[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.
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    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:
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    \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 
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        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.
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    \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.
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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:
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    \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\
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    \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\
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    \8\ Ibid.
    \9\ Ibid.
    \10\ Ibid.
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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.
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    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\
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    \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\
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    \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\
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    \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\
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    \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 
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        Fund should be able to withstand.''\16\

    \16\ Ibid.
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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:
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    \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\
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    \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.
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    \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.
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    \20\ Ibid., fiscal year 2007 Budget, Analytical Perspective.
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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:
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    \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 
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        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\
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    \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\
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    \23\ Congressional Budget Office Cost Estimate dated June 14, 2006, 
H.R. 5121, Expanding American Home Ownership Act of 2006, p. 2.
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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.
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    \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\
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    \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\
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    \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.
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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.
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    \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.
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    \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.
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    \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.
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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.
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    \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\
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    \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.
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    \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.
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    \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 
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        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.
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    \37\ Brookings, Op. Cit., p. 1.
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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.
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    \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\
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    \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.
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    \42\ CBO Report, Op. Cit., p. 7.
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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\
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    \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.
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    \44\ CBO Op. Cit., p. 7.
    \45\ Ibid.
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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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \4\ Analysis by the National Multi Housing Council of quarterly 
National Delinquency Surveys conducted by the Mortgage Bankers 
Association.
---------------------------------------------------------------------------
    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
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