate, which is to aid the underserved and underprivileged
    obtain the dream of home ownership. PMI will dominate the low and zero
    downpayment market with little competition among the few players in
    that industry. The subprime mortgage market will fulfill the needs of
    those unable to obtain PMI insurance. Foreclosure rates could escalate.
    Minority families and first-time home buyers may be underserved or even
    shut out of the housing market entirely. It is possible that FHA will
    have a pool of loans too small to effectively manage risk. Ultimately,
    FHA could be removed as a helping hand to those who need it the most.
    The ripple effect of negative consequences could easily extend to the
    homebuilding industry and to the general economy as well.
        On the other hand, Congress has the opportunity to revitalize the
    FHA program with this Proposal. Borrowers will receive better loan
    programs at lower interest rates. We strongly urge this committee to
    support the Proposal.
    Increase FHA Mortgage Amounts for High-Cost Areas
        Congress and this Administration have made home ownership a
    priority in this country and indeed, the growth of home ownership in
    this country has been steadfast for the past few years. Unfortunately,
    the demand for homes continues to outstrip new housing development and
    sales of existing homes, causing escalation of home prices. In an
    environment of rising interest rates, many first-time, minority, and
    low- to moderate-income home buyers will need the safer and less-
    expensive financing options that the FHA program can provide. For this
    reason, NAMB uniformly and unequivocally supports increasing FHA loan
    limits in high-cost areas.
        To accommodate the escalating demand for homes, NAMB believes the
    formula used to calculate FHA maximum loan amounts should be revised to
    make the FHA program accessible to those home buyers living in high-
    cost areas. The benefits of the FHA program should belong equally to
    all taxpayers; especially those residing in high-cost areas that often
    are most in need of affordable mortgage financing options.
        For example, in California, twenty-nine of the fifty-eight counties
    are currently at the FHA ceiling of $362,790, with another six counties
    approaching the ceiling when one factors in the latest escalation in
    home prices. These twenty-nine counties represent approximately eighty-
    five percent of California's population, many of whom are struggling to
    become or remain homeowners in an area where the median house price is
    currently $535,470. California is not alone. High-cost areas exist in
    many states across the country. Maryland, for example, has 5 of 24
    counties currently at the $362,790 FHA maximum with another seven
    counties within $1,885 of the limit. Again, these counties represent a
    great majority of the population for Maryland. Additional states that
    currently feature counties at or approaching the maximum FHA loan limit
    include Pennsylvania, Connecticut, New York, and New Jersey among
    others.
        Recognizing high-cost areas with regard to FHA loan limits is not
    new to this legislative body. Congress already recognizes high-cost
    areas for FHA loan limits in Hawaii, Alaska, and various U.S.
    Territories. These areas feature an exception that takes their
    available loan limit to 150 percent of the current FHA loan limit.
        We must not forget that the FHA program was created by the National
    Housing Act of 1934 with the intent of increasing home ownership and
    assisting the home-building industry. Since its inception, FHA has
    insured over 33 million loans and is the largest insurer of mortgages
    in the world. FHA-insured loans are the staple for first-time home
    buyers. FHA-insured loans are more accommodating to first-time home
    buyers than other types of loan programs. The program is designed to
    incorporate flexibility for debt-ratios, income and credit history
    items not included in the government sponsored enterprise (i.e., Fannie
    Mae and Freddie Mac) guidelines.
        Congress must ensure that FHA-insured loan programs continue to
    serve as a permanent backstop for all first-time home buyer programs.
    For this reason, we believe that Congress should create the ability for
    FHA loan limits to be adjusted up to 100 percent of the median home
    price, thereby providing a logical loan limit that will benefit both
    the housing industry and the consumer. Tying the FHA loan limit to the
    median home price for an individual county, and letting it float with
    the housing market, allows the FHA loan limits to respond to changes in
    home prices instead of some esoteric number computed through a
    complicated formula. In this fashion, the FHA loan limit will reflect a
    true home market economy. Rather than restrict purchases of new homes
    through a legislatively mandated ceiling, the FHA loan limit can
    automatically adjust under current guidelines established for
    increasing the FHA loan limit on a county-by-county basis.
    Conclusion
        NAMB appreciates the opportunity to offer our views on the FHA
    program. I am happy to answer any questions.
                                     ______

                      PREPARED STATEMENT OF IRA GOLDSTEIN
       Director of Policy and Information Services, The Reinvestment Fund
                                 June 20, 2006
        Good afternoon. My name is Ira Goldstein and I am the Director of
    Policy and Information Services for The Reinvestment Fund (TRF). I am
    honored to be asked to comment on changes proposed for the FHA program
    and I hope that my remarks help you establish the framework for an FHA
    program that provides added individual and social benefit.
        The organization of which I am part--TRF--is a national leader in
    the financing of neighborhood revitalization. Founded in 1985, TRF has
    invested $500 million in the creation and preservation of affordable
    housing, community facilities, commercial real estate, and renewable
    energy. Since inception we have financed the creation of more than
    12,000 affordable housing units, 15,000 charter school slots, 4.3
    million square feet of commercial space, and 250 businesses. We also
    have been actively involved in research related to various aspects of
    the housing market.
        Our work in the areas of mortgage lending, foreclosure, and
    predatory lending has been supported through grants from foundations,
    as well as contracts from local and State governmental entities. The
    research we do has both a strong data-based component, as well as a
    qualitative component that brings us personally in touch with people
    from all sectors of the mortgage lending process--from the borrower to
    the broker to the lender to the servicer and securitizer to the
    attorneys who represent borrowers and those who represent lenders to
    the sheriffs who auction off properties on which homeowners are no
    longer paying their mortgage.
        Home ownership is undeniably the critical component in the
    accumulation of wealth for most American families. Over the last 40
    years, home ownership has risen from 63 percent in 1965 to 69 percent
    in 2005; the number of homeowners has risen from 36 million to 75
    million--a 108 percent increase--over that same time. Much of that rise
    is among minority households and households of lower and moderate
    income. At the same time, typical home prices in the United States
    between 1968 and 2005 (or virtually any other period in between) rose
    substantially faster than inflation. So as a nation we have more people
    owning an asset that is yielding true appreciation.
        Going forward, the demographic groups available to become
    homeowners are younger, lower income, and minority households. These
    are the groups currently with the lowest ownership rates. These are
    also households that statistically have least net worth. So many who
    have recently and will in the future become owners are least able to
    weather the financial impact of a significant financial event such as
    often occurs with new homeowners.
        I think that it is important to think of the proposed changes to
    the FHA in the larger social context of whether we're approaching (or
    have passed) the peak societal benefit of home ownership. As former
    Federal Reserve Governor Gramlich stated ``There is a valid debate as
    to whether continuing to increase overall home ownership rates much
    further is feasible or even desirable.'' \1\
    ---------------------------------------------------------------------------
        \1\ Remarks by Governor Edward Gramlich at the Home Ownership
    Summit of the Local Initiatives Support Corporation (11.8.01).
    ---------------------------------------------------------------------------
        Legislation under consideration would seek to raise the home
    ownership rate through a variety of products and processes, essentially
    leveling the playing field so that FHA can effectively compete with the
    subprime mortgage market. One such change is zero-downpayment
    mortgages. That's important because so few Americans are saving and
    household debt service ratios are currently at such high levels. The
    evidence seems to be fairly clear that those zero-down loans have a
    much higher probability of failure. Our review of the foreclosures in
    the cities of Philadelphia and Baltimore and State of Delaware suggests
    that people who purchased homes with two mortgages--one covering the
    downpayment--were prominently represented among those in foreclosures.
    According to reports from Fitch Ratings, those products we now call
    ``exotic'' mortgages work well for higher net worth individuals seeking
    to manage their finances more advantageously; they are very risky for
    the person who is trying to afford a home for which they are only
    marginally qualified.
        With respect to the proposal that FHA adopts a risk-based pricing
    approach, that is an idea that I think is certainly supportable--
    assuming that the models are properly conceived, developed, and
    monitored. The problematic part of the risk-based pricing model is that
    the price only compensates the lender for the risk the borrower
    presents. In the end, assuming the model is correct, the lender and FHA
    can make money even if some borrowers default. But that assumes that no
    one other than the borrower and the lender matter. Research conducted
    by TRF and EConsult Corporation--commissioned by the Federal Reserve
    Bank of Philadelphia--shows that there is a statistically demonstrable
    adverse effect of mortgage foreclosures on local property markets. In
    fact, after applying an appropriate set of statistical controls, we
    found that each foreclosure within \1/8\ of a mile of a sale and 1-2
    years prior to that sale reduces the value of the home by 1 percent. In
    Philadelphia, the typical home sale has 4-5 foreclosures within the
    specified time and distance and so it is reduced by more than 5
    percent. The implication of this is that everyone within the area has
    lost some of the wealth. This is not an argument against risk-based
    pricing; it is an argument to consider the social costs beyond those of
    the transaction.
        My final point has to do with servicing. It is a well-settled fact
    that certain servicing and loss-mitigation techniques increase the
    likelihood that a delinquent loan returns to paying status (e.g., early
    intervention or reasonable access of borrowers to their servicers)--or
    that loss to the investor is minimized. The servicing and loss-
    mitigation efforts on FHA loans are not the best, and TRF's work with
    practitioners suggests that HUD has not enforced compliance with its
    current procedures. Even assuming they were complied with, the rules
    themselves are flawed. Pennsylvania's Homeowners' Emergency Mortgage
    Assistance Program (not currently available to people with FHA loans)
    is a remarkably successful example of a loss mitigation strategy that
    in the case of FHA could reduce claims against the FHA insurance pool.
    Servicing and loss mitigation takes on added importance if FHA expands
    its current customer base, as it is proposed. This legislative body can
    and should require accountability on the servicing and loss mitigation
    efforts on FHA loans to ensure that with the enhanced risk these new
    loans create that all efforts are made to keep the loans in a paying
    status. There will be a cost to an added servicing burden undoubtedly
    passed on to the consumer, but that cost would likely be justified by
    increasing the likelihood that a homeowner can keep their home through
    a financial hardship.
        In closing, success is not just changing the rules so that FHA can
    originate more loans or compete with subprime lending. Success would be
    that FHA replaces those products within the subprime mortgage market
    that disadvantage borrowers, with products and processes that enhance
    the likelihood of sustainable home ownership.
        Thank you.
                                     ______

                     PREPARED STATEMENT OF BASIL N. PETROU
              Managing Partner, Federal Financial Analytics, Inc.
                                 June 20, 2006
        It is an honor to appear today before this Subcommittee to discuss
    reform of the Federal Housing Administration (FHA). My comments today
    will be limited to discussion of the FHA single-family mortgage
    insurance program. I am managing partner of Federal Financial
    Analytics, a consulting firm that advises on U.S. legislative,
    regulatory and policy issues affecting financial institution strategic
    planning. We thus advise a variety of companies on the implications of
    legislation and regulation in the mortgage and housing markets. Clients
    in this practice include trade associations, mortgage insurers, and
    mortgage lenders.
        Key points to consider for FHA reform include:

        As a government program, FHA should serve its targeted
            borrowers if they are not already being adequately served by
            the private sector. It is not appropriate for FHA, as a
            government program, to launch initiatives to expand its
            ``market share.''

        Recent General Accountability Office (GAO) and Department
            of Housing and Urban Development (HUD) Inspector-General
            reports, as well as the President's fiscal year 2007 budget
            raise serious questions about the Mutual Mortgage Insurance
            (MMI) Fund's financial soundness. The most recent available MMI
            Fund data are for only mid-fiscal year 2005, and these show a
            serious reduction in the economic value of the fund that
            undermines its capital adequacy. Mortgage-market trends since
            then have shown significant weakening, as evident by recent
            guidance from the Federal bank regulatory agencies designed to
            protect insured depository institutions.

        The FHA should not seek to grow its way out of its current
            financial problems. Doing so is reminiscent of the actions
            taken by distressed savings-and-loans during the 1980s.

        The MMI Fund is already taking financial risks. For
            example, 50 percent of all FHA loans insured in 2004 had
            downpayment assistance, with nonprofit organizations that
            received seller funding accounting for 30 percent of these
            loans. GAO analysis indicates that these sellers raised the
            price of their properties to recover their contribution to the
            seller-funded nonprofit--placing FHA buyers in mortgages that
            were above the true market value of the house. The Internal
            Revenue Service (IRS) is curtailing these programs, but the
            significantly higher claim rates FHA has experienced from these
            loans will continue for those remaining on its books.
            Indicative of FHA's problems is that its delinquency rates are
            higher than those associated with private subprime loans.
            Adding yet more risk means potentially profound FHA losses that
            will heighten the risk of calls upon the taxpayer.

        From a budgetary perspective, the MMI Fund now is only
            breaking even, but even this is based only on out-dated
            information. Any shift in the MMI Fund's financial condition
            will convert the program into a net cost to taxpayers,
            increasing the Federal budget deficit.

        Concerns about specific reform proposals made by the FHA and others
    include:

        Raising FHA area loan limits--both the base limit and high-
            cost area ones--will not help low- and moderate-income families
            to become homeowners. Raising the base limit would push the
            FHA-insured loan amount in low-cost areas to $271,000 and the
            income of borrowers qualifying for a mortgage of this size is
            over $86,000. Raising the high-cost limit would push the
            mortgage amount that could be insured by the FHA to $417,000,
            which would only reach borrowers with incomes over $132,000.

        In key markets, raising the base limit would mean that the
            FHA would insure homes well above the median house price in an
            entire State. This would further distance the FHA from its
            mission, as well as expose the MMI Fund to increased risk from
            regional economic downturns.

        Giving FHA authority to replace its current premium
            structure with a risk-based premium is a very risky
            proposition. It raises serious questions about whether some
            low- and moderate-income borrowers and minorities will be
            priced out of the entire mortgage market. Further, GAO and HUD
            reports indicate that FHA does not have the necessary data or
            analytical capability to establish a successful risk-based
            premium. A mispriced FHA premium structure would be devastating
            to the MMI Fund and the borrowers it was meant to serve.

        Eliminating the 3 percent minimum downpayment requirement
            must be carefully structured to prevent risk to borrowers,
            communities, and the rest of the MMI Fund. Careful underwriting
            is critical. HUD should rely only on proven FHA lenders,
            validated by increased sampling of the loans they underwrite. A
            zero downpayment program should begin only as a pilot program
            and, if subsequently expanded, should always be limited to low-
            and moderate-income buyers who prove they do not have the
            necessary 3 percent minimum downpayment.

        Although the pending proposed changes to the FHA pose serious
    concerns, the program can be and should be revised to assure it meets
    its mission. Recommended changes include:

        It is time that FHA became an income-targeted--rather than
            a loan amount targeted--housing program. The current system for
            setting FHA area loan limits is skewed toward raising these
            limits above the true median house price for an area, never
            lowering them, even if house prices fall. Income targeting
            FHA's single-family program will assure that low- and moderate-
            income borrowers become the primary focus of the program. It
            should also make housing more affordable for these targeted
            borrowers.

        The 100 percent Federal guarantee behind FHA insurance
            undercuts the financial health of the MMI Fund, provides
            incentives for lax underwriting, and is not needed to make FHA
            insurance useful for most of its target borrowers.

        I now will address in more detail the current health of the FHA and
    the serious problems posed by several proposals: implementing a zero
    downpayment program, raising the FHA loan limits and replacing the
    current premium structure with a risk-based premium.
    Implementing a Zero Downpayment Program
        Zero downpayment loans are viewed by the private sector as
            higher risk, resulting in reliance on careful underwriting.
            Thus, FHA entry into zero downpayment loans must be carefully
            structured to prevent risk to borrowers, communities, and the
            rest of the FHA Mutual Mortgage Insurance (MMI) Fund.

        It is critical to the health of the FHA Fund that the zero
            downpayment program be designed to bring new borrowers into the
            FHA, rather than serve as a means for those borrowers who have
            the wherewithal to make a 3 percent downpayment simply to avoid
            doing so. Some lenders and real estate brokers may look to the
            zero downpayment program as a way to move an FHA borrower into
            a larger mortgage rather than bringing low- and moderate-income
            potential borrowers who otherwise would not qualify for an FHA-
            insured loan into a starter home.

        The latest Actuarial Report for the MMI Fund notes that,
            ``nearly 80 percent of the mortgages originated in fiscal year
            2005 have LTV ratios of 95 percent or more, and over 85 percent
            have LTV ratios above 90 percent. LTV ratios between 95 percent
            and 98 percent comprise the most popular category with 80
            percent of loans falling in this range.''\1\ Clearly, FHA is
            already exposed to the risk associated with very high LTV
            loans. The addition of a zero downpayment program will increase
            this exposure. Thus, an FHA fund with a relatively large share
            of zero downpayment borrowers would significantly increase the
            MMI Fund's risk exposure during periods of regional house price
            declines or economic contraction. For this reason, the program
            should begin as a pilot program to test the success of FHA's
            new underwriting criteria.
    ---------------------------------------------------------------------------
        \1\ Actuarial Study of the MMI Fund for fiscal year 2005 available
    on the HUD web site in sections at: www.hud.gov/offices/hsg/rpts/actr/
    2005actr.cfm. Section IV, pp. 38-39.

        Since the zero downpayment borrower starts home ownership
            owing more on a mortgage than the house is worth, an inflated
            appraisal puts that borrower further behind the goal of
            building equity. The combination of a bad appraisal, economic
            problems for the zero-downpayment borrower and stagnant home
            values can result in a high level of foreclosures in those
            inner city and moderate income areas where these FHA mortgages
            will be concentrated. The result of concentrated foreclosures
            is further downward pressure on home prices that escalate the
    ---------------------------------------------------------------------------
            downward spiral for that neighborhood.

        To protect borrowers, communities, and the MMI Fund, HUD
            should impose limits beyond those currently proposed for zero
            downpayment loans. These should include starting the program as
            a pilot program, targeting it to low- and moderate-income
            borrowers, limiting it only to proven FHA lenders with low
            claim rates, and higher sampling rates for these loans.
    Financial Condition of the MMI Fund
    MMI Fund Actuarial Study
        The most recent actuarial study released in early 2006 for fiscal
    year 2005 \2\ indicates the MMI Fund has a 6.2 percent capital ratio
    but this does not indicate that the Fund is financially healthy:
    ---------------------------------------------------------------------------
        \2\  Actuarial Study of the MMI Fund for fiscal year 2005 available
    on the HUD web site in sections at: www.hud.gov/offices/hsg/rpts/actr/
    2005actr.cfm.

        Loan data for the second half of the fiscal year was not
    ---------------------------------------------------------------------------
            available and not analyzed.

        The MMI Fund's capital ratio improved from the fiscal year
            2004 level because FHA's market share fell. Thus, current and
            future capital ratios cannot be inferred from this data. FHA's
            decrease in market share took place at a time when home
            ownership rates were high and there is no indication that FHA
            target borrowers were not served by private sector
            alternatives.

        The Fund's economic value fell by $2.8 billion--11 percent
            below its projected value from the previous year. The
            significant decrease in the economic value of the MMI Fund is
            to a great extent attributable to factors that remain today and
            actually worsened during the past year.

        Negative factors include an alarming new trend in FHA.
            Loans with non-relative third-party downpayment assistance
            comprised 18 percent of FHA's new business for the time covered
            by the actuarial study and the losses on those loans reduced
            the MMI Fund's economic value by $1.7 billion.

        A subsequent November 2005 study by the GAO reported that
            FHA's share of these types of loans was actually 50 percent
            with 30 percent accounted for by seller contributions to
            nonprofit organizations.\3\ This report also had the disturbing
            conclusion that ``property sellers often raised the sales price
            of their properties in order to recover the contribution to the
            seller-funded nonprofit that provided the downpayment
            assistance. In these cases, home buyers may have mortgages that
            were higher than the true market value price of the house and
            would have acquired no equity through the transaction.''\4\
            This fact may partially explain the significantly higher claim
            rates suffered by these products.
    ---------------------------------------------------------------------------
        \3\ GAO-06-24, Mortgage Financing, Additional Action Needed to
    Manage Risks of FHA-Insured Loans with Down Payment Assistance.
    November 2005.
        \4\ Ibid., pp.19-20.
    ---------------------------------------------------------------------------
    HUD Inspector General Report
        A November 2005 HUD Inspector General (IG) report \5\ notes the
    inadequacy of the actuarial study which FHA uses to predict losses. The
    IG report concluded that FHA does not have enough historical data on
    the various risk factors of its own borrowers to effectively evaluate
    loan performance:
    ---------------------------------------------------------------------------
        \5\ Audit of the Federal Housing Administration's Financial
    Statements for Fiscal Years 2005 and 2004, November 7, 2005, Audit Case
    Number 2006-FO-0002.

        It noted as a material weakness that ``FHA must incorporate
            better risk factors and monitoring tools into its single-family
            insured mortgage program risk analysis and liability estimation
            process.''\6\ Specifically, it found that FHA lacks a formal
            process to effectively evaluate the impact on the MMI Fund of
            loan factors, ``such as borrower credit scores, downpayment
            assistance sources, and other portfolio characteristics.''\7\
    ---------------------------------------------------------------------------
        \6\ Ibid., Appendix A, p. 7.
        \7\ Ibid.

        It concludes that ``FHA also cannot determine current risk
            trends in its active insured mortgage portfolio.''\8\ That is,
            FHA is not sure what is driving the current surge in its
            claims. As a critical example of this failure, the HUD IG notes
            that the MMI Fund's independent actuary determined that the
            claim rates for loans where the borrowers received non-relative
            assistance for the initial loan downpayment was ``as high as
            three times those that did not receive assistance.''\9\
            However, the report concludes that ``FHA has not had sufficient
            data to segregate these loans into a separate risk category for
            loss estimation purposes.''\10\
    ---------------------------------------------------------------------------
        \8\ Ibid.
        \9\ Ibid.
        \10\ Ibid.
    ---------------------------------------------------------------------------
    GAO Study of September 2005
        A GAO study released in September 2005 detailed the reasons behind
    a $7 billion reestimate for the MMI Fund.\11\

        \11\ GAO-05-875,  Mortgage Financing, FHA's $7 Billion Reestimate
    Reflects Higher Claims and Changing Loan Performance Estimates.
    ---------------------------------------------------------------------------
        The points raised in this study include:

        Actual claim activity in fiscal year 2003 exceeded
            estimated claim activity ``by twice as much in some cases--for
            majority of loan cohorts.''\12\
    ---------------------------------------------------------------------------
        \12\ Ibid, p. 3.

        Events that may explain the reasons for this increase
            ``include changes to underwriting guidelines, competition from
            the private sector, and an increase in the use of downpayment
            assistance.''\13\
    ---------------------------------------------------------------------------
        \13\ Ibid.

        GAO concludes that while ``FHA has taken some steps to
            tighten underwriting guidelines and better estimate loan
            performance . . . it is not clear that these steps are
            sufficient to reverse recent increases in actual and estimated
            claims and prepayments or help FHA to more reliably predict
            future claim and prepayment activity.''\14\
    ---------------------------------------------------------------------------
        \14\ Ibid.

        Importantly, with respect to future MMI Fund Actuarial
            reports the GAO notes that ``Because the loan performance
            variables underlying the $7 billion reestimate will likely
            persist to varying degrees, they are also likely to affect
            estimates of the Fund's long-term viability . . . if the Fund's
            economic value declines or is restated at a lower level than
            previously estimated because of higher claims, and if the
            insurance in force remains steady, because of declining
            prepayments, then the capital ratio will decline.''\15\
    ---------------------------------------------------------------------------
        \15\ Ibid, pg. 4.

        Finally, with respect to the MMI Fund actuarial analysis,
            GAO makes the telling point that ``neither Congress nor HUD has
            established criteria to determine how severe a stress test the
    ---------------------------------------------------------------------------
            Fund should be able to withstand.''\16\

        \16\ Ibid.
    ---------------------------------------------------------------------------
    The President's fiscal year 2007 Budget
        The President's fiscal year 2007 budget notes that FHA has serious
    risk-assessment issues. Specifically, it notes that `` . . . the
    program's credit model does not accurately predict losses to the
    insurance fund.''\17\ The results of this failure are serious:
    ---------------------------------------------------------------------------
        \17\ Fiscal year 2007 Budget, Analytical Perspectives, Credit and
    Insurance, p. 70.

        It shows the impact of the $7 billion reestimates noted
            above by GAO for each year of business. Each book of business
            for the last 10 years essentially experienced reductions of 30
            percent to 50 percent or more in their net budget impact.\18\
    ---------------------------------------------------------------------------
        \18\ Fiscal year 2007 Budget, Federal Credit Supplement, Table 8.
    Loan Guarantees: Subsidy Reestimates, pp. 51-52.

        While the MMI Fund had been estimated last year to generate
            a net negative subsidy rate of 1.7 percent, the reestimates
            resulted in the Fund only just breaking even for fiscal year
            2007 with a 0.37 percent net negative subsidy rate.\19\ The
            bottom line is that the MMI Fund is on the verge of costing
            taxpayers money for the first time in its history.
    ---------------------------------------------------------------------------
        \19\ Fiscal year 2007 Budget, Appendix, p. 556, Table entitled
    Summary of Loan Levels, Subsidy Budget Authority and Outlays by
    Program, line 232901.

        The budget states that ``despite FHA efforts to deter fraud
            in the program, it has not demonstrated that these steps have
            reduced such fraud.''\20\ FHA needs to remedy this problem
            before it expands through introduction of riskier products to
            penetrate subprime markets.
    ---------------------------------------------------------------------------
        \20\ Ibid., fiscal year 2007 Budget, Analytical Perspective.
    ---------------------------------------------------------------------------
    GAO Study of April 2006
        The latest GAO report on FHA dated April 2006 \21\ notes
    technological problems within FHA that raise questions about expanding
    its operations into riskier markets:
    ---------------------------------------------------------------------------
        \21\ Op. Cit., GAO 06-24.

        GAO studied the Technology Open to Approved Lenders (TOTAL)
            scorecard through which credit factors are input by the loan
            originator and, if a target score is achieved, the loan is
            determined to be eligible for FHA insurance. Otherwise, the
    ---------------------------------------------------------------------------
            loan requires manual underwriting.

        GAO suggested that, conceptually, this system could be used
            to do risk-based pricing, but HUD is far from ready for use to
            this effect. In addition, HUD in a March 31, 2006 letter to GAO
            included in the report notes that, while TOTAL was not intended
            for risk-based pricing, that FHA ``is exploring how it might be
            used for that purpose,'' but that ``[t]his could be a lengthy
            exercise with an unknown outcome . . . '' and that if FHA is
            given authority by Congress for new products, FHA ``will
            certainly explore the benefits that TOTAL may present in
            developing such products.''\22\
    ---------------------------------------------------------------------------
        \22\ Ibid., Appendix III, p. 30.

        The reasons why TOTAL is not ready for risk-based pricing
            include: antiquated data inputs, absence of a formal plan to
            update data, absence of key variables such as type of loan
            instrument type of home and exclusion of data from loans that
            FHA had rejected. GAO notes that this latter point could mean
            that a higher percentage of loans that are likely to default
            will be accepted rather than referred to manual underwriting.
    CBO Report of June 14, 2006
        The Congressional Budget Office in its analysis of the FHA
            Reform bill, H.R. 5121, released on June 14, 2006 reflects the
            0.37 percent net negative subsidy rate in its estimate of any
            additional business that may accrue to FHA as a result of an
            increase in the loan limits. It is interesting to note that
            even with a 10 percent annual increase in the volume of FHA
            borrowers the budget benefits of higher loan limits are
            minimal--literally only $11 to $15 million a year because of
            the performance of existing FHA loans. Of course, should FHA
            performance worsen the estimated budget benefits would turn
            into budget costs.\23\
    ---------------------------------------------------------------------------
        \23\ Congressional Budget Office Cost Estimate dated June 14, 2006,
    H.R. 5121, Expanding American Home Ownership Act of 2006, p. 2.
    ---------------------------------------------------------------------------
    High Relative Delinquency Rates
        Delinquency data compiled by the Mortgage Bankers
            Association for the fourth quarter of 2005 \24\ shows that FHA
            loans have a 13.18 percent total delinquency rate versus 2.47
            percent for prime conventional loans and 11.73 percent for
            subprime loans--the market FHA seeks to enter.
    ---------------------------------------------------------------------------
        \24\ Mortgage Banker's Association, National Delinquency Survey,
    Fourth Quarter, 2005, pp. 10-11.

        These comparatively high delinquency rates do not augur
            well for the Fund in light of the problems noted above by GAO
            and the HUD IG.
    Raising FHA Loan Limits
    Current FHA Area Limits Are Higher Than Median Area House Prices
        The current structure for setting FHA loan limits is skewed
            toward setting them at a level above the true area median house
            price. The current system ties the calculation of the median
            house price for an MSA to the median house price in the highest
            cost county within the MSA.\25\ The result is that the FHA loan
            limit for the MSA is clearly not reflective of the true median
            house price for the entire MSA--it is higher. Moreover, anyone
            can request a higher limit for the MSA by presenting data to
            HUD that house prices within a single county within the MSA
            have gone up to a level above that reflected in the current FHA
            area loan limit.\26\
    ---------------------------------------------------------------------------
        \25\ For FHA limit setting process see HUD Mortgagee Letters 2003-
    23 and 95-27. As evidence of how quickly real estate brokers and others
    took advantage of the new law to seek higher area FHA limits see ``HUD
    Raises Limits for FHA-Insured Mortgages in 1999, Numerous Appeals Are
    in the Works.'' Inside Mortgage Finance, January 8, 1999, page 9.
        \26\ See HUD web site at www.hud.gov/offices/hsg/sfh/lender/
    sfhmolin.cfm.

        Further aggravating the bias toward an artificially high
            MSA median house price is that, when data are compiled to show
            recent house price sales, new house sales are over-weighted.
            That is, if new house sales comprise less than 25 percent of
            all house sales in the county and the value of existing house
            prices is static or declining, then the median price for new
            houses is calculated separately but given equal weight to the
            median sales price for existing house sales. Since new home
            prices are generally higher than existing house sales prices
            this acts to raise the FHA limit above what would be the true
            area median house price.\27\
    ---------------------------------------------------------------------------
        \27\ FHA has proposed shifting the FHA area limit calculation from
    95 percent to 100 percent of ``median house price'' as calculated under
    the existing formula. This change would aggravate the current
    distortion in the calculation.
    ---------------------------------------------------------------------------
    Which Borrowers Will Benefit From Even Higher FHA Loan Limits?
        Raising the FHA base loan limit or the FHA high-cost area
            limit will not allow a borrower with a $50,000 income to
            qualify for a $271,000 FHA-insured 30-year fixed-rate
            mortgage--even at today's low--but rising--interest rates. As
            interest rates rise, the larger FHA loan is placed that much
            further out of the reach of the moderate-income borrower.

        The base FHA loan limit nationwide is set at 48 percent of
            the Freddie Mac national loan limit. Today, this is equivalent
            to a mortgage of $200,160. Thus, even if the median house price
            in an area is well below $200,000 the FHA will insure loans in
            that area up to $200,160. On the other hand, the ceiling on the
            maximum FHA loan amount is set at 87 percent of the Freddie Mac
            loan limit. Today, this is equivalent to $362,790. This means
            that, if the FHA process determines that 95 percent of the
            median house price in an area is greater than $200,160, then
            that amount will be the FHA limit for that area up to a maximum
            ceiling of $362,790.

        FHA seeks to raise the FHA base limit to 65 percent of the
            Freddie Mac national limit and to raise the high-cost area
            limit to 100 percent of the Freddie Mac limit.\28\ Today, this
            proposal would mean that the base limit would increase from
            $200,160 to $271,050 and the high-cost area limit would
            increase to $417,000.
    ---------------------------------------------------------------------------
        \28\ See Testimony of FHA Commissioner Montgomery before the
    Housing Subcommittee of the House Financial Service Committee on April
    5, 2006, p. 5.

        If we assume a borrower fully qualifies for the FHA loan on
            an income basis and has no other debt that would act to limit
            the loan amount for which they would qualify, then, assuming
            current FHA mortgage rates and average property taxes and
            property insurance \29\ the borrower income needed to qualify
            for the current $200,160 base FHA loan is over $63,000. Raising
            the base limit to $271,050 would mean that the base limit would
            reach borrowers with incomes of over $86,000. For the current
            FHA high-cost area loan of $362,790, the needed borrower income
            is over $115,000. Raising the high-cost area limit to $417,000
            would mean that the FHA loan would reach borrowers with incomes
            of over $132,000.
    ---------------------------------------------------------------------------
        \29\ Interest rate of 6.75 percent for a 30-year fixed-rate FHA
    loan. Annual property taxes and insurance were assumed at a combined 2
    percent of house price. FHA's recently raised income ratio of 31
    percent was also factored into these calculations.

        No matter how one looks at the proposed new FHA loan limits
            they target the top level of individual taxpayers on a
            nationwide basis. IRS data for 2003 shows that only the top 8.8
            percent of all individual income tax returns had adjusted gross
            income of over $100,000 and only 16 percent had incomes over
            $75,000.\30\ Furthermore, looking only at individual income tax
            returns with adjusted gross income between $75,000 and
            $100,000, we find that 70 percent of these returns reported a
            deduction for home mortgage interest--indicating that the filer
            already owned a residence with a mortgage--and 72 percent took
            a deduction for real estate taxes, indicating that they owned a
            residence. For returns with incomes between $100,000 and
            $200,000 the percentage reporting a home mortgage interest
            deduction was 79 percent and the percentage paying real estate
            taxes was 85 percent.\31\ In short, if the FHA base and high-
            cost area limits are raised to the levels suggested by the FHA
            Commissioner, then the borrowers taking advantage of these
            higher limits are almost assuredly not first-time home buyers
            and are certainly not buyers with low, moderate or middle tier
            incomes.
    ---------------------------------------------------------------------------
        \30\ See Individual Income Tax Returns, 2003, article by Michael
    Parisi and Scott Hollenbeck, available on the IRS web site at http://
    www.irs.gov/pub/irs-soi/03indtr.pdf.
        \31\ Ibid.
    ---------------------------------------------------------------------------
    Raising the FHA Base Loan Limit Causes Special Problems
        The critical policy issue for Congress to consider is
            whether raising the base limit of FHA in low-cost areas to 65
            percent of the Freddie Mac nationwide limit will bring in more
            first-time, low- and moderate-income and minority home buyers
            or otherwise serve these borrowers. Across the country the
            current FHA base loan limit of $200,190 is now higher--often
            significantly higher--than the median existing house price.\32\
            Raising the FHA base limit to 65 percent of the GSE loan limit
            would move the FHA limit for these areas to $271,000--two to
            three times the current median existing house price in many
            areas.
    ---------------------------------------------------------------------------
        \32\ See generally, National Association of Realtors Median Sales
    Price of Existing Single-Family Homes for Metropolitan Areas available
    on NAR web site.

        Entire states--for example Texas, Louisiana, and
            Mississippi--are now within the FHA base limit. Analysis of NAR
            median existing sales price data shows that raising the FHA
            base limit to $271,000 would bring roughly 83 percent of the
            metropolitan areas it covers within the new FHA base limit.
            This means that additional states will likely fall within this
            higher limit. This further means that, in many low- and
            moderate-priced areas of the country, the additional homes
            insured under the higher FHA base limit would only be
            affordable to borrowers with the highest incomes in the area.
            These are the borrowers who can afford homes priced well above
            the entire State's median priced house. These borrowers are
            unlikely to be first-time, moderate-income, or minority ones. A
            recent study by the Brookings Institution notes that counties
            with higher mean incomes also had higher home ownership rates,
            while counties with lower incomes had lower ownership
            rates.\33\
    ---------------------------------------------------------------------------
        \33\ Credit Scores, Reports, and Getting Ahead in America, May
    2006, The Brookings Institution, Survey Series, Matt Fellowes, see p.
    1.

        Raising the FHA base limits thus means that FHA could
            become over-exposed to risk in entire states and MSAs. With
            this concentrated risk position, FHA would take on heightened
            risk in periods of economic stress. If this over-exposure were
            done to serve moderate-income first-time home buyers, then it
            might be justified. However, this would not be the case because
            higher FHA base limits would serve only those borrowers who can
            afford the highest priced homes in their area.
    Targeting Higher-Income Borrowers Will Add to FHA Risk
        It is commonly assumed that borrowers with higher incomes
            are safer credits than low- and moderate-income borrowers.
            Evidence from the private mortgage insurance industry shows
            that this is not the case for low-downpayment borrowers during
            periods of regional economic stress and falling home
            prices.\34\ It is one thing to have a relatively high income
            and owe a large mortgage on a home with equity of 20 percent or
            more. It is quite another issue to have a large mortgage with
            very little or no equity at all in the house during a period of
            falling house values. When borrowers start the ownership
            process with little or no downpayment, using an FHA-insured
            mortgage loan, they are extremely dependent on a continuing
            advance in home prices to build their equity. Any reversal in
            personal fortunes will find them underwater on their mortgage--
            owing more than the house is worth after real estate brokerage
            and other fees have been paid. This is especially the case for
            zero downpayment mortgages.
    ---------------------------------------------------------------------------
        \34\ For evidence of loan performance during stress periods see
    testimony of Charles Reid, President of the Mortgage Insurance
    Companies of America, before the Subcommittee in Housing and Community
    Development, on FHA's Mutual Mortgage Insurance Fund, July 27, 1993,
    Attachment A, Incremental Risk of Higher Mortgage Amounts, 1981-1989.

        The nature of the residential real estate market in the
            past decade has been very good to most risk-takers. Home prices
            have appreciated across the board--although with wide
            geographic variations. Unfortunately, there is no assurance
            that rapid house price appreciation will continue and signs of
            weakening home prices have already begun to materialize in
            certain areas of the country. Furthermore, past experience with
            regional downturns in house prices has shown that houses at the
            upper end of the price distribution are likely to suffer more
            serious declines in property values than more moderately priced
            houses.\35\ This is not surprising. By definition, there are
            fewer people with the wherewithal to purchase higher-priced
            homes than those able to purchase more moderately priced homes.
            During a period of economic stress and falling home prices, the
            lack of liquidity at the higher end of the house price market
            will hurt these borrowers.\36\ Since FHA insures 100 percent of
            the loan amount, the FHA stands to lose a great deal in this
            situation.
    ---------------------------------------------------------------------------
        \35\ There are already some early signs of declining prices for
    higher priced houses. See for example, the Wall Street Journal for
    Friday, June 16, 2006.
        \36\ In this regard it is interesting to note that the FHA loan
    limits that existed in the late 1980s and early 1990s may well have
    protected the MMI Fund from the severe losses that were incurred in the
    private sector by the house price declines in New England and Southern
    California during these years.

        The potential loss for FHA from raising its loan limits
            will be significant during a period of falling regional house
            prices. A 30 percent loss on a foreclosed $100,000 FHA-insured
            loan costs the single-family Fund $30,000. A 30 percent loss on
            a $271,000 loan costs the Fund $81,000 and a similar loss on a
            $417,000 loan would cost the Fund $125,000. If, as is the case
            in the private sector, larger FHA loan amounts that go to
            foreclosure during periods of severe economic stress suffer
            larger percentage reductions in value, then the Fund would
    ---------------------------------------------------------------------------
            suffer still greater, unanticipated losses.

        New moderate-income borrowers seeking to qualify for an FHA
            loan during this period of economic stress will feel the impact
            of these losses to the Fund. Just as new borrowers paid the
            higher FHA loan premiums needed to return the single-family
            Fund to economic solvency in the early 1990s, so too will
            future moderate-income borrowers bear the higher costs
            associated with the losses resulting from defaults on larger
            loans. Will there be a regional house price decline resulting
            in heavy losses to FHA? We don't know. However, we do know that
            low- and moderate-income borrowers gain nothing and may well
            lose from retargeting FHA to higher-income borrowers because
            FHA would suffer larger losses than would otherwise have been
            the case.
    A Risky Proposition: A Risk-Based FHA Insurance Premium
        FHA proposes to change its premium structure from one relying on
    cross subsidization to a risk-based structure. This will be a
    significant change from FHA's current premium structure and poses new
    risks on FHA and its traditional borrowers.
    The Present Premium Structure
        The present FHA premium allows FHA to charge a fully
            financed upfront premium of as high as 2.25 percent and an
            annual premium of as high as 50 basis points for loans with
            initial LTVs of 95 percent or less and 55 basis points for
            loans with initial LTVs above 95 percent. The upfront premium
            does not count as part of the borrower's loan-to-value (LTV)
            calculation for purposes of the annual premium calculation.
            Currently, HUD charges a 1.5 percent upfront premium and 50
            basis points annual premium for all loans. FHA has also
            implemented a mortgage cancellation program whereby the
            insurance premium payments are canceled for the borrower when
            the LTV reaches 78 percent (5 years of payments required).
            Although the borrower no longer must pay the premium, FHA
            continues to insure the loan.

        Cross subsidization is the key to this system. Borrowers
            with the same downpayment pay the same premium regardless of
            different credit characteristics--provided they cross a minimum
            credit hurdle. This is a key reason why FHA has had such a
            large share of minority and low-income borrowers and why it
            continues to serve this market. As the Brookings Institution
            report notes, the borrower with a poor credit rating often has
            comparatively lower income.\37\ These are the borrowers who
            benefit under cross subsidization.
    ---------------------------------------------------------------------------
        \37\ Brookings, Op. Cit., p. 1.
    ---------------------------------------------------------------------------
    Low-Income and Minority FHA Borrowers Are Likely to Pay More
        The Brookings Institution study concluded that low-income
            and minority borrowers are often the ones with the lower credit
            scores. Specifically the report found that ``counties with
            relatively high proportions of racial and ethnic minorities are
            more likely to have lower average credit scores.''\38\ The
            report noted that ``this evidence does not suggest that a bias
            exists, or that there is a causal relationship between race and
            credit scores, raising questions for future research.''\39\
            With respect to income distribution, the report found that
            ``[t]he average county with a low, mean credit score had a per
            capita income of $26,636 and a home ownership rate of 63
            percent in 2000. Meanwhile, the typical county with high-
            average credit scores had higher per capita incomes ($40,941)
            and a higher share of homeowners (73 percent).''\40\ If FHA is
            seeking to lower the premium price for higher credit score
            borrowers and raise the premiums for lower scored borrowers,
            then higher-income borrowers in areas where home ownership is
            already high would benefit.
    ---------------------------------------------------------------------------
        \38\ Ibid., p. 8.
        \39\ Ibid., p. 1
        \40\ Ibid. See also p. 10.

        FHA staff harbor concerns about using credit scores to set
            premium prices. The November 2005 report from the HUD IG
            mentioned above notes, ``[m]anagement has indicated some
            sensitivity to focusing solely on credit scores because of the
            risk of discouraging lenders from underwriting loans to some of
            FHA's target borrowers who may have low credit scores.''\41\
    ---------------------------------------------------------------------------
        \41\ HUD IG Report, Op. Cit., Appendix A, p.7.

        The Congressional Budget office also suggest that FHA will
            get few if any net new borrowers as a result of a risk-based
            premium. In its analysis of the FHA reform bill, H.R. 5121,
            released on June 14, 2006 it sees no net increase in the number
            of FHA loans guaranteed through a risk-based premium because
            ``while some borrowers may turn to FHA because of better
            pricing and the ability to obtain insurance for more attractive
            loan products, other borrowers may turn away from FHA because
            of higher pricing.''\42\ Those other borrowers who would turn
            away from FHA are likely to be those who FHA perceives to be
            weaker credit risks.
    ---------------------------------------------------------------------------
        \42\ CBO Report, Op. Cit., p. 7.
    ---------------------------------------------------------------------------
    FHA Could Well Get a Risk-Based Premium Wrong
        The HUD IG report, the MMI Actuarial study and GAO reports all
    conclude that FHA does not have adequate data to correctly evaluate the
    credit risk associated with its borrowers.

        The HUD IG notes that, ``[w]ithout adequate data on
            borrower credit scores, FHA is unable to determine whether . .
            . declining borrower credit scores have contributed to
            significant unexpected upward re-estimates of its insured loan
            guarantee liability in recent years.''\43\
    ---------------------------------------------------------------------------
        \43\ HUD IG Report, Op. Cit., Appendix A p. 7

        CBO in its analysis of the FHA reform bill, H.R. 5121,
            notes that risk-based pricing is ``complicated, requiring much
            precision in the underwriting process.''\44\ CBO also
            references the GAO report on the TOTAL scorecard noted above,
            which raised concerns about the effectiveness of the
            underwriting system that exists today and recommends
            improvements. As a result of FHA's current systems
            inadequacies, CBO expects that developing and maintaining
            appropriate systems for managing a risk-based pricing structure
            would take FHA ``several years to implement.''\45\ In short,
            CBO recognizes that a risk-based premium is a difficult process
            to effectively implement and requires sophisticated systems
            that FHA simply does not now have that would take years to
            develop.
    ---------------------------------------------------------------------------
        \44\ CBO Op. Cit., p. 7.
        \45\ Ibid.
    ---------------------------------------------------------------------------
    Market Impact of a Risk-Based FHA Premium
        FHA does not operate in a market vacuum. A decision by FHA
            to set a risk-based premium will pressure its private sector
            alternatives to follow suit to remain attractive to those low-
            downpayment borrowers that are perceived to be lower risk under
            whatever risk-based premium structure FHA develops. Today's FHA
            and private premiums serve low-income and minority low-
            downpayment borrowers so that they too can take the first step
            of building equity in a home. However, a turn to a market-wide
            risk-based premium structure would undermine potential home
            ownership for this group.
    Broad-Based Reform Recommendations
        The current system for setting FHA eligibility on loan
            size, rather than the income of the borrower, makes no sense
            for a government insurance program. A government program must
            focus on the people it serves and this is best determined by
            looking at them, not abstract indicators, proxies, or
            substitute factors.

        It is time that FHA became an income-targeted--rather than
            a loan amount targeted--housing program. The current system for
            setting FHA area loan limits is skewed toward raising these
            limits above the true median house price for an area, never
            lowering them, even if house prices fall. Income targeting
            FHA's single-family program will assure that low- and moderate-
            income borrowers become the primary focus of the program. It
            should also make housing more affordable for these targeted
            borrowers.

        Income targeting would also be simple to implement.
            Borrowers would bring to the lender their most recent tax
            returns (as they currently do) and, if their income was within
            the parameters for their area, then they could qualify for an
            FHA-insured loan. Their loan size would depend on their income
            and interest rates--much as it does now. Incentives for sellers
            to raise their prices as area loan limits are increased would
            end.

        The 100 percent Federal guarantee behind FHA insurance
            undercuts the financial health of the MMI Fund, provides
            incentives for lax underwriting, and is not needed to make FHA
            insurance useful for most of its target borrowers.

        A logical approach would be to set a maximum FHA coverage
            ratio and have it apply only to the lowest income borrowers. As
            the income of the borrower increases, the level of the FHA
            insurance coverage would fall. In this way, the protection of
            Federal insurance coverage would go to lenders making loans to
            lower-income borrowers. Further, linking insurance coverage to
            income in this way creates a positive incentive for the market
            to serve these borrowers.
                                     ______

     RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM WILLIAM B.
                                 SHEAR

    Q.1. What are the most critical problems that FHA needs to
    address if it is to carry out the proposed changes? How long
    would you expect it to take to make these changes?

    A.1. To successfully implement the proposed program changes,
    including risk-based pricing and lower downpayment
    requirements, FHA will need to improve its ability to assess
    and manage risk. In particular, FHA will need to address
    limitations with its TOTAL scorecard and be more open to
    adopting the risk management practices of other mortgage
    institutions. Although FHA's overall approach to developing
    TOTAL was reasonable, the data FHA used to develop TOTAL were
    12 years old by the time that the agency began using the
    scorecard. Therefore, the data may not reflect recent changes
    in the mortgage market affecting the relationship between loan
    performance and borrower and loan characteristics. Without
    regular updates, TOTAL may become less reliable for assessing
    credit risk and, therefore, less useful for implementing risk-
    based pricing and developing new mortgage products. Some of the
    practices of other mortgage institutions offer a framework that
    could help FHA manage the risks associated with new mortgage
    products such as no-downpayment mortgages. These practices
    include piloting and requiring stricter underwriting on these
    products. Although piloting products requires an investment of
    resources, the potential costs of making widely available a
    product whose risk is not well understood could exceed the cost
    of implementing such a product on a limited basis.
        The amount of time FHA will need to address TOTAL's
    limitations and develop pilot programs for new products is
    uncertain but will depend on the commitment of FHA management
    and the availability of resources necessary to implement these
    changes. FHA has a contract to update TOTAL by 2007; however,
    it is unclear whether the update will address all of the
    concerns we have raised with the scorecard or how long it will
    take FHA to field an updated version of TOTAL once the
    contractor has completed its work. It is also unclear how long
    it would take FHA to develop pilot programs for new mortgage
    products. FHA officials have said that they lacked sufficient
    resources to appropriately manage pilot programs, a factor that
    could prevent the agency's use of pilots in the near term.

    Q.2. Based on your knowledge of FHA's current operations, are
    there alternative ways to reorganize FHA that would allow it to
    better compete and to better serve low-income households?

    A.2. We have not studied options for reorganizing FHA nor have
    we evaluated why the agency is now serving fewer borrowers in
    its traditional segment of the mortgage market. However, we
    have identified a number of steps that the agency could take to
    help it succeed in a competitive marketplace. For example, we
    recommended that FHA explore additional uses for TOTAL,
    including applying the scorecard to proposed initiatives--such
    as risk-based pricing and the development of new products--
    which may help strengthen the FHA-insurance fund and reach
    additional borrowers. We also recommended that FHA improve
    TOTAL by developing policies for regularly updating the
    scorecard. This action may help FHA reduce its vulnerability to
    adverse selection that occurs when conventional mortgage
    providers approve lower-risk borrowers in FHA's traditional
    market segment, leaving relatively high-risk borrowers for FHA.
    Finally, we recommended that if Congress authorized FHA to
    insure mortgages with smaller or no downpayments, the agency
    adopt practices used by other mortgage institutions--such as
    piloting--that could help FHA to design and implement products
    with the potential to broaden the agency's customer base.
                                    ------

     RESPONSE TO A WRITTEN QUESTION OF SENATOR REED FROM          BASIL N.
                                     PETROU

    Q.1. You have been a consultant to the Mortgage Insurance
    industry. If FHA's proposed changes are implemented, how will
    these changes affect the members of this industry and the way
    that they do business? Would you expect the use of risk-based
    pricing by the industry to expand?

    A.1. As I noted in my testimony, the FHA does not operate in a
    market vacuum. In my opinion, a decision by FHA to set a risk-
    based premium will pressure its private sector alternatives to
    follow suit so as to remain attractive to those low-downpayment
    borrowers that are perceived to be lower risk under whatever
    risk-based premium structure FHA develops. Consequently, I
    would expect the use of risk-based premiums to expand beyond
    FHA into the borrower-paid private mortgage insurance market.
                                    ------

                 STATEMENT OF THE MORTGAGE INSURANCE COMPANIES
                                   OF AMERICA
                                 June 20, 2006
        The Mortgage Insurance Companies of America (MICA), the trade
    association representing the mortgage insurance industry, is pleased to
    provide a statement for the hearing to take a comprehensive look at the
    Federal Housing Administration (FHA) and the reforms that are needed to
    improve its financial security and the overall operation. We hope you
    will find it helpful.
        The FHA is the government alternative to private mortgage
    insurance. Like FHA, we insure mortgage loans when borrowers put down
    less than 20 percent. The mortgage insurance industry has been
    extremely successful in expanding home ownership opportunities for
    Americans. Since the industry was founded in 1957 it has helped almost
    25 million people buy homes with low downpayments by protecting lenders
    against the risk of default. The mortgage insurance industry also has
    worked aggressively to target mortgage money to underserved families
    and has pioneered ways to better serve this market.
        Mortgage insurers have insured almost $2.4 trillion in mortgages
    since the industry was founded. As a result of our experience we are in
    a unique position to evaluate the changes to the FHA program that the
    Administration is suggesting. Like FHA, mortgage insurers have their
    capital on the line in every loan that they insure. If the borrower
    defaults, then the borrower and insurer experience a loss. The
    insurer's job--whether a private or government insurer--is to strike a
    balance between putting as many families into homes of their own as
    possible and ensuring the loans do not go to default. Private mortgage
    insurers have been very successful in doing this and we hope our
    insight will help you as you consider ways to reform FHA.
        We are very concerned with two of the changes to FHA being proposed
    by the Administration--the proposed risk-based premium and the increase
    in the base FHA loan limit. We believe that with the mortgage market
    softening, FHA's financial situation deteriorating, and FHA's lack of
    appropriate analytical tools this is the exact wrong time to institute
    these changes FHA is suggesting. Not only will they hurt the people FHA
    was established to serve but they will hurt FHA financially. In our
    statement we will discuss FHA's financial condition, the proposals by
    the Administration to reform FHA, and offer other suggestions on how to
    reform FHA.
    FHA's Financial Condition
        There is a growing amount of evidence that not only is FHA's
    financial condition deteriorating but that it does not have the proper
    tools to evaluate risk. Discussed below are several studies showing
    that FHA has serious problems both with its model and with its ability
    to measure loan performance.
    Actuarial Study
        In 1990, FHA's Mutual Mortgage Insurance (MMI) Fund was losing
    about $1 million a day. Congress, working with the Administration,
    enacted the National Affordable Housing Act of 1990. That legislation
    instituted a number of changes to FHA which were designed to put it on
    the road to financial health. One of those changes was that it required
    FHA to do a yearly actuarial study.
        The most recent actuarial study was released in early 2006 and was
    for fiscal year 2005. While on its face the study might seem to
    indicate that the MMI Fund was well capitalized--because it indicates
    the MMI Fund has a 6.2 percent capital ratio--that is only part of the
    story.
        First of all, the actuarial study for fiscal year 2005 was not
    tactually a study for the entire fiscal year. It only covered loans for
    the first half of the fiscal year. The actuarial study notes that the
    reason it was not for the complete fiscal year was because loan data
    for the second half of the fiscal year was not available. No new
    actuarial data or study has been released so one can presume that FHA
    has no new data for almost the first three quarters of fiscal year
    2006. As a result, FHA does not know what its capital position has been
    for almost the last five quarters.
        Second, the primary reason the MMI Fund's capital ratio improved
    from the fiscal year 2004 level is because of a decrease in FHA's
    market share. This decrease took place at a time when the private
    sector was serving the mortgage market well and the country experienced
    very high home ownership rates.
        Third, it is misleading to simply look at the capital ratio at a
    time when FHA's market share is declining because the capital ratio is
    the ratio between the MMI Fund's economic value and FHA's insurance in
    force.\1\ The actual economic value fell by $2.8 billion, an 11 percent
    reduction in the value from the previous year.
    ---------------------------------------------------------------------------
        \1\  For purposes of FHA's actuarial report the economic value of
    the MMI Fund is calculated as Total Capital Resources plus the present
    value of future cash-flows accruing to the MMI Fund. Total Capital
    Resources is defined as the sum of total assets (cash, investments,
    properties and mortgages, and other assets and receivables) less
    liabilities and with the addition of net gains from investments and net
    insurance income. FHA's capital ratio increased for the first half of
    fiscal year 2005 only because the insurance in force denominator of the
    ratio fell more sharply than its economic value.
    ---------------------------------------------------------------------------
        Finally, the actuarial study notes an alarming new trending FHA.
    Loans to people whose downpayments were from someone other than
    relatives comprise 18 percent of FHA's new business and the losses on
    those loans reduced the MMI Fund's economic value by $1.7 billion. A
    subsequent November 2005 study by the General Accounting Office
    reported that FHA's share of these types of loans was actually 30
    percent. While the Internal Revenue Service has questioned the true
    charitable nature of some of these charitable downpayment entities and
    some of them may be expected to close down in the near future as their
    tax exempt status is revoked, the poor performance of the existing
    loans will prove to be a continuing problem for FHA.
    HUD Inspector General Report
        A November 2005 HUD Inspector General (IG) report sheds more light
    on the inadequacy of the actuarial study FHA is using to predict
    losses. The IG report concluded that FHA does not have enough
    historical data on the various risk factors of its own borrowers to
    effectively evaluate loan performance. The IG report noted as a
    material weakness that ``FHA must incorporate better risk factors and
    monitoring tools into its single-family insured mortgage program risk
    analysis and liability estimation process.'' Specifically, it found
    that FHA lacks a formal process to effectively evaluate the impact on
    the MMI Fund of loan factors, ``such as borrower credit scores,
    downpayment assistance sources, and other portfolio characteristics.''
        Finally, and perhaps of more immediate concern, the HUD IG
    concluded that ``FHA also cannot determine current risk trends in its
    active insured mortgage portfolio.'' That is, FHA is not sure what is
    driving the current surge in its claims. As a critical example of this
    failure, the HUD IG notes that the MMI Fund's independent actuary
    determined that the claim rates for loans where the borrowers received
    non-relative assistance for the initial loan downpayment was ``as high
    as three times those that did not receive assistance.'' However, the
    report concludes that ``FHA has not had sufficient data to segregate
    these loans into a separate risk category for loss estimation
    purposes.''
    GAO Study
        The General Accountability Office (GAO) in a study dated April 2006
    pointed out another technological problem, which makes FHA ill-equipped
    to enter risky new ventures. Like the two studies discussed above, the
    GAO study again illustrates that FHA needs to spend time gathering data
    and developing systems.
        GAO studied the Technology Open to Approved Lenders (TOTAL)
    scorecard, an automated underwriting system developed by HUD from 1998-
    2004. The scorecard is not a credit model but rather, as GAO notes, a
    vehicle whereby certain credit factors are input by the loan originator
    and, if a certain score is attained, the loan is determined to be
    eligible for FHA insurance. If the necessary score is not attained, the
    loan will require manual underwriting to determine suitability.
        Since 2004, FHA and its lenders have used TOTAL to evaluate
    applications for FHA-insured loans and inform underwriting criteria
    used in approving loans. In its study, GAO suggested that this system
    could be used to do risk-based pricing. In addition, HUD in a March 31,
    2006 letter to GAO included in the report notes that while TOTAL was
    not intended for risk-based pricing that FHA ``is exploring how it
    might be used for that purpose,'' but that ``this could be a lengthy
    exercise with an unknown outcome . . . '' and that if FHA is given
    authority by Congress for new products, FHA ``will certainly explore
    the benefits that TOTAL may present in developing such products.''
        The GAO study provided reasons why TOTAL in its present form is not
    up to the task of being used to risk base price FHA loans. Some of the
    reasons include, first, the data used in the system is 12 years old,
    which severely limits its effectiveness because the market has changed
    so significantly. Importantly, FHA has not developed a formal plan to
    update the data on a regular basis. Second, FHA did not develop
    important variables such as type of loan instrument (adjustable rate or
    fixed-rate loan) and type of home (condominium or single-family home)
    that are vital to explaining expected loan performance. Third, FHA only
    used data from loans it had agreed to insure and did not include data
    from loans it rejected. As GAO points out, this will impair the ability
    of TOTAL to evaluate people with poorer credit scores and could mean
    that a higher percentage of loans that are likely to default would be
    accepted rather than referred to manual underwriting.
        In its written response to the GAO study HUD took issue with some
    of these criticisms or indicated that TOTAL's effectiveness is being
    reassessed. However, we do not know if FHA has brought TOTAL up to the
    standards needed to properly evaluate risk.
    FY 2007 Budget
        The fiscal year 2007 budget discusses the fundamental problems that
    remain with FHA's analytical techniques and brings into question FHA's
    ability to enter new, risky areas. First the budget notes that FHA does
    not have the technical ability to accurately assess risk. Specifically,
    it says `` . . . the program's credit model does not accurately predict
    losses to the insurance fund.'' A credit model is an integral part of
    an actuarial analysis and a flawed credit model will generate flawed
    actuarial results.
        The fiscal year 2007 budget document then goes on to discuss and
    provide data on the effect of not having a credit model that predicts
    losses. For the first time the fiscal year 2007 budget document reports
    that FHA had to re-estimate the value of the loans in the MMI Fund.
    Each book of loans put in the MMI Fund from 1996 through 2005--
    effectively all loans still in the MMI Fund--were re-estimated to show
    a reduction in their value compared to the original estimate that had
    been sent to Congress. The reductions were significant. The most recent
    books of business--the ones since fiscal year 2000, which comprise the
    bulk of the MMI Fund--showed reductions of more than 50 percent in
    their value to the MMI Fund. As a consequence, whereas the MMI Fund had
    been estimated last year to generate a budget benefit (referred in the
    budget as a net negative subsidy rate) of 1.8 percent, the re-estimates
    resulted in the MMI Fund only just breaking even for fiscal year 2007.
    Any worsening in the MMI Fund performance will result in the FHA
    program costing the government money in budgetary terms.
        Finally, the fiscal year 2007 budget documents note another
    recurring problem with FHA--fraud. The budget says that ``despite FHA
    efforts to deter fraud in the program, it has not demonstrated that
    these steps have reduced such fraud.'' FHA needs to remedy this problem
    before it expands into riskier programs it has not previously done.
    Industry Data
        Industry data also illustrates FHA's financial problems. Recent
    data on delinquencies from the Mortgage Bankers Association for the
    fourth quarter of 2005 shows that FHA loans have a 13.18 percent total
    delinquency rate, while prime conventional loans have a 2.47 percent
    delinquency rate. Looking only at fixed-rate mortgages the FHA total
    delinquency rate was 12.02 percent versus 2.21 percent for prime loans.
    Total delinquency rate for all subprime loans was 11.63 percent and
    total delinquency rates for subprime fixed-rate mortgages was 9.7
    percent. Given the fact that FHA does not have the technical ability to
    adequately predict losses, is just breaking even, and has substantially
    worse default rates than the prime conventional market, it should not
    attempt to enter a new and very risky area of risk-based premiums. If
    new loans are not priced correctly FHA will simply suffer more losses.
    Housing Market is Beginning to Soften
        This is the wrong time for FHA to be instituting some of the
    changes it is suggesting because the housing market is softening. Many
    academic and industry professionals have written that the housing
    market has entered a new cycle--not a market crash, but just a slow
    down in the rate of future house price appreciation in certain regions
    of the country. In other words, in many regions of the country, overall
    home prices are either remaining steady or declining, but they are not
    increasing. Declining values will dramatically increase foreclosures on
    all categories of loans and particularly on loans with low or no
    downpayments.
        Rapidly rising house prices can--and undoubtedly have in recent
    years--bailed out some bad FHA mortgage decisions. As long as the house
    can be sold for more money than it cost most people will avoid
    foreclosure and simply sell. However, when prices stop rising the FHA
    borrower, Ginnie Mae and FHA are left with the consequences of any bad
    underwriting decisions. Therefore, it is questionable whether FHA
    should now be seeking to expand its market presence and engage in risky
    activities such as risk-based premiums when the mortgage markets may
    just be turning to their down cycle.
    Proposed Changes to FHA
        The Administration proposes some key changes to FHA which MICA
    believes will hurt it financially and will push it away from the people
    it was intended to serve. We will focus on two proposals--the proposals
    to change FHA's premium to a risk-based premium and to raise FHA's base
    loan limits.
    The Pitfalls of Risk-Based Pricing
        FHA proposes to change FHA's premium structure from one that relies
    on the concept of spreading the risk (often referred to as cross
    subsidization) to one using a risk-based premium structure where each
    individual loan is priced separately. Risk-based premiums will be
    detrimental in two ways. First, they will hurt FHA's core
    constituency--low- and moderate-income people--because they will end up
    paying more for their FHA loan. Second, as noted above, FHA does not
    have the analytical capability or the financial soundness to suddenly
    start to risk-base prices in a softening mortgage market. These points
    are discussed in more detail below.
        Present Structure Works--The present FHA premium was also part of
    the 1990 reforms to FHA mentioned above. In the law, Congress
    authorized the Secretary of HUD to charge borrowers an initial upfront
    premium as high as 2.25 percent at closing and then an annual premium.
    The upfront premium can be fully financed as part of the mortgage and
    does not count as part of the borrower's loan-to-value (LTV)
    calculation. The annual premium is a cash payment paid on a monthly
    basis. It was set at 50 basis points for loans with initial LTVs below
    than 95 percent and 55 basis points for loans with initial LTVs at or
    above 95 percent. In addition, the lower the amount of the downpayment
    the longer the borrower would have to pay the monthly premium. Since
    1990, HUD has chosen to reduce its upfront premium for first some, and
    then all, FHA borrowers. Similarly, HUD has chosen not to implement a
    higher annual premium for borrowers with initial LTV ratios at or above
    95 percent. Additionally, FHA has implemented a mortgage insurance
    cancellation policy whereby for mortgages with terms of more than 15
    years the annual mortgage premium will be canceled when the LTV reaches
    78 percent provided the mortgagor has paid an annual premium for at
    least 5 years.
        The key to this system is spreading the risk because a person
    putting down for example, 3 percent, and a second person putting down
    the same amount pay the same premium even if the second person has a
    few blemishes on their credit report. As the discussion on the
    Brookings Institute data below suggests, the person with the blemished
    credit rating is often lower income. Under FHA's existing premium
    structure low downpayment mortgages are affordable for everyone because
    the risk is spread among all borrowers with the same amount of
    downpayment.
        This system also works on a nationwide basis because no one knows
    when or where a sharp reduction in regional house prices will occur.
    The MMI Fund, therefore, needs geographic distribution to support
    future regional downturns. The MMI Fund needs people in a part of the
    country with stable house prices and their premium incomes to protect
    the fund against regional house price downturns.
        A major rationale given for the FHA entering into risk-based
    pricing is that it would become able to insure subprime loans currently
    being originated in the private market. The higher risk-based mortgage
    insurance rates proposed for subprime loans supposedly would enable the
    FHA to profitably insure such business. However, given that current FHA
    business has even higher delinquency rates than the subprime market,
    both for total business as well as fixed-rate business, one could
    conclude that the higher rates proposed for new subprime market loans
    would also apply to much of future FHA business with characteristics
    similar to business originated today at current lower, non-risk-based
    rates. Therefore, risk-based pricing very probably will lead to
    effectively higher rates for a very large proportion of the current FHA
    market. Such an effect may seriously impact the FHA's mission to offer
    affordable loans to its current clientele.
        Lower Income and Minority Borrowers will be Hurt--Proposals to
    allow FHA to risk base price means that risk spreading will no longer
    exist in the FHA program. Instead, the basis for the premium apparently
    will be to a great extent based on credit scores. The higher the credit
    score, the lower the premium, and the lower the credit score the higher
    the premium. A recent Brookings study concluded that low-income and
    minority borrowers are often the ones with the lower credit scores.
    Specifically the report found that ``counties with relatively high
    proportions of racial and ethnic minorities are more likely to have
    lower average credit scores.'' The report noted that ``this evidence
    does not suggest that a bias exists, or that there is a causal
    relationship between race and credit scores, raising questions for
    future research.'' With respect to income distribution the report found
    that ``[t]he average county with a low, mean credit score had a per
    capita income of $26,636 and a home ownership rate of 63 percent in
    2000. Meanwhile, the typical county with high average credit scores had
    higher per capita incomes ($40,941) and a higher share of homeowners(73
    percent).''
        Importantly, the November 2005 report from the HUD IG mentioned
    above discussed HUD's reluctance to use credit scores in pricing loans.
    The report says, ``[m]anagement has indicated some sensitivity to
    focusing solely on credit scores because of the risk of discouraging
    lenders from underwriting loans to some of FHA's target borrowers who
    may have low credit scores.'' [Appendix A, page 7] The report goes on
    to talk about an issue discussed above and that is FHA's inability to
    properly underwrite based on credit scores because FHA does not have
    adequate data to properly evaluate borrowers. The report says,
    ``[w]ithout adequate data on borrower credit scores, FHA is unable to
    determine whether . . . declining borrower credit scores have
    contributed to significant unexpected upward re-estimates of its
    insured loan guarantee liability in recent years.'' This fact alone
    raises serious questions as to whether FHA has the historical data
    needed to include credit scores as an effective risk factor in setting
    a new premium structure.
        Borrowers are hurt by FHA's inability to control losses. FHA's
    claim rates represent families who have gone through the personal and
    financial tragedy of foreclosure. FHA should be in the forefront of
    eliminating predatory lending and MICA applauds FHA's desire to do so.
    However, careful underwriting of FHA loans, thereby reducing the number
    of foreclosures in the FHA program, is an important first step in doing
    this. As the bank regulators have noted, a predatory loan encompasses
    one that is based without regard to the borrower's ability to repay the
    loan according to its terms. Careful underwriting becomes even more
    important as FHA reduces the downpayment requirements, lowers credit
    underwriting standards and otherwise modifies its underwriting to
    extend its operations into the subprime arena.
        As noted above, claim rates on certain parts of FHA's current book
    of business are exceedingly high, as evidenced by the total delinquency
    rates for the FHA single-family program. Before FHA expands deep into
    the subprime market it is important that it determine what went wrong
    in the underwriting of its existing loans that proved to have high
    claim rates. FHA should not repeat these same underwriting problems as
    it expands into other markets.
        FHA Lacks Analytical Capabilities--The first section of this
    statement discusses in detail the various studies and reports that
    demonstrate FHA does not have the analytical ability to risk-base
    price. This analytical ability is the key to FHA's financial health.
        A mortgage insurer has two essential tools to determine the best
    way to serve the market for low downpayment mortgages and maintain its
    financial health--underwriting the loan and setting the premiums at the
    level to match the risk. If a premium is set at a very high level the
    underwriting criteria could be very liberal and, therefore, allow many
    borrowers to get mortgage loans. However, the premium is likely to be
    so high that many borrowers could not afford the loan. Conversely, if
    the underwriting is so strict that the premium is very low, while many
    borrowers might be able to afford the loan, they might not meet the
    underwriting criteria. The key to enabling a large number of borrowers
    to buy homes with low downpayments is to balance the underwriting
    criteria with the premium.
        FHA needs to work on developing its analytical systems so that it
    can understand the risk to the MMI Fund of the loans it is insuring and
    properly manage that risk through appropriate underwriting and premium
    levels. The present premium parameters set by the National Affordable
    Housing Act of 1990 give FHA flexibility to adjust premium levels to
    manage the risk of loans with varying downpayments, yet maintain the
    system of risk spreading that ensures a large pool of borrowers can
    afford FHA-insured loans. FHA simply is not ready to jump into the
    world of risk-based pricing where premium are set on a loan-by-loan
    basis.
        Note that the Congressional Budget Office (CBO) in its analysis of
    the FHA Reform bill, H.R. 5121, released on June 14, 2006, agrees that
    FHA does not have the systems in place to begin risk-based pricing. CBO
    notes risk-based pricing is ``complicated, requiring much precision in
    the underwriting process.'' CBO references the GAO report on the TOTAL
    scorecard noted above, which raised concerns about the effectiveness of
    the underwriting system that exists today and recommends improvements.
    As a result of FHA's current systems inadequacies, CBO expects that
    developing and maintaining appropriate systems for managing a risk-
    based pricing structure would take FHA several years to implement.
    FHA's Base Loan Limit Should Not Be Raised
        FHA also proposes to raise the amount of the loans it can insure in
    areas with moderate house prices from 48 percent to 65 percent of the
    Fannie Mae/Freddie Mac loan limit. When considering whether to increase
    the FHA base loan limit it is important to remember exactly why the FHA
    base limit exists. It currently covers those areas where 95 percent of
    the area median house price is less than 48 percent of the Fannie/
    Freddie nationwide loan limit. In other words, in areas where the
    median house price is, for example, $140,000, FHA will insure a
    mortgage as large as $200,000. To put this into its proper context,
    each year the Fannie/Freddie nationwide loan limit is set looking at
    house sales across the country--in both high-cost and low-cost areas.
    The limit is determined looking at transactions where borrowers made
    low downpayments and high downpayments and at transactions which
    reflect first-time home buyers getting their starter homes and move-up
    buyers using equity from their previous homes to purchase relatively
    costly homes.
        We believe that policymakers should ask ``are all of these buyers
    the ones meant to be served by FHA?'' Certainly, the composition of the
    current FHA user does not reflect all of these types of home buyers,
    and it should not. The latest FHA information for the week of May 1
    through May 15, 2006 (available on the FHA web site) notes that 79.3
    percent of the loans FHA insured were for first-time home buyers and
    29.2 percent of these were minority households. These are the type of
    borrowers that have come to be associated with FHA as a government
    program and these are the type of borrowers who may well need a Federal
    Government guarantee. The existing FHA loan limits help assure that
    these are borrowers whom lenders direct to FHA.
        The issue then to consider is whether these first-time and minority
    home buyers will still be served by FHA in low-cost areas if the base
    limit is raised. FHA's proposal would increase this amount to $271,000.
    This means in many low- and moderate-priced areas of the country FHA
    will essentially be insuring houses that are only affordable to
    borrowers with the highest incomes in the area. For example, the median
    existing house price in Binghamton, New York, South Bend, Indiana, and
    Yakima, Washington, are all reported at below $100,000 according to a
    report from the National Association of Realtors (NAR). The current FHA
    base limit of $200,160 applies in all these areas and is double the
    existing house price. Raising the FHA base limit to 65 percent of the
    GSE loan limit would move the FHA limit for these areas to $271,000 or
    almost three times their median existing house price. Areas affected
    are not necessarily small towns. For example, the NAR calculates that
    the median existing house price in the Dallas, Texas-Fort Worth-
    Arlington MSA is now $148,000 and the current FHA base limit applies to
    this MSA. Raising the base limit to $271,000 would take it to almost
    twice the median existing house price in this large MSA.
        Borrowers getting FHA mortgages with the new base limit are not
    likely to be first-time home buyers, moderate-income buyers, or
    minority buyers. The Brookings study on credit scores mentioned above
    notes that counties with higher mean incomes also had higher home
    ownership rates while counties with lower incomes had lower ownership
    rates.
        Raising the FHA base limits also means that FHA will be
    unnecessarily insuring a larger share of the homes in these moderate
    cost areas so that it will be over-exposed to economic downturns in
    these regions. If this over-exposure was being done to serve moderate-
    income first-time home buyers then, perhaps, it might be justified.
    However, by definition this will not be the case. It will be to serve
    only those borrowers who can afford the higher priced homes in their
    area. And combined with risk-based pricing, it may be done to the
    detriment of the traditional FHA borrower.
    MICA's Suggested Reforms to FHA
        In order to effectively ``modernize'' FHA, MICA believes it has to
    get back to the basics. In other words, it has to take some elementary,
    but vital steps to be able to understand and manage the risk it is
    insuring. Without the fundamental ability to understand and manage its
    risk, FHA's financial condition will so deteriorate that it could end
    up costing the taxpayers money. The following are MICA's suggested
    reforms to FHA:

      1.  FHA should develop modern systems that allow it to analyze the
            data it currently has available on its existing portfolio of
            insured mortgages and their performance. It is imperative that
            FHA follow up on the HUD IG request that it determine what
            factors are driving the current surge in its claims.

      2.  FHA should comply with GAO and HUD IG recommendations on
            improving the accuracy of its credit models. Both severity and
            frequency of claims should be assessed by loan type and
            borrower credit characteristics.

      3.  Underlying problems with the performance of downpayment
            assistance loans must be assessed and corrected. Downpayment
            assistance can be an important part of serving the needs of
            low- and moderate-income groups. An explanation is required for
            why the problems arose in the first place. The underwriting of
            these loans should be thoroughly analyzed to assure that the
            same mistake is not made again for new FHA-insured loans.

      4.  A system must be developed to update the TOTAL scorecard to
            reflect access to timely data.

      5.  Once Congress is satisfied that FHA's analytical capabilities are
            up to par with the private sector, GAO should study the
            feasibility of FHA engaging in risk-based pricing. GAO should
            initially determine whether risk-based pricing is necessary for
            FHA to serve its core constituency--lower-income and minority
            borrowers--or whether the existing premium structure which
            depends on the amount of downpayment and utilizes the concept
            of risk spreading enables FHA to help these people buy homes
            while properly managing risk. Part of analyzing this initial
            question should include whether FHA is utilizing all the
            premium options available to it under the National Affordable
            Housing Act of 1990. As noted above, current law allows FHA to
            charge higher premiums based on the amount of downpayment. It
            should also include an analysis of whether risk-based premiums
            will actually result in higher-priced loans for FHA's core
            constituency than the existing premium structure. If GAO
            determines that the present premium is a failure, it should
            make recommendations on the factors FHA should put into a risk-
            based premium.

        MICA recognizes that implementing these suggestions will require
    very skilled outside resources which will be expensive. However,
    developing these analytical tools should be its top priority to assure
    that the program can continue to operate as a budget benefit while
    providing assistance to first-time and low- and moderate-income home
    buyers. Spending FHA funds on secondary efforts should be postponed
    until such time as FHA has a better grasp on how to manage the key
    risks that exist in its portfolio of insured loans.
        We hope the members of the Committee have found this statement
    helpful.
                                     ______

             STATEMENT OF THE NATIONAL ASSOCIATION OF HOME BUILDERS
                                 June 20, 2006
    The Importance of the Federal Housing Administration
         The National Association of Home Builders (NAHB) and its 225,000
    member firms have long been steadfast supporters of the Federal Housing
    Administration (FHA). Since it was created in 1934, and for much of its
    existence, FHA has been viewed as a housing finance innovator by
    insuring millions of mortgage loans that have made it possible for home
    buyers to achieve home ownership. Without FHA, many of these buyers
    would have had to delay their purchase, been unable to purchase a home,
    or would have done so at an unnecessarily high cost.
        FHA matters for a lot of reasons, not the least of which is that
    throughout its more than 70-year history, FHA's single-family mortgage
    insurance programs have served home buyers in all parts of the country
    during all types of economic conditions. Moreover, FHA has done this
    without any cost to America's taxpayers.
    FHA's Growing Irrelevancy
        Over the past two decades, the popularity and relevance of FHA's
    single-family mortgage insurance programs have waned as FHA's programs
    have failed to keep pace with competing conventional mortgage loan
    programs. In many respects, this is due to statutory and regulatory
    constraints that have limited FHA's ability to respond to the needs of
    borrowers who might have otherwise chosen FHA.
         All too often, the differences between FHA's requirements and
    those for conventional mortgages have been viewed by lenders,
    appraisers and others as a disincentive to use FHA programs. Likewise,
    FHA's unique and often burdensome requirements have caused many home
    builders to avoid using FHA's programs to build homes--including
    condominiums--that otherwise would have been well-suited to borrowers
    who planned to use FHA-insured mortgage loans.
         Furthermore, FHA's lack of responsiveness to market needs has
    created opportunities for predatory lenders to charge unreasonably high
    fees and interest rates to borrowers who, despite limited cash
    resources and/or tarnished credit, could have qualified for market-rate
    FHA-insured loans.
         The recent decline in FHA mortgage insurance activity, both in
    real terms and when measured against conventional loan programs, is
    bothersome in other respects as well. For example, FHA-insured loans
    serve as collateral for mortgage-backed securities issued by the
    Government National Mortgage Association (Ginnie Mae), which, like the
    FHA, is part of the U.S. Department of Housing and Urban Development
    (HUD).
         Ginnie Mae serves a vital role in America's housing finance system
    by providing liquidity for lenders to offer mortgages that are insured
    or guaranteed by FHA and other government agencies. Because the bulk of
    Ginnie Mae securities are backed by FHA-insured loans, the declining
    trend in FHA-insured loan originations, if unabated, could call into
    question the viability of the Ginnie Mae program.
    FHA's Revitalization Bodes Well for Its Future
        Important strides have been made to revitalize FHA under the
    leadership of Assistant Secretary for Housing/FHA Commissioner Brian
    Montgomery with the support of HUD Secretary Alphonso Jackson. NAHB was
    gratified to learn that, upon taking office in June 2005, Commissioner
    Montgomery challenged his staff to identify obstacles that stood in the
    way of more widespread use of FHA's single-family programs. The
    Commissioner, furthermore, charged his staff with the task of finding
    ways to overcome those obstacles.
         The benefits of Commissioner Montgomery's efforts are already
    being realized as FHA has aligned its appraisal requirements with
    market practices by eliminating some bothersome paperwork requirements
    that needlessly created extra work for lenders, appraisers and home
    builders simply because a home buyer chose to use an FHA-insured loan
    to finance the purchase of a home. Other steps that have made the
    program more user-friendly are FHA's new policies that increase the
    allowable loan-to-value (LTV) ratio for cash-out refinancing
    transactions and revisions to the 203(k) rehabilitation program.
    Congress Should Quickly Act To Empower FHA
        Despite these positive moves, FHA's loan limit structure,
    downpayment requirements, and mortgage insurance premium scales, which
    are established by Congress, seriously constrain FHA's ability to
    deliver the range of mortgage products that are needed for FHA to
    fulfill its mission. FHA has proven through the years that it can serve
    some of the riskiest segments of the borrowing population, and do so in
    an actuarially sound manner.
        The Expanding American Home Ownership Act of 2006 (H.R. 5121),
    which incorporates many significant concepts that were articulated in
    the Administration's fiscal year 2007 budget proposal, has received
    broad bipartisan support among members of the House Financial Services
    Committee and has been voted out of Committee for consideration by the
    full House. NAHB believes strongly that H.R. 5121 would increase FHA's
    flexibility to mold its mortgage-insurance programs in ways that meet
    the borrowing needs of unserved, underserved, and improperly served
    families and others who desire to purchase a home. These are people
    who, for a variety of reasons, either cannot get a mortgage loan or who
    needlessly pay extraordinarily high costs for mortgage credit.
    Mortgage Limits
        The limit for FHA-insured mortgages is established in statute as 95
    percent of the median home price of an area, within the bounds of a
    national ceiling and floor. FHA's single-family loan limit for the 48
    contiguous states is currently capped at $362,790, which is 87 percent
    of the Fannie Mae/Freddie Mac conforming loan limit. This limit is too
    low to enable deserving potential home buyers to purchase a home in
    many high-cost areas. Likewise, the FHA ``floor'' of $200,160, which is
    indexed at 48 percent of the conforming loan limit, sets and
    unrealistically low boundary in many of the markets in which it
    applies.
        The artificially low FHA loan limits restrict choices for home
    buyers who use FHA-insured mortgage loans to the lowest echelon of
    available homes throughout much of the country. In many areas, FHA
    borrowers are precluded from considering the purchase of a new or
    recently constructed home. NAHB does not believe that Congress created
    the FHA in 1934 with the intent of constraining borrowers to homes
    priced at the absolute lower end of the market. NAHB supports the
    Administration's proposals to recalibrate local loan limits to 100
    percent of the area median from the current 95 percent and to increase
    the national ceiling and floor for FHA loan limits to 100 percent and
    65 percent, respectively, of the conforming loan limit.
    Downpayments
         One of the most common factors preventing potential home buyers
    from achieving their dream of home ownership is the lack of financial
    resources to pay the downpayment and closing costs. FHA's current
    statutory requirement for a cash contribution of 3 percent by a home
    buyer was innovative when downpayments of 10 percent or more were the
    norm for conventional loans. Recent strides in credit modeling, such as
    FHA's TOTAL Mortgage Scorecard, have made it possible to predict with a
    reasonable certainty the likelihood that a borrower will default on
    their loan and, therefore, have rendered the downpayment a less
    critical variable in the underwriting process.
        NAHB believes that Congress should grant FHA the flexibility to
    eliminate downpayment requirements for its single-family programs as
    long as the programs are operated on an actuarially sound basis. NAHB
    also believes it is important for FHA to have the flexibility to
    establish other reduced-downpayment mortgage options to more fully
    address market needs.
    Mortgage-Insurance Premiums
        Likewise, NAHB believes FHA should have the authority to set
    mortgage insurance premiums at whatever levels deemed necessary to
    maintain actuarial soundness while striving to serve borrowers who have
    a wide variety of risk profiles. NAHB was pleased that the President's
    fiscal year 2007 budget request included an initiative for a risk-based
    mortgage insurance premium and that this proposal is included in H.R.
    5121. Such a premium pricing structure would temper the current
    structure where better-performing loans are cross-subsidizing weaker
    loans in the FHA-insurance fund. The ability to vary mortgage insurance
    premiums according to risk would allow FHA to extend home ownership
    opportunities to families and individuals who currently are locked out
    of the mortgage market, while also attracting additional business by
    lowering mortgage insurance charges for lower-risk borrowers.
    Loan Maturities
        One underlying theme of FHA's revitalization is based upon the need
    to increase the affordability of the home financing process for
    prospective home buyers. By extending the maximum loan maturity to 40
    years, FHA will enable borrowers' monthly loan payments to be reduced.
    Unlike the interest-only loans that are currently popular, an FHA-
    insured mortgage loan with a 40-year maturity will ensure that some
    part of the borrower's monthly payment is used to reduce the
    outstanding loan balance. NAHB believes that 40-year maturities will
    become commonplace in the not-too-distant future and that FHA should be
    well-positioned to meet emerging market needs.
    Condominium Loans
        In many communities, condominiums represent the most affordable
    path to home ownership. Unfortunately, FHA's requirements for
    condominium loans are burdensome and differ significantly from the
    requirements for mortgage loans that are secured by detached single-
    family homes.
        For a condominium unit to be eligible to be sold to a purchaser who
    uses an FHA-insured loan, FHA requires the condominium developer to
    provide documentation related to historical and environmental reviews
    for the entire project. In contrast, on conventionally financed
    condominiums, requirements of this nature are commonly dealt with at
    the State or local level. Moreover, it is common to have townhomes that
    are sold as part of a condominium located near townhomes that are part
    of a Planned Unit Development (PUD).
        In early 2003, FHA found that its PUD approval process was
    redundant with local governmental review practices and subsequently
    dropped its PUD approval requirement. FHA's condominium approval
    processes are similarly redundant; however, FHA has been forced to
    retain these because of statutory requirements.
        These different requirements exist because condominiums and
    detached single-family homes are authorized under different sections of
    the National Housing Act and insurance for these loans is backed by
    different insurance funds. NAHB has heard from its members who develop
    condominiums that the burden of the additional and unnecessary
    requirements, and the delays encountered in attempting to comply with
    FHA's requirements, have caused them to withdraw from the FHA
    marketplace. On more than one occasion NAHB has urged HUD to move
    condominium unit financing under FHA's single-family mortgage insurance
    program. NAHB is very pleased that H.R. 5121 includes provisions which
    would unify all of the single-family mortgage insurance programs under
    one section of the National Housing Act. NAHB urges the Senate to
    include similar provisions in any FHA revitalization legislation it
    considers.
    Reverse Mortgages
        FHA's program for insuring reverse mortgages (formally called Home
    Equity Conversion Mortgages, or HECMs) is limited by unrealistically
    low limits on loan size and on annual program activity, as well as by
    restrictions on eligible homes. Currently, FHA is not permitted to
    insure HECMs on the purchase of a home.
        Reverse mortgages have become an extremely important tool for
    helping seniors take care of their housing and other financial needs.
    It allows them to access the equity in their homes without having to
    make mortgage payments until they move out.
        H.R. 5121 eliminates the current ($250,000) cap on FHA's HECM
    originations. The bill also establishes a single, national loan limit
    for the program at the conforming loan limit (currently $417,000).
        In addition, the bill contains a new provision that would allow
    seniors to receive a HECM at the time of settlement for the purchase of
    a new home. This would permit a borrower to purchase a different home
    and utilize their home equity without incurring multiple mortgage
    transaction costs. This makes sense for seniors who want to tap their
    equity through a reverse mortgage but also want to move into a more
    manageable house or a location near another family member.
        While NAHB supports the HECM provisions in H.R. 5121, we believe
    that additional language is needed to clarify the eligibility of HECMs
    for newly built homes. We understand that although the law currently
    allows HECMs for homes less than 1 year old, there is some ambiguity on
    this point. Builders are increasingly developing specialized products
    and communities for seniors, so such a clarification would help expand
    seniors' housing choices.
    Conclusion
        In closing, the National Association of Home Builders strongly
    supports FHA and its revitalization under the leadership of Secretary
    Jackson and Commissioner Montgomery. This leadership team at HUD is
    working hard at re-establishing FHA's relevance while keeping the
    program financially sound.
        On April 5, 2006, NAHB's Chief Executive Officer Gerald Howard
    testified on behalf of NAHB in support of the Administration's budget
    proposal, significant portions of which subsequently were incorporated
    into H.R. 5121. NAHB urges Congress to enact this measure
    expeditiously. With Congress' help, FHA will be empowered to continue
    its long record of serving America's home buyers.
                                     ______

                           NMHC  National Multi Housing Council
                            NAA  National Apartment Association
                                          Washington, DC, June 20, 2006
    Honorable Wayne A. Allard
    U.S. Senate
    521 Dirksen Senate Office Building
    Washington, DC.
    Via Fax: 202-224-6471

    Dear Senator Allard:

        As the Subcommittee considers legislation to modernize and update
    the National Housing Act and enable the Federal Housing Administration
    (FHA) to use risk-based pricing to reach underserved borrowers, we
    respectfully urge you to consider the impact of these types of programs
    in light of the high foreclosure rate. The government's desire to reach
    underserved borrowers is a potentially laudable goal, but the
    ``Expanding American Home Ownership Act of 2006'' would place the
    program administered by the U.S. Department of Housing and Urban
    Development (HUD) at higher risk. We anticipate that because it allows
    a credit subsidy the proposal will potentially adversely affect the
    Mutual Mortgage Insurance Fund (MMIF) and may raise costs for all FHA
    borrowers.
        HUD claims that this proposal will not cause the FHA mortgage
    insurance premium to increase because these loans will be subsidized
    with credit subsidy from other FHA loan programs. However, we are
    concerned that the other FHA loan programs cannot support the risk-
    based capital needs of these higher-risk loans over the long-term, and
    an increase in FHA premiums will indeed be necessary.
        HUD itself confirms that these loans present higher risk, and
    ultimately a higher cost, to FHA by the mere fact that the loans cannot
    be priced at current program levels and require cross-product credit
    subsidy. Such cross-product subsidy will ultimately require higher
    premiums across all loan programs to adequately fund needed risk-based
    capital accounts. In other words, despite HUD's claims, allowing FHA to
    undertake higher risk loans will inevitably increase insurance premiums
    for other borrowers.
        In addition, the proposal also expands the amortization period from
    35 to 40 years. On the face of it, it appears that this change may help
    more families get into home ownership, but in actuality, it will
    further erode the borrower's equity investment. This will negatively
    affect the partnership that home ownership requires between the lender
    and the borrower.
        Even more disturbing is the impact the bill would have on
    foreclosure rates. Foreclosures of all loans jumped 68 percent from
    February 2005 to February 2006.\1\ As of April, the national
    foreclosure rate is one filing for every 1,268 U.S. households.\2\ In
    Colorado, 1 out of every 494 households is in some state of
    foreclosure.\3\
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        \1\ RealtyTrac press release at: www.realtytrac.com/news/press/
    pressRelease.asp?Press
    ReleaseID=93.
        \2\ RealtyTrac press release at: www.realtytrac.com/news/press/
    pressRelease.asp?Press
    ReleaseID=106.
        \3\ Ibid.
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        FHA foreclosure trends are even worse. At the end of 2004, FHA
    foreclosures were at their highest level ever, more than double the
    average for the past 21 years. In the fourth quarter of 2005, FHA
    mortgages that were seriously delinquent (three or more months overdue)
    were at record levels, suggesting that foreclosures may continue to
    rise in the near-term.\4\ If foreclosures are this high under a program
    that requires a 3-percent downpayment, it is not hard to imagine the
    situation becoming even worse if Congress allows the FHA to reduce the
    downpayment even further.
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        \4\ Analysis by the National Multi Housing Council of quarterly
    National Delinquency Surveys conducted by the Mortgage Bankers
    Association.
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        Zero-downpayment mortgages failed miserably in the 1980s when tens
    of thousands of home buyers had no recourse but to abandon their house
    and mail the keys back to their lender. Despite this experience and the
    great strain it put on the nation's banking industry, here we are once
    again considering the merits of zero-downpayment loans.
        The government must also be careful not to oversell home ownership.
    The pursuit of home ownership is a worthy goal, but the time has come
    to ask whether a ``home ownership above all else and at any cost''
    policy is wise. There is a dangerous disconnect between our nation's
    housing policy and our nation's housing needs. Local mayors and
    congressional commissions agree that our top housing priority should be
    creating more rental housing, yet every year more of our limited
    resources are diverted to subsidizing home ownership. We simply cannot
    solve all of our nation's housing problems on the back of home
    ownership alone. What the nation truly needs is a more balanced housing
    policy.
        The nation's experience with the 2005 Gulf Coast hurricanes serves
    as the latest and most dramatic evidence to date of why the nation
    needs to more explicitly value its rental housing industry. When the
    nation needed to find housing for hundreds of thousands of evacuees, it
    turned to the apartment sector. The industry's response was immediate,
    creative, and generous. As a result, victims across the country are now
    starting to rebuild their lives in apartments. Without rental housing
    stock, such a massive relocation effort would never have been possible.
        Promoting home ownership is a worthy goal, but our home ownership
    programs should be structured to ``first, do no harm.'' The current
    proposals do not meet this standard. We have real housing problems we
    need to solve, and we can only do that through a more balanced housing
    policy that does not view home ownership as a panacea to all that ails
    struggling Americans. We urge the Subcommittee to carefully examine all
    of the ratifications of the proposal contained in the legislation
    before proceeding to enact changes in law that could negatively impact
    borrowers.

            Sincerely,

                                                    Doug Bibby,
                              President, National Multi Housing Council

                                        Douglas S. Culkin, CAE,
                              President, National Apartment Association