[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]




 
                  USING FHA FOR HOUSING STABILIZATION
                  AND HOMEOWNERSHIP RETENTION, PART I

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                             April 9, 2008

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-103



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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut   MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma                  KEVIN McCARTHY, California
BILL FOSTER, Illinois                DEAN HELLER, Nevada
ANDRE CARSON, Indiana

        Jeanne M. Roslanowick, Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 9, 2008................................................     1
Appendix:
    April 9, 2008................................................    89

                               WITNESSES
                        Wednesday, April 9, 2008

Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance 
  Corporation....................................................    13
Blinder, Alan S., Ph.D., Gordon S. Rentschler Memorial Professor 
  of Economics and Public Affairs, Princeton University..........    66
Dugan, Hon. John C., Comptroller, Office of the Comptroller of 
  the Currency...................................................    15
Kroszner, Hon. Randall S., Board Member, Board of Governors of 
  the Federal Reserve System.....................................    18
Montgomery, Hon. Brian D., Assistant Secretary for Housing-
  Federal Housing Commissioner, U.S. Department of Housing and 
  Urban Development..............................................    20
Reich, Hon. John M., Director, Office of Thrift Supervision......    16
Sinai, Allen, Chief Global Economist, Strategist and President, 
  Decision Economics, Inc........................................    71
Wesbury, Brian S., Chief Economist, First Trust Advisors L.P.....    69

                                APPENDIX

Prepared statements:
    Neugebauer, Hon. Randy.......................................    90
    Putnam, Hon. Adam H..........................................    91
    Bair, Hon. Sheila C..........................................    94
    Blinder, Alan S..............................................   114
    Dugan, Hon. John C...........................................   123
    Kroszner, Hon. Randall S.....................................   144
    Montgomery, Hon. Brian D.....................................   160
    Reich, Hon. John M...........................................   165
    Sinai, Allen.................................................   185
    Wesbury, Brian S.............................................   198

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    Letter from Larry Lindsey, dated April 12, 1995..............   206
    Letter from the National Association of Realtors, dated April 
      9, 2008....................................................   208
    Statement of Marc H. Morial, President and CEO, National 
      Urban League, Inc..........................................   210
Barrett, Hon. J. Gresham:
    Responses to questions submitted to Hon. Sheila C. Bair......   214
    Responses to questions submitted to Hon. John C. Dugan.......   217
    Responses to questions submitted to Hon. Randall S. Kroszner.   219
    Responses to questions submitted to Hon. John M. Reich.......   222
Kanjorski, Hon. Paul E.:
    Letter from Hon. John C. Dugan, dated May 16, 2008, providing 
      additional information for the record......................   224
Price, Hon. Tom:
    Article from The Wall Street Journal, dated April 3, 2008, 
      entitled, ``Uncle Subprime''...............................   226


                  USING FHA FOR HOUSING STABILIZATION
                  AND HOMEOWNERSHIP RETENTION, PART I

                              ----------                              


                        Wednesday, April 9, 2008

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, Waters, 
Maloney, Velazquez, Watt, Sherman, Moore of Kansas, Capuano, 
Clay, McCarthy of New York, Baca, Lynch, Miller of North 
Carolina, Scott, Green, Cleaver, Bean, Moore of Wisconsin, 
Ellison, Klein, Mahoney, Wilson, Perlmutter, Murphy, Donnelly, 
Foster; Bachus, Castle, Royce, Lucas, Manzullo, Biggert, Miller 
of California, Capito, Hensarling, Garrett, Barrett, 
Neugebauer, Price, McHenry, Campbell, Putnam, Bachmann, 
Marchant, and Heller.
    The Chairman. The hearing will come to order. I said, the 
hearing will come to order; that means people will please be 
quiet and shut the doors. People can come in or out, but the 
door has to be shut. Members of the staff, please go and shut 
that door. There is an overflow room. There isn't an overflow 
room? I apologize for the misinformation. We do share our room 
with the Appropriations Subcommittee, and that apparently 
preempted it.
    First, procedurally, under the rules of the--excuse me. Do 
not stand in the doorway. The door is either to be open or 
closed. Are there any empty seats? I would urge people to take 
empty seats. If they are set aside for someone who is not here, 
feel free to take them. There are some seats over there; there 
is a seat in the front row; and all seats are available. I 
apologize for the overflow room. We will have to make some 
arrangements in the future.
    First, procedurally, under the rules of this committee, 
opening statements are 10 minutes on each side, with each side 
having the ability to ask questions for an additional 10 
minutes. Regrettably, that is the case today, so we are going 
to have 20 minutes of opening statements on each side. I 
apologize to the witnesses. It is an important subject. I would 
urge members to be as brief as possible, but we will proceed 
now with opening statements, and I will begin with mine.
    First of all, I do want to say that those who don't believe 
in coincidence have been undercut today by the remarkable 
coincidence of the announcement by the Bush Administration of 
substantial changes in the FHA Secure Program on the day before 
our hearing. We had heretofore heard from them that they were 
pretty satisfied with it, that it was doing wonderful work. In 
February, the then-Secretary said it helped 100,000 people. We 
had heard some in the Administration say that they did not 
think that we should do anything to increase taxpayer risk.
    Now the proposal we are considering today would urge those 
who hold the loans to reduce the principal amount, a suggestion 
made first by the Chairman of the Federal Reserve, Mr. 
Bernanke, and we then said that if the principal amount was 
reduced sufficiently by the securitizers with no order from us, 
since we are not eligible or able to do that, that we would 
broaden the eligibility of the FHA and let these people come to 
the FHA with the mortgages to be financed. Some said, 
correctly, that is putting taxpayers at risk, and some pointed 
out that there are people who borrowed more money than it turns 
out they can now repay, who would be the beneficiaries of this. 
That is, they would be the beneficiaries of their mortgages 
being written down in principal by the holder, and they would 
then be able to come to the FHA under more liberal terms than 
previously. And I am pleased to see that the Bush 
Administration now agrees with that approach.
    We have some differences, obviously, in degree, but there 
does now appear to be agreement that it would be a good thing 
for the servicers to write down the principal. And the reason 
for that is, the original Administration approach was simply to 
hold off increases in the interest rate so that people could 
refinance.
    But we discovered that people who now have house equity 
less than the mortgage could not be financed, so that some 
approach has to be made to the principal. We have a substantial 
amount of agreement now, and those who think that we should do 
nothing that could theoretically or even actually expose 
taxpayers to more risk will have to deal with me and the Bush 
Administration together and we will work this out.
    There are still some differences, and we will address them. 
There is the notion of an auction mechanism, and that is 
something which evolved out of discussions we had with the 
Federal Reserve System. I know Governor Kroszner talks about 
that, and we will talk about that some more in the 
conversation. There is a question of the speed.
    But now I have one other issue I want to address. The 
linchpin of what we are doing, of what Secretary Paulson began 
doing, of what HUD Secure does, all of it begins with a 
decision by the people who hold the mortgages to write them 
down in some way, to defer. We recognize the sanctity of a 
contract. We have passed legislation in this House that will 
make it less likely that some of these mortgages will go 
forward in the future, but we are not empowered, nor should we 
be, to abrogate existing contracts, and we are not trying to do 
that. This begins with voluntary action on the part of the 
holders.
    We believe that what many of them will discover is that 
going to foreclosure would leave them worse off than if they 
were to make these arrangements. And so we encourage them to do 
that, and both the approach we take, and the approach the 
Administration is now taking offer them incentives to do that. 
It basically deals in part with the economist problem of the 
commons. That is, there are things which you might not want to 
do if you were the only one doing them, which you might be more 
willing to do if you knew that a lot of other people were doing 
them because there could be a cumulative beneficial effect. So 
we have agreed on that, but it still requires voluntary action.
    We have recently heard from some of those who are in the 
business of servicing mortgages that there is a reluctance to 
go along. One of the neighborhood advocacy groups most involved 
in this said, well, they have run into problems because they 
find that it's not the investors who are so resistant as it is 
some of the servicers. Our colleague from Delaware, not yet 
with us, Mr. Castle, proposed a bill to try and immunize the 
servicers from lawsuits if they in fact did what was 
economically responsible. But the securitizers say, well, they 
don't want that. They think it might be--as I read in 
yesterday's Congress Daily--pressure on them.
    I am troubled, and there have been people who argue that 
from the securitizer's standpoint, some of them have 
transaction fees that might be lost if these things were 
resolved. We cannot compel the securitizers--the servicers. I 
keep saying securitizers, but I mean servicers. We cannot 
compel the servicers to take certain actions, because they have 
rights. On the other hand, this committee and the House and the 
Congress are considering legislation going forward. We in fact 
put some obligations in the bill that passed this House which 
were somewhat controversial, but the bill passed the House by 
well over two-thirds, to put some obligations on those who did 
the securitizing.
    We will be acting next year, and as is now clear--Secretary 
Paulson and others have said so--we are going to have to do a 
substantial redo of financial institution regulation. I want to 
put the servicers on notice. We can't make them cooperate. But 
if we see a widespread refusal on the part of servicers to 
cooperate voluntarily in what we think is an important economy 
problem, and in which are trying to accommodate their interests 
and not be coercive, they can expect much tougher regulation in 
the future. Tough regulation is no one's first choice, and it 
should not be anyone's first choice. But if we do not get the 
degree of voluntary cooperation we want--and we are asking. We 
are trying to give incentives. We are trying to make this--the 
gentleman from Delaware who has now joined us has a bill that 
would help them to not be sued. We are trying to give them some 
economic incentive to help us stabilize the whole economy. But 
if the anecdotal evidence I have heard, that the servicers are 
resistant to cooperating, turns out to be the case, and if we 
were to get this approach adopted--and there are differences, 
but some commonality between ourselves and the Administration--
and we don't get much of a voluntary buy-in to this, then I 
have to say that the response will have to be probably more 
regulation than people might like to see.
    So I do want to put that element on notice, that they have 
the ability to influence what this Congress will do going 
forward. Because like I say, we will work as hard as we can to 
respect their contract rights to create conditions in which it 
will be in their interest to cooperate. And if that doesn't 
work, then we can't abrogate contracts, but going forward, we 
can be much more restrictive.
    The gentleman from Alabama.
    Mr. Bachus. I thank the chairman for holding today's 
hearing on proposals to stabilize the housing market, prevent 
avoidable foreclosures, and therefore stabilize the economy.
    It is important for the committee to continue to focus its 
attention on the housing market and its effect on borrowers, 
financial institutions, the economy, and communities at large. 
And we have, I think, if anything else in this past year, come 
to appreciate the interconnectivity of our different 
industries; a problem in one area becomes a problem in all 
areas.
    We have a situation today, and whether you call it a short-
term liquidity and credit crisis or whether you say we are in 
the throes of a recession, it is a serious problem, and we have 
alternatives. Any time you are confronted with a crisis, one 
alternative economically is the laissez-faire approach. You can 
let the market sort it out. Capitulation can be a very painful 
thing--sometimes refer to that as a washout--can be very 
costly. We have already apparently chosen not to do that in the 
intervention in Bear Stearns where counterparties at least have 
been--in a sense, their losses have been mitigated or prevented 
on at least a short-term basis. So we have intervened on Wall 
Street, maybe not on Main Street, but we have intervened. We 
have stepped in between what could be a very painful self-
regulation by the markets, which can be very efficient and very 
quick.
    And another approach is--another approach and the approach 
we have done, is to intervene after the fact, after we have a 
problem, after the problem has already happened. And we--that's 
what we're faced with. We all agree the problem is here. So you 
can intervene after the fact, or you can just let the market 
sort it out.
    There is a third approach, and the chairman mentioned this 
approach. I'm not--we don't have this approach in this 
situation, but we ought to remind ourselves that there's always 
a more reasonable approach than letting the market sort it out 
or government intervention, which carries with it terms like 
``bailout'' and ``taxpayer expense.'' And that third 
alternative is a regulatory environment approach where you have 
reasonable regulations, where the government sets standards of 
transparency and operations within well-defined boundaries.
    For example, in the subprime market, to prevent the fraud, 
misconduct, and misrepresentation which was rampant in the 
subprime lending market, Chairman Frank and I together began to 
collectively warn that this was happening. The industry said 
they were regulating themselves. They were doing a good job of 
it. We found that--and that's always a wonderful approach, if 
it works. If the industry will regulate itself, that's great, 
but they didn't do that.
    We passed a licensing and registration for brokers, for all 
mortgage originators. That's still over in the Senate. That 
hasn't happened. The problems we had with renegade brokers and 
mortgage originators within the banks still exist. We have done 
nothing to prevent future crises in that regard. As we talk 
about this, I hope all the regulators--and these problems, I 
have been here 17 years, and we have problems that we have all 
agreed on when I came here that still have not been 
collectively addressed. And one, I think, is one that right now 
has been some period of time, is past due, is getting together 
and coming up with some comprehensive solution that sees we 
don't--we're not up here again with a whole new round of these 
things, once the market gets liquidity again.
    Warren Buffet said that it is only when the tide goes out 
that you learn who has been swimming naked. The tide on home 
price appreciation has ebbed, and unfortunately, we are now 
seeing that everyone is exposed. The ingredients of the current 
turmoil in our economy were individual loans of borrowers and 
lenders who did not appreciate the risk. Mortgage-backed 
securities that investors and financial institutions 
overvalued, and complex structured financial instruments that 
regulators, credit reporting agencies, and investors did not 
understand.
    The consequences of these market and regulatory failures 
continue to resonate through the global economy. The focus of 
today's hearing is Chairman Frank's proposal to encourage 
lenders and investors to write down the principal on certain 
mortgages to a percentage of current market value and refinance 
those loans with an FHA guarantee, with the goal of permitting 
borrowers to remain in their homes, thus stabilizing house 
prices. He should be commended for developing a proposal that 
addresses a complex problem in a creative and ambitious way.
    Nonetheless, any plan that would require American taxpayers 
to assume the risk incurred by mortgage lenders, investors, and 
other borrowers during the runup in housing prices earlier this 
decade raises serious questions. The fundamental question and 
issue is fairness. Out of 55 million mortgages currently 
outstanding, 51 million are being paid on time. Now the 
challenge is, there are 4 million that aren't. Some of those 
are just lenders who borrowed money, and knew they shouldn't 
have borrowed it, speculators. There are others who were truly 
the victim of fraud and misrepresentation.
    But does the chairman's plan unfairly confer a benefit on 
these borrowers, some of them trying to do the right thing, 
others being very reckless, at the expense of all taxpayers? As 
I understand it, the proposal rewards some homeowners who 
assumed housing prices would continue to rise by permitting 
them to avoid the consequences of their wrong assumption. For 
these homeowners, the chairman's plan seems to me to be a heads 
I win, tails you lose, proposition. The losers are the 
homeowners and renters, investors and speculators who behaved 
irresponsibly, or who were the victims in certain cases of 
fraud, and those are the real hard cases.
    The losers, however, are going to be the homeowners and 
renters who behaved responsibly, yet will now be required or 
could be required to pony up their hard-earned dollars in a 
time of rising gas prices and other stresses to bail out those 
who did not act responsibly or were the victims of fraud. And 
if housing prices continue to decline and borrowers prove 
incapable of making the payments on their FHA-insured 
mortgages, under this plan, the taxpayers would pay.
    Mr. Chairman, this sends a dangerous message. When 
financial institutions and individuals take on excessive and 
ill-advised risk, the government will always ride to the 
rescue, or so they will assume. Sending this message now will 
only incentivize such behavior in the future, encouraging 
future severe market disruptions like the one we're living 
through today.
    None of us who owns a home enjoys watching the value of 
that asset decline. But the simple fact of the matter is that 
housing prices rose at an unsustainable rate over the past few 
years, far outstripping gains in personal income and the long-
term trend in housing price appreciation. Until the markets 
stabilize, prices will need to return to the levels ordinary 
Americans can afford. That is a beneficial effect of what we're 
seeing now. This process of market correction, while undeniably 
painful, is a necessary and unavoidable reality.
    Government intervention to impede the return to the long-
term trend line, no matter how well-intentioned, is likely to 
do more harm than good. I think kicking the can down the road 
for even a more severe day of reckoning, particularly with 
our--the deficits in government spending for the government to 
assume more liability is particularly risky.
    Finally, in addition to asking whether proposals like the 
chairman's represent good public policy, we must also ask 
ourself whether they can be implemented in practice. Critics 
have pointed out the enormous cost and time it would require to 
re-underwrite millions of new mortgages. And there remains the 
problem of existing second liens on existing mortgages while 
the chairman's discussion draft addresses--or does not address 
these issues, or not adequately.
    Thank you again, Mr. Chairman, for holding this hearing. I 
thank all of our witnesses for joining us this morning. We look 
forward to your testimony.
    The Chairman. The gentlewoman from California, chairman of 
the Housing Subcommittee.
    Ms. Waters. Thank you very much, Mr. Chairman. I'm very 
pleased about these hearings that you are holding. I think that 
we're almost a day late and a dollar short on helping the 
citizens of this country who have been foreclosed on and others 
who are facing foreclosure. And I think the proposals that you 
are bringing forth, that I am bringing forth, are good 
proposals that will finally give real assistance to the 
citizens who have been wondering what are we waiting for here 
in Washington, D.C.
    I understand that the President, this Administration, is 
announcing some proposal as of yesterday. I don't know what it 
is, but let me just say that we have all been fiddling while 
Rome has been burning. And I want to thank you for convening 
this hearing on the Federal Housing Administration and 
homeownership retention. The Administration's efforts to deal 
with this crisis have fallen short. The so-called HOPE NOW 
Alliance is clearly a failure. HOPE NOW states that it helped 
545,000 homeowners in the last half of 2007, but 33 percent 
more homeowners actually lost their homes to foreclosure during 
the same time period. In addition, through January of this 
year, HOPE NOW servicers have been loathe to reduce interest 
rates or to otherwise modify loans that are unaffordable. 
Instead, 72 percent of the homeowners being helped by HOPE NOW 
are only receiving repayment plans.
    Our current tactics, be they the Fed's monetary policy of 
reducing interest rates, or HOPE NOW's workout program, are 
simply coming up short. Plummeting home prices have left many 
homeowners with negative equity, meaning they owe more on their 
homes than they are worth. According to Moody's Economy, 8.8 
million homeowners, or 10.3 percent of all borrowers, are 
upside down on their mortgages. Goldman Sachs estimates that 15 
million homeowners could be upside down by the end of the year. 
However, these families cannot refinance into more affordable 
or sustainable loans because of tighter lending standards and 
their lack of equity.
    For months now, I have called on the Administration to do 
more to keep families in their homes. I agree with Chairman 
Frank that the time has come for the Federal Government to take 
a more active role in preventing foreclosures and rescuing our 
economy from the effects of mass foreclosures.
    We have long recognized that FHA has the potential to 
assist families in staying in their homes. That is why we moved 
quickly to pass FHA reform legislation on September 18th of 
last year. The chairman's proposal would create a mechanism to 
get lenders and mortgage holders to work with FHA and FHA-
approved lenders to write down the principal on a significant 
number of these unsustainable mortgages and allow families to 
benefit from a more affordable loan that is guaranteed by FHA. 
Using FHA as a tool for assisting homeowners to stay in their 
homes is a natural progression of the overall reform of FHA 
that Chairman Frank and I have been pushing since early in this 
Congress when I introduced H.R. 1852, the Expanding American 
Homeownership Act of 2007. I'm disappointed that the Senate 
failed to include a similar proposal to use FHA to write down 
mortgages in its housing stimulus bill.
    The proposal put forth by Chairman Frank would give 
servicers a much-needed incentive to stop the wave of 
foreclosures currently overtaking our country. In today's 
market, servicers still have reasons to either let the property 
go into foreclosure or, as it is said, kick the can down the 
road and hope that homeowners can catch up on missed payments.
    Under the chairman's plan, the lender or mortgage holder 
can have a bad loan removed from their books at a discounted 
price. Using FHA-approved lenders to buy these mortgages at no 
more than 85 percent of their appraised value would improve the 
poor decisionmaking of some servicers who still see foreclosure 
as their only alternative.
    In addition, because FHA will guarantee these loans, the 
market and home prices will begin to stabilize. The family 
would get to stay in their homes with a mortgage they can 
afford, and the Federal Government could potentially make a 
profit on these loans if and when home prices begin to 
appreciate and the homeowner decides to sell.
    Of course, I'm interested to hear the views of the 
witnesses on how this program would work in bulk. Chairman 
Frank has proposed allowing for a bulk refinance facility that 
would allow servicers to submit large numbers of loans to HUD, 
Treasury, and to the Fed for refinancing.
    Let me just say that while I appreciate very much all of 
the effort that is going into the chairman's bill, I still have 
another bill that I think may be a bit more controversial, but 
it will help the servicers to really do good mitigation. As a 
matter of fact, many of our financial institutions supposedly 
have mitigation departments, but when you call, you can't find 
a mitigator. You can't find anybody. So I have a mitigation 
bill, and the first thing in that bill, the first point of that 
bill is there has to be a telephone number, identifiable 
telephone number, that has been well-promoted, that the 
homeowners can locate and try and get some help with their 
mortgage before it goes into foreclosure.
    Of course, my mitigation bill includes in it several other 
things that I think will be very helpful in determining whether 
or not real mitigation is going on. As I mentioned earlier, 
many of the servicers are doing these very limited, almost fake 
workouts where they say, ``We will extend the payment.'' They 
are doing nothing to allow homeowners to do workouts that would 
allow them to continue the mortgage payments that they had when 
they got into the loan and before the ARMs reset.
    And so having said that, it is just fair warning that while 
we have waited too long to really get tough on this issue, some 
of us are going to have to go beyond what would be considered 
even reasonable to force some real discussion on this issue and 
see if we can't get the Members of Congress so serious about 
this issue that everybody is prepared to fight as hard as they 
can to assist the homeowners who have been waiting for us.
    I yield back the balance of my time.
    The Chairman. The gentleman from California, Mr. Royce, is 
recognized for 3 minutes.
    Mr. Royce. Thank you, Mr. Chairman. This hearing of course 
is being held during a very troubling time for our housing 
sector, a very troubling time for our capital markets. And I 
think the potential wave of foreclosures will continue to 
threaten our economy until these troubled mortgages are 
restructured.
    Because of the significant costs associated with a 
foreclosed property, we have a situation where the investors, 
the servicers, the lenders, and the borrowers all have an 
enormous monetary incentive to come to the table and try to 
restructure those loans. And to that end, much progress has 
been made since last fall. The numbers I have since March 3rd 
is that the 18 loan servicers, which are the biggest part of 
the HOPE NOW Alliance, that's two-thirds of the mortgage 
industry for both prime and subprime loans, have helped over 
one million homeowners, 1,035,000 people, rework their loans 
and stay in their homes.
    Now if you look instead at the proposals being discussed 
here to empower the FHA to ensure a greater share of the 
outstanding mortgages, one of the concerns I have there is that 
this would transfer a lot of this risk--which is currently 
spread to investors all over the globe; institutions all over 
the world hold this risk, many institutions in Europe and many 
in Asia--onto the backs of the American taxpayers. And parties 
would be discouraged, in all probability, from renegotiating 
the terms of their contract through the HOPE NOW Alliance. In 
other words, if you're a lender or you're a borrower and you 
understand that rather than a reduction in the interest rate 
and restructuring that loan, there's the opportunity 
potentially to be bailed out. My concern is that takes the 
pressure off the servicers, off the borrowers, off the lenders 
to stay at the table and work out the workouts that we have 
seen in over a million loans.
    Also, the FHA and the CDBG, these are two government 
agencies which are expanded under the various proposals being 
discussed, and these are agencies that have struggled with 
mismanagement and improper uses of funds over the years and 
have cost the taxpayers billions of dollars in that regard.
    So, in closing, we have a program that we know have helped 
restructure over a million loans. We have raised the conforming 
loan limit for the GSEs through the end of the year. The 
Federal Reserve has lowered the Fed Fund's rate by 300 basis 
points, which continues to provide more needed liquidity to the 
market, and I believe Congress should avoid undermining the 
progress being made. We should do more to encourage those 
lenders and servicers and borrowers to get to the table, but we 
should allow those actions to play out rather than pull the rug 
out of the incentives that we want to create there and instead 
send a different message, a different message to the market to 
pull back away from those agreements and instead wait to see if 
you can have a bailout. I think that is a bad policy. I look 
forward to hearing from our panel of witnesses today, and I 
yield back the balance of my time.
    The Chairman. The gentlewoman from New York, the chairman 
of the Financial Institutions Subcommittee, is recognized for 2 
minutes.
    Mrs. Maloney. Thank you. I welcome this hearing and support 
this very necessary legislation. New problems in the economy 
are popping up like a not very funny version of whack-a-mole, 
as Alan Blinder, a former Vice Chair of the Fed, recently 
observed, who will be testifying on the second panel.
    The decline in home prices is causing banks to readjust 
their balance sheets and to build up capital, which is at the 
core of the liquidity crisis. Economists warn that containing 
financial volatility will be difficult until housing prices 
stop falling, which is why Congress is working on solutions to 
keep people in their homes and avoid a deep downturn.
    The Administration says it wants to use the FHA to help 
people and to help homeowners, too, but to date, the 
Administration's plan, FHA Secure, has helped fewer than 3,000 
people, a tiny and inadequate drop in the bucket. Today we 
learned that the Administration plans to expand FHA Secure 
without, they say, any investment of government funds. But to 
me, their math just does not add up. I have serious questions 
as to how substantially more homeowners can be helped through 
the FHA without an infusion of government funds. And I refer to 
an article in the Wall Street Journal that outlines this new 
program.
    The crisis in the housing market has brought to light the 
inability of our most sophisticated and respected institutions 
to measure their exposure to opaque assets, and more 
importantly, to manage the risk associated with them. The 
Federal Reserve has recently come under fire for making a $29 
billion line of credit available to J.P. Morgan Chase to 
acquire the investment giant Bear Stearns. This action to head 
off a sudden collapse of one of the Nation's largest investment 
banks very likely prevented widespread financial panic, and a 
potential domino effect among other financial institutions.
    Now that we have helped Wall Street, I believe it is time 
that we help Main Street. And we have a bill, an important bill 
before us today that does just that.
    I just wanted to mention--I would like to reference a 
report on the need to have helped Bear Stearns, and I will put 
it in the record without any comment.
    But just finally, we need to move quickly to keep families 
in their homes and to blunt the devastating effects of this 
weakening economy.
    The Chairman. The gentleman from Texas is recognized for 2 
minutes.
    Mr. Hensarling. Thank you, Mr. Chairman. I fear the bill 
before us may offer short-term gain to a few and promise long-
term pain to many. We all know that there has been an economic 
wreck in our housing market. And as a Nation, the sooner we can 
clear away the rubble, the sooner that we can rebuild this 
market. However, that is unlikely to happen, as many borrowers 
and lenders and investors and trustees all sit on the sideline 
awaiting their expected congressional bailout.
    I mean, why should anyone help clear away the rubble that 
they may have helped cause if somebody else can be forced to do 
it for them, namely the U.S. taxpayer. And we cannot legislate 
away losses as much as we would like to. But apparently, we can 
redistribute them. And I fear that is the thrust of the bill 
that is before us today; putting taxpayers at risk for over 
$300 billion, which could be equivalent to a tax increase of at 
least $2,000 per American family. Now this is on top of the tax 
increase that American families will see that was included in 
the last budget passed by Congress, which is roughly $3,000 per 
family.
    This bill can also exacerbate even a greater crisis, and 
that is the spending crisis which CBO, OMB, and GAO all say 
threatens the next generation with a tax burden double our own, 
meaning that there could be fewer housing opportunities for 
future generations. Again, short-term gain for some, long-term 
pain for many.
    This bill has many interesting features, not the least of 
which is that it will clearly help bail out Wall Street as 
investors quickly dump their worst performing assets on 
taxpayers, yet it will ignore much of Main Street, those who 
paid off their homes, those who rent their homes, or those who 
made prudent decisions not to buy more home than they can 
afford; in other words, 98 to 99 percent of America.
    The most important policy decisions we could make to help 
the housing market would be to forestall the automatic huge tax 
increases that are in the system, bring certainty to the 
marketplace, and lower capital gains tax rates to add liquidity 
to the market.
    I yield back, Mr. Chairman.
    The Chairman. The gentleman from Georgia is recognized for 
2 minutes.
    Mr. Scott. Thank you, Mr. Chairman. This is indeed a very 
timely and an important hearing, and I think that just to set 
it in its stark reality, we are faced, ladies and gentlemen, 
with the worst economic crisis, particularly in terms of 
liquidity, since the Great Depression. And we need to face this 
urgency with that stark reality.
    One of the examples that we moved very swiftly with in 
terms of helping Bear Stearns, that was important logic. That 
was important to do. But we need to apply that same logic to 
helping homeowners and families. And that logic was this. If we 
failed to help Bear Stearns, it would have had a cascading 
effect. We are the leading financial world market in the world 
here in the United States. If we had not worked very 
vociferously in the government with a strong arm to come in and 
to save Bear Stearns, there would have been a worldwide 
collapse.
    Well, that same logic must apply to home mortgages and 
families. And it's particularly true because within the next 3 
or 4 years, there are going to be about 2 million mortgages 
that are going to be reset because of these teaser rates, and 
these adjustable mortgage rates are going to be reset, and 
that's going to have a very serious, calamitous effect on the 
economy.
    So this move, this bill, is very important. FHA is at the 
centerpiece of it. It's very important that we move 
forthrightly and deal with this housing and mortgage crisis 
with the urgency that we moved with Bear Stearns. To do 
otherwise would be forfeiting our great responsibility to the 
American people. And the American people are watching to see if 
we apply the same logic. If it works for Bear Stearns, then it 
ought to work to help American families and homeowners.
    Thank you, Mr. Chairman.
    The Chairman. We are running out of time on this side, but 
we will accommodate the last three members for 1 minute each, 
but we are going to have to hold to that. The gentleman from 
Texas, Mr. Neugebauer, for 1 minute.
    Mr. Neugebauer. Thank you, Mr. Chairman. Several points 
have been made that I would make, but what I would say is that 
we have to be very careful that we make policy in this country 
that starts picking winners and losers. Many people have 
suffered the devaluations of their stock portfolios, but it's 
not the role of government to come in and make sure that 
everybody makes a profit, nor is it the role of government to 
make sure that everybody's home value goes up.
    A lot of people are currently making their mortgage 
payments today all across the country and the value of their 
homes has gone down. What the marketplace is really waiting for 
Congress to do is get out of the way. How we got to the highest 
homeownership in the history of country was not because the 
Federal Government was providing opportunities for people to 
own homes. It was because the marketplace was providing 
opportunities for people to own homes, and we had a financial 
market that was financing those.
    One of the things that we cannot do is take people and 
create equity for them. That is not the role of government, nor 
do the American taxpayers who have been paying their mortgage 
payments, who bought their homes at a certain time, think it is 
fair that now because they bought theirs last year or 2 years 
ago, that somehow the Federal Government now is going to make 
these new homeowners whole. And so I think we're going down a 
very slippery slope here, and I would hope members would give 
serious consideration to what we are doing here.
    Thank you.
    The Chairman. I apologize, but, you know, it's 20 minutes 
that's coming out of other members' time on your side when we 
do this, because we're already slightly over, frankly. The 
gentleman from Texas, Mr. Green, for 2 minutes.
    Mr. Green. Thank you, Mr. Chairman. Mr. Chairman, there are 
many who conclude that we're in this crisis because of some of 
the deregulation that took place in the 1980's, which allowed 
exotic products such as 3/27s and 2/28s to come into existence. 
And as a result, there are persons who conclude that we ought 
to have some hand in trying to make whole or make right the 
circumstance that we in part created.
    I believe that this plan, as I have viewed it, is 
voluntary, and it does not require that institutions who hold 
loans do certain things. It merely gives them an inducement to 
do things that can be of benefit to the consumer, who happens 
to be the borrower. In my district, I hear hue and cry from 
persons who are concerned about this issue, and they are indeed 
asking that Congress get involved and do something to help 
prevent this crisis from becoming an even more severe crisis. 
We're talking about the possibility of a recession. There are 
some people who are already living in a depression.
    I yield back the balance of my time.
    The Chairman. The gentleman from California, Mr. Miller, 
for 1 minute.
    Mr. Miller of California. Thank you very much. There is no 
doubt that we are facing a severe liquidity problem today. 
Every housing recession I have experienced has been a little 
different. The mid-1970's was one way, the 1981 recession, 
prime went to 21 percent. You could get money, you just 
couldn't afford to borrow the money. The recession of the 
1990's, very difficult recession also. And I guess it's a 
housing recession if your house is in foreclosure. If it's not, 
you aren't that concerned about it.
    The biggest problem we have today is liquidity. We have to 
do something to create liquidity within the marketplace, and 
that's the whole purpose of GSEs to begin with, to make sure we 
do have liquidity. I think we made a right move and we need to 
make it permanent in raising conforming loan limits in high-
cost areas, FHA, Freddie Mac, and Fannie Mae, those are hugely 
important to getting the market to turn around.
    I don't understand the bulk refinancing programs proposed 
in this bill. I need to talk to the chairman about that to 
understand. I am kind of concerned about that a little bit. I 
don't know also how we impact the market if we're taking 85 
percent of what the home is worth in the market value. Does 
that somehow in the future impact appraisers when they're going 
out appraising the market value of a home? Is the appraiser 
going to say, well, the market value should be 500 but it's now 
425, because that's what lenders are taking to pay off the 
debt? I don't know those answers to those questions, but I 
think it is something we have to get to.
    Thank you.
    The Chairman. I thank the gentleman. The final 1 minute 
goes to the gentleman from California, Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman. Mr. Chairman, you 
referenced a coincidence with the Bush Administration 
yesterday. I think there was another coincidence yesterday, 
which was the information that apparently Citibank may have 
reached a deal with private equity firms to buy $12 billion of 
their troubled loans. And it raises for me three questions 
here, which I hope to ask over the next 2 days as we have these 
hearings. One is, who are we bailing out here? Are we really 
bailing out truly disadvantaged troubled homeowners, or are we 
bailing out Citibank? Are we adding advantage to private equity 
firms? What are we doing here?
    Second, how do we avoid adverse selection if we are 
offering to have the FHA to take over certain loans? And third, 
is this kind of--I would say secondary, except it's really kind 
of a third tier market for these troubled mortgages developing 
already as we saw yesterday with some private equity firms.
    And so with that, I yield back, Mr. Chairman.
    The Chairman. I thank the gentleman, and we will now begin 
with our panel. Let me say as we begin that I am very grateful, 
especially to our colleagues in the bank regulatory area. I 
don't want to put words in anybody's mouth, and people have 
their own independent views, but every one of the agencies 
represented here has been very helpful. And without signing on 
in principle, we have found both the public and private 
comments and the availability of the staffs of all the agencies 
very helpful. Because I think there are a number of ideological 
issues, there are some practical issues, and I am very grateful 
to the staffs of all the regulatory agencies and to the heads 
of them for making them available so that we can come together. 
And I will say that there are comments that were made by all 
the regulators that, frankly, before we began to put this bill 
together I think you will find much of what you said reflected 
in the bill, not always necessarily the way you like it, but 
then, as we age in particular, we are not always entirely 
pleased by our reflections, but they are nonetheless our 
reflections.
    We will begin with the Chair of the Federal Deposit 
Insurance Corporation, Ms. Bair.

 STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN, FEDERAL 
                 DEPOSIT INSURANCE CORPORATION

    Ms. Bair. Thank you, Chairman Frank, Congressman Miller, 
amd members of the committee. I appreciate the opportunity to 
testify today.
    The problems we face in the housing and credit markets were 
caused by a very complex set of interrelated events. Steps 
taken to date have helped, but more proactive approaches are 
needed to stop the escalation in foreclosures and to restore 
stability to housing markets. We do need more intervention, and 
to be honest, it will probably cost some money. No single 
solution can fully address the problem. Resolving these issues 
will require a number of strategies for the different segments 
of the mortgage market.
    The FDIC has aggressively advocated systematic, voluntary 
loan modifications to deal with millions of unaffordable loans, 
particularly in the subprime market. While significant progress 
has been made, it must be acknowledged that the pace has been 
too slow to achieve the scale necessary to contain broader harm 
to communities and our economy.
    I think all of us are painfully aware of the extent of the 
damage and the ongoing effects on virtually every State in the 
union. So in the time remaining, I would like to make a few 
comments about the pending legislation.
    The proposal by Chairman Frank addresses many of the 
principles the FDIC considers necessary for an effective 
program. It converts troubled mortgages into loans that should 
be sustainable over the long term and convertible into 
securities. It requires that investors recognize current 
losses, while preventing borrowers from being unjustly enriched 
if home prices appreciate. It uses existing government and 
market structures, which should allow the program to be 
implemented more quickly. And the legislation provides a 
financial cushion in the program to help insulate the Federal 
Housing Administration and taxpayers from losses.
    Still, there are some specific issues that need to be 
addressed, we feel. A major obstacle to refinancing many 
troubled first mortgages is that a significant percentage of 
them are subject to second liens. Resolving this issue is 
essential to ensuring the effectiveness of any proposal.
    A second concern is whether the FHA, at least in the short 
term, will have adequate capacity to run the program.
    Third is the unintended consequence of promoting adverse 
loan selection, which could increase the potential of losses 
for the program.
    And a final issue, which Chairman Frank already mentioned, 
was the incentives or lack of incentives for servicers to 
modify loans. The reality is that the success of this proposal 
in achieving scale restructurings depends on servicers devoting 
significant resources to writing down these loans.
    In my prepared testimony, we have made suggestions for 
addressing many of these issues. These include holding back a 
certain portion of refinancing proceeds which would then be 
released to investors and servicers over time, depending on the 
continued performance of the loan.
    The FDIC supports long-term solutions that fairly share the 
costs and risks of modifying or restructuring loans that use 
existing government market systems and that mitigate the 
potential exposure to taxpayers. The FDIC is committed to 
working with this committee and others in Congress to find the 
right combination of strategies to stem the rising tide of 
foreclosures and corresponding declines in home values.
    I think all of us share the goal of restoring health and 
vibrancy to mortgage markets and to repairing the damage done 
to America's promise of owning a home.
    Thank you very much.
    [The prepared statement of Chairman Bair can be found on 
page 94 of the appendix.]
    The Chairman. The Comptroller of the Currency, Mr. Dugan.

 STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER, OFFICE 
               OF THE COMPTROLLER OF THE CURRENCY

    Mr. Dugan. I appreciate the opportunity to testify today 
concerning the draft FHA Housing Stabilization and Home 
Ownership Retention Act of 2008.
    Today's hearing takes place in the context of broad efforts 
by the government, the industry, and community organizations to 
respond to challenges presented by rising rates of foreclosure. 
The Act would establish a new program that would provide a 
distressed borrower who could no longer afford his or her 
mortgage and the holder of the mortgage with an alternative to 
the costly prospect of foreclosure.
    This program has three key elements. First, if the borrower 
and mortgage holder agreed, and the borrower met certain 
criteria, the mortgage holder would reduce the mortgage 
principal to an amount that would be affordable for the 
borrower. Second, the mortgage holder would accept the 
corresponding loss. And third, the mortgage would then be 
refinanced into a new FHA-insured mortgage product at the lower 
amount.
    The concept is that the alternative would be less costly 
than foreclosure for many such loans, which would be the 
incentive for mortgage holders to agree to it; that it would 
allow borrowers to remain in their homes with lower mortgage 
payments, which would be their incentive for agreeing to it; 
and that the written-down mortgage would be an acceptable risk 
for the government to assume in order to lessen the prospect of 
widespread foreclosures and all their related costs.
    Because the program is voluntary, the Act could be a useful 
new tool, and safety and soundness considerations for banks 
would be manageable. Each bank or mortgage holder could 
evaluate the range of risks and benefits of the new program 
relevant to its particular situation.
    If the option proved to be an attractive and less costly 
alternative to foreclosure, as intended, it could save national 
banks significant amounts of time and money, and benefit their 
borrowers and their communities. The pivotal question is the 
extent to which borrowers and mortgage holders would actually 
choose this new voluntary option. This will depend on a 
potentially complex mix of factors.
    On one hand, the direct cost of foreclosure is steep in 
most cases, with lenders' and investors' losses on foreclosure 
typically in the range of 40 percent, although this number can 
vary. On the other hand, depending on particular circumstances 
such as the amount of home price decline and the borrower's 
documented income, the direct cost from exercising the 
program's refinancing option may also be steep. We include a 
number of specific examples in our written statement to show 
that in some very plausible circumstances, exercising that 
option may or may not be less costly than foreclosure.
    Another variable is the extent of payment shock faced by 
some borrowers with adjustable rate mortgages, or ARMs. Initial 
fixed interest rates on hybrid ARMs reset to higher variable 
rates, but these rates have recently declined as key ARM 
interest reference rates dropped sharply this year. Thus, more 
ARMs may be affordable than previously envisioned so long as 
interest rates remain low.
    Nevertheless, recent property value declines have left many 
borrowers owing more than their houses are worth, sometimes 
referred to as negative equity. Foreclosures are still up, and 
it appears that negative equity is contributing significantly 
to that problem.
    Where second mortgage holders are present, refinancing 
under the new program faces additional challenges. As I explain 
in my written testimony, when a borrower has insufficient 
equity in his or her home to cover first and second mortgages, 
the second mortgage holder's objectives and incentives are very 
different from the first mortgage holder. This suggests that it 
will be essential to understand the concerns that second 
mortgage holders have and to identify incentives they regard as 
workable. The existence of private mortgage insurance further 
complicates matters.
    In conclusion, I would note that designing incentives that 
balance the needs of borrowers, lenders, and investors is a 
very complex and delicate task. There is no easy solution, and 
we have made suggestions in our written statement to address 
some of the issues we have identified.
    At the end of the day, the more constructive the options 
that stakeholders have to address the prospect of foreclosure, 
the greater the chance that homeowners can remain in their 
homes.
    Thank you very much.
    [The prepared statement of Comptroller Dugan can be found 
on page 123 of the appendix.]
    The Chairman. Next, the Director of the Office of Thrift 
Supervision, John Reich.

 STATEMENT OF THE HONORABLE JOHN M. REICH, DIRECTOR, OFFICE OF 
                       THRIFT SUPERVISION

    Mr. Reich. Good morning, Chairman Frank, and members of the 
committee. I appreciate the opportunity to testify on how to 
turn back the rising tide of home foreclosures in America, and 
particularly to offer the views of the Office of Thrift 
Supervision on the FHA Housing Stabilization and Home Ownership 
Retention Act of 2008.
    I would like to commend you, Mr. Chairman, for your 
diligence and leadership on this important subject, and also to 
thank you for the cooperative approach and exchange of ideas 
that my staff has had with yours as we and others work towards 
this essential common goal.
    In my comments, I would like to share a few thoughts about 
loan modifications, and then speak to the similarities and the 
points of departure between the OTS foreclosure prevention 
proposal and the FHA Housing Stabilization and Home Ownership 
Retention Act, which I will refer to as the chairman's bill.
    Regarding loan modifications, the data that we are seeing 
confirms that the sheer volume of foreclosures is overwhelming 
normal resolution channels. In addition, foreclosures are 
reducing the prices of other homes in affected neighborhoods, 
creating a cascading problem. We are at a crossroads in 
addressing the combined effects of reduced home prices and the 
next wave of rate resets for subprime, 2/28, and 3/27 mortgage 
loans.
    About 1.3 million American families have subprime mortgages 
that are scheduled to reset by the end of 2008. Despite a 
decline in interest rates, foreclosures among subprime 
borrowers holding these types of mortgages are expected to 
continue to rise.
    Although some loan modification programs have been 
reasonably effective, more needs to be done, and soon. That 
being said, any solutions must preserve the integrity of the 
broader mortgage markets. Although some might argue that these 
markets fuel speculative and unsafe mortgage lending, many U.S. 
consumers own homes solely because of favorable mortgage rates 
and terms received through the efficiency of the U.S. capital 
markets. We must ensure that efforts on behalf of consumers who 
entered into bad deals do not compromise the greater collective 
interest of all consumers for affordable housing finance.
    Regarding the chairman's bill, and the OTS foreclosure 
prevention proposal, both seek to preserve homeownership and 
prevent foreclosures through the use of the new FHA-guaranteed 
loans based on the current fair market value of the property.
    As we have met during recent weeks with major servicers, 
investors, and fellow regulators about the OTS proposal, we 
have done some fine-tuning in some ways that has brought our 
proposal closer to the proposed legislation. For example, we 
now think that it makes sense for borrowers to share in the 
potential upside when their home appreciates in value in the 
future as an incentive not only to remain in the home, but to 
maintain it as well, and even make improvements to get the best 
possible price upon resale.
    However, we still think that the key to success for this 
approach is for the loan servicer to have enough incentive 
through a stake in the future upside potential to be moved to 
action to save the home from foreclosure. If the servicer, 
acting on behalf of the original loan holder, does not have 
sufficient incentive, then no action will be taken, more homes 
will be lost to foreclosure, and this crucial foreclosure 
prevention effort will fall painfully short of the mark.
    In another example of fine-tuning the OTS proposal, we 
originally proposed the new FHA loan be at almost 100 percent 
of the fair market value of the home. We now believe that there 
is merit in lowering that amount to minimize risk to the FHA. 
However, if the holder of the loan takes this bigger haircut up 
front, it makes all the more sense to provide a potential share 
of the upside down the road.
    While we do not think that using FHA as a financing vehicle 
to prevent foreclosures will be the silver bullet that stops 
the housing slide, we do think that it is an important 
additional tool that lenders can use to stem the rise in 
foreclosures.
    Thank you again for having me here today, Mr. Chairman. I 
look forward to your questions.
    [The prepared statement of Director Reich can be found on 
page 165 of the appendix.]
    The Chairman. Thank you, Mr. Reich. And you accurately 
reported the degree of cooperation between the staffs, as is 
the case also, and we are very grateful to the Federal Reserve 
System, and we welcome Governor Kroszner.

 STATEMENT OF THE HONORABLE RANDALL S. KROSZNER, BOARD MEMBER, 
        BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Kroszner. Chairman Frank, Ranking Member Bachus, and 
other members of the committee, I am pleased to be here to 
discuss the efforts to address current problems in the mortgage 
and housing markets, including some aspects of the discussion 
draft of the FHA Housing Stabilization and Home Ownership 
Retention Act of 2008.
    The mortgage market has long been a source of strength in 
the U.S. economy, but it is facing very significant challenges 
today. Both delinquency and foreclosure are dramatic 
experiences for the families and communities who are affected. 
Recent declines in house prices have eroded the equity that 
homeowners have in their homes, and this has made it difficult 
or impossible for many of them to be able to refinance their 
mortgage. Tighter lending standards have also limited 
opportunities for these families to refinance.
    Moreover, when struggling homeowners cannot put themselves 
on a sustainable financial footing, neighborhoods also suffer 
because the properties are not maintained and because 
foreclosure puts further downward pressure on housing prices.
    The fact is that many borrowers having trouble making 
payments also have mortgages that are underwater, that is, have 
negative equity. This suggests that principal reductions can be 
an appropriate option in a loan modification toolkit. In the 
discussion draft, principal reductions would be facilitated by 
providing the FHA with the flexibility to ensure a broad range 
of refinancing products for a larger number of at-risk 
borrowers.
    The voluntary nature of the program assures that not only 
borrowers whom the servicer believes cannot successfully carry 
their current mortgage contracts would be considered for such a 
program.
    If the Congress decides to move down this road, it should 
carefully consider five very important issues:
    First, mitigating moral hazard. Homeowners who can afford 
to pay their current mortgage should not be encouraged to 
default in order to qualify for a write-down.
    Second, mitigating adverse selection. A robust defense 
against adverse selection, that is, the incentive of current 
servicers or lenders to send only their worst credits to 
government-insured mortgage programs, is necessary to protect 
the interests of the taxpayer.
    Third, turning the FHA into a world-class mortgage insurer. 
With modernization and expansion, the FHA could play an 
important role in relieving stress in the mortgage and housing 
markets as well as restarting the securitization markets.
    Fourth, protecting the taxpayer. Any government-insured 
mortgage offered under a refinance program needs to be 
prudently underwritten, regardless of whether the principal 
write-down is part of the deal or not. First and foremost, this 
means establishing a meaningful amount of homeownership equity. 
Second, it means using sound underwriting criteria to ensure 
that borrowers are reasonably likely to be able to repay the 
government-insured loan on a sustainable basis. Third, it means 
allowing the FHA to engage in sensible risk-based pricing of 
its mortgage insured products, including substantial 
flexibility in setting its initial premium and annual premiums.
    Fifth, negotiating the junior liens. Typically, the junior 
lien holder must agree to remove his lien in order for a 
portion of the proceeds from the refinancing or resubordinate 
his claim to the new loan. The valuation of the junior lien 
holder's claim on the property is often very difficult to 
renegotiate.
    Elements of these considerations are already reflected in 
many parts of the discussion draft. For example, Title 1 of the 
discussion draft includes exit fees, shared appreciation 
mortgages, and a relatively high debt payment to income ratio 
before the program starts in order to address concerns about 
borrower moral hazard.
    It also contains features to protect the taxpayer, such as 
widening the range of insurance premiums and creating a 
meaningful amount of borrower home equity. As for adverse 
selection, the risk-based insurance premiums paid by the 
servicer are crucial, and Title 1 could be clearer about the 
FHA's authority to use risk-based premiums.
    Other steps to guard against adverse selection could 
include adding a loan seasoning requirement, that is, for 
example, a period during which a new loan could be sent back to 
the original servicer or lender if it redefaults, and a fee 
structure that imposes costs on the original servicer or lender 
if the new government-insured loan goes bad within a specified 
period or probationary period.
    In the design and details of a principal reduction program 
based on a government-insured refinancing, it is critical to 
strike the right balance between the interests of borrowers, 
servicers, investors, and taxpayers by seriously considering 
the issues I have outlined above.
    Moreover, although principal write-downs may be especially 
germane today given the prevalence of negative equity 
positions, they are not necessary or appropriate for all 
borrowers who have negative home equity or who become 
delinquent on their mortgage.
    Given the magnitude of the potential foreclosures on the 
horizon, Congress should carefully evaluate whether to take 
additional actions to reduce the rate of preventable 
foreclosures. Properly designed, such steps could promote 
economic stability for households, neighborhoods, and the 
Nation as a whole.
    Thank you very much.
    [The prepared statement of Governor Kroszner can be found 
on page 144 of the appendix.]
    The Chairman. Thank you, Governor.
    And finally, the Commissioner of the Federal Housing 
Administration, Assistant Secretary Brian Montgomery.

   STATEMENT OF THE HONORABLE BRIAN D. MONTGOMERY, ASSISTANT 
   SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER, U.S. 
          DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

    Mr. Montgomery. Thank you very much, Mr. Chairman, and 
Ranking Member Bachus, for inviting me to testify this morning.
    Mr. Chairman, I want to say that we are aligned in our 
goals for addressing this mortgage crisis. We agree that we 
must restore liquidity to the credit markets and stability to 
the real estate markets.
    We agree that there is an appropriate role for the 
government to play, and that we must use government resources 
wisely. And we agree that we must help families in need without 
transferring risks and costs from the private sector to 
taxpayers.
    As you well know, for more than 2 years, the Administration 
has requested FHA modernization legislation to prevent the very 
circumstances in which we now find ourselves. And I want to 
reiterate that it is even more critical now that this bill be 
enacted.
    I am grateful for the support that you, Ranking Member 
Bachus, and bipartisan majorities of this committee have given 
to this important legislation. And I would urge you, I would 
ask you, to quickly reach an agreement with the Senate so the 
final bill can be sent to the President's desk.
    As you have heard previously, Mr. Chairman, there are two 
key components that must be part of the final bill. To ensure 
the future solvency of the FHA fund, the legislation must 
permit risk-based premiums, and it must prohibit seller-funded 
downpayment assistance. Foreclosures on these loans are 3 times 
as high as loans for borrowers who make their own downpayments. 
We can no longer sustain the mutual mortgage insurance fund 
without an appropriation if we do not address these problems.
    Now, while modernization should be the highest legislative 
priority, expanding the FHA Secure program administratively is 
the most appropriate and fastest means to help more families in 
need. As you know, we have been exploring options, and I would 
like to share the Administration's plan.
    We believe it is appropriately tailored to reach homeowners 
who have demonstrated their commitment to making on-time 
payments, even during times of financial stress. I want to 
emphasize that we believe it is critically important to focus 
on those homeowners who are working hard to fulfill their 
obligations.
    FHA will now back loans for borrowers who are financially 
capable, but who have a spotty credit record. To qualify for a 
standard 97 percent LTV loan, borrowers will still be eligible 
if they were late on two monthly payments, either consecutively 
or at different times over the previous 12 months.
    For borrowers who cannot meet this standard, FHA will 
permit up to 3 months of delinquency, but FHA will limit the 
LTV ratio for these borrowers to 90 percent. We will permit and 
we will encourage lenders to voluntarily write down outstanding 
principal.
    Lenders will also be allowed to make other arrangements, 
including new subordinate liens, to fill the gap between an 
existing loan balance and the new loan amount, be it a 97 
percent or a 90 percent LTV loan.
    These underwriting changes will also be coupled with a new 
and more flexible pricing policy at FHA. As you know, the FHA 
program is funded through insurance premiums that homeowners 
pay themselves. And we are rolling out a new pricing plan that 
will base new premiums on an individual's risk profile.
    This new administrative change will ensure the integrity of 
the FHA insurance fund over the long term, it will protect the 
taxpayer, and it will guarantee that FHA will be around in the 
future to help struggling homeowners. We believe that by year's 
end, this new version of FHA Secure will reach more than half-
a-million homeowners. This figure represents a substantial 
portion of the total universe of homeowners with subprime ARMs 
who are owner occupants, have documentation to demonstrate 
their ability to repay the loan, and who are not already in 
foreclosure.
    While I believe that these actions are consistent with 
parts of your proposal, I want to point out some areas where we 
do not agree.
    The mandatory write-downs remove any ability of a 
subordinate lienholder to negotiate a short payoff, and would 
severely restrict the number of lenders and borrowers who would 
participate. A simpler approach, more in line with existing 
market practices, we believe, would be more effective.
    Underwriting standards should also not be set in statute, 
and we don't believe the current proposal is sufficiently 
targeted. It mandates a loosening of the underwriting criteria 
that could also saddle FHA with too much risk. For example, the 
proposal would have lenders disregard some underwriting 
criteria, and allow borrowers with much higher debt to income 
ratios to be eligible. Preserving our administrative 
flexibility to help homeowners and protect taxpayers is 
critically important.
    The Administration also strongly opposes the $10 billion in 
loans and grants for the purchase and rehab of vacant and 
foreclosed homes. The principal beneficiaries of this type of 
plan will be private lenders who are now the owners of the 
vacant or foreclosed properties.
    Finally, we do not support proposals to create a system 
where lenders would have an opportunity to sell bad loans to 
FHA and to the taxpayer through an auction process, a 
clearinghouse, or some other wholesale mechanism. We do not 
believe that it is necessary to encourage mortgage holders to 
sell portfolios at a discount to new investors. The market does 
not need a government entity to play this role.
    Again, Mr. Chairman, and Ranking Member Bachus, while we 
disagree with some components of the bill, other elements are 
similar to the expansion of FHA Secure. These are my thoughts 
on the bill. I again stress that our common ground can be used 
to help FHA become a safe harbor for many more Americans, and I 
look forward to working with you on this committee. Thank you.
    [The prepared statement of Assistant Secretary Montgomery 
can be found on page 160 of the appendix.]
    The Chairman. Let me begin with that, Mr. Montgomery. You 
are right, there is some common ground. In particular, as I 
understand it, you are going to use your administrative 
authority to broaden the universe of people who can come to the 
FHA, and they would be people who had defaults.
    You are also agreeing that we should be asking the 
servicers or telling the servicers that were they to write down 
the principal, then the FHA would take on, I think it is fair 
to say, a greater degree of risk than before.
    Now, you have heard several members of the committee today 
be very critical of this notion of the taxpayers being at risk. 
What you are talking about is an FHA guarantee. How do you 
respond to the criticisms we have heard that we should not be 
at this right now?
    Again, these are people who, to quote some of the members 
today, borrowed more money than they can pay back. And we agree 
with you, we should be asking the holders of those loans to 
write them down, and we should let them into the FHA and give 
them a federally taxpayer-based guarantee more than we would 
have in the past. We would differ about how much.
    How do you respond to the criticism that this is putting 
taxpayers' funds at risk for people who had imprudently 
borrowed?
    Mr. Montgomery. That is precisely what we don't want to do, 
put taxpayers at risk. FHA is an insurance fund, sir, as you 
know. We have to balance the risk characteristics of all of our 
borrowers, and we want to be able to help borrowers in the 
future. There is a family somewhere in--
    The Chairman. Mr. Montgomery, let's not filibuster. I 
understand we want to help people in the future. We all want to 
do a lot of things. How do you answer the criticism that by 
expanding the eligibility so that people who have mortgage 
loans they cannot now make, we ask that they be written down in 
the principal. They now come to the FHA, and you are now going 
to extend an FHA guarantee, according to the announcement of 
yesterday, to people who hadn't previously been eligible 
because they had a default, etc.
    How do you answer the argument that this is taking people 
who borrowed imprudently, giving the lender an incentive to 
relax it, and then giving them a Federal guarantee?
    Mr. Montgomery. Yes. The point I was getting to, sir, is 
that 90 percent LTV loans in the FHA's portfolio perform very 
well. In going forward, whatever a lender and whatever the 
current borrower want to agree to, if they are underwater, as 
long as they don't have more delinquencies than I have outlined 
before, I am saying today FHA, assuming they pass our 
underwriting criteria, will step in and take 90 percent of 
that--
    The Chairman. I understand that. You are just repeating it. 
But does that not expose us to greater risk than we were before 
you announced this program?
    Mr. Montgomery. Look, there were borrowers who had no-doc 
loans, low-doc loans. Many of those--
    The Chairman. Mr. Montgomery, please just answer my 
question.
    Mr. Montgomery. I am answering. Many of them will qualify.
    The Chairman. No, you are not. Does this change, which 
expands the eligibility, waives some of the objections on 
default--does it expose us to people who are riskier than 
previously we had taken into the FHA program?
    Mr. Montgomery. Yes. Yes, sir, it does.
    The Chairman. It does. Thank you.
    Mr. Montgomery. Yes.
    The Chairman. Okay. That is the answer. And I appreciate 
your doing that. I think it is appropriate. But while there are 
some differences, we are in agreement that the current crisis 
calls for a greater risk tolerance on the pat of the taxpayer, 
which puts some taxpayer funds at risk, and the beneficiaries 
of that greater risk tolerance are going to be people who 
borrowed more than they should have.
    Let me just ask Governor Kroszner now, because one of the 
criticisms that we have heard was on this federally funded 
mechanism, essentially the notion that we should have in the 
bill, as we do, an auction mechanism. That is actually 
something, as you know, Governor, that we discussed with the 
Federal Reserve.
    You mentioned it favorably in your testimony. Would you 
explain why you think that would be a useful option for us to 
have an auction? Let me say, and I have drawn this from 
Chairman Bair, the problem with the original approach was that 
you do these loans one at a time. I mean, FHA Secure has done 
about 2,400 loans. We are talking about a very long time before 
they are done.
    There are a couple of things about the auction mechanism. 
One is a price-setting, but also, it allows you to move more 
than by onesies and twosies. But I wonder if you would address 
that issue about the desirability of that as an option, 
Governor Kroszner.
    Mr. Kroszner. Sure. Thank you, Mr. Chairman. If Congress is 
concerned that a loan-by-loan approach will not address the 
problem sufficiently, it certainly could consider adding what 
is in Title 2, and the ability to expand the program quite 
significantly so that it could operate on a larger scale.
    If properly structured, and of course this is going to be 
very difficult to address all of the concerns of moral hazard, 
protecting the taxpayer, adverse selection, in developing such 
a mechanism, it could have the potential to mitigate some of 
the turmoil in the housing market.
    And so, if you do decide to go ahead on this, it is very 
important that the agencies that are given the ability to 
implement this have the full latitude of such authority and a 
great deal of flexibility to do the implementation.
    The Chairman. Thank you, and my time is expired. I am going 
to hold members to time. We have a lot of members, a lot of 
witnesses, and a lot of interest.
    The ranking member, the gentleman from Alabama.
    Mr. Bachus. Thank you. I appreciate your testimony here 
this morning. And Chairman Bair, I thought on page 2, your 
paragraph about the complex set of interrelated causes was a 
very succinct and very accurate description, at least in my 
opinion, of what happened leading into this. And it--well, I 
will just say that. I won't go into more detail.
    I appreciate everyone's testimony. I thought it was all 
very thoughtful. And Mr. Montgomery, I want to commend you for 
streamlining FHA and making it more user-friendly. You have 
heard a lot of compliments from both sides of the aisle about 
that process, and I thank you.
    Governor Kroszner, let me ask you the first question. I 
read in the Wall Street Journal where Senator Clinton had 
compared our present situation--equated it to the lost decade 
in Japan, the Japanese economy of the 1990's. It is getting a 
lot of currency recently.
    I don't see that. I think it is just the opposite. I think 
that the banks are being aggressive in writing down their 
losses, that the regulators are being responsive. You are 
supplying liquidity. I don't think the banks or the regulators 
are in denial.
    But what are your thoughts on that? Is that, in your 
opinion, accurate?
    Mr. Kroszner. I think the various government entities have 
taken a much more aggressive stance in the United States than 
Japan did during their lost decade. I mean, just for example, 
the Federal Reserve alone has cut interest rates by 300 basis 
points. We have provided a great deal of liquidity to the 
financial system through traditional and new mechanisms, 
providing liquidity to longer term, taking a larger number of--
different types of collateral, and expanding the number of 
types of institutions that could borrow from us.
    Firms have been much more aggressive now than they were in 
Japan in writing down the problem loans. We have seen tens of 
billions, literally hundreds of billions of dollars of write-
downs that have occurred in the last 6 months alone. We didn't 
see that in Japan for many, many years.
    And also, the Congress was able to, and the Administration 
was able to move very quickly with a targeted fiscal stimulus 
package. I think all of these are very different kinds of 
responses in the last 6 months to this turmoil than we saw in 
Japan during their lost decade.
    Mr. Bachus. Thank you. I think they are very different, 
too. I think they are comparing two very different situations. 
So I agree with your response.
    Commissioner Montgomery, today--and this is the Wall Street 
Journal again; I do read things other than the Wall Street 
Journal, by the way, but I will just use it as kind of a basis 
of the question--they said ``The expansion of FHA Secure will 
be funded by risk-based premiums rather than up-front cost, 
between $10 billion and $20 billion in Chairman Frank's plan.'' 
So that is not me. That is at least--
    The Chairman. That is the objective Wall Street Journal.
    Mr. Bachus. Yes. But can you explain the difference? Is 
that a valid comparison? Explain the difference between the 
funding mechanisms for the Administration's plan versus 
Chairman Frank's plan?
    Mr. Montgomery. Well, going forward, we think our premium 
structure, as Governor Kroszner also said, needs to be based on 
risk. This is not a new concept. It is something we have been 
discussing for 2 years.
    I am going to tie in the seller-funded downpayment for one 
second because that is what is driving us to the brink of 
financial insolvency. We cannot continue to accept that without 
having some flexibility in our pricing. Now, we think we can do 
this proposal administratively, going to our statutory limit of 
2.25 on the up-front premium.
    I understand the chairman's proposal would go to 5 percent 
for those borrowers. That is something that we can certainly 
discuss going forward if it means in an actuarial standpoint 
that we could help more borrowers. Certainly that is on the 
table. I am just bound to what my current constraints are on 
premiums.
    Mr. Bachus. So this would be paid for by premiums?
    Mr. Montgomery. We are a self-sustaining agency. We take no 
taxpayer funds except to pay our salaries and expenses.
    Mr. Bachus. Will all homeowners, through the payment of 
higher premiums, will they all pay more for the default of a 
few? Many on this side of the aisle, you heard this morning--
    Mr. Montgomery. I am going to say--I am sorry, sir, but I 
am going to say, going forward, a lot of the borrowers--
remember, these are not FHA borrowers. These are subprime 
borrowers who have defaults.
    Mr. Bachus. Well, yes.
    Mr. Montgomery. It is safe to say many of them would pay at 
the higher range of that 2.25. But going forward, some purchase 
borrowers may also realize a small discount that they would not 
see today.
    Mr. Bachus. So if they have a good credit history--
    Mr. Montgomery. Yes, sir. That is correct.
    The Chairman. The gentleman's time has expired.
    Mr. Bachus. Thank you.
    The Chairman. The gentlewoman from California.
    Ms. Waters. Thank you very much.
    Chairman Bair, I want to focus on the servicers. They are 
kind of in the driver's seat here. We have been talking a lot 
about them, and I think you mentioned something about 
incentives. I am not clear because I have heard that the 
servicers actually earn a profit on foreclosures. And then I am 
hearing that in order to foreclose, it costs so much money that 
you lose a lot of money on foreclosures.
    I want to know, what do you know about the truth in all of 
this, and what other kinds of incentives do the servicers need 
to do modifications? We are told we can't interfere with that 
contract that they have with the investors. So what other kinds 
of incentives do we have to get them to do real modifications?
    Ms. Bair. Well, in terms of incentives for foreclosure 
versus modification, most of the pooling and servicing 
agreements that we have looked at will provide for servicer 
reimbursement for administrative costs associated with 
foreclosure. They should not be making a profit, but they do 
provide for reimbursement from the pool for administrative 
costs associated with foreclosure.
    There are no such provisions for administrative costs 
associated with loan modifications. So, even though it is the 
fiduciary obligation of the servicer to maximize the economic 
benefit to the pool as a whole, in terms of the reimbursement 
structure, there is reimbursement for administrative 
foreclosure costs generally, and not for modification costs.
    We recommend, going forward, that pooling and servicing 
agreements be changed so that servicers can get reimbursed for 
costs associated with modification as well. But again, I 
reiterate that our view is that regardless of the reimbursement 
structure, it is the fiduciary obligation of the servicer to 
maximize the benefit to the pool as a whole. And generally that 
will mean a modified loan will perform better and have more 
economic value than a foreclosed loan.
    But we do think that--as Chairman Frank mentioned--there 
may be a way to build in some ability to reimburse the 
servicer's costs for performing loans. But we think that it 
should be tied to whether the loan actually performs once it is 
written down. I think Governor Kroszner referred to that type 
of incentive as well. I think you want to make sure that if you 
try to enhance economic incentives for servicers, that they are 
doing real write-downs and giving FHA a loan that will re-
perform over the long term.
    Ms. Waters. Have you or anybody taken a look at these 
administrative costs? One of the problems we have up here is 
with our regulators. We knew nothing about the no-doc loans. We 
didn't know the extent to which the ARMs were being offered. We 
didn't know about these exotic products. And our regulators 
didn't oversee them. They didn't tell us anything. They didn't 
warn us. They didn't vet them.
    Now we are being told that the servicers are making money 
on foreclosures. And you are saying no, they are reimbursed 
only for administrative costs. Are the administrative costs 
truly administrative costs? Do you know that? Can you represent 
to us that they are not making a profit on it, that there are 
simply administrative costs being reimbursed?
    Ms. Bair. Some servicers are parts of large organizations 
that have affiliate units that do foreclosures. There has been 
some publicity surrounding that, and there have been issues 
raised. These are not institutions that we regulate, so I can't 
really comment.
    But there are some servicers that have affiliates that 
perform foreclosure functions, and--
    Ms. Waters. Who regulates--
    Ms. Bair. I don't talk about specific institutions, but we 
would be happy to talk with your staff.
    Ms. Waters. Does anyone know who has the responsibility for 
knowing the question that I am asking about whether or not the 
servicers are making a profit on foreclosures? Who can give us 
information on that? Anybody?
    Mr. Dugan. Ms. Waters, it is my understanding that most of 
the agreements with servicers, and a number of the national 
banks that we regulate do perform servicing functions, provide 
for normal servicing costs, which is generally about 50 basis 
points, plus administrative costs. And it may include some 
overhead.
    But the whole point here is that they do have to be 
compensated for the services that they are providing.
    Ms. Waters. Yes. I don't mind compensation, if I may.
    Mr. Dugan. Sure.
    Ms. Waters. But I asked a question about whether or not 
they are making money. The problem that we have here is we 
don't understand the details and the nuances of all of the 
servicing. And I simply want to know who understands it, and 
who knows it, and it seems as if nobody does.
    I yield back.
    The Chairman. The gentleman from Illinois, Mr. Manzullo, is 
next on the list I was given.
    Mr. Manzullo. Thank you. I appreciate your coming here. And 
Mr. Chairman, I appreciate your putting out a working draft 
before moving to the exact language on your proposal.
    I have some issues dealing with the liens. The draft talks 
about eliminating existing liens on mortgages--I am sorry, 
existing liens on the title, and that those would be 
extinguished when the mortgage is refinanced. At any given 
time, I am assuming that there could be a typical mechanics 
lien on the property from somebody who put in new windows and 
was not paid for it, to a home equity lien, to a property tax 
lien because of failure to pay real estate taxes.
    I am very much interested in how eliminating these liens 
would be resolved, and if it could be resolved in something 
like that, which is similar to an 11 cramdown in bankruptcy in 
a corporate setting, the impact that this would have on the 
people who possibly gave the liens, such as the home equity 
lien, or the people who obtained the liens by way of a 
judgment, or a mechanics lien. Anybody can answer.
    Mr. Dugan. Well, I will start. It is my understanding that 
it is voluntary for the lienholder.
    The Chairman. If the gentleman would yield, that is 
correct. It is a voluntary--
    Mr. Dugan. And so what that means is in order to get the 
second lienholder to participate, I think that there is going 
to have to be some kind of concession made as a matter of 
negotiation. The reality is it would probably mean a bigger 
write-down in the value of the first loan with some negotiated 
payments to second lienholders.
    Mr. Manzullo. So it is a composition?
    Mr. Dugan. Pardon me?
    Mr. Manzullo. You are talking about a composition.
    Mr. Dugan. Well, it is a voluntary negotiated structure to 
see what it would take for them to extinguish the--
    Mr. Manzullo. Okay. And that would apply to judgment 
creditors and property tax liens and mechanics liens, anybody 
who has a lien on title?
    Mr. Dugan. I am most familiar with the second--the home 
equity lien. I don't know about the other liens.
    The Chairman. If the gentleman would yield to me?
    Mr. Manzullo. Of course.
    The Chairman. I guess the important question--yes, the 
assumption at this point is it would be--if anybody had a valid 
lien, we couldn't extinguish it. We wouldn't try to extinguish 
it. It would be voluntary. The servicer who was making the 
overall deal would have the obligation to pay it down. And if 
it was too much, and it didn't pay, then we wouldn't have a 
deal. But it would come out of the servicer's--it would be the 
servicer's obligation, or the borrower's, to make the deal with 
those people.
    Mr. Manzullo. The second question would be: If you have one 
of these proposals and there is a write-down on the mortgage 
because the property has decreased in value, what happens after 
5 years if the property increases dramatically in value? Does 
the taxpayer get stuck because they in effect put this into 
effect?
    Or does the homeowner make out like a bandit because he 
bought the house at ``X'' price, the property fell in value 
dramatically, then he got a mortgage refinancing at a reduced 
price, and then the property went up in value again. I mean, 
what happens after 5 years?
    Under the first 5 years, there is a sliding scale. But why 
should the U.S. taxpayer step in, rewrite somebody's mortgage 
because there is a loss of equity in the property, and then 
when the person goes to sell the property, there is actually a 
profit, and the taxpayer gets stuck? Anybody?
    Ms. Bair. I don't want to speak for Chairman Frank, but my 
understanding of the rationale behind it was to give the 
borrower an incentive to stay in the house and keep making 
mortgage payments. I don't think any aspect of this situation 
is fair, frankly. I think, as has been pointed out, most people 
do make their mortgage payments on time. We just have a very 
difficult situation.
    Now we have a situation where we have a lot of unaffordable 
mortgages out there, and because they are going underwater, 
there are more and more loan defaults. We are moving from an 
ability to pay to a willingness to pay situation.
    So I think even though this bill focuses on affordability, 
it recognizes that negative equity can impact the borrower's 
willingness to stick with a mortgage.
    The Chairman. If the gentleman would yield to me?
    Mr. Manzullo. Yes.
    The Chairman. I think I can address that. It is a very good 
point. There is no magic to the 5 years, and that would be one 
of the issues that--
    Mr. Manzullo. Well, my issue would be, for me to go along 
with something as dramatic like this, if you want a handout 
from the taxpayer, then be prepared to hand it back when you 
sell the property at a profit.
    The Chairman. I was trying to agree with the gentleman.
    Mr. Manzullo. That is what really bothers me about this 
legislation, Mr. Chairman, is--
    The Chairman. I was trying--if the gentleman would yield, I 
have been trying to agree with that point. But I will withdraw 
that effort if he doesn't want to be agreed with.
    Mr. Manzullo. Thank you.
    The Chairman. What I am saying is that there is no magic to 
the 5 years. And yes, that is open for discussion, but I don't 
want to say that it is not fair to put it on them because--
    Mr. Manzullo. No. I just want to make another comment is, 
you know, anybody who has bought a brand-new automobile at 100 
percent financing, the very next day it drops 20 percent in 
value. So, I mean, what is wrong about making payments on an 
item when your lien is more than the value of the property? It 
is done on $25- and $30,000 automobiles. And what is wrong with 
doing that on a house? Because the house eventually will 
appreciate in value. Just a point, Mr. Chairman. Anybody want 
to handle that one?
    Mr. Dugan. Well, I guess I was going to say that there is 
nothing wrong with that. I think the assumption is if a 
borrower can afford to make the payments, they should continue 
making the payments. It is only when they can't afford to make 
the payments, and are in threat of foreclosure, that they 
shouldn't.
    But one of the concerns expressed by servicers, and I know 
you will have a chance to ask them that question, is it may 
give an incentive for people who can afford to pay not to do so 
in the hope of getting a written-down mortgage at a lower 
amount. That is one of the issues.
    Mr. Manzullo. Thank you.
    Ms. Bair. I would also say that the write-down is designed 
to protect the government, because if FHA is refinancing these 
loans, you are building an extra cushion in case there is a 
default. There is a much better chance that, if FHA has to go 
into a foreclosure, they are going to recoup their costs.
    So building in that cushion protects the government, even 
though you are right--if the loan continues to perform, then 
under this bill, the borrower will be able to capture that 
appreciation if they remain current on their loan. But if they 
stay current on their loan, there will be no cost to the 
government. The loan will perform and FHA will not have a 
credit loss.
    Mr. Manzullo. Thank you.
    The Chairman. The gentlewoman from New York.
    Mrs. Maloney. Thank you very much.
    In order to forestall a meltdown of the financial sector, 
the Fed recently employed some creative, unprecedented, and I 
would say controversial steps to ease the credit crunch. But 
the Fed does not have a tool to address the real problem, the 
decline in home prices that is causing the banks to have a need 
to readjust their balance sheets and build up capital. And 
therefore, we have this proposal that Chairman Frank and the 
Democrats have put forward.
    I would like to thank Chairwoman Bair and Governor Kroszner 
for your supportive comments of our efforts. And I would like 
both of you to comment further on the legislation on the very 
important need that, Chairwoman Bair, you pointed out in your 
testimony, that we need to encourage incentives for lenders and 
servicers to buy in and to support this program.
    What other steps need to be taken? Obviously, if there is a 
foreclosure, there is a loss to all concerned. And what does 
the future hold for us. Is this going to work, or will the 
economy continue to decline? Will this stabilize the economy? 
Your comments, please, Chairwoman Bair and Governor Kroszner, 
and then anyone else who would like to comment.
    Ms. Bair. I think this is an important additional tool, an 
important initiative. I think Chairman Frank has tried to very 
thoughtfully structure it to build in the right incentives for 
investors and servicers and borrowers, and protect the 
government.
    It is one tool. I think we need a combination of 
strategies. But, I think this is a very thoughtful proposal. We 
have some additional suggestions. The trick will be to convince 
investors who frankly, at this point, have not been showing an 
eagerness to realize losses on these loans.
    And so the question will be whether they are willing to go 
ahead, take the principal write-down, realize the loss, and 
enable the loan to be refinanced out of the pool. The benefit 
to them, of course, is that then the credit risk is gone.
    Finding that magic number, finding those right incentives, 
I think, is very challenging. But this is a very, very 
thoughtful approach, and I think it will be a very important 
tool. I think perhaps it needs some further fine-tuning, which 
is why he has proposed it as a discussion draft. I think it 
will be a very important tool, but, we do need a combination of 
strategies. This could be very, very important.
    You know, FHA traditionally did this. Traditionally, they 
were the guarantor of low- and moderate-income loans with their 
nice, stodgy 30-year fixed mortgages, which we all fondly 
remember now. I think bringing some of this market share back 
to FHA makes sense. If there is a policy reason for government 
providing support in the mortgage area, it is probably the 
strongest with an entity like FHA and its role of supporting 
low- and moderate-income housing.
    Mrs. Maloney. Governor Kroszner?
    Mr. Kroszner. Thank you. Yes, I think it is important to 
remember that the Fed does have limited tools. Some people 
think that we have every tool available, but there are many 
tools that we don't have. I think it is important to be 
considering other actions, and that is why we have been working 
very closely with the committee on thinking about alternatives.
    The incentive issue is really the key issue, and I am 
really glad that you focused on that, because in my testimony I 
emphasize the role of moral hazard, of people taking advantage 
of a program like this. And that would be for the borrowers 
trying to get into this program inappropriately, or for 
servicers putting bad loans into the program.
    These issues have come up, and I think the bill tries to 
address some of these concerns through exit fees. This also 
addresses an earlier question that, my understanding is from 
the draft legislation, that anyone who got into this, a 
borrower who got into this program, whenever they would leave 
the home or refinance, would have to pay an exit fee of 3 
percent, even if that were beyond the 5-year horizon. So there 
would be some sort of fee that would be collected by the 
government.
    There is some risk-sharing that goes on up to 5 years, and 
obviously that could be--there is no particular magic about 
those 5 years.
    With respect to adverse selection of putting bad loans onto 
the taxpayers' books, it is very important, as a number of us 
have emphasized, to make sure that the risk premium that is 
charged, the insurance premium that is charged, is risk-based. 
And so that is one important way to protect the taxpayer, and 
clarifying that in the bill would be valuable.
    But there could be other things, things that are standard 
parts of loan servicing contracts, that if something were to go 
wrong with a loan within a specified period of time, they would 
be able to put the loan back into the servicer. So they 
couldn't just get away with putting bad loans back on.
    Given the challenges and the turmoil in the financial 
market, I think it is important for Congress to be considering 
alternative options.
    Mrs. Maloney. Thank you. My time has expired.
    The Chairman. The gentleman from Texas, Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. Undoubtedly, we on 
this committee and in the entire Congress have some very 
important policy decisions to make. And as we make these 
decisions, it is always nice to make sure that we also know the 
facts.
    I would like to review the facts as I know them, and see if 
anybody on the panel has substantial disagreement. As I 
understand it, if we took a snapshot today, we still--we have 
roughly 5 percent of mortgage borrowers who are delinquent, 
roughly 2 percent who are in the process of foreclosure. Is 
that a fairly accurate snapshot of where we are today? I don't 
see any dissent.
    I also understand that we have roughly--of 108 million 
occupied housing units in America, roughly 25 million have paid 
off their mortgage, and roughly 33 million are renters, which 
means the universe of those with mortgages is less than half of 
the families in America. Is that a fairly good ballpark figures 
for the numbers? I see a lot heads nodding in assent.
    One question I have, clearly I am troubled by certain moral 
hazard aspects of various policy solutions that I have seen put 
before me. I am curious if any of you on the panel are familiar 
with this report from FinCEN, the Financial Crimes Enforcement 
Network, entitled, ``Mortgage Loan Fraud.'' It is a fairly 
recent report. Is anybody familiar with the report from FinCEN? 
I know you are all acquainted with FinCEN. No one has read this 
specific report?
    Mr. Dugan. I am familiar with it. I have seen the press 
reports, but I have not read the report itself.
    Mr. Hensarling. Well, I reviewed this report last evening. 
And when we are looking at the different people who may be 
assisted under various legislative proposals--and I am 
unfamiliar with who might have greater credibility on the 
subject of these activities; I am sure there are folks at HUD 
who would be well acquainted as well--but according to a FinCEN 
analysis, as I read it, fraud is up over 1,000 percent. 
Mortgage fraud is up over 1,000 percent in the last 4 years, 
with over half of it being attributable to misrepresentation of 
income, assets, debts, and occupancy fraud, with a fair amount, 
28 percent, attributable to forged and fraudulent documents.
    At almost every hearing we have in this committee room, we 
hear the phrase ``predatory lending.'' But I am curious whether 
this might suggest that a fair amount of ``predatory 
borrowing'' has taken place, and that there are many borrowers 
who do not have clean hands who still might benefit 
substantially under a bill that we are considering now.
    Is anybody troubled by the moral hazard aspect of that and 
how that could affect future behavior? Does anybody care to 
offer an opinion on the subject?
    Mr. Dugan. We have seen a very sharp rise in mortgage fraud 
from a variety of different directions, not just from the 
borrowers, as you suggested, but from the purveyors of the 
products as well. I do think it's quite important that the bill 
have standards in it to screen out people who have not only had 
fraud in the past, but can't find their way into an FHA loan 
that they can't afford to repay, and I think that is what the 
standards are intended to do by the underwriting strictures 
that are in it.
    But I think, going forward, the whole notion of having to 
document income, which is I think a critical feature of this 
bill and certain of the guidance that had been put out by the 
Federal banking agencies, is part of that process and is 
absolutely critical.
    Mr. Hensarling. Although I don't have a copy of it, I was 
also reviewing a Fed study from the Boston Fed that I think is 
maybe a month or two old, dealing with the reason for subprime 
defaults. And in that particular report, it seems to make the 
point that it's not so much the reset that is causing the 
default; it is the devaluation or diminution of the value of 
the asset, which would seemingly suggest that a number of 
people entered into these financial transactions, never 
intending on being able to pay the reset, but they were banking 
on the appreciation of the asset.
    Mr. Kroszner, I suppose you may be familiar with this 
study, and if so, is that a proper take-away?
    Mr. Kroszner. Yes. I think that study really tried to look 
very carefully at the role of resets versus the role of the 
asset prices, and I think what the study suggested is that at 
least through 2007, the resets were not the key to driving the 
increase in the delinquencies and the foreclosures, but really 
these were early payment defaults, in many cases within just a 
few months of initially taking out the loan. That suggests that 
it's not the reset, which comes 2 to 3 years later, but the 
value of the property or the reduction in the value of the 
property that is driving the consumer behavior here.
    The Chairman. The gentleman from North Carolina.
    Mr. Watt. Thank you, Mr. Chairman.
    Let me direct a couple questions to Mr. Montgomery and Mr. 
Kroszner. First of all, Mr. Montgomery, I'm having a little 
trouble understanding your response to an earlier question from 
the chairman that this program would have the effect of 
exposing taxpayers to greater risk. As I understand it, this is 
an FHA-insured program, which has increased flexibility to set 
rates by FHA, and then subsequently has the potential that FHA 
can share in the sale appreciation value if there is sale 
appreciation value. I don't understand how we get under those 
circumstances to increased risk for taxpayers over what FHA 
currently has in place.
    Mr. Montgomery. FHA is a self-sustaining entity and we want 
to remain that way, so by pricing our premiums based on risk 
from an actuarial standpoint, these new modifications we want 
to make will allow us to remain a self-sustaining entity.
    In our proposal, there would be no profit at the end of it, 
so to speak.
    Mr. Watt. No, I am not talking about your proposal. I am 
talking about the proposal contained in the chairman's bill. I 
don't understand your earlier response that this bill increases 
taxpayer risk.
    Mr. Montgomery. Oh, I'm sorry if you heard that. I didn't 
say that. I said that the chairman's premium structure contains 
risk within that structure. We do the same.
    Mr. Watt. Okay. That's fine. If I misunderstood what you 
said, I just misunderstood what you said. I thought you said 
that this program would increase the risk to taxpayer--
    The Chairman. Would the gentleman yield briefly?
    Mr. Watt. I am happy to yield.
    The Chairman. I caused the confusion, so let me clarify it. 
There was some criticism aimed at the bill we had, and my point 
was that it would be aimed at the Administration--namely, that 
if we greatly underestimated the default rate, it would break 
through the barrier of the premiums, and that is where the 
taxpayer would be exposed, because the taxpayer is the backup 
to the FHA. And I was simply trying to make the point that 
would be a common factor of both.
    Mr. Watt. Okay. That helps me because--but that's the risk 
that we have now, I suppose, through the regular FHA process.
    Mr. Montgomery. That is correct.
    Mr. Watt. Okay. To the extent that insurance premiums have 
to go up or GSE is being encouraged under various programs--
GSEs are being encouraged to either take greater risks or help 
build some of these properties out, one of the concerns always 
is that we are increasing risk to other entities that are 
designed to shield the government against risk or shield 
taxpayers against additional risk.
    I'm looking at a 1999 report called, ``Over-The-Counter 
Derivatives Markets, A Report of the President's Working Group 
on Financial Markets.'' There were a series of suggestions made 
back in 1999 about how to shield GSEs, FHA, and anybody who is 
doing swaps and derivatives against greater exposure. One of 
those was to encourage a clearing process that allowed those 
swaps and derivatives to be put on a platform just like stocks. 
What is happening with that, Mr. Kroszner? Are we making any 
progress on that currently?
    Mr. Kroszner. These are very important issues, and I'm very 
glad that you raised them, because this is often what is 
characterized as the plumbing of the system, sort of the 
background that people don't see, but is crucial to the 
functioning of the system.
    And actually, in all of the credit market turmoil that we 
have seen, we so far haven't seen a problem with the clearance 
and settlement of these types of contracts. I think part of 
that is because there has been an initiative in the Federal 
Reserve System headed by the New York Fed that tried to address 
some of these issues, making sure that the clearing and 
settlement process is well-functioning, to make sure that 
trades are settled rapidly, to know who the responsible person 
is if that trade needs to go through quickly.
    There is still a large growth of over-the-counter 
derivatives, but there is still a very robust market of things 
that are on exchanges, a healthy competition between the two. 
But we have been working tirelessly to try to make sure that 
background plumbing in the over-the-counter market works as 
smoothly as it can. And so we have been heartened, at least so 
far, that the credit market turmoil hasn't turned up problems 
there, but we still need to do more work.
    Mr. Watt. Thank you, Mr. Chairman.
    The Chairman. Thank you. The gentleman from California, Mr. 
Campbell.
    Mr. Campbell. Thank you, Mr. Chairman. I think three out of 
five of you mentioned adverse selection as a potential problem 
with this, and several of you mentioned proposed ways to 
mitigate that. And I guess my question, which is for the entire 
panel, is that no matter what you do in terms of mitigation, 
doesn't someone holding this loan, Merrill, CitiBank, UBS, 
WAMU, or now Blackstone, TPG, or whomever, sit here and say, if 
it's voluntary and loan-by-loan, they say, ``All right, we have 
this loan, and the FHA will pay us `X.' If we think we're going 
to get less than `X,' give it to you. If we think we're going 
to get more than `X,' keep it.'' So that no matter what 
mitigation you do, you will have adverse selection; you must 
reduce the amount of it, based on what the money center banks 
believe the loan is worth. And I am asking any of you that.
    Mr. Montgomery. I would just say that in the case of FHA, 
one corner that we will never cut is our underwriting criteria. 
By the way, we currently have an adverse selection within FHA 
to the point I referenced earlier on the seller-funded 
downpayment assistance. By mitigating that risk, by pricing 
that risk accordingly with the premiums, we can mitigate going 
further and helping more subprime borrowers refinance through 
FHA.
    I want to be very clear that not everyone is going to be 
able to qualify because of our very rigid front-end and our 
very rigid back-end ratios. So we think we can mitigate a lot 
of that going forward.
    Mr. Campbell. Under the chairman's proposal? The 
President's proposal? Or both?
    Mr. Montgomery. Well, certainly under our proposal we--and 
I won't speak for the chairman--he has some form of risk-based 
pricing that goes even higher than us, so I'm assuming he's 
probably going to get at the same issue.
    Mr. Campbell. Yes, Governor?
    Mr. Kroszner. Yes, on this issue, adverse selection is 
extremely important, and it is a problem that is never fully 
solved even in private insurance contracts, because there is 
always the case if you were buying insurance, you're going to 
the insurance company, you may know a little bit more about 
yourself than the insurance company does. They may ask you a 
lot of questions, but they can't ask every possible question. 
And so, who is most likely to buy any type of insurance at a 
current rate? Well, the person who finds it most valuable for 
themselves.
    That is why insurance companies in the private sector 
charge risk-based premiuns; they use a variety of other 
criteria to try to screen out people who are just trying to put 
bad activities to them. And that is why something like what I 
have proposed here, if you were to go down this path, to make 
sure that there is an ability to put back a loan that goes 
badly quickly. Because if it goes badly within just a few 
months, that suggests that the servicer knew something about 
that loan that was very difficult for the FHA to find out, and 
so to have that option to put that back would be valuable.
    That's a standard part of private-sector service contracts, 
to try to mitigate exactly this moral hazard problem. It's not 
perfect, but it's an attempt to address it.
    Mr. Campbell. Anybody else with to comment? Yes, Chairman 
Bair?
    Ms. Bair. Yes. I would just note that I think it's an 
inherent issue, and it is with any kind of government program 
along these lines. We think it is important to have strong DTI 
standards--underwriting standards--as part of this, while 
recognizing that you want to be flexible to reach out to a 
broad range of borrowers. Also, put-back provisions are a 
common private-sector tool. In addition, holding some portion 
of loan proceeds back and releasing them later if the loan 
continues to perform is another way you can try to address this 
problem.
    Mr. Campbell. Okay. My second and final question is related 
to what I mentioned earlier in my opening statement about 
Citibank's apparent sale of $12 million of leverage loans off 
to private equity. I am aware of some other smaller 
transactions going on where there appears to be a market 
developing out there now where there appear to be buyers, and I 
have heard 50 cents on the dollar. I don't know what the 
numbers are, but there appear to be buyers for loan portfolios 
that are out there now.
    If this is developing, and this is going on, first, do we 
really need to do what is being proposed here? Or does this 
mean the private market is going to deal with it? And second, 
if you are Blackstone or TPG, and you buy this thing for 50 
cents on the dollar, and along comes an FHA guarantee that 
enables you to get 60 or 65 cents--and you know, maybe these 
numbers are wrong--but 60 cents on the dollar, then aren't we 
really providing an exit strategy for this secondary or 
tertiary, if you will, market?
    Mr. Montgomery. I have heard some of the same--and this is 
Title II of the chairman's bill--but we would just submit that 
FHA is not there to do these wholesale auctions of loans. I do 
want to say that obviously you do bring up one, some have 
called another moral hazard, but I want to say from our 
perspective, from the Federal Housing Administration, we just 
want to do what we can to keep that family in the home, and by 
putting these parameters around it, yes, some may benefit as 
you have described, but we think going forward, the important 
thing is that we help mitigate the ripple effect, but more 
importantly give the family a lifeline to stay in their home.
    Mr. Campbell. Governor Kroszner, do you have any comment? 
Or anybody else?
    Mr. Kroszner. Yes. I think it is very important to make 
sure that the taxpayer would be protected in any program that 
goes forward to take care of the moral hazard and adverse 
selection problems, so that the risk premia that the FHA can 
charge would accurately reflect risk on average. They may get 
individual ones wrong, but it's trying to get right on average, 
trying to deal with the moral hazard problem. That is extremely 
important.
    The Chairman. The gentleman's time has expired. Mr. 
Capuano?
    Mr. Capuano. Thank you, Mr. Chairman. Gentleman, I'm having 
a hard time following some of this, and I just want to ask some 
questions particularly relative to the moral hazard, and some 
of the concerns that I have heard mentioned. I want to be 
specific, if I can. The moral hazard you are concerned with is 
it somehow rewarding people who engaged in bad behavior, or is 
it being concerned about making sure that no one else engages 
in similar bad behavior in the future? Or is there something 
else?
    Mr. Kroszner. Well, in particular, what I had been focusing 
on with respect to the draft legislation is that you would get 
people to come into this program who otherwise aren't in 
trouble and who don't need a program like this. And so that is 
why having standards about the high--
    Mr. Capuano. So you are concerned about helping people who 
don't need the help?
    Mr. Kroszner. Yes, exactly.
    Mr. Capuano. Okay. And Mr. Montgomery, is that the same for 
you? Your concerns are that we are concerned about helping 
people who may not need the help?
    Mr. Montgomery. Yes. I would share in that concern. Ours is 
focused more at those who have missed payments and those who 
are now also underwater in their loan as well.
    Mr. Capuano. All right. So neither one of you are opposed 
to the concept of helping people. If we could all come up with 
a clear definition of who is deserving of help, or who is in 
deep trouble, would you be opposed to helping them a well?
    Mr. Montgomery. Certainly that's something we can discuss 
going forward. You know, again, ours is a measured response 
that is targeted at those--
    Mr. Capuano. I understand that. But you wouldn't be opposed 
to the concept of helping somebody?
    Mr. Montgomery. We can certainly discuss any options you 
would ask, Congressman.
    Mr. Capuano. Mr. Kroszner, would the Fed be opposed?
    Mr. Kroszner. As I said in my testimony, I think we need to 
think of creative ways to try to deal with preventable 
foreclosures, and so if there's a way to get the servicers to 
come up with good standards, to be more proactive in doing 
principal write-downs and other modifications, these are one of 
the many types--
    Mr. Capuano. So you're saying that if we get into helping 
somebody, we should then hold the industry to some sort of 
standards and requirements going forward?
    Mr. Kroszner. Well, I think one of the things that the 
industry has started already with the Treasury Department is 
the HOPE NOW Project focusing on resets, but in response to the 
earlier question--
    Mr. Capuano. No, no. I want you to respond to my question. 
Are you saying that if we get involved right now, we should 
hold people that we are going to help to certain standards, 
going forward?
    Mr. Kroszner. Absolutely.
    Mr. Capuano. All right. So then, I don't disagree with the 
general concept, but if that is the case for individual 
homeowners who are losing their homes, could you explain to me, 
then, why as we speak, right now, right this minute, the Fed is 
loaning money, billions of dollars, to people who are held to 
no standards, who are not regulated by anybody at this table or 
anybody else, and we don't even know whether they meet any 
capital requirements? Could you explain to me why we're doing 
that?
    If it's so important on the individual homeowner to hold 
them to certain financial standards, why are we not holding 
investment banks and hedge funds and others to those same 
standards as we are loaning them billions of dollars? Not we 
might, we are. Right now, right this very minute we are doing 
it.
    Mr. Kroszner. With respect to the lending facility to the 
primary dealers and lending supporting the Bear Stearns 
transaction, Congress has given us the power in unusual and 
exigent circumstances to make exactly such loans.
    Mr. Capuano. Well, that's not responsive. First of all, I'm 
not so sure we have, which is a discussion for a different day. 
If it's okay--and I don't disagree with you--I absolutely agree 
with the concept, if we're going to do something extraordinary 
that we should ask those that we are helping, both the 
borrowers and the lenders, to be held to certain standards--I 
have no problem with that, yet for some reason it's okay for 
homeowners, but it doesn't apply to investment banks. And I'm 
just curious as to why that is.
    Mr. Kroszner. Well, I don't think that's true. The--
    Mr. Capuano. So you're telling me that right now the Fed is 
holding people who are coming to the discount window that you 
do not regulate, that you're holding them to different 
standards than you held them to yesterday?
    Mr. Kroszner. You had suggested that there was no 
regulation of the investment banks. There is regulation of the 
investment banks.
    Mr. Capuano. Virtually none. I should have been more clear. 
Virtually none.
    Mr. Kroszner. The SEC does have a number of standards out 
there. They are the regulator of those institutions.
    Mr. Capuano. Yes. I know who regulates them. I know what a 
great job they have done thus far, which is exactly why you had 
to come in to save Bear Stearns. Now, I don't have any problem 
with saving Bear Stearns, and I would argue that maybe the law 
allows that; but I have some concerns about the Fed opening the 
discount window for 60 days, and not a single person here has 
said anything about it. We're all concerned about maybe taking 
a risky loan from some working stiff who is about to lose their 
home, but we're not concerned at all, we don't seem to be 
concerned one bit about making loans in the billions of dollars 
to people who actually participated and encouraged and made the 
profits, the billions of dollars of profits on those very same 
risky loans.
    And that's what bothers me. We have several standards, one 
for the typical homeowner--let's hold them to a higher 
standard--and another standard, which for all intents and 
purposes doesn't exist, to investment banks and others who 
engage in the very same risky behavior that you and the rest of 
the regulators did nothing about for the last 6 years. My time 
has expired.
    The Chairman. The gentleman's time has expired.
    Mr. Marchant, you are next on the list.
    Mr. Marchant. Thank you, Mr. Chairman. My question is for 
HUD, Mr. Montgomery. Mr. Montgomery, in my time on this 
committee and in watching all the programs, HOPE NOW, and all 
of these programs that come out, it seems that the major 
problem comes in the implementation stage, and I'm trying to 
get a handle on who would be the person in Mr. Frank's draft 
bill, what party will instigate the request for the loan to be 
reappraised, bought, and then recast?
    Mr. Montgomery. I don't want to speak for the chairman, but 
I could say for FHA's part, what is happening now with people 
who are looking to refinance, either they contact us, or they 
contact a lender or a servicer. It all depends on the 
borrower's behavior. You know, a lot of borrowers who are in 
dire straits never contact anyone. So for our part, it could be 
any number of parties who would initiate it.
    Mr. Marchant. So it couldn't solely be the servicer? The 
servicer could not come forward and say I have this loan, this 
loan is in trouble. I would be willing to put this loan into 
this program and will HUD buy the loan from me?
    Mr. Montgomery. As is the case now, there's a current 
mortgage or obviously they have to agree to some sort of 
refinancing mechanism, and any subsequent other lienholders as 
well.
    Mr. Marchant. So in this bill, how much does the homeowner 
have to say about the actual refinancing? Because if you have, 
let's say you have 2 million loans that are rolling over in the 
next 6 months, and let's say that there's a reasonable 
expectation that for a good number of those, the interest rate 
will put the borrower into a situation where they may have to 
default. Will it be the borrower who will step forward and say, 
``I would like to take advantage of the provisions of the Frank 
bill?'' Or will it be the servicer who steps forward and says, 
``I would like to take advantage of the provisions of the Frank 
bill?''
    Mr. Montgomery. I can't speak to what the chairman's bill 
does in that respect. I would say that as is the current 
practice, in most cases it is the mortgagor who is in the 
subprime loan, or whatever loan right now, who wants to 
refinance with FHA, and does so through their lender, who then 
works--it has to be an FHA-approved lender, obviously, who then 
starts the process there.
    So certainly a servicer, as we have discussed, has a say in 
that process as well, especially to the degree that we want to 
do a write-down of that principal, again whether it's a first 
lien or second lien.
    Mr. Marchant. So what is the practicality of $300 billion 
worth of loans being--either the servicer or the borrower 
coming forward and saying, ``We want to rework this loan; we 
need to go get an appraisal; we need to get title work; we need 
to knock out the seconds, and we need to re-originate this loan 
with sophisticated loan documents that carry a silent second,'' 
and you know, what is the practicality of getting those loans? 
Are they going to come one by one? Are they going to come in 
big bundles? Is the servicer going to have the ability to 
advertise on TV that, you know, if you qualify for this 
program, come in, and then they are going to bundle them up and 
send them to you like in a Ginnie Mae commitment? What are the 
mechanics of how HUD will end up with those--will they be 
Ginnie Mae instruments eventually?
    Mr. Montgomery. Well, for our part, they would certainly 
be, you know, backed by the full faith in credit. They would be 
Ginnie Mae's. You know, one or two, whatever particular pool.
    But you did bring up the issue of the $300 billion, and 
again I don't want to speak for the chairman's bill, but that 
is a loan allocation amount. Congress gives this amount every 
year. Since I have been FHA Commissioner, that number has been 
about $185 billion. I do want to say going forward that we 
expect for the first time in several years to exceed that 
amount for this fiscal year. I think ultimately we'll probably 
get to about $230 to $235 billion.
    So I don't know, again under his bill whether he has a 
separate allocation just of $300 billion, or it raises our 
allocation to $300 billion. To put the number in perspective, 
our overall insurance in force today is roughly 4 million homes 
with a value of a little more than $400 billion, to put that 
$300 billion--
    Mr. Marchant. But do you foresee--
    The Chairman. The gentleman's time has expired. I was 
trying to allow the response, but are you all through 
responding?
    Mr. Montgomery. I could certainly follow up with the 
Congressman afterward, if he'd like.
    The Chairman. The gentlelady from New York, Ms. McCarthy.
    Mrs. McCarthy of New York. One of the questions that I'm 
concerned with is, because obviously all of us care about our 
constituents back at home--and this can go to everybody--is how 
will this bill assist homeowners in high-cost areas, such as 
where I live on Long Island? So even though I have a small part 
of it, I'm going to look at Long Island as a whole, because 
what affects a district right next door to me is going to 
affect my district and so forth.
    Right now, we see almost a 33 percent increase of 
foreclosures just in Nassau County. My concern is too because I 
tend to look at things out, with 33 percent foreclosures, that 
is going to hurt the tax base in the county and in the towns, 
and that is going to reflect again on police service, school 
service, and everything else like that.
    So for a high-cost area, you know, I will use my little 
home as an example--I have been in it for 58 years, it is a 
tiny home, and I am assessed for an amount that I know I could 
never sell it for--I think they had me assessed for maybe 
$885,000--it is now down to, I think, $468,000. But I'm still 
being assessed on the higher level. I am going to fight that, 
but that means it is going to come down.
    But how is this going to help someone to buy a home in 
Nassau County, even a starter home? The cheapest you are going 
to find as long as it has, you know, doors and a frame--is 
probably almost $350,000, but most of them are much higher--how 
will this help them and how are we going to stop the bleeding 
that is going on? If one house goes down, that lowers the whole 
neighborhood. That's the problem that I think this Nation is 
going to be seeing, not just the losing of one home, but how 
it's going to affect the neighborhood, how it's going to affect 
the community, the stores, the tax bases, and everything.
    I don't hear a lot of people talking about that kind of 
stuff.
    Ms. Bair. Well, I think there are a lot of external costs 
to foreclosures--to neighborhoods, to communities and to local 
tax bases. And I think that is exactly the public policy 
rationale for moving forward with a proposal like this.
    I think this proposal, in particular, is focused on those 
who are currently in unaffordable mortgages and cannot 
refinance because their loans are underwater. They would be 
subject, I assume, to the FHA conforming loan limits. So in 
very high-cost areas, it may or may not be relevant.
    A lot of the foreclosure activity is being driven by 
subprime loans, particularly the subprime hybrid ARMs. On a 
national basis, the average subprime loan is $200,000. So, I 
think for this particular proposal, the impact would be more in 
that sector--again people who have unaffordable loans and who 
are underwater and can't refinance out of these unaffordable 
loans.
    I don't know, Brian, if you want to--
    Mr. Montgomery. Yes. Congresswoman, your Nassau County, 
Suffolk County are both in the--they are 2 of the 75 counties 
in the United States that went to the maximum ceiling for FHA 
and the GSEs as a result of the stimulus. So up to $729,000, 
they would now be eligible to apply.
    Mrs. McCarthy of New York. Thank you.
    The Chairman. Does the gentlelady yield back?
    Mrs. McCarthy of New York. I'm sorry, yes. I turned my 
microphone off before. Yes.
    The Chairman. Okay. Then the gentleman from California, Mr. 
Miller, for 5 minutes.
    Mr. Miller of California. Thank you very much, Mr. 
Chairman.
    A lot of the problems we have in the marketplace with 
people trying to buy today is that they can't get a loan. There 
is no liquidity. And I have always strongly supported raising 
conforming in high-cost areas for Freddie Mae, Fannie Mac, and 
FHA. I think that is really something we need to do.
    But I have some questions based on some different 
testimony. Mr. Montgomery--and you were very clear in what you 
said, you were talking about when FHA makes a loan of 90 
percent based on market value--that's generally a very safe 
loan, because you use the standard underwriting criteria and 
you use risk-based criteria as it applies to loans. Is that not 
true? Would you consider a 90 percent loan using your standard 
criteria and the criteria applied to this bill? Would that be a 
reasonable loan for FHA to make?
    Mr. Montgomery. Yes. Certainly. We propose 90 percent LTV. 
I believe the chairman has an 85 percent LTV--
    Mr. Miller of California. But the concept is the same. 
You--95 percent would be held in retention, but--my concern 
that Governor Kroszner, you have stated in your testimony that 
you believe that there should be some form of a loan seasoning 
requirement or other form of warranties on the part of the 
lender, who currently has the loan that is probably going into 
default because the person can't make the payment based on a 
trigger or whatever.
    And I have a real problem with that, because my concern is 
that you are then placing an obligation on the previous lender 
to guarantee FHA that there would be a repayment, and I'm sure 
there is some risk associated with that, and if the lender is 
trying to cut a deal where he says, ``Okay, I'll take 85 
percent,'' what is the bank regulator going to do? There has to 
be a risk. Is he going to require some sort of reserves on the 
lender, who thinks they're getting out from underneath the 
loan, but they possibly might not be getting out from 
underneath from the loan.
    That's problematic. I don't know how we do that. Maybe you 
can explain that a little more.
    Mr. Kroszner. Sure. I mean one of the reasons for doing 
this is that we don't want the taxpayer to just take all of the 
very high-risk--
    Mr. Miller of California. Yes, but the FHA is not going to 
let that happen. FHA is using a risk-based criteria. FHA--Mr. 
Montgomery, you're going to go make sure the person has an 
income, they have the ability to repay that loan, and the loan 
is based on sound underwriting criteria and an appraiser that 
reflects what the value of the home is. Is that not true, Mr. 
Montgomery?
    Mr. Montgomery. Yes, sir.
    Mr. Miller of California. Then, my position is that the 
lender should be out of this loan at that point in time; he 
should not have to be obligated to FHA, if FHA has done their 
job and done proper appraisals and used underwriting criteria. 
If the person is not qualified, FHA should not make them the 
loan. So I'm having a real problem with the concept of taking a 
previous lender and leaving them on the hook in some fashion if 
something goes wrong because we are basically charging a 5 
percent reserve on the loan--because we're lending 90, we're 
reserving 5 back because we're only paying 85 percent of what 
the value is--I think the lender should be out of this.
    So, Mr. Chairman, I have real, real concerns with leaving a 
lender on the hook when FHA has done a proper job on their 
appraisal standards and they have come up with a loan that is 
qualified. Because if it's not qualified, Mr. Montgomery, don't 
make the loan. And I think you're saying we're not going to. So 
I have a real problem with leaving the lender on the hook, 
because there's going to be some reserve set aside on the 
lender's part, and lenders today are having problems with 
liquidity, with money in the system. So I think we need to 
really look at that.
    I think there are some reasons why this could be a very 
popular program with lenders, more than most people might 
assume. If you figure what the lenders' costs are when they go 
through a foreclosure, the cost of foreclosure, they're going 
to generally employ a Realtor to handle the transaction; 
they're going to have to set up reserves and the costs of carry 
associated with that loan when it's not producing; title and 
escrow fees that are going to be normal to any transaction on 
any foreclosures they have; damage that occurs to the unit, and 
in some cases people do vandalize units because they're angry 
because they got evicted from a home--not everybody but some 
people do it, and we have seen that happen.
    Some even have to go to the cost of using an auction to 
unload a unit because it sit on the books too long and it's not 
moving. And then there's a maintenance cost and a risk 
associated with holding that house.
    So some lenders are going to say 85 percent? Hmm, I'll take 
85 percent. And I think you're going to see more people looking 
to do that than not.
    I guess I have a concern that we're talking about how we're 
going to deal with eliminating or extinguishing a second trust 
deed that might exist on a home. The concern I have is that 
some people have used their home as an ATM; they borrowed for 
vacations and other costs. I think we need to look at what some 
of those seconds are, if we're asking some lender to take a 
bath on it and not really do much to encourage it when it has 
been used for personal reasons.
    A question I have is: If we implement a program like this 
where we say the lender is going to taking 85 percent of market 
value, my concern is: Is there some undisclosed occurrence that 
could happen where an appraiser down the road says, ``Well, the 
house really is only worth--if it was $500,000 before if the 
lender took $425,000, really the market value is--''
    The Chairman. We will have to wrap that up so they can 
answer, please.
    Mr. Miller of California. Okay. Could it somehow impact the 
market, you saying it's no longer worth $500000, it's really 
worth $425,000, because the lender took $425,000 for that?
    Mr. Montgomery. Well, in this case, whatever that delta is 
between the appraised value and our 90 percent insurance could 
be put in the form of a soft second with a note due on sale 
clause.
    Mr. Miller of California. Does it impact the value of the 
marketplace?
    Mr. Montgomery. No, sir. That second lien would have to be 
resolved to--
    Mr. Miller of California. Too many questions, and so little 
time. Mr. Chairman, thank you.
    The Chairman. Let me, before turning the gentleman from 
Pennsylvania, ask unanimous consent to put in the record a 
letter we received from the National Association of Realtors 
saying with regard to the discussion draft, ``Your measure will 
allow homebuyers to refinance their mortgage with an FHA loan 
at a rate and level they can afford to pay. We commend your 
efforts.'' And also, a letter from Marc Morial on behalf of the 
National Urban League, also expressing support for the 
discussion draft.
    I ask unanimous consent to put these items in the record. 
Without objection, they will be, and the gentleman from 
Pennsylvania is recognized for 5 minutes.
    Mr. Kanjorski. Thank you, Mr. Chairman. I am not sure to 
whom on the panel I should direct this question. Anybody can 
take it. But, it seems to me for the chairman's proposal to be 
successful, there are two major elements that are required to 
be adopted in the law: One would be encouraging a loan 
modification. We have to do something about getting a 
servicer's liability worked out to create a safe harbor. And of 
course, we have, Mr. Castle and myself have proposed a bill to 
accomplish that. Would you agree as a panel that it is 
essential that we have a loan modification safe harbor in place 
if we are to implement the chairman's bill here on servicing?
    Ms. Bair. We are very supportive of your and Congressman 
Castle's efforts, and yes, the servicer will have to write down 
the principal amount. They will have to modify these loans to 
facilitate them being refinanced out of the pool. So at a 
minimum, I would assume you would want to have some insulation 
from liability for that and also for other long-term 
sustainable loan modifications, even when the loan stays in the 
pool. So yes, we're highly supportive of that.
    Mr. Kanjorski. All right. Yes?
    Mr. Dugan. We support it as well, Mr. Kanjorski, because as 
you know, we have done some work on our staff. We think it 
clarifies what is the legal authority already that you have to 
support, and protects the interests of the whole pool and not 
an individual tranche or investor within that pool. We do think 
that is quite an important principle, going forward.
    Mr. Kanjorski. Thank you.
    The other major area I throw out, which is now pending over 
in the Senate and which we passed in the House, is independent 
appraisals. Everywhere I look, one of the major failures in 
subprime lending is the abuse, fraud, and mistake of not having 
appropriate, independent appraisals. If we go through this 
process again and do not have the proper appraisals, all we are 
going to do is compound the problem.
    Is there anybody who disagrees that the now pending 
amendment in the Senate--I think it is the Casey amendment, 
which incorporates a lot of the issues that we have passed in 
the House--should go through?
    Mr. Dugan. Mr. Kanjorski, we don't agree with this point. 
We do think you have to have independence and structures within 
organizations to make sure that there is independence between 
the person who underwrites the loan and the person who 
appraises it. But there are circumstances in which you can have 
better appraisers and be able to control the risk better by 
having it within your organization than get it from a third 
party. I don't think it is necessary or that it is even a good 
idea to mandate that every single appraisal be separate from 
the entire lending organization.
    Mr. Reich. At the Office of Thrift Supervision, I agree 100 
percent with the comments that Comptroller Dugan just made. 
There are excellent appraisals being made within many 
institutions that we supervise and we believe that they ought 
to be able to continue to be able to utilize those facilities.
    Mr. Kanjorski. I think there may be a little confusion 
between what we do in our bill and the attorney general of New 
York's agreement. I understand your disagreement with some of 
the stringent positions that he has adopted, but our bill is 
quite different. Do you see that distinction? Or should we take 
that up later?
    Mr. Dugan. We will take that up later.
    Mr. Kanjorski. Okay. Good.
    Let me ask one question of the Federal Reserve. I just had 
a very upsetting meeting in my office with a hedge fund 
operator who called to my attention the fact that that some 
people may be using the Federal Reserve Bank, some folks in the 
investment banking industry, to draw down billions of dollars 
in funds, and then turning around and issuing dividends based 
on the use of those funds.
    Do you know, Governor, whether that is true? What does the 
Federal Reserve intend to do, as quickly as possible, to put 
some constraints on the use of these funds? Tell me whether or 
not you need legislative authority to do so? Do we have some 
pieces of legislation suggested by the Federal Reserve to get 
control?
    I, myself, will be incensed if after going to the rescue of 
these institutions, there are these types of abuses occurring. 
I will be particularly incensed if the Federal Reserve has not 
marched up here with an emergency siren, saying there is 
something happening that should not happen, and it is to the 
great jeopardy of the American taxpayer. Can we get a response?
    Mr. Kroszner. Those are very important questions. I think 
that I do not know of such circumstances, but certainly will be 
delighted to work with you and your staff to see if there are 
such circumstances. I agree that they should not be tolerated. 
We are working very closely with Securities and Exchange 
Commission in analyzing and reviewing the financial statements 
and the financial health of the primary dealers to which the 
new facility is available. There are very high standards for 
becoming a primary dealer, so it's a limited number of 
institutions with which we have had a long-standing 
relationship that now have access to this facility. We only 
make loans on a fully collateralized basis, and it is going to 
be an issue going forward that Congress will need to consider 
whether there will be additional regulatory authority needed if 
this facility were to continue.
    The Chairman. The gentlewoman from Illinois, Ms. Biggert.
    Mrs. Biggert. Thank you very much, Mr. Chairman. And let me 
just say that I have a real concern that while the House and 
Senate leadership are engaged, it seems, to outbid each other 
on how much taxpayer funding they can spend to bail out various 
actors, that I think we should instead being passing FHA 
reform, GSE reform, and the other basic reforms that can start 
to help homeowners now. And my hope is that the leadership will 
move what is right in front of them instead of grasping, 
looking for new giveaways that may or may not help those who 
are actually now in trouble.
    With that said, I want to turn to FHA Secure, and I would 
really like to compliment Mr. Montgomery and HUD for their work 
on FHA Secure and for already helping 150,000 families to stay 
in their homes, and for projecting that they will help 400,000 
families by the end of this year. Congratulations. I think you 
are doing a great job.
    I have a question for Mr. Kroszner and for Mr. Montgomery. 
In your testimony, Mr. Kroszner, you mentioned the importance 
of Congress giving FHA the flexibility to price FHA loans, 
especially loans being refinanced through FHA Secure. Why is 
this flexibility necessary? And do any of the current FHA 
modernization proposals under consideration provide FHA with 
the flexibility it needs to a risk-based price so that the FHA 
can serve more borrowers without jeopardizing the financial 
stability of the program and putting taxpayers on the hook for 
the money?
    Mr. Kroszner. Well, I think very much consistent with the 
last part of your question, that is the reason for thinking 
about risk-based pricing. Just as in the private sector, people 
who are riskier drivers have to pay higher premia; if you are a 
riskier borrower, you will have to pay a higher insurance 
premium in order to get a mortgage, all other things being 
equal. And if the FHA is going to be a world class mortgage 
insurer, it needs to have that flexibility to charge a higher 
price when there are more risks and also to charge a lower 
price when there are lower risks. And so this should be a very 
important part of any FHA modernization and reform proposal.
    Mrs. Biggert. And so this can be done without legislation? 
FHA Secure?
    Mr. Kroszner. Well, FHA Secure certainly is being 
undertaken without further legislation. I believe there are 
statutory limits that exist in current legislation, and I know 
the Administration and Mr. Montgomery have been thinking of 
ways to deal with greater flexibility within those limits.
    Mrs. Biggert. Okay. Now, Mr. Montgomery, do you want to 
comment on the flexibility?
    Mr. Montgomery. The pricing flexibility is key going 
forward, especially if we're going to take on more risk. And I 
do want to say that in the House bill that passed on FHA 
modernization, a lot of the pricing categories were not way off 
between what this committee has passed, and I thank you again 
for that.
    I do want to say going forward, though, that it is an 
interesting dynamic that the borrowers in FHA's world who have 
the higher FICO scores--above 680--are our lowest income group. 
I know that seems counterintuitive, but they are the hard-
working families who save their money for the downpayment, and 
enjoy the many benefits of FHA. Our proposal we're going to 
submit soon is a little different than we originally were going 
to do administratively. But we just want to give those families 
a small little price break, going forward.
    Mrs. Biggert. So for those families to refinance, they will 
have to come up with more of a downpayment?
    Mr. Kroszner. For some families going forward, especially, 
again, as we take on more risk, yes, some of those would go to 
our statutory ceiling, which is 2.25 percent.
    Mrs. Biggert. Thank you. Then, Mr. Kroszner, you also 
talked about FHA needing substantial flexibility in providing 
incentives to the servicers to negotiate with junior 
lienholders. Does Congress need to provide FHA with this 
flexibility? Or does FHA already have the authority to do that?
    Mr. Kroszner. That is, I think, a legal question that I am 
not sure of the answer to. I think it's perhaps--Mr. Montgomery 
would know the specifics better.
    Mrs. Biggert. Mr. Montgomery?
    Mr. Montgomery. If you could repeat that? I'm sorry.
    Mrs. Biggert. It's just whether you have the authority to 
negotiate with the junior lien providers.
    Mr. Montgomery. Certainly. That would be whatever, between 
the current mortgagor and the mortgagee, because certainly 
whomever is holding that second lien has a stake going forward 
as well.
    Mrs. Biggert. But you could negotiate with them?
    Mr. Montgomery. Certainly.
    Mrs. Biggert. Without legislation?
    Mr. Montgomery. Let me triple-check that for you, please.
    Mrs. Biggert. Thank you. Yes, my time has expired.
    The Chairman. The gentleman from California, Mr. Baca.
    Mr. Baca. Thank you very much, Mr. Chairman. My question is 
for Governor Kroszner and Mr. Montgomery. One key issue is the 
extent to which voluntary loan modification programs are 
working. The New Hope Initiative, for example, is shared by 
Secretary Paulson, and is widely cited by industries as 
evidence of good work. While it is good that they got 
everything together, the fact is that voluntary programs aren't 
working.
    So my question is what impacts have the voluntary loan 
modifications had on the efforts of reduced foreclosure rates? 
That's question number one. Number two, are there other efforts 
the regulators are pursuing to help families retain their 
homes? Governor Kroszner first, and then Mr. Montgomery?
    Mr. Kroszner. There has been some progress that has been 
made. The number of modifications has gone up. But as we were 
discussing in some of the earlier questions, the HOPE NOW 
Alliance Focus initially was on the resets. The resets are less 
of a challenge now for a variety of reasons, including the 
reduction in interest rates that the FOMC has undertaken. 
Because now the most--the so-called 2/28 and 3/27 subprime 
mortgages would reset to a fixed amount, usually 600 basis 
points, over a short-term interest rate. Now that we have taken 
the short-term interest rates down significantly, the payment 
shock has been mitigated dramatically, and so it's now in most 
cases--or I should say on average less than 1 percentage point. 
So that has been helpful.
    We have been undertaking a number of other programs with 
NeighborWorks America, on which a number of us sit on the 
board, to try to expand counseling programs, to try to deal 
with real estate challenges after the properties go into 
foreclosure. The regional Federal Reserve Banks, all 12 of 
them, have very active programs working with local governments 
and local community groups to try to keep people in their 
homes, to try to provide counseling services.
    And so we have been doing a lot in a lot of different 
areas, and continue to do a lot, and more needs to be done.
    Mr. Baca. Mr. Montgomery?
    Mr. Montgomery. FHA Secure has been a part of the options 
available to people going through the HOPE NOW Alliance, and 
again borrowers contacting us on their own. Before today we 
required 6 months on-time payments before the interest rate 
reset; that was one of the barriers that we heard in the 
comments as to why families wouldn't qualify. And again with 
our announcement today, we are making exceptions to that, going 
forward.
    Mr. Baca. Thank you. The next question I have is for Sheila 
Bair and for the Honorable John Dugan, and of course John 
Reich. Minority communities have been disproportionately 
affected by the downturn in the housing industry due to the 
large number of recent first-time homebuyers and the wide-
spread use of subprimes and Alt-A loans among minority 
homebuyers. Additionally, the foreclosure rate of subprime 
loans has had a disproportionate impact on minorities and has 
put our communities at risk for losing their homes.
    The question would be: What polices or procedures and 
incentives can we anticipate your respective organizations are 
developing as part of the CRA in a fair lending examination 
process to ensure disciplatory and financial institutions 
assist depressed borrowers to prevent foreclosures? Any one of 
you three may answer. And then, I have a second question.
    The Chairman. We won't have time for a second question.
    Ms. Bair. Well, Congressman, you're absolutely right. The 
disparities that we see in neighborhoods that are getting high-
cost loans are completely unacceptable, if you look at the HMDA 
data. We are trying to tackle this through a variety of means. 
First of all, working with the other regulators, we issued 
subprime guidance to address the abusive nature of many of 
these products. The Federal Reserve Board has proposed rules 
under the Home Owners Equity Protection Act, applying stronger 
lending standards across-the-board. We have commented on those. 
One of the issues tackled there is yield spread premiums, which 
affirmatively, I believe, give incentives to steer people into 
higher cost loans. I think we should aggressively address that.
    We are having a conference this summer, in July actually, 
on responsible ways to serve low- and moderate-income 
communities with mortgage lending--getting away from these 
abusive payment shock products, getting to fixed-rate 
mortgages, those that do not have payment shock, that are 
affordable. There are other product innovations, such as shared 
equity, extended amortization, where we believe you can, in a 
responsible way, make mortgages more affordable to low- and 
moderate-income communities. But it needs to be done the right 
way.
    And finally we are looking very aggressively at CRA, to 
determine whether we should look at both quality as well as 
quantity of lending that qualifies for CRA, and whether a 
broader range of financial services needed by lower-income 
communities is adequately addressed under CRA.
    The Chairman. We have time for either the Comptroller or 
the Director. Comptroller? Please.
    Mr. Dugan. Just in direct response and very quickly, I have 
in fact given a speech in support of expanding CRA to widen its 
scope to cover distressed mortgage communities in a broader 
array of circumstances that I think could help address this. 
And in addition, this committee has passed legislation that has 
expanded the public welfare investment authority of national 
banks, and so has the full House; it's still pending in the 
United States Senate. But if we could get that legislation 
passed, it would also help bring, we believe, even more 
investment from banks to distressed communities, and 
particularly minority and low-income communities.
    Mr. Baca. Thank you.
    The Chairman. Let me just clarify that when we talk about 
public welfare, we are talking about giving the banks more 
ability to do housing and other community-related activities, 
which has become a constraint. How will it take the--quickly 
please.
    Mr. Reich. I could be mistaken about what I'm about to say, 
but I believe that we have authorized our financial 
institutions that we supervise to give double CRA credit to 
investments in low- to moderate-income communities, which would 
include, of course, many minority communities.
    The Chairman. But let's put it this way, Director, if you 
were mistaken, you won't be tomorrow, because you could do it. 
So, we will consider that as done.
    The gentleman from Georgia, Mr. Price.
    Mr. Price. Thank you, Mr. Chairman. Before I begin, I would 
like to ask unanimous consent to include in the record a recent 
Wall Street Journal article from April 3rd of this year, 
entitled ``Uncle Sub-Prime.''
    The Chairman. Without objection, it is so ordered.
    Mr. Price. I know it is hard to believe, but I, for one, am 
proud to live in the greatest nation on the face of the Earth, 
a nation that has created more prosperity for more individuals 
across all demographic sectors of society than any nation in 
the history of the world. I think it is important that we put 
things in context, especially as we hear some of the dour 
predictions and dour assessments on the need for remarkable 
intervention by the Federal Government. We have been the most 
prosperous nation ever in the history of the world for a 
reason. If we meddle with that reason, we risk significant 
changes to our society and to the opportunities that all 
Americans currently enjoy.
    I was meeting with a group of high school seniors, bright 
high school seniors last week, and they wanted to know about 
the housing crisis, and I asked them what percent of 
individuals do you believe who currently hold a mortgage are 
current on their payments? These were bright high school 
seniors, and the highest anybody would give me was 17 percent--
17 percent.
    The media has been adept, as have many in Congress, at a 
remarkable, remarkable misrepresentation of the entire market. 
Ninety-two percent, as you all know, are current on their 
mortgage right now. Ninety-two percent of homeowners in this 
Nation are current on their payments.
    There has also been an impression that nothing has been 
done, that the FHA--that none of you at this table have done 
anything to try to assist Americans and homeowners across this 
Nation. Just to highlight a couple of items, in August of last 
year, FHA Secure was launched. As of March 19th of this year, 
126,000 homeowners have been assisted, and they expect to help 
more than 300,000 families by the end of 2008. In October, the 
HOPE NOW Alliance was formed, a group of lenders, investors, 
and mortgage counselors working to help keep Americans in their 
homes. Since July of last year, they have assisted more than a 
million homeowners The number of borrowers receiving help is 
now rising faster than the number of foreclosures. We may be 
seeing some significant effect of the work that has already 
been done.
    The Mortgage Forgiveness Debt Relief Act of 2007 was signed 
into law on December 20, 2007, protecting individuals from 
higher taxes as they refinance, and on, and on, and on. The Fed 
has attempted to increase liquidity. Project Lifeline was 
announced with HOPE NOW in February of this year.
    So the question really becomes to us what else needs to be 
done, if anything? As a physician, I am always reminded that if 
I don't make the right diagnosis, it is difficult to treat the 
right problem. Some on this panel, on this committee, have 
talked about the excessive and dangerous deregulation that has 
occurred in the past.
    Governor Kroszner, I was interested to read about the 
Boston Fed Reserve recently studying or determining that they 
felt that much of the challenge that we currently have is due 
to declining housing prices, as opposed to the excessive 
``deregulation.'' I wondered if you have any comment about the 
input of those two items in terms of the challenges that we are 
currently facing.
    Mr. Kroszner. Well, if I recall correctly, the Boston Fed 
study was not looking at the broader question that you're 
trying to address on the role of regulation or deregulation, 
but trying to look at some more narrow issues on is it interest 
rate resets, is it house price changes, is it a number of sort 
of economic, current economic factors.
    And so what they determined is that housing price changes 
are really a primary determinant, at least in the data set that 
they had looked at, for driving the foreclosure and delinquency 
rates. I don't think they were addressing the bigger question 
that you are raising.
    Mr. Price. And would you care to address that bigger 
question?
    Mr. Kroszner. I think that is one that is a very, very 
difficult one to address but an extremely important one to 
address, to try to bring together the data and analysis to try 
to understand exactly what were the issues that may have driven 
some of these challenges. And I don't have a specific answer 
for you today.
    Mr. Price. I thank you. I would be interested in the 
thoughts of the Board as we move forward. In my brief time 
left, I would like to ask Mr. Montgomery about legislating 
specific underwriting standards and decreasing the ability of 
FHA or anybody to look at risk in terms of covering a mortgage.
    Mr. Montgomery. You know, one of the reasons we were 
championing FHA reform way back when is there were some things 
that were set in statute that I, as Commissioner, was 
performing, did not have the ability to change, because they 
were set in statute. And we would like to keep underwriting as 
part of that--those things that the FHA Commissioner going 
forward would have the flexibility to change. The same on 
premium pricing structures. Certainly Congress, through our 
normal reporting channels, would have a say in that process. 
But I think going forward, flexibility is a key thing, whether 
it's underwriting, setting premiums and the like.
    Mr. Price. Thank you.
    The Chairman. The gentleman from North Carolina will be our 
last questioner before we break.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman. I 
don't want to talk about the turmoil in the markets. I want to 
talk about the original sin of our mortgage lending problems 
now, and what it did to borrowers.
    First, about fraud. The question that Mr. Hensarling asked 
earlier about fraud and mortgage lending, the statistics I have 
seen are that the subprime loans made in 2006-2007 when things 
went to hell in a handbasket, that 43 to 50 percent of those 
loans were made without full income verification, full income 
documentation. Is that correct? Is that range about right?
    [Panel nods in the affirmative]
    Mr. Miller of North Carolina. Now, it is very easy to 
document income for a mortgage. You can get employer 
verification. You can show a wage statement. You can show your 
tax returns. You can show bank statements, and you pay more if 
you don't fully document your income. You pay a higher interest 
rate if you do not--does anyone really think that the New York 
investment banks that were buying these mortgages to securitize 
them really had no clue something was up?
    They were really getting half of all loans, subprime loans, 
without full income verification. And the people who were 
taking out those loans were middle-middle to lower-middle 
class. They weren't investors. They weren't self-employed. They 
didn't own a business. They weren't professionals. They worked 
for an employer who paid them wages. The easiest possible 
income to verify. Do any of you really think that no one buying 
those loans really had a clue that there was a problem there? 
Chairman Bair?
    Ms. Bair. I don't think they looked. It's amazing to me. 
Investors were holding the ultimate risk in these loans, and I 
don't think they looked. I don't think the rating agencies 
looked. It is one of the breakdowns of the system we have that 
that market discipline was not there. Nobody was looking.
    Mr. Miller of North Carolina. Okay. Does anyone here think 
that the masters of the universe on Wall Street who bought 
these loans really were played for chumps by the middle-class 
families who were borrowing?
    Mr. Dugan. If I may?
    Mr. Miller of North Carolina. Mr. Dugan?
    Mr. Dugan. Yes. What I would say is this: I think there was 
this belief that income was no longer predictive of people 
paying their loans back, that you could rely on this history of 
house prices going up. And so they ignored it. And I think that 
proved to be a very dangerous decline in underwriting 
standards.
    Mr. Miller of North Carolina. Well, and in fact the reason 
for that was--no one involved in mortgage lending, in subprime 
lending, expected for a second that people would actually pay 
off those loans over the course of 30 years.
    The loans were designed to become unaffordable, become 
unpayable, so that people would have to borrow again. And when 
they borrowed again, they would have to pay a prepayment 
penalty to get out of the last loan. They would have to pay 
points and fees cost to get into the next loan, and every time 
they did it, they lost more of the equity in their home. That 
was the intent, that was the design. What went wrong was not 
that people couldn't pay the loans according to their terms. 
What went wrong from the industry point of view was that the 
housing prices stopped appreciating and you could no longer 
count on people getting out, either refinancing or just selling 
their house.
    These loans were not about homeownership. That is one of 
the claims made, the arguments made is that these were loans 
that were made to allow homeownership for people who otherwise 
would not have qualified for traditional mortgages, and what we 
have seen, in fact, is a decline in homeownership.
    The rate, according to the Census Bureau, for the fourth 
quarter of 2004, was 69.2 percent. For the last quarter it was 
67.8 percent. When the figures come out for last quarter, first 
quarter of this year later this month, it's going to be down 
again, down again in the second quarter, down again in the 
third quarter, down again in the fourth quarter. It will 
continue to decline.
    Those are millions of American families who owned a home 
and no longer own a home. The worst cases were the 
foreclosures. There are also a lot of people who sold their 
homes, could sell their homes, had some equity still, could 
sell their homes, who quietly sold their homes, and a lot of 
them are embarrassed about it, because they couldn't pay the 
mortgage.
    And then finally, the question I have is about the millions 
of American families who were able to get out but were stripped 
of the equity by equity-stripping practices like prepayment 
penalties. Do you--what I have seen is that the lenders have 
only agreed voluntarily to what is in their obvious self-
interest. But they continued to enforce equity-stripping 
provisions where they could extract the money still from the 
borrower. Should we pay some attention to what is happening in 
the other loans when we agree to buy some of the loans, the 
ones that obviously cannot--are not being paid?
    Ms. Bair. I'm not sure--
    The Chairman. The gentleman's time has expired. Maybe he 
can submit it in writing and get an answer, but we are out of 
time.
    Mr. Miller of North Carolina. All right.
    The Chairman. And we have to go vote. Why don't we--the 
gentleman from North Carolina will submit that question in 
writing, and we would like an answer for the hearing record.
    Ms. Bair. Could I--
    The Chairman. Ms. Bair, quickly.
    Ms. Bair. Just to respond briefly. The FDIC is opposed to 
stated income. We think that should apply across-the-board. We 
are suggesting that you get rid of prepayment penalties 
completely, and also that we think all originators, bank and 
non-bank, should underwrite at the full indexed rate to make 
sure that the borrower can make the reset rate. I just want to 
make sure we're on the record.
    The Chairman. Thank you. We will be in recess for 35 
minutes. And 2 words of encouragement--fewer members. We will 
ask you to stay if you could for--we will be gone about 35 
minutes probably, and then we will come back and finish up. 
Fewer members come back, so it will be quick. There are three 
votes. I would say we will be back here in a half hour or less.
    [Recess]
    The Chairman. We will reconvene. I apologize for the delay. 
I got stuck trying to get an elevator. We will now hear from 
the gentleman from Delaware, Mr. Castle, for 5 minutes. Please 
take your seats.
    Mr. Castle. Thank you, Mr. Chairman. Comptroller Dugan, I 
was not here for your testimony. I had to duck in and out to 
another markup at another meeting, but I have read your 
testimony, which I understand you did not discuss orally, with 
respect to legislation which I have been involved with, which 
is H.R. 5579. It's on pages 7 and 8 of your testimony.
    And basically, without spending all our time summarizing 
the legislation, it sets standards by which--the legislation 
would set standards by which lenders, who may be assignees or 
whatever of the mortgage, could renegotiate the mortgage terms 
with the borrower. And, obviously, if they could meet those 
standards, they could use that in defense with respect to 
possible litigation.
    This would be open for some period of time, and it 
essentially would I think serve the purpose of allowing the 
individual lenders or assignees of the mortgages or whatever to 
be able to sit down and negotiate terms that might be favorable 
to the borrowers and perhaps lock in a lower rate or a 
different rate than the lower rate and whatever the adjustable 
rate may be.
    But from experience in this area, it seems to me that 
nobody wins in a foreclosure. Clearly, the banks don't want to 
take back property which may be worth less. Obviously, 
homeowners don't want to give up property. And the only issue 
that has been raised by anybody that is somewhat negative to 
all this are obviously the downstream noteholders as they take 
the various mortgages and whack them up into principal and 
interest or whatever. I guess there are those who potentially 
could lose in all this, although I would argue that if you're 
going into a foreclosure, you may lose even more than you would 
if you had a reduced interest circumstance.
    I would be interested in your comments concerning this 
legislation, which is not directly a part of the legislation 
before us, I don't believe, at this time, but it has been under 
discussion in this committee, as to the benefits of possibly 
doing this, either together with legislation that might emanate 
from this committee or separately, and legislation that might 
emanate from this committee, and in terms of any potential 
downsides that we should worry about in that legislation.
    Mr. Dugan. Well, Mr. Castle, we support this legislative 
effort, as I indicated in the testimony, and we have tried to 
provide some comments to your staff earlier before it got put 
in its current form.
    We think it clarifies the basic principle that is already 
in the law, which is that when a servicer is acting to 
restructure a loan, that they do so on behalf of the whole loan 
pool rather than try to be guided by different interests of 
different investors in the pool that have different interests, 
under the principle that you can't serve two or three masters. 
You have to serve the whole pool at once. And we think your 
legislation clarifies that point, and we think it's helpful in 
that regard, because I think it does remove some of the 
ambiguity that people have had about this point. I think it 
would be useful to remove that friction point so that when it 
makes sense and services want to voluntarily enter into a 
modification that benefits the pool more than would be the cost 
of foreclosure, they should be able to do so.
    Mr. Castle. And what are your--you sort of spoke generally 
to that, and I appreciate that, but what about the argument 
that there are those who would be hurt by it? That is, 
noteholders further down the line who would not receive what 
they might have received otherwise or whatever. Is there a 
response to that?
    Mr. Dugan. Well, I think the point again is it is different 
interests within the pool. And the issue is that I think the 
servicer can only act on behalf of the whole pool. They can't 
act on behalf of one group of investors and also at the same 
time serve another group within the pool that has a slightly 
different interest. It's just impossible to do both, and I 
don't think they're legally bound to do both now, although that 
could be different in different agreements. And I think this 
just clarifies that they can.
    It will always be the case that if you have different 
interests in the pool, some will be hurt or harmed, depending 
on whether you go to foreclosure first or last. But you could 
have a situation where one investor would benefit by going to 
foreclosure, even though it would be more expensive to the pool 
as a whole, while another investor would never want foreclosure 
in the pool, just because of the way payment streams work. This 
is a simple test that says if the net present value of the 
savings by doing this is more to the pool than foreclosure 
would be, then they can go ahead and do it. And I believe that 
makes sense, and I think others do as well.
    Mr. Castle. Thank you. I'm not sure if other members of the 
panel are even familiar with this, but does anybody else have 
any comments they wish to make on it?
    Ms. Bair. Yes. We are highly supportive of it. I think you 
and I actually discussed this some months ago in your office 
when the original bill that Chairman Frank was putting together 
was under consideration. And I think some of the political 
resistance, frankly, that you are running into now comes from 
those same senior tranche holders who have been pushing back 
before.
    So I am disappointed, because the American Securitization 
Forum in June of last year said very clearly that servicers' 
obligations are to the pool as a whole. There are some who 
think this is an excuse and others who think it is real. I have 
heard it enough to think it's real. But clearly, servicers are 
concerned about potential investor liability. So I think this 
could be a carrot incentive to further the loan modification 
process along, and we're happy to keep working with you on it.
    Mr. Castle. Okay. Thank you.
    The Chairman. If the gentleman would--
    Mr. Castle. I yield back, Mr. Chairman.
    The Chairman. Let me just briefly say, and I want to repeat 
what I began by saying, we cannot order anybody to go along 
with this, and the gentleman's bill doesn't try to do that, 
because we're dealing with contracts already written. But I do 
want to make it clear to the American Securitization Forum and 
everybody else that if in fact we are not able to get 
substantial progress in this kind of voluntary situation, then 
I can pretty much guarantee them that going forward, they will 
face a very tough set of rules. If this can't be worked out 
voluntarily now with existing contracts, then it will be our 
obligation to give a set of rules and priorities for contracts 
going forward.
    So I hope they will take the opportunity to work this out, 
because if they don't, I think you're going to see a more 
prescriptive regulatory framework going forward. It is not the 
ideal, but if that is the only choice, then that is what I 
think you will see pressure to do. And that is what I want to 
do. You never know. As this thing--if things continue to 
deteriorate, if the gentlewoman from California, Ms. Waters, 
gets into mitigation, then people are going to really get 
mitigated in ways they don't like.
    [Laughter]
    The Chairman. So, I do urge people to take this into 
account. The gentlewoman from Illinois, Ms. Bean.
    Ms. Bean. Thank you, Mr. Chairman. Thank you to our 
panelists for sharing your expertise on a very critical issue 
facing our Nation. My question to the panel is to address the 
moral hazard and recoup risk for the Federal Government. The 
chairman's bill has an aggressive exit fee structure in the 
first 5 years, 100 percent of equity gained in year one, up to 
20 percent of equity gained in year five. After the fifth year, 
borrowers are assessed an exit fee equal to 3 percent of the 
loan amount.
    Do you believe this fee structure is aggressive enough to 
prevent moral hazard and deter the perception of 
nonparticipating taxpayers that the government is unjustly 
bailing out troubled borrowers?
    Mr. Kroszner. The moral hazard issue is an extremely 
important one, and I'm glad you have emphasized it, and I'm 
also very pleased to see that the draft legislation tries to 
deal with it.
    I think there are three pieces that try to deal with it. 
One is the exit fees that you spoke about, the 3 percent that 
whenever someone will leave the loan, they will have to pay 
that 3 percent. Second, that there's some sharing of the 
appreciation that would go on over a 5-year period. I don't 
think that is particularly set in stone, whether that's the 
exact appropriate level or not, is something that I think is 
open to discussion. But that type of feature is a sensible one 
to try to protect against moral hazard. And also that there has 
to be a high debt payment-to-income ratio before the 
legislation has been contemplated, and that there's no--you 
can't intentionally default to get into the program.
    So I think there are a number of issues that are there. The 
exact levels of them, I can't tell you what the right levels 
are, but it's important to at least be considering those and 
thinking very seriously about them.
    Ms. Bean. Thank you. Are there any other panelists who want 
to comment? And I would also throw in that the Senate proposal 
has a 50 percent exit fee on equity gained, if you have a 
comment on the contrast between those two.
    The Chairman. Will the gentlewoman yield briefly before 
they do, just for me to point out that--
    Ms. Bean. Certainly.
    The Chairman. And certainly that is a serious issue. There 
is one other thing that we think deals with moral hazard, and 
that is the bill we passed last year, so that going forward, 
you are likely to have--we have a set of rules in place 
governing mortgage brokers and others so that there will be 
much less opportunity. In other words, it is not purely a 
disincentive. Many of the loans that caused the problems, there 
will be laws about there. So that is a piece of it.
    Ms. Bean. You're talking about the mortgage reform bill. 
Okay.
    Ms. Bair. I think like anything, it's a balancing act. If 
you give the borrower the prospect of getting 100 percent of 
that home price appreciation after 5 years, you have more of an 
incentive for them to stay--stick with that loan, perform on 
the loan, keep paying, but then you have--perhaps exacerbate 
potential hazard, so I think the Senate takes a different 
approach with only 50 percent equity. I think you can argue it 
either way.
    I would point out, though, that there's a moral hazard with 
investors here, too, I think--but there's been a lot of focus 
on borrower moral hazard, and clearly that's, you know, an 
issue. But an 85 percent payoff of appraised value, there are 
probably still for a lot of loans getting paid more than they 
would if they had gone to foreclosure. And I think again one of 
the reasons why you have to have this writedown that creates 
this 15 percent equity piece to begin with is that you need to 
protect the government and also guard against moral hazard with 
investors.
    So it's a balancing act. It's a complex process, but I 
think this bill does a good job of trying to juggle the 
different interests.
    Ms. Bean. Thank you. Does anybody else want to comment?
    Mr. Dugan. I would agree with both sets of comments. I 
guess I would just say, it's hard to know. We don't really have 
experience with which of the numbers that you set it at are 
going to work best. I think actually the FHA probably has the 
most experience about what over time has created the right 
incentives without creating undue losses and moral hazard.
    Ms. Bean. All right. I guess I would like to also comment 
that the chairman mentioned previous bills that we have passed 
to address this area. We did the mortgage reform bill; we had 
FHA reform and GSE reform. How important do you feel it is that 
we move forward on those as well? As the chairman said, we need 
to go back to moving forward on newly originated loans. What's 
your sense of urgency?
    Mr. Montgomery. Certainly on FHA reform--I am preaching to 
the choir on that issue, obviously--if I could just go back to 
your previous point real quickly, we're coming at it from a 
little different direction. We share in the goal that people 
shouldn't benefit or profit from this. We do want to keep the 
homeowner in the home. We would probably propose some sort of 
resale restrictions, some recapture provision, similar to what 
a lot of State housing finance agencies do. I think we share 
the same goal. We just conceptually might come at it a little 
differently.
    Ms. Bean. Yes?
    Mr. Dugan. On your other question, I think the most 
important part of the mortgage reform legislation, is that it 
basically takes the Federal standards that have been adopted by 
the bank regulators on guidance and it tries to extend them in 
a uniform way to all loans, not just loans originated by banks, 
but loans originated under the purview of State regulators.
    I think that's the single most important part of it. And 
it's the single thing that really needs to go forward so we do 
have a uniform standard going forward. I think right now the 
market, frankly, has already adjusted. There aren't many 
subprime loans being made, but that will change someday, and 
when it does, we do want to be in a world where they're 
basically underwritten so that borrowers can repay their loans 
without having to rely on the price of their house going up.
    Mrs. Maloney. [presiding] The gentlelady's time has 
expired.
    Ms. Bean. Thank you. I yield back. I see I'm over my time.
    Mrs. Maloney. The Chair recognizes Congresswoman Capito for 
5 minutes.
    Mrs. Capito. Thank you, Madam Chairwoman. I thank the 
panelists for their length and depth of their answers. I would 
like to thank Mr. Montgomery for his dedicated service in 
trying to help us get this FHA modernization bill through. I 
know that many of us on this committee have worked on hard on 
that, and we are frustrated that we have not been able to reach 
an agreement, but I think this is giving us more impetus to 
keep moving forward on it.
    In light of the fact that legislation probably will not be 
passed as quickly and in light of the fact of the announcements 
that you have made today to expand FHA Secure, which I 
congratulate you on finding a way to help another 100,000 
homeowners, particularly those who might have some 
delinquencies, particularly those who might have some 
extenuating circumstances, particularly those whose property's 
value is now way below what their loan is. And these are 
probably that get up probably in a panic every month trying to 
figure out how to meet their obligations. What is the timeline 
for implementing these administrative policies that you put 
forward today?
    Mr. Montgomery. Well, heretofore, we have charged a uniform 
premium and part of this proposal to make it work from an 
actuarial standpoint, as previously mentioned, is the risk-
based pricing structure. FHA, as you know, is not the mortgage 
company, we are the mortgage insurer, so we operate through our 
network of FHA-approved lenders and certainly they have to make 
some systems changes to now as we define the various risk 
tranche and price those accordingly, probably anywhere from 60 
to 70 days before we would be able to stand this up completely.
    Mrs. Capito. Thank you, certainly it would be nice to think 
our legislation could move as swiftly but it looks like with 
the situation in the Senate, the Administration's position on 
that bill and then Mr. Frank's bill, it looks like we are 
probably going to have a lengthier discussion here.
    One of the questions I wanted to ask you as well is a point 
that you brought up in your opening statement about the seller-
funded downpayments and that FHA is the only organization that 
is still accepting that. Could you elaborate on that? And you 
mentioned that those who received the seller-funded downpayment 
assistance go to foreclosure as many as three times the rate of 
the loans made to the borrowers, could you explain that a 
little bit?
    Mr. Montgomery. Well, we have looked at similar years to 
what FHA has seen right now in terms of purchase and re-finance 
transactions, I will put reverse mortgages to the side for now. 
We went back and looked at the books of business from about 
1995 to 2003, before the proliferation of the seller-funded, 
and to look at the credit subsidy rates and the claim rates, we 
did not have such a high percentage of our book of business as 
seller funded to a point in time where now we have about 33 
percent of that, the claim rate almost doubled. In fact, it 
actually a little more than doubled. And our credit subsidy 
rate, which was averaging about minus 2.0, which as we know in 
government parlance, a negative subsidy rate is good, actually 
trended more positive. And there is probably a reason that no 
one else accepts this form of assistance because they have 
really hurt our ability to function and also have a lot to do 
with the fact we have to do this risk-based pricing.
    The Internal Revenue Service has also addressed this issue, 
and we are going to continue to look forward because we need to 
be able to function without taxpayer support.
    Mrs. Capito. Thank you. I just want to say that this issue 
is something that even though my State is 47th in foreclosure, 
the State of West Virginia, it has a cascading effect really in 
all areas of the credit markets and it is important that I 
think that we, as you and I mentioned in discussions before, 
that the floor is established so that we can then begin 
building back. So I thank you for your efforts in that behalf, 
and I would like to mention on behalf of my constituents, who 
do all of the IT for this program and for HUD and for FHA, I 
have 100 people who are working hard and they are seeing the 
fruits of their efforts, so thank you.
    Mrs. Maloney. Thank you. The Chair recognizes Congressman 
Ellison for 5 minutes.
    Mr. Ellison. Thank you, Madam Chairwoman. And also let me 
join in thanking the panelists. Mr. Montgomery, in my City of 
Minneapolis, we have obviously a number of foreclosed homes and 
our Public Housing Authority would like to be able to acquire 
some of those homes and use those to fill the backlog they have 
for people who have applied for public housing. What is the 
public housing backlog like around the country?
    Mr. Montgomery. The public housing backlog?
    Mr. Ellison. Yes, for public housing and also these 
scattered site type housing as well.
    Mr. Montgomery. Sorry, I don't have the answer. Public 
housing is not under my realm, and I apologize.
    Mr. Ellison. But what about institutions like the 
Minneapolis Public Housing Authority being able to get loans 
from the government to get some of these homes to put people in 
them, do you think that would help advance the cause of trying 
to address this burgeoning housing issue we have?
    Mr. Montgomery. Certainly, Congressman. In fact, we have a 
similar program. Within the Federal Housing Administration, we 
have done pilot programs across America where we have a 
concentration but again I can only speak for the HUD-foreclosed 
inventory.
    Mr. Ellison. If a local housing authority were able to get 
loans to buy up these properties, would not that advance--would 
that not be something that Title 3 of the proposed legislation 
would help to correct, if they have the availability of that--
if that was available to them?
    Mr. Montgomery. Certainly, again, I can only speak for the 
FHA inventory, but principally lenders would be benefitting, so 
many of these are government resources, FHA or otherwise, and I 
think we just need to be cautious. While we all want to see 
these homes, especially those that need some repair, be 
occupied, again we have to ask where would the source of funds 
come from to provide loans or grants.
    Mr. Ellison. I will yield back at this time, Madam 
Chairwoman.
    Mrs. Maloney. Congressman Garrett, for 5 minutes.
    Mr. Garrett. I thank the Chair and I thank the members of 
the panel as well. I appreciate your coming for this forum. I 
think it is important. I will begin where Secretary Montgomery 
was cut off at his initial testimony or answering a question. I 
think we all agree on the same point, that at the end of the 
day we want to do all that we can to address the situation to 
make sure that we have a secure system now but also our housing 
plans in the future as well.
    When we look at the economy today, as we have it, it is 
somewhat clearer now that we may be moving into a recession. I 
heard the former chairman just on TV the other day, former 
Chairman Greenspan, saying that we are now moving into a 
recession, and so we have the experts telling us that and the 
folks on TV, Larry Kudlow, who was always the epitome of the 
optimist, whom I followed up until 2 days ago when he went 180 
degrees the other day and says he even agrees that we are in a 
recession now as well, so everyone is on the same page, I 
guess, to that extent.
    But even when you move those words away, when I look at my 
constituents back at home, however you define it, they are 
hurting. I am from the State of New Jersey and it is not just 
the housing situation, we are a commuter State, so we are 
paying at the pump continuously. And just in this session alone 
we have seen the price of gas go up by almost a buck and so 
when you are in a commuting State, you are seeing your cost of 
living going up. That is tied of course to other energy costs, 
and food prices are going through the roof. Mr. Kroszer, you 
can probably tell us about the inflationary pressures, and I 
could probably have a debate with you as far some monetary 
policy on that as well, but we see the inflationary pressures 
just impacting the family budget in so many ways and housing 
then is just--these housing prices just exacerbates it.
    But what you miss sometimes, I think, or the media misses 
sometimes is that on this housing situation, things have been 
done already. The Administration came out with a program a 
while ago to remediate the situation. The Administration has a 
new proposal now. This committee, of course, has done--we just 
discussed the issue as far FHA reform and the private sector, I 
believe, has also stepped up to the plate to a pretty large 
extent as well to address it. I am wondering, besides the 
proposal on the table right now, and, Chairman Bair, I will 
throw this out to you, are there other avenues that we should 
be looking at specifically that might be in your bailiwick, if 
you will, to provide some more credit relief in a way that 
would address the overall economic situation and maybe 
indirectly to this and that is in the area of covered bonds. 
Could you bring us up to date on what you are doing and what 
the outlook calls for that?
    Ms. Bair. Sure. Well, actually, we will be having a board 
meeting next week, and I expect the Board will be putting out 
for comment a policy statement to facilitate more covered bond 
offerings here in the United States. It will help. It is not a 
magic bullet, but I think it will help provide some additional 
capital market liquidity given the problems the private label 
securitization market has had. We think it is a mixed bag for 
the FDIC. If a bank who does the covered bond offering would 
eventually get into trouble, it would increase our resolution 
costs because these are secured offerings. It removes some high 
quality assets that we could otherwise sell off.
    Mr. Garrett. Okay.
    Ms. Bair. But that is a fairly remote possibility. I think 
for the institutions that we are looking at, who would probably 
be interested in doing this, we will be building in some 
conditions such as primary regulator approval in order to make 
the covered bond offering. But I think it is something we 
should facilitate.
    On the positive side from a regulatory standpoint, those 
mortgage assets do stay on banks' balance sheets, so hopefully 
there is more underwriting discipline than we have seen in the 
securitization market. Also they would have to hold capital 
against these assets, whereas if they are securitized again, 
they move off balance sheets. So I think there are some 
positives from a supervisory standpoint and certainly anything 
we can do to help provide liquidity for mortgage funding right 
now is something we want to encourage.
    Mr. Garrett. Two quick questions: First, is there a 
timeline on any of this; and, second, is there any legislative 
action that we should be working with you on this end?
    Ms. Bair. No, I don't think so. I think this is something 
we can do by regulation, by policy statement and, as I said, 
the FDIC Board will be formally considering this matter. I have 
two of my Board members here with me, but I think it is 
generally known publicly that we are going to be moving ahead 
with this. The Board will vote next week and it will be out for 
comment for a period, but I think just the fact that we put it 
out will immediately send a signal to banks that might want to 
do these and provide information to rating agencies regarding 
what the conditions are.
    Mr. Garrett. Okay, if there is anything we can do on that, 
please let us know.
    Ms. Bair. I will.
    Mr. Garrett. And my final question in the time remaining 
is, the action that we are doing here and continuing the debate 
on this, does this do anything to the broader marketplace which 
is basically holding their assets on the sidelines at this 
point as far as the credit markets are concerned and saying we 
are really waiting to see what Congress does, all the time 
keeping the credit market tighter than maybe it should be, do 
any of you have an opinion that we may be exacerbating this 
problem, if you will, by just continuously throwing out new 
proposals and not moving--either not moving on them or just 
continuing the debate?
    Mr. Reich. I do believe that servicers may be among those 
that are waiting to see what is likely to come from current 
discussions. We have been talking with them about a proposal 
that we put on the table that is very similar to the chairman's 
proposal but it includes a negative equity piece that would 
offer to servicers the opportunity to hold the amount that is 
underwater and opportunity to recoup the potential value on 
down the road when the house is ultimately sold. Providing the 
servicer some incentive, in our opinion, is one of the keys to 
incentivizing them to be more aggressive in offering and 
working with the borrowers that are within the securitizations.
    Mr. Garrett. Anyone else?
    The Chairman. Thank you.
    Mr. Garrett. Thank you.
    The Chairman. The gentleman from Colorado?
    Mr. Perlmutter. Thank you, Mr. Chairman. And, Mr. 
Montgomery, I appreciate your comments about looking out for 
the taxpayer, you have to do that in your organization, and we 
have to do that as Members of Congress. But the FHA is not an 
island unto itself, and so I want to start with Chairman Bair 
and just ask if we do not do anything, and I see that there are 
some pitfalls to the legislation the chairman has proposed, but 
if we do not do anything, how many claims do you think are 
going to be made against the FDIC?
    Ms. Bair. Congressman, as a matter of policy, I really do 
not make those kinds of predictions, but I do think we are in a 
very serious situation here. It may sort itself out sooner 
rather than later. We do not know. There are a lot of 
uncertainties, but I think the situation is getting serious 
enough that we do need--as I said in my written and oral 
statement--to be more proactively instituting government 
programs to try to stabilize the situation.
    Mr. Perlmutter. And really, again, Mr. Montgomery, that is 
where I am coming from, having been a product of the 1980's, 
the RTC and the FHA suffered some pretty heavy losses during 
those years as well. Ultimately, the taxpayer of this country 
steps behind things and so when the Federal Reserve steps in to 
underwrite $30 billion for Bear Stearns because at the heart of 
it was mortgage-backed securities that seemed to be 
questionable for everybody, I feel like we have already stepped 
in on Wall Street, so we better also help on Main Street to 
some degree. So I am going to ask the Governor, of the $30 
billion, and I understand that there is $1 billion that JP 
Morgan is on the hook for and $29 billion that the taxpayers 
may be on the hook for, what if we do not do anything, how 
solid do you think your $29 billion underwriting of Bear 
Stearns is going to be?
    Mr. Kroszner. Well, this is, as you said, exactly why we 
wanted to put the acquirer in the first loss position on the 
first $1 billion. We have hired an expert on doing valuation, 
and we are assessing that. We believe that good collateral has 
been pledged, but obviously we will depend on the evolution of 
the markets over time to know what the extent of payouts are, 
either positive or negative.
    Mr. Perlmutter. And if I understood that particular deal, 
the underwriting comes at a figure where there has been a 
write-down of the Bear Stearns assets, right, to market at this 
time? We do not know if it is going to get worse or better or 
whatever.
    Mr. Kroszner. Yes, a haircut has been taken on the assets.
    Mr. Perlmutter. And as I understand the chairman's bill, 
there would be a haircut or write-down or whatever to some 
appraised value, and I feel sorry for the appraisers in this 
deal. There is a lot of pressure and, Mr. Chairman, I do not 
know--I am concerned about the pressure that is placed on the 
appraisal industry, whether it is independent or within the 
institution, to establish that market price. But here, and Mr. 
Montgomery, this is my question to you, if there is this write-
down to market and then 90 percent of that is guaranteed, I 
understand there is some risk to the taxpayer if in fact the 
market continues to fall, but I am sure--how in what you are 
doing, in what the Administration has proposed is there any 
less risk than what is proposed in this bill?
    Mr. Montgomery. Well, there is certainly risk with the 
existing FHA portfolio, the non-subprime part that we are 
talking about assisting more of, so we have that concern today. 
Again, I think we share some of the ultimate goal that there 
needs to be some sort of write-down to get to a more realistic 
number in between, whether it is 85 percent LTV or 90 percent 
LTV, again, based on actuarial modeling, those loans perform 
fairly well for us. I would say the timing is probably good for 
these. My opinion is, I think prices may go down a little more, 
but I think we are kind of near the bottom of that trough, and 
I think we all want prices to go back, maybe not the run-up we 
just saw, but the timing might be good for doing this type of 
proposal.
    Mr. Perlmutter. Okay, and I guess the last comment, and 
this is to you, Mr. Comptroller, I think one of the biggest 
problems that I have seen here is just the way, whether it is 
Bear Stearns or how it was capitalized in this thing, whether 
it was a 1 percent, you can borrow 99 percent against the 1 
percent on these mortgage-backed securities, and so I just 
think there needs to be some stiffer regulation within the 
capitalizing these mortgage-backed securities, and I yield 
back.
    The Chairman. The gentleman from North Carolina, Mr. 
McHenry?
    Mr. McHenry. I thank the chairman. I do want to start by 
saying I disagree with my colleague. I believe that we should 
not feel sorry for the appraisers; they are going to make a 
mint under this House bill. Talk about pressure, their pressure 
will be being able to get enough hours in the day to process 
all their checks. But I digress.
    Mr. Montgomery, in terms of FHA action, I wanted to bring 
up an article, a recent Wall Street Journal article entitled, 
``Uncle Subprime.'' It contends that Mr. Frank's bill waters 
down the FHA underwriting standards, namely, ``Borrowers cannot 
be denied FHA insurance due to low credit scores or a 
delinquency on existing mortgages. It also cannot be the sole 
reason to deny FHA insurance.''
    In the fourth quarter of 2007, FHA, you all were the only 
component to see a decline in foreclosures in the mortgage 
market, isn't that correct?
    Mr. Montgomery. That is correct. It has gone up and down a 
tenth or a hundredth of a percent but very little.
    Mr. McHenry. Okay, but it is less than the rest of the 
mortgage marketplace.
    Mr. Montgomery. Way less than subprime, it is about 2.15 
right now.
    Mr. McHenry. But less than the whole rest of the 
marketplace. So how would you expect this rate to change under 
the chairman's mark, this discussion draft before us?
    Mr. Montgomery. Well, the beauty of FHA for decades has 
been there is no FICO score requirement. There is not one FICO 
cutoff. We look at the totality of what the borrower's 
portfolio is. I would say we are looking at risk identifiers 
maybe a little differently. We are more concerned about the 
number of delinquencies going forward. I think the chairman's 
bill is looking at it from a DTI aspect as well, which we are 
doing similarly. But, again, I do not think we are looking to 
throw the baby out with the bath water here in underwriting. We 
are going to continue to put some parameters around who 
qualifies and who does not, and there will be some who will not 
qualify.
    Mr. McHenry. How would you expect the rate of foreclosures, 
would it go up or go down, under the legislation before us in 
the House?
    Mr. Montgomery. I think given the narrow constraints that 
we are putting on, again, I cannot control market dynamics, but 
as our foreclosure rate does and has for many years, sometimes 
it will up-tick a little, sometimes it will go back down. I 
cannot see that it would measurably change a lot one way or the 
other.
    Mr. McHenry. Okay.
    Mr. Montgomery. At least in the short term. That is just my 
opinion.
    Mr. McHenry. So just a guess is what you are saying, okay.
    Mr. Montgomery. A little better than a guess.
    Mr. McHenry. Okay, but based on my reading of it, it looks 
like the underwriting standards would be watered down based on 
legislative action and FHA would be forced to ensure loans that 
they normally would not and that is a contention that we will 
make.
    But I will go on to Governor Kroszner. We have some 
discussion today that Citigroup--there is a report today that 
Citigroup has $12 billion in loans. A private equity firm has 
stepped forward and offered them 80 cents on the dollar. How 
would this proposal from the House affect a proposition like 
that? Could this private equity firm in fact make money off of 
this proposal? Instead of being worth 80 cents on the dollar, 
it would be worth 85 cents on the dollar?
    Mr. Kroszner. Well, I cannot comment on anything specific 
to this transaction because I do not have any details on that, 
but the issues that you raise are important ones because we do 
not want an adverse selection problem where the government only 
gets the bad assets, or a moral hazard problem to arise. And so 
that is why it is very important in contemplating any such 
legislation, that there are very important ways of trying to 
deal with some of the adverse selection problem. One way of 
doing that is giving more flexibility to the FHA to do risk-
based pricing, so that if a riskier loan comes to them, they 
can charge a higher premium, just as in the private markets, if 
you are a riskier driver, a higher premium is charged to you. 
And there are a number of aspects of the proposal that I think 
are in important in thinking about that.
    One thing that is done very often in the private sector is 
a so-called loan seasoning or put-back provision so that if a 
loan is sold to someone else, here it would be sold to the FHA, 
if it were to go delinquent very quickly within a few month 
time period, it could be put back to the person who gave it.
    Mr. McHenry. Sure, you mentioned that earlier in your 
testimony. Is the private sector beginning to sort out some of 
this debt question? Are there groups being formed that are 
trying to do some assessment of purchasing some of the loan 
packages, mortgage packages, and trying to make some profit by 
doing some workouts by purchasing this?
    Mr. Kroszner. Again, I am not familiar with any particular 
circumstances.
    Mr. McHenry. Sure, well, Ms. Bair, if you could comment on 
that, and I appreciate your rapping the gavel but she was 
interested in answering.
    The Chairman. We generally allow the last answer. Go ahead.
    Mr. McHenry. Well, Ms. Bair is the last answer, thank you.
    The Chairman. Ms. Bair, please go ahead.
    Ms. Bair. Yes, I just want to add that I think those were 
leveraged loans that were sold; I am only familiar with the 
published press accounts. Those are corporate loans, they were 
leveraged loans, they were not mortgage loans or mortgage-
related assets, so I just wanted to make that clarification. In 
terms of whether mortgages or mortgage-related securities are 
finding their bottom, so to speak, the economic analysis that I 
am getting from our staff indicates that we are still looking 
at very, very steep discounts. Home prices themselves continue 
to go down. We had very steep declines last year, in some areas 
15 to 20 percent, and the futures markets are still predicting 
declines as well as most of the analysts I am reading. So I 
think for housing and housing-related assets, there are a lot 
of uncertainties about where this is still going to go.
    The Chairman. The gentleman from Illinois? Let me ask the 
gentleman to yield me 30 seconds first. The gentleman from 
North Carolina talked about weakening of standards and 
delinquencies. The changes that are proposed permit a 
borrower--because now delinquencies keep you out of this--
permit a borrower to have either one 60-day delinquency or two 
30-day delinquencies if it is 97.75 LTV, and permit borrowers 
who exceed such delinquency histories with extenuating 
circumstances.
    The proposed changes also permit borrowers who only borrow 
90 percent LTV to have as many as one 90-day delinquency or 
three 30-day delinquencies. That is the FHA's proposal from the 
Administration. So the tolerance for delinquencies, and I 
appreciate the Commissioner's answers, what I have just read 
would be a weakening of standards, if that is what you want to 
call it, which is the Administration's proposal.
    The gentleman from Illinois?
    Mr. Foster. I would like to thank the panel for staying 
around to the point where you are now listening to the first-
ever questions from a 3-week old Congressman.
    [Laughter]
    Mr. Foster. The first question has to do with the regional 
and State balance and mortgage relief. In the discussion draft, 
the allocation of grant amounts and loan authority goes 
preferentially to States first that have high real estate 
prices because they are scaled to the median home price. And, 
secondly, to States that have a high fraction of failing 
mortgages since they are scaled to the total number of 
mortgages in trouble or foreclosure. The problems that occur to 
me are that, first, you are allocating funds preferentially to 
States with high real estate prices, and so maybe you are not 
allocating funds in a way to help the greatest number of people 
since it presumably is cheaper to bail out homeowners in low-
cost real estate markets than in higher cost real estate 
markets. And in a related issue, you are implementing what 
amounts to a differential Federal subsidy, which has the effect 
of supporting real estate prices in areas where the prices are 
already high and thereby making a bigger spread in real estate 
prices than the market might normally support.
    And the second problem that I have with this is that if you 
allocate funds to States with high fractions of bad mortgages, 
then you may be creating a State-by-State moral hazard in which 
States that have lots of bad actors in them get a 
preferentially large bailout. And I was wondering, this sort of 
discussion has to come up over and over again in things like 
the FHA and if any of you have comments on this, how it is 
handled and whether there are issues are that could be handled 
differently?
    Ms. Bair. Congressman, I used to work in the Senate for 
many years for Bob Dole and one thing I learned is never get 
involved in congressional debates about where money is 
allocated among States, so I think you raise legitimate issues, 
but I think it is really more one of congressional policy than 
it is regulatory or supervisory issues.
    Mr. Foster. Fair enough, okay. I will ask a hopefully 
simpler question, which is that when this is all played out, 
would we have been better off to simply ban ARMs or maybe 
reduce the range over which they can be reset?
    Ms. Bair. I think that is an excellent question. I think 
what the bank regulators have told the banks is that they 
underwrite loans at the fully indexed rate, meaning you can do 
an adjustable rate mortgage but you need to make sure that the 
borrower has the income to make the reset. The Federal Reserve 
Board has proposed similar rules that would apply to all 
mortgage originators, not just banks. So, yes, adjustable rate 
mortgages may be a good product, but the underwriter--the 
originator--needs to make sure that the borrower can make the 
reset rate when the payments adjust up.
    Mr. Dugan. I would just add that I do not think it is a 
good idea to ban adjustable rate mortgages. There have been 
many that have been very good consumer products that have saved 
consumers a lot of money. Some have performed better than 
others. I think it has really been the underwriting features, 
as my colleague just suggested, that have been the big problem 
with this, and I think adjusting the underwriting standards 
through guidance and through regulation is really the 
fundamental way to get at this.
    Mr. Reich. I agree with that. I think that banning specific 
products is not a good idea. I think that you could name almost 
every product and find that there is significant responsible 
borrower utilization of those products and it is the 
underwriting on which we need to focus our attention.
    Mr. Foster. Okay, I yield back.
    The Chairman. I would ask the gentleman, since we have some 
time, on the first part of the question in terms of the State-
by-State allocation, I just want to be clear, with regard to 
buying up property that is already foreclosed there is an 
allocation, but in the first part, there is no allocation 
formula. The part about the FHA, going to the FHA, there is no 
State-by-State allocation formula. The State-by-State 
allocation--
    Mr. Foster. I believe that there is language in there that 
indexed, this index that was constructed related to the 
average--
    The Chairman. Yes, that is for the part of it that 
distributes the funds to buy a property already foreclosed, not 
for the foreclosure avoidance.
    Mr. Foster. Okay.
    The Chairman. Yes, of course, the foreclosure avoids pieces 
case by case by case. The gentleman is correct as to the 
formula but that goes in the distribution--of course, there is 
no distribution of Federal funds in the first two titles. In 
the last title, that is to buy up property already foreclosed 
and that is according to that formula. But the first part of 
where there is a write-down, presumably an FHA guarantee, there 
is no formula there. It is on a case-by-case basis.
    The gentlewoman from Minnesota? You are the last 
questioner.
    Mrs. Bachmann. Thank you, Mr. Chairman. And I thank the 
panel members who are here as well. I wish I could have been 
here for all of your testimony today, but I do have a question 
for you. You may be familiar with today's edition of the New 
York Times and the headline that read, ``Looming Deficit 
Impedes Federal Housing Agency.'' I would like to read two 
quotes from the New York Times article from this morning. The 
article said, ``Housing officials say the agency will face a 
deficit for the first time in its 74 year history starting in 
the fiscal year that begins in October of this year. They blame 
the seller-financed downpayment loan program, which has 
suffered from high delinquency and foreclosure rates in recent 
years.'' And as I went on to read the article, it is stunning, 
the level of the delinquency under this program.
    Here is a second quote from the article: ``The program 
continues without any changes. Congressional officials say the 
FHA would face a $1.4 billion shortfall in fiscal 2009. This 
would mean that Congress and American taxpayers would have to 
subsidize the FHA for the very first time.'' I am concerned and 
I am wondering whether you are concerned that this proposal 
that we are now considering today will only add to or lead to 
this scenario? We are in a weakened condition now, and I am a 
little nervous that a bill of this magnitude would only add to 
this scenario. I would be happy to hear from any of you, 
particularly Mr. Montgomery.
    Mr. Montgomery. Thank you, Congresswoman. I have a very 
simple solution, and that is to just eliminate seller-funded 
downpayment assistance. If our portfolio was 100 percent 
seller-financed downpayment assistance, we would not be in 
business. And everybody has heard my opinion so I will probably 
defer to someone else but that would be a simple solution. We 
are their only customer by the way. No one else will accept it.
    Mrs. Bachmann. And as I understand it, the Senate has that 
provision included in their bill, is that right?
    Mr. Montgomery. That is correct.
    Mrs. Bachmann. But the House does not?
    Mr. Montgomery. That is correct.
    Mrs. Bachmann. Okay, is there any other comment on that?
    Ms. Bair. Well, I think Chairman Frank's proposal, 
especially with the 15 percent cushion for FHA, does provide 
additional protection in terms of this particular program. I 
think the chairman is making real efforts to build in some 
safeguards to protect the government from future losses. There 
may be some other areas that can be adjusted, but I think that 
there are some protections built into this proposal.
    Mrs. Bachmann. Anyone else? It is a concern of mine because 
it seems that there is a tendency to have the American taxpayer 
be the insurer of last resort, the banker of last resort, and 
we saw recently, and this is unrelated to the Federal Reserve, 
in their move putting essentially $29 billion worth of taxpayer 
money on the hook regarding the Bear Stearns, JP Morgan, Chase 
contract arrangement that was made and that was unprecedented. 
That was the first time since 1932 that something like that had 
occurred. That was the first time that the Fed had exercised 
that power, so the U.S. taxpayer does not seem to have a lot to 
say about their financial position but it seems very easy to 
put the taxpayer in some unique positions that we have never 
seen before: to be banker of last resort; and to be insurer of 
last resort.
    I am concerned that we will be setting a precedent where we 
can go back to the deep pocket every time there is a blip on 
the screen. And, again, I am not trying to say that the current 
situation where we are dealing with foreclosures is a blip; it 
is not a blip. This is very real. People are suffering, and we 
recognize that, but at the same time, this is a private 
contract, these are private contracts that were entered into by 
borrowers and by lenders, and so I am concerned that now we are 
going to be bringing the American taxpayer into a contract that 
they neither began nor did they ask to be invited to be a part 
of. Do you have any comments about that?
    Mr. Montgomery. Well, in some ways the loans with that type 
of assistance are almost a subprime product. And the IRS has 
moved toward eliminating, they had some concerns about the 
circular financial arrangement, and we tried to do the same 
with a proposed rule, but we did not prevail on that. And, 
again, I had one request and that is that the House would 
follow the Senate in this respect and eliminate them 
altogether.
    Mrs. Bachmann. Mr. Montgomery, what do you foresee for the 
FHA as far as solvency goes, down the road? What are you 
seeing? It appears that the American taxpayer will have to be 
bailing out the FHA.
    Mr. Montgomery. I have immense faith in Congress that they 
will finally pass FHA reform, and we can price according to 
risk and we will thus eliminate hopefully this problem on 
October 1st of this year.
    Mrs. Bachmann. Thank you.
    The Chairman. I thank the panel. It has been a long day but 
I appreciate the candor and thoughtfulness with which you have 
answered questions. I do have one disclaimer: To the extent 
that several of the panelists paid tribute to some pieces of 
the bill that we have, they were basically reflecting the fact 
that we listened to them. So I thank them for the nice words. 
They were being both modest and immodest, modest in giving me 
credit; immodest in bragging about what they told me to do. 
With that, the first panel is dismissed, and I will call forth 
our second panel.
    We will begin with Dr. Alan Blinder, a professor at 
Princeton, and a former Vice Chair of the Board of Governors of 
the Federal Reserve. Dr. Blinder?

   STATEMENT OF ALAN S. BLINDER, PH.D., GORDON S. RENTSCHLER 
 MEMORIAL PROFESSOR OF ECONOMICS AND PUBLIC AFFAIRS, PRINCETON 
                           UNIVERSITY

    Mr. Blinder. Thank you very much, Mr. Chairman and members 
of the committee, at least those of you who have had the 
stamina to last this long. I was thinking, as I was waiting, 
that I am glad I do not have a mortgage; it might have been 
foreclosed while I was waiting. But I have no mortgage on my 
property.
    This is a very important piece of legislation. I am very 
glad to come here and testify in support of it.
    The credit markets in the United States and around the 
world, and this is broader than the mortgage market, have now 
been in turmoil since last August--at times improving a bit but 
then deteriorating once again. I would have to say my 
assessment, indeed I think almost everybody's assessment, is 
that the overall trend since August has been downhill, not 
uphill, which is most unfortunate.
    Ameliorating the mortgage foreclosure problem, which is the 
target of this bill, will not cure all the ills that afflict 
the credit markets, but I think it will help. And for reasons I 
will elaborate in just a second, I furthermore think it is 
central, that is, it is not the only thing that needs to 
happen, it is not the magic bullet, but I think it is central. 
I will explain why in a second.
    First, I want to note that there is another point of view, 
one that holds, first of all, that housing prices are too high 
and must be allowed to fall to their market clearing levels, 
and secondly, that homeowners and lenders who made foolish or 
irresponsible decisions should suffer the consequences of their 
own actions. There is a legitimacy to each of these points. 
However, the Social Darwinist sentiment, to which this often 
comes down, reminds me of what Andrew Mellon said in 1931--and 
which, by the way, Herbert Hoover had the good sense to reject. 
It is short and pithy, so I am going to quote it. (The quote is 
right at the top of page two of my testimony.) Mellon said in 
1931: ``Liquidate labor, liquidate stocks, liquidate the 
farmers, liquidate real estate. It will purge the rottenness 
out of the system. People will work harder, live a more moral 
life and enterprising people will pick up the wrecks from less 
competent people.'' Well, I think we outgrew that attitude in 
the 1930's, but it is making a comeback in this decade.
    I want to take that statement as a jumping-off point to 
address the very legitimate question of putting the taxpayer on 
the hook. This bill would, as has been said by several people, 
leave the taxpayer holding the bag if things go wrong. I want 
to point out, very importantly, that the taxpayers, or if you 
just broaden it slightly the citizens, who are a slightly 
bigger group, although if you count sales tax and every kind of 
tax, taxpayers include everybody, are on the hook if the 
economy goes into a slump. Indeed, they are on the hook 
already, for the economy is in a slump. If we have a severe 
slump, or what I fear more, a protracted period when we are 
simply not growing as we should be because of a broken credit 
mechanism, every American is on the hook for that. So it is 
exactly the same people. What this legislation is about, and 
what I think this whole effort should be about, including all 
the things the Federal Reserve is doing, is to make the bill, 
in whatever form it comes, smaller. And I think there is a good 
chance that this bill can contribute to that.
    The first part of my testimony, which I am going to go over 
very, very quickly in the interest of time, lists six reasons 
why I think, in contradistinction to Andrew Mellon, that the 
government should intervene to try to make this problem 
smaller. I will really touch on only two of them in the time 
allotted to me here at the witness table.
    If I could call your attention to the inverted pyramid that 
I sketched, not that well, on page three; this looked better 
when it came from my secretary, but then I fiddled around with 
the document and made a mess, so I am sorry. The bottom of this 
pyramid shows homes and then mortgages. The point I am making 
in this diagram is that the problems in the housing market, 
which of course immediately become problems in the mortgage 
market, sit at the bottom, at the apex of this triangle. And 
lots of financial instruments are then built above mortgages, 
so the most obvious is mortgage-backed securities, MBS. Then 
you have the notorious CDOs and an entire alphabet soup of all 
kinds of other things. And then at the top of this diagram, it 
shows in large letters the entire credit market, which has by 
now been infected by the contagion. So the problem spiraled up 
from the bottom in this diagram, from falling housing prices to 
more actual and feared defaults on mortgages, to lower values 
for MBS, to decimated values for a variety of derivatives built 
on them, and hence to the whole credit market.
    The basis of the Federal Reserve's much applauded, although 
in some quarters criticized, intervention in the Bear Stearn's, 
J.P. Morgan matter was exactly stopping contagion. The Federal 
Reserve really did not care about Bear Stearns per se, but it 
cared a great deal about contagion to the rest of the financial 
system and thus to the entire economy. That is what this effort 
is about, as I see it. There has been tremendous contagion 
already from the bottom of this pyramid filtering up and that 
is why it is appropriate, I believe, to start at the bottom to 
reverse this cycle and turn it into a cycle where the 
foreclosure problem starts looking smaller rather than larger, 
the mortgage-backed securities start gaining value rather than 
losing value, and so on up the pyramid. Then you start creating 
more confidence in the entire credit system.
    The second point I want to make, which is very much related 
to that, is that all modern economies run on credit and when 
the credit system malfunctions, the whole economy malfunctions. 
That takes us back to the question I raised earlier about who 
is on the hook for all this? Every single American is on the 
hook for this, and the worse the economy gets, the worse it is 
for all of us, Andrew Mellon notwithstanding. While the moral 
hazard problem is perfectly valid, this could be a very 
expensive moral hazard problem to solve if we just let laissez-
faire do it. Laissez-faire will do it in rough but reliable 
ways, and, by the way, it seems to be taking a long time. That 
is why I emphasized that this crisis started in August, and 
here we are in April and the credit markets are looking worse, 
not better--which to me was a huge surprise. I would not have 
thought in August that we would still be in crisis in April.
    So I just want to pick out a few points in the legislation 
and mention them. How many minutes do I have left?
    The Chairman. About 2 or 3 minutes.
    Mr. Blinder. Two or three, alright, I will be very 
selective. First of all, one of the keys to the moral hazard 
problem is the haircuts that both borrowers and lenders will 
have to take. Borrowers in this bill give up certain privileges 
of price appreciation. I would actually like to see them give 
up more privileges in terms, for example, of the ability to 
take out a second mortgage, which includes a home equity loan, 
on the property. Ordinary homeowners have that privilege as 
long as the bank will give them the money. For these special 
mortgages, I think it would be appropriate to take that 
privilege away as another way of controlling the moral hazard 
and controlling the demand for the program, as well.
    When it comes to the lenders, the right thing to do, of 
course, is to mark the mortgages down to market. The problem, 
the catch here, and it is a gigantic catch, is that the market 
for re-selling these mortgages has practically evaporated. I 
would like to see the bill--and I think it is the intent, it is 
your intent, Mr. Chairman and the intent of other people who 
have input into this bill--to try to mimic something like what 
the market would do if the market was functioning. My idea on 
this was a little bit different. It was to have the FHA post 
buying prices for mortgages of various qualities, based on the 
best guess it could make of what the market price would be, and 
then watch. If it gets flooded with servicers trying to sell 
mortgages, it has set the prices too high. If nobody shows up, 
that will show it has made the prices too low and try to 
iterate in that way towards market prices. But, really, the 
point I want to make is that in this respect, trying to mimic 
what the market would do if there was a market is an important 
way to think about framing the legislation.
    I had a number of things in here about eligibility 
criteria, which is going to go to determine the size of the 
pool of mortgages that get refinanced this way, but let me skip 
most of that and just make two points. One is that nobody knows 
how many mortgages will need this treatment, so to speak, so 
nobody can sit here and say, well, this will be 1 million 
mortgages or 1.5 million mortgages, and I think the Congress 
needs to allow in the legislation flexibility and just 
understand in Members' own minds and in citizens' minds that 
nobody really knows what the scale of this operation must be, 
and once we embark on it, it would be foolish to cut it short 
before it has done what it was supposed to do.
    The other point I wanted to make, because it came up in the 
previous panel more than once, I think, is that we ought to be 
pretty tough about fraud, that is, people who committed fraud 
and misrepresentation to get their original mortgages ought not 
to be eligible for this program. I would like to see this 
program administered as a high-document one, in 
contradistinction to the low-document or no-document mortgages, 
including such things as proof of residency and a whole variety 
of other things.
    [Gavel]
    Mr. Blinder. Am I out of time?
    The Chairman. Yes.
    Mr. Blinder. Then I will stop, thank you.
    [The prepared statement of Dr. Blinder can be found on page 
114 of the appendix.]
    The Chairman. We will get to some of this in the questions. 
I gave you a little extra time because these three witnesses 
were very forbearing for a long morning and into the afternoon.
    Mr. Brian Wesbury, the chief economist at First Trust 
Advisors. Mr. Wesbury?

   STATEMENT OF BRIAN WESBURY, CHIEF ECONOMIST, FIRST TRUST 
                         ADVISORS L.P.

    Mr. Wesbury. Thank you, Mr. Chairman. Thank you, members. 
It is good to be here. Thank you for inviting me. I will try to 
be brief but if I could put my entire testimony into the 
record, that would be great.
    The Chairman. Yes.
    Mr. Wesbury. It is interesting that Dr. Blinder brings up 
Andrew Mellon's quote to ``liquidate, liquidate, liquidate'' 
because we have heard a lot of talk about the Great Depression 
in recent weeks and Herbert Hoover and a lot of it has been 
about how he sat idly by while the economy crashed, and we use 
his image as a kind of a dart board, I suppose, these days 
politically about what is going on, and I think this is just 
false in two ways: Number one, Herbert Hoover was extremely 
active in the late 1929, early 1930 period; and number two, we 
have done unprecedented things in the last 7 months as well, 
and I think there are great parallels. One of the reasons that 
a recession turned into the Great Depression in the 1930's, in 
my opinion, is because the government overdid things; they 
became too active. Herbert Hoover signed a tax increase in 
1932, signed the Smoot Hawley Tariff Act, which raised tariffs 
on exports and imports, and literally shut down world trade. He 
increased--
    The Chairman. Mr. Wesbury, we do have time, but the 
economic history part, if we could get to the more current 
stuff, that would be helpful.
    Mr. Wesbury. Okay. My feeling is that the history is 
relevant here.
    The Chairman. Alright, but it comes out of your time if 
that is how you want to use it.
    Mr. Wesbury. And I have 5 minutes, I was going to use it in 
a way--
    The Chairman. Go ahead.
    Mr. Wesbury. Just to skip to today, we have been extremely 
active. The Federal Reserve has cut interest rates by 57 
percent in the last 7 months; that is the fastest rate cutting 
we have had in 60 years. There have been hundreds of billions 
of dollars lent to financial institutions to help them through 
this period of time. FHA, Fannie Mae, Freddie Mac, and the 
Federal Home Loan Banks all have had rules changes to allow not 
the FHA yet but to allow more lending to take place. The HOPE 
NOW Program has by most accounts helped almost a million 
homeowners restructure the terms on their loans. This is a 
very, very active government, and I think with a matter of 
time, we are going to see the impact pick up and the economy 
pick up as well.
    Now, let me go to my next point and that is this: How did 
we get in this mess? Was it really about fear and greed, greed 
of homebuyers, greed of lenders, people taking advantage of 
each other, or was it about something else? And my belief is 
that people, human beings, do not change from spendthrifts to 
misers overnight. They do not go from not wanting to buy homes 
to wanting to buy everything in sight that has a two-by-four in 
it overnight. Something has to happen to create a change in 
their behavior, and I think what changed was that the Federal 
Reserve drove interest rates to 1 percent back in 2003 and held 
them there for too long. What this did is it drove up home 
prices and it made mortgages extremely cheap. Everyone thought 
interest rates were going to stay down low forever and, as a 
result, we saw a surge in activity. In fact, if you look at 
almost any measure of housing activity between 2003 and 2006, 
it surged well above its trend, and I believe that is how we 
got here.
    The interesting thing is that this kind of mirage in the 
marketplace has happened before. In the 1970's, the Federal 
Reserve was also too easy, it drove up oil prices, Penn Square 
Bank made too many oil loans, and sold participation in those 
loans to Continental Bank and Seafirst Bank, and all three of 
these banks went under. In other words, we have seen financial 
problems caused by this occur before and in the 1980's, we 
continued to grow, the economy was fine, and one of the reasons 
that we did continue to grow is that the government was not too 
active in the 1980's like it was the 1970's or in the Great 
Depression.
    So what I would come back to, Mr. Chairman, is that I would 
encourage the committee to think twice and be very, very 
patient with the economy before interfering with the 
marketplace. Interfering with the marketplace, as we did in the 
1930's, can often lead to even worse economic problems in the 
future and make our issues less tolerable.
    Thank you.
    [The prepared statement of Mr. Wesbury can be found on page 
198 of the appendix.]
    The Chairman. If you need more time, we did give Mr. 
Blinder more time, if you want a couple more minutes, please.
    Mr. Wesbury. That is okay. Five minutes is what you gave 
me.
    The Chairman. Finally, Allen Sinai, who is the chief global 
economist and president of Decision Economics, Incorporated.

 STATEMENT OF ALLEN SINAI, CHIEF GLOBAL ECONOMIST, STRATEGIST 
            AND PRESIDENT, DECISION ECONOMICS, INC.

    Mr. Sinai. Thank you, Mr. Chairman. Let me summarize some 
major points and the context in which the proposed draft 
legislation fits in an array of public policy measures that 
need to be taken to deal with the current situation. No one 
measure will do it, but many will.
    The U.S. economy is in recession as we speak. It has been 
in recession since around the turn of the year. The recession 
is intensifying and widening as indicated by an increasing 
array of monthly key economic and financial indicators. The 
recession, already I believe in its 4th month, cannot be short. 
The average length of U.S. recessions has been about 10\1/2\ 
months. The last two in 2001, 1990 and 1991 were 8 months each 
and before 1980 to 1982 and 1973 to 1975, we had 16-month 
recessions. This one cannot be mild. Forget GDP has the 
measure. It is misleading as to what is really going on where 
it counts, in jobs, for the consumer, in housing, and for small 
businesses on Main Street. The downturn is also this time, in 
the eyes of Wall Street, a holy terror. This is what one sees 
in the end and in an unwinding of a boom and asset price 
bubble, often in business cycles occurring in real estate, the 
stock market or both and not just in the United States.
    Now, the pinnacles of the bust in housing--declines in 
housing prices and effects on credit have attached to 
consumption spending, currently growing at a sharply lower 
pace, more than 3 percentage points below its historical trend 
and itself now touching and causing reductions in business 
sales and earnings so that business cutbacks, more firing than 
hiring, decreased production and lower inventories and reduced 
capital spending are adding to the economy's downward thrust.
    As for housing, where a huge overhang of inventories of 
unsold single multi-family homes exist relative to sales, as 
the recession intensifies and widens and the unemployment rate 
rises, the demand for housing will weaken further and the 
overhang of supply raised by more foreclosures in the absence 
of legislation like the one suggested by this committee will 
probably remain and home prices will keep declining. The end to 
the declines in housing prices cannot yet be seen therefore. 
The U.S. recession not only cannot be short, it could also be 
quite severe.
    The anatomy and process of the downturn suggests that we 
are still its early stages, much is familiar but what is new is 
an overlay of a financial crunch and crisis that will prolong 
it. What is old is an inflationary shock of higher food, energy 
inflation, and that will prolong it. Sticky high inflation from 
also high health care inflation and a lower dollar will prevent 
all the stimulus that is needed and/or the rising purchasing 
power that typically is an automatic self-correcting mechanism 
in a recession to bring about their recovery. The temporary tax 
cut stimulus will probably provide only transient help.
    The process of the downturn started in housing and a 
decline of activity in the aftermath of an incredible boom. The 
housing downturn turned into a collapse, and now I think it is 
a bust. And the unprecedented fall in housing prices, now down 
10 percent to 16 percent from previous peaks, we are not 
through yet, in published measures took down the value of 
housing as asset collateral, upon which has been built and 
leveraged so much credit, debt, spending, businesses, new 
financial instruments and the business of financial 
intermediaries, bank and non-bank. The ongoing credit and 
balance sheet crunch has cracked the U.S. financial system and 
made financial intermediaries the lever risk in a hurry, 
unwilling to lend much within and outside of the financial 
system. All Americans are adversely effected by this.
    Housing is in crisis. There is also a financial crisis. And 
so one should ask, what is the role of public policy in this 
situation? Well, since housing is at the very heart of this 
episode, a place to start is with policies that seek to reduce 
the excess overhang of the housing stock relative to housing 
demand and the excess bad collateral built on the now collapsed 
housing sector and falling housing prices and excess supply of 
mortgage debt and mortgage-based, a derivative securities and 
structured finance built on that.
    What are the policy choices? Certainly, one that has been 
taken and is absolutely necessary is low interest rates. These 
must be maintained and reduced even more. In some fundamental 
sense, low interest rates under normal circumstances can stop 
the declines of housing prices that are taking down the value 
of housing as collateral and as a source of ultimate value in 
so many derivative financial instruments and for those 
financial institutions whose balance sheets and businesses are 
tied to it and where those businesses are declining. But with 
the negative price dynamic of a bursting asset price bubble, 
the psychology associated with declining house price 
expectations could well overwhelm the fundamental health that 
lower interest rates provide; they may not work.
    The second choice line of defense is an aggregated fiscal 
policy measure, such as tax cuts or increased government 
spending. The fiscal policy stimulus recently passed provides 
one time tax reductions to households and businesses that may 
cushion the overall economy from the consequences of the 
housing downturn for a time, but they cannot get at the root 
cause of the housing and financial crises: too much available 
housing, too little demand, too large a supply of mortgage 
debt, mortgage-derivative securities and structured investment 
vehicles relative to the demand. And, unfortunately, these tax 
reductions, since they are only temporary, on our work are not 
going to make a big difference for a very long time in the 
economy.
    Third, there are measures in public policy that can be 
taken. The Federal bank central bank have done a number of 
these. And, of course, the fourth choice is to do nothing. 
Politically this is virtually impossible in the current 
situation. For many Americans, owning a home is a lifetime 
dream and the value of their house is much, if not all, the 
family net worth and what is needed for retirement. With so 
many abuses and so much laxity in supervision over what went on 
in housing, housing finance subprime lending and borrowing and 
the huge payouts to executives and workers in many financial 
intermediaries, the taxpaying public is justifiably enraged and 
concerned about what we call moral hazard.
    The Chairman. Mr. Sinai, we have to move to a close.
    Mr. Sinai. Doing nothing, however, would be too little and 
that is part of the 1930's history, public policy is here and 
free markets can solve many problems but there is a legitimate 
role for government intervention when there are market failures 
and casualties of capitalism.
    The public policy measure being considered here is a good 
one. This potential legislation that would enhance the FHA to 
help stabilize housing, and facilitate homeownership would work 
through the forces of demand and supply and help to arrest the 
decline in housing prices. It makes lenders better off by not 
having to deal with foreclosure costs or the refusal or failure 
of borrowers to make monthly payments. It saves a lot of 
litigation and legal costs. Many homeowners would keep their 
homes; the FHA-approved lender would take the loan, reconfigure 
it, restructure it, and refinance it in a reasonable fashion, 
and it would be insured or guaranteed at little risk to the 
government. This enhanced program provides benefits to all, 
some penalties to all, retires some of the supply of mortgage 
debt that needs to be taken off books or mortgage-backed 
securities relative to demand, and should strengthen the demand 
for housing relative to supply.
    In conclusion, as one approach of Federal Government action 
to intervene and cushion in this particular situation where 
housing has been a big source of our problems, my conclusion is 
Congress should move this proposal ahead, integrate 
Administration comments and other ideas into it, fine tune it 
and get it passed in a hurry, quickly, quickly, quickly. Time 
is of the essence.
    [The prepared statement of Dr. Sinai can be found on page 
185 of the appendix.]
    The Chairman. Thank you, Mr. Sinai. Let me begin by saying 
that obviously, I am in agreement, and I appreciate two of our 
economist members of this panel stressing that we are dealing 
here with the macroeconomic problem, not just the specific 
problem of mortgages. I understand a lot of the criticisms, and 
if it were not for the fact that we have lost 230,000 jobs this 
year, that we are in a recession that I believe was 
exacerbated, there was no factor that was more of a cause of 
this problem than the subprime crisis reverberations. The 
argument for moving here is the broader economic effect. The 
foreclosure damage occurs in concentric circles. The main 
burden falls on the person whose house is lost and in some 
cases, they made mistakes. In an ideal world, we would let 
those individuals bear the burden of their own mistakes, but 
the other people who own houses on the block are hurt, the city 
is hurt, and the whole economy is hurt, so that is the 
justification.
    One other issue I just wanted to note, the President issued 
a statement today about, and of course Commissioner 
Montgomery's testimony made clear, we have moved closer in some 
ways here. There was one statement in which the President says, 
``The Administration opposes legislation that would allow 
lenders or services to sell bad loans to the taxpayers through 
an auction process, clearinghouse, or other wholesale 
mechanism.'' That is a straw man; no such legislation is before 
us. The proposal today, at the encouragement of the Federal 
Reserve, does include an auction process but at no point will 
the FHA be compelled to accept any of those loans. The FHA 
screening procedures will remain in effect and an auction 
process we believe will help set a price, but before any 
guarantee is attached to any loan, the FHA will do an 
individual analysis and we will accept it or reject it, so we 
agree with that.
    Mr. Wesbury, I was just interested that you questioned a 
number of things that the government has already done, and I 
appreciate that, but as I read your testimony, it sounds like 
you wish they had not, or we had not. The last page of your 
testimony, ``Government action,'' talking about the 
contemporary situation, ``Government action has compounded 
problems faced by the U.S. economy,'' and particularly you note 
for instance that the Federal Reserve recently, the Fed's sharp 
cuts in interest rates over the past 7 months have probably 
prolonged the recovery process. And specifically, for example, 
Fed rate cuts are the most likely cause of a spike in oil 
prices from $70 in August to a recent all-time high, so you 
believe that in this past year, the Federal Reserve has done a 
lot more harm than good. You also mentioned the HOPE NOW 
Program. Is that also one that has done more harm than good in 
your judgment?
    Mr. Wesbury. No, actually I think the HOPE NOW Program, 
because it is voluntary between borrowers and lenders, I think 
borrowers and lenders would have come together even without 
HOPE NOW to restructure many of these mortgages or restructure.
    The Chairman. So it was not harmful; it was just not 
effective?
    Mr. Wesbury. No, I am not saying it harmed but what I am 
getting at there is that Federal Reserve rate cuts, especially 
if I am a potential homebuyer today, and I think the Fed may 
cut interest rates again next month, why would I buy a home 
today, why would I do that?
    The Chairman. I understand that but--
    Mr. Wesbury. That is what I am talking about. And also when 
the Federal Reserve cut interest rates in August dramatically, 
starting in September and cut them dramatically, we saw a surge 
in gold and silver and corn and wheat and oil prices. Oil 
prices went from $70 to $100, and today $111 or $110 a barrel, 
four airlines have gone bankrupt in the last week, partly 
because of high energy prices. My belief is the inflation--
    The Chairman. I appreciate that, the President, for example 
has said that it was not anything we were doing domestically 
that was causing oil prices to go up, that this was worldwide 
factors, etc., but you disagree with that. You believe that the 
Federal Reserve's interest rate cuts are, as you say, the most 
likely cause of the spike in oil prices?
    Mr. Wesbury. Absolutely.
    The Chairman. The other issue, I was struck by this because 
I must say I have also felt that the emphasis on homeownership 
has been overdone and there has been a lot of pride taken in 
increased homeownership and it has been the goal, you say in 
your next to last paragraph, ``A widespread effort by the 
Federal Government to create more homeowners is one of the key 
causes of today's financial market problems.'' Would you in the 
last minute or so elaborate on that?
    Mr. Wesbury. Sure, and I am not saying anything that Ned 
Gramlich, the late Ned Gramlich, the Federal Reserve Board 
Governor--
    The Chairman. Sadly, not available, so we will have to have 
you say it.
    Mr. Wesbury. Right or Larry Lindsey has also said the same 
thing, and they both chaired the Community Reinvestment Act 
panel or--I'm not sure of the name of it internally at the Fed, 
but that subcommittee of the Federal Reserve Board that 
enforced the Community Reinvestment Act. They both have 
highlighted the fact that this forced many banks and cities to 
issue subprime loans in lower income--
    The Chairman. Oh, no, I would disagree. Larry Lindsey has 
said no such thing and neither did Ned Gramlich. What they were 
concerned about was the failure of the Federal Reserve, Mr. 
Gramlich was, to use the authority granted under the 
Homeowners' Equity Protection Act. Without objection, I will 
put into the record the letter from Mr. Lindsey--which he sent 
a couple of years ago when he had that position--in which he 
said, ``No, the CRA caused none of these problems.'' He was a 
strong supporter of the CRA and of expanding it and said it did 
not lead to any unsafe or unsound practices. And Mr. Graham 
specifically was critical, Mr. Blinder was there, of the 
failure to use the Homeowners Equity Protection Act. Neither 
one of them blames CRA. If you have any evidence to the 
contrary--
    Mr. Wesbury. I do.
    The Chairman. --we will take it to the record, but I have 
Larry Lindsey's repudiation of that argument.
    Mr. Wesbury. I have somewhere with me, I did not bring all 
this stuff with me, but Ned Gramlich gave a speech, he didn't 
actually give it, someone gave it in his stead in Wyoming last 
year for the Kansas City Fed in 2007 and Larry Lindsey wrote an 
editorial for the Wall Street Journal, both of which said the 
Community Reinvestment Act was part of the problem with 
subprime loans.
    The Chairman. Well, again, Mr. Lindsey contradicted that 
earlier when he was on the Board. And the problem also, Mr. 
Gramlich was talking very much about was the Homeowner's Equity 
Protection Act and the insufficient regulation. I will be glad 
to have that testimony. I will put in Mr. Lindsey's letter that 
he submitted to this committee specifically on that issue.
    The gentleman from Texas?
    Mr. Hensarling. Thank you, Mr. Chairman. Again, we have 
many important policy decisions to make here. It is always 
useful to have the facts. I believe that Dr. Sinai, in your 
testimony, you spoke of the unprecedented fall in the value of 
real estate that we have seen recently. But preceding that, 
have we not seen an unprecedented increase in the value of real 
estate in, at least at the moment taking a snapshot, aren't 
home values on a nationwide basis roughly where they were 3 
years ago?
    Mr. Sinai. The answer is yes. The unprecedented decline is 
in the published indices from 10 to 16 percent, depending on 
the index, relative to the previous peak. And in Table 1 at the 
back of my testimony, the price increases are shown and they 
were much, much higher than that. So, there are two ways to 
look at that. I think we are going to lose a lot of those 
extraordinary boom and bubble price increases that we had, and 
at the moment, we are in the process of the declines and that 
is really what we have to deal with unfortunately.
    Mr. Hensarling. Listening to the debate surrounding these 
issues, I suppose there are two compelling reasons to have 
Federal Government intervention, particularly taxpayer exposure 
to the housing market. One is we have a lot of innocent victims 
out there and it is the fair and right thing to do to give them 
Federal assistance, which ultimately is taxpayer exposure.
    The other argument is we have such a precarious 
macroeconomic mess that even though these people may not be 
deserving of help, that we have to do it for the greater good 
of the economy. Let me first explore what is typically called 
the fairness argument, one we hear frequently in Congress. 
Again, as I look at the universe of people who may be helped by 
legislation, either what the chairman has put forth or similar 
pieces of legislation, I do not, one, conceptually believe you 
can help borrowers without simultaneously helping the lenders.
    I fundamentally think it is an impossible task, so 
therefore I am sitting here wondering, we have a lot of smart 
people on Wall Street who supposedly knew a lot about real 
estate, and maybe they didn't know a whole lot about real 
estate. And so, at least under this piece of legislation as I 
understand it, potentially we are allowing those people to 
unload their worst performing assets for 15 percent haircuts so 
it is kind of a stop loss.
    When I look at the borrowers' side, there is no doubt in my 
mind that some people were taken advantage of. Some people were 
victimized by what is often called predatory lending. I think 
it is probably basic fraud. But for every utterance we hear of 
the phrase ``predatory lending,'' we rarely hear the phrase 
``predatory borrowing.''
    In an earlier panel, I don't have it with me now, I had a 
copy of a FinCEN report, which I think comes about as close to 
an expert in Federal Government in financial crimes, that talks 
about a huge spike in the last 4 years of mortgage fraud, much 
of that being borrowers. Apparently my reading of the report is 
well over half of the borrowers who have either given false 
asset statements, liability statements, income statements, 
occupancy statements. So we have a whole group of these people 
who don't seemingly make a very sympathetic poster child for 
taxpayer exposure and help.
    I also cited a Boston Fed report that came across my desk a 
few days ago that seemingly makes the case that the real reason 
for default on subprime mortgages isn't necessarily the 
inability of people to make the reset payment. Instead, it has 
to do with the devaluation of the asset. In other words, these 
were people seemingly arguably counting on the appreciation of 
the real estate so they could flip it or they could refinance 
with the additional equity, or they use the additional equity 
to trade out of the 6-year old station wagon into the Lexus, or 
get the big screen television. They also don't seem to be a 
very sympathetic figure.
    So, again, if I am sitting here thinking am I going to 
reward all these people, again, it suggests to me the moral 
hazard issue, and ultimately, I guess I am mixing metaphors 
here, kicking the housing bubble down the road. And I see I am 
almost out of time, so that is the only question I have, 
starting with you, Mr. Wesbury, if you would comment.
    Mr. Wesbury. Sure. I believe that one of the things that 
happened in that 2003 to 2006 period is that extremely easy 
Federal Reserve policy caused borrowers, lenders, and everyone 
involved in the whole process of making mortgages and packaging 
them up to believe that interest rates would stay low forever 
and that housing prices would rise forever.
    By the way, Penn Square Bank believed this about oil back 
in the late 1970's, early 1980's; they thought oil was never 
going to go down so they made loans like crazy and then sold 
off their participations. This has happened before. And the way 
that these markets correct is when prices fall and the loans go 
bad, people pay for their bad decisions.
    What is interesting is that in the last few years of this 
process, a lot of these loans were made with no money down. So 
you can sort of kind of think of a bank not as a mortgage 
holder but as a landlord because the homeowner had no skin in 
the game. With no money down, there was no skin in the game, 
and therefore what everybody hoped was that the price of the 
home would appreciate, then the homeowner would accumulate in 
the skin in the game.
    But what happens is, if prices don't keep going up, then 
no, there's no skin in the game and people walk away from their 
mortgages. I think trying to lock people into those mortgages 
is a moral hazard situation that could actually make this 
problem worse down the road.
    Mr. Blinder. Did you want each of us to answer that?
    The Chairman. Very quickly. We only have time for one more.
    Mr. Blinder. Yes, I think that there isn't any doubt that 
if you try to classify people as to who is morally deserving 
and who is not morally deserving, first of all, it is virtually 
impossible to do. There are certainly cases of the sort that 
you are talking about--no doubt. There were huge numbers who 
were duped into mortgage contracts that they didn't understand. 
That is plain. And my view is that when you come in with a 
fixed, generically and certainly in this case as well, when you 
come in with some kind of fix-up after a mess occurs, which is 
where we are right now, some people are going to be helped who 
ought not to be helped. I view that as the collateral damage 
that you pay in order to pull the economy out of the soup. That 
is the big picture here. There will be some of those cases.
    The Chairman. Let me just ask to take 15 seconds on the CRA 
point. I just want to make this point. I think it is fairly 
clear. The disproportionate share of the mortgages that should 
not have been made in the subprime area were made by people not 
covered by CRA. Mortgage brokers are not covered by CRA. In 
fact, if you look at the banks, which were covered, they did a 
relatively better job. So the other point is that the worst 
records were by the mortgage brokers not covered by CRA. The 
gentlelady from California.
    Ms. Waters. Thank you very much. Mr. Chairman, members, and 
panelists, the discussion about macroeconomics is an 
interesting one, but I am so focused on the foreclosures all 
over America and the fact that I have been in several cities, 
including Cleveland, Ohio, and parts of California, such as the 
San Bernardino, Riverside area, and in Detroit, Michigan, where 
I have seen entire blocks boarded-up that I am singularly 
focused on helping American citizens who are in trouble. Those 
people that we can save from foreclosure, we need to do it and 
we need to do it quickly. And for those people who have been 
harmed by foreclosure, we need to find ways by which we can 
help them also.
    You mentioned government's involvement and you talked about 
the HOPE NOW Alliance, Mr. Wesbury, and you mentioned how many 
modifications or workouts they have done. How do you know how 
many they have done?
    Mr. Wesbury. It was in the testimony of Mr. Montgomery in 
the panel before us. He talked about it, and this has fallen 
pretty much in the public record.
    Ms. Waters. Well, let me just say this. One of the problems 
I have with trying to do oversight is the fact that we have to 
depend on information from regulators and those who are 
managing some of our agencies that should know information when 
they come before us. There is nobody that I have talked to who 
can document the number of workouts that have been done by the 
HOPE NOW Alliance.
    As a matter of fact, there are those who have information 
to say they haven't done very well at all. It is indicated that 
HOPE NOW states that it helped 545,000 homeowners in the last 
half of 2007, but 33 percent more homeowners actually lost 
their homes to foreclosure during the same time period. In 
addition, through January of this year, HOPE NOW servicers have 
been allowed to reduce interest rates or to otherwise modify 
loans that are unaffordable. Instead, 72 percent of the 
homeowners being helped by HOPE NOW are only receiving 
repayment plans. I share that information with you because the 
industry has had time to show what it could do.
    But is the HOPE NOW Alliance or Wall Street or servicers 
that had time to show that they could straighten out this 
situation; that they could do loan modifications; that they 
could do voluntary things. It has not worked. It has not been 
done. The people do have some reasonable expectation that their 
government is supposed to have regulation and regulators who at 
least watch closely enough to know when citizens are being 
ripped off; when products are being invented that are 
misleading; and when citizens will be harmed. And, thus, when 
the regulators are not doing their job, and we are not doing 
our jobs, and the people are harmed, I think it is reasonable 
for them to expect some government intervention. Don't you?
    Mr. Wesbury. Well, I think that there are always unintended 
consequences to government intervention and that is what I try 
to remind people of all the time, and that is if we are to bail 
out people today who made bad decisions, who thought housing 
prices were going to go up forever, what is next? Are we going 
to help out because their stock portfolios fall? Are we going 
to do this the next time, the next time housing prices are 
running, are we going to--
    Ms. Waters. My question--
    Mr. Wesbury. --tell me people, no, don't buy a house 
because if you get in trouble--
    Ms. Waters. --my question is, we have a problem; we have a 
crisis; we have a subprime meltdown. Do you think people should 
have reasonable expectations that their government will do 
something to help them now?
    Mr. Wesbury. I listed all of these things. We can go back 
and talk about them. The Federal Reserve has cut interest rates 
dramatically.
    Ms. Waters. Do you think that--
    Mr. Wesbury. We have a rebate check coming starting in May. 
The Federal Government has been extremely active. I mean, this 
has been amazing. Hundreds of billions of dollars, the Federal 
Reserve doing unprecedented things to shore up the mortgage 
market. I mean, I think the Federal Government has done 
something.
    Ms. Waters. Do you think that there is a crisis that still 
remains?
    Mr. Wesbury. I mean, are we out of the woods in terms of 
the economy?
    Ms. Waters. No, I mean, you can claim it any way you want. 
My question is, do you think we still have a subprime crisis?
    Mr. Wesbury. I'm not sure what--I don't even--I am not 
trying to be--
    Ms. Waters. Okay, that is okay.
    Mr. Wesbury. --combative.
    Ms. Waters. If you don't know what it is, I will understand 
that. If you don't know what a subprime crisis is, if you don't 
think that what we are confronted with now is a crisis, okay, 
that is fine. And if you don't think that the government should 
intervene, would you tell me again what the citizens of this 
country who depended on the regulators that are paid for by the 
people to give them some measure of protection, what do you 
think they should do? Should they just suffer until, I think as 
you described, there is a natural turn and a change of things 
that will straighten this out; is that what you are saying?
    Mr. Wesbury. No, I guess what I am saying, Congresswoman, 
is this, and that is that is that I believe a lot of people 
went into the housing market with their eyes wide open. In many 
cases, in these no-document loans, people were lying about 
their income. They knew they were lying.
    Ms. Waters. So you think that if they--do you think the 
regulators should have vetted no-doc loans and do you think 
there should have been some regulation and oversight on no-doc 
loans?
    Mr. Wesbury. Yes, there should and there is regulation on 
that. One of the interesting things that the chairman said 
about CRA was that it did not cover the mortgage lenders. That 
is true, but subprime loans, when they were packaged into pools 
and then purchased by banks, counted towards CRA rules. So, in 
fact, even the mortgage lenders were influenced by the CRA 
program.
    Ms. Waters. Well, I think there is just a difference of 
opinion about who caused this mess, and if you are trying to 
lay off a significant responsibility to CRA for the mess, we 
don't believe that, most of us on this side of the aisle, just 
don't believe that. All right. My time is up so I would like to 
engage with you, but it would not be fair so I am going to go 
on to the gentlelady from New York. Thank you.
    Mrs. Maloney. I thank the gentlelady for yielding. Dr. 
Blinder, you say that the most urgent problem before us is the 
potential tsunami of home foreclosures, as you put it. I agree 
with you, and I am pleased to see that you support Chairman 
Frank's proposal to provide $300 billion in FHA home loan 
guarantees. Fed Chairman Bernanke testified before the Joint 
Economic Committee last week, and when we asked his opinion of 
this approach, he said, ``I am still focused on the loan by 
loan approach where servicers would voluntarily modify loans to 
make them eligible for FHA refinancing.'' Given that the 
evidence is that this is not working, don't we need a new, 
large scale-strategy like the Frank proposal for this new 
large-scale challenge that we confront? Dr. Blinder.
    Mr. Blinder. Well, I obviously think that we do need that. 
The numbers here are tremendous, and as I said, and as you just 
said, they are in some sense at the apex of our broader credit 
and economic problem. What I would say, however, is that those 
pieces of Chairman Bernanke's testimony that you just cited 
seem to me quite consistent with the approach in this bill. It 
is voluntary. Nobody is going to be dragged into this against 
their will. And in large measure, it is loan by loan. There is 
this title, too. But in substantial measure it is, in fact, 
loan by loan. It is not saying that we are going to take this 
entire category of loans and apply a cookie-cutter treatment in 
which all loans are going to be treated exactly the same. So at 
bedrock, this is a loan-by-loan approach, although one that has 
enough financing behind it and enough scale behind it that you 
could start getting into the millions of loan refinancings.
    Mrs. Maloney. In February, Dr. Blinder, in your writings, 
you argued that we should bring back the Home Owners Loan 
Corporation, the Depression-era entity that functioned as a big 
bank and bought up old mortgages and issued new more affordable 
mortgages. But the Frank proposal, which you now support, is 
for the government to be an insurer of new mortgages instead of 
being a bank like the old HOLC.
    Since the effects would be much the same, doesn't it seem 
more prudent to limit government liability by being the insurer 
rather than the bank? And further, some have argued that we 
should not be putting taxpayers' dollars at risk this way, 
however, the Fed put taxpayers' dollars at risk to rescue Wall 
Street with the Bear Stearns deal, arguing that it was too big 
to fail. Isn't the prospect of letting millions of main street 
homeowners fail also too risky for our economy, Dr. Blinder?
    Mr. Blinder. Yes, let me take them backwards, starting with 
the one you just asked, and the answer is absolutely yes. I 
mean, we are looking at a very serious economic situation here. 
The center of the problem, as I said, is with housing, and the 
center of that is with foreclosures. I don't think we can 
afford the risk of saying, well, it may be another 2, 3, or 4 
million houses that are foreclosed, but let's just let it 
happen because there is a bigger economy at stake. If it gets 
to 4 million houses, that is 4 million families. There are over 
100 million families in America, and everybody has a stake in 
the overall economy.
    On your question about the HOLC versus the insurance 
approach, as I say in the testimony, and as you just said, you 
get to a similar place by either having the government come in 
as a big banker or having the government come in as a big 
insurer. You get a lot of mortgages refinanced to more 
affordable mortgages, and ultimately, the taxpayers are holding 
the bag.
    Mrs. Maloney. One way the Frank plan seeks to recoup some 
of the cost of this program is for homeowners to relinquish 
some of the price appreciation of their homes as long as they 
have an FHA guaranteed mortgage. You would go a step further 
and limit beneficiaries. Beneficiaries should have to forfeit 
second mortgages and home equity loans. Are there other measure 
we should be considering that will help recoup the Federal 
costs?
    Mr. Blinder. To help recoup the costs--one thing I was 
going to say takes me back to your previous question. One 
reason I actually preferred the HOLC approach, which is not 
going to happen and therefore I am very happy to support this 
approach, but one reason I did is there was a considerable up-
side potential for the taxpayer in return for taking the risk. 
The HOLC in the 1930's, under pretty adverse circumstances, 
actually turned a profit. No one could guarantee that would 
happen again, but it did have that aspect.
    So I think the prospects, you know, the up-side 
participation of the government is quite limited. I think it 
could be bigger, by the way. I mean, it phases down and I don't 
think it would be a bad thing if it was greater. It is, after 
all, a legitimate question being asked by a lot of Americans 
and it came up in this hearing, especially in the previous 
panel, why should we be paying for this; and the more that we 
can explain to the people who didn't do the wrong thing, shall 
I say worked hard and played by the rules, that we are not 
making such an attractive proposition for the people in 
trouble. We are just trying to keep them above water and that 
they have to pay for this privilege, I think the more saleable 
the proposal becomes.
    Mrs. Maloney. I understand.
    The Chairman. The gentleman from North Carolina.
    Mr. Watt. Thank you, Mr. Chairman. I just want to ask one 
question that I hope never happens, but I guess we have to 
consider the potential that it could. I am looking at a chart 
that was prepared by OFHEO and I actually started to pay 
attention to this yesterday when I watched the news and they 
ran a chart that was similar to this that suggested that home 
prices from 1975 up through 2007 increased double, more than 
double, but that most of that increase in value or prices was 
between 2000 and 2007, in fact, probably 90 percent of it. 
Suppose--since Mr. Frank's proposal talks about the FHA 
insuring this program applying to loans to new mortgages based 
on 90 percent of the current appraised value, you have some 
play in there because you have 90 percent, but you are talking 
about doing it on the basis of current appraised value-- 
suppose housing prices keep going down.
    What would be the--first of all, what is your assessment of 
the likelihood of that, and what would be the consequences of 
it, Mr. Blinder and Dr. Sinai? I will start will Dr. Sinai, 
since he raised his hand first.
    Mr. Sinai. I think from my comments, you can tell that I 
think housing prices are going down a lot more. It is an asset 
price bubble that is bursting. And what we have seen when that 
happens is a small part of where we eventually go, point number 
one.
    Point number two, the new mortgages would, over time, end 
up underwater and then it would cost the government money 
because of the insured nature of the draft legislation.
    Number three, how much money will it cost the government 
compared with the lost tax receipts if nothing is done in a 
macroeconomy that gets worse because nothing was done? And, 
indeed, how much is the cost actually of this draft legislation 
now? It is simply the risk of the insurance. So I think you 
would have to think about the ultimate magnitude of a negative 
scenario to get comfortable with the scenario that you are 
talking about.
    Mr. Watt. So you are saying my reference point should be 
not this chart that I am looking at but the prospect that 
nothing is done and housing prices continue to go down.
    Mr. Sinai. You know, taxpayer monies are already out. The 
economy is a lot worse. Tax receipts are down at the Federal, 
State, and local government by a lot. Taxpayers are paying now. 
The cost of this draft legislation administratively, I think it 
was what, $350 million?
    Mr. Watt. Let me let Dr. Blinder, and I want to get Mr. 
Wesbury's--I don't want him to feel left out because I would 
like to get his opinion on it, too.
    Mr. Blinder. The straightforward answer to your question is 
yes. So I took the question to be, is there residual risk to 
the FHA, or whatever the institution is called, if home prices 
continue to plummet, and the answer is yes. Now I want to 
qualify that with two things in addition to everything Dr. 
Sinai just said. First of all, it is not the case that every 
mortgage that goes underwater in that sense defaults. Most 
people want to stay in their homes and, as long as they can 
keep current on the mortgage payment, they will. So it is not 
like, even if housing prices fall another 10 percent we 
shouldn't think that these mortgages--
    Mr. Watt. Right, okay.
    Mr. Blinder. --new mortgages are going start defaulting in 
massive amounts. But maybe the more important point is how much 
housing prices will eventually fall and I don't know the answer 
to that. It will depend on a lot of things, but among those 
things are the actions that either Congress does take or does 
not take. And one of the subtexts of this legislation and other 
things that are going on, what the Federal Reserve is doing for 
example, is to try to put some sort of cushion under this 
decline so that we don't just fall right off a cliff.
    Mr. Watt. Mr. Wesbury, quickly.
    Mr. Wesbury. Sure. I look at the Case-Shiller home price 
index. In 1996, it was 80. It had risen to 190 in 2007, so more 
than a doubling in home prices. Sixty percent of that move--
    Mr. Watt. You are describing the same thing I described. I 
am trying to get a response to--
    Mr. Wesbury. --right, and I promise you I am getting to 
that. Sixty percent of that move was between 2001 and 2005 and 
2006 when housing prices peaked. And that is when we had most 
of the subprime loans. We have fallen back to 2005, which means 
that the homes that are underwater today are the most recent 
mortgages, which many of them are subprime, which many of them 
have very low downpayments; in fact, many have no downpayments 
at all. Those are the kinds of mortgages that would be 
refinanced in this FHA proposal, I believe, and they are very 
vulnerable to further declines in home prices, especially 
because many of those are in high price appreciation areas 
like, let's say, Las Vegas or Florida or Southern California 
where we had very rapid price appreciation, lots of new home 
buying, and lots of exotic mortgages. I think that is where you 
are going to see most of the problem and that is where you are 
going to see most of the price decline as well. So I do think 
that the government becomes more vulnerable to price declines 
under this program because of that very reason.
    Mr. Watt. Thank you, Mr. Chairman.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. Thank you, Mr. Chairman. I just have one 
question for all three of you. I watched with great interest 
last evening an interview with Jesse Ventura about the state of 
affairs in America, and while I don't equate his responses with 
those of Ben Bernanke, I was interested in the fact that he 
spoke, I think very powerfully, about how in this crisis it 
appears as if the corporate interests are dealt with first and 
the people are considered secondarily. His comments struck home 
with me because that is what I hear at home, whether fact or 
fiction, that is a growing belief out in the world. And it is 
based on a number of things, the Bear Stearns bailout being 
one. And so when you add in the fact that in the President's 
budget, he either zeroed out or, in some instances, underfunded 
programs to aid the poor in housing, Section 8, for example, it 
does appear that Jesse Ventura makes a point that is being made 
elsewhere.
    My question: Does not the chairman's proposal equal out, or 
at least reduce, the way in which government appears to be 
leaning in this crisis?
    Mr. Sinai. The answer is yes. What happened is outrageous 
from the point of view of America and the sleepiness of the 
regulators that Congresswoman Waters referred to is obvious to 
anybody with any common sense and it is the job of government 
to fix those things when they happen and I think you are on the 
right track and you are up to doing that, and that proposal is 
in that spirit.
    Mr. Blinder. I also think the answer is yes. I was 
advocating a proposal something like this, the HOLC proposal 
that Congresswoman Maloney mentioned before, before the Bear 
Stearns, J.P. Morgan transaction, but I didn't think it would 
get anywhere. But the asymmetry thereby created exactly what 
you are referring to, I think changes things in a very 
fundamental way. So I think it did change. I think it is 
unbalanced if you leave it the way it now is and I think it is 
both good politics, if I may say that, but also good economics 
to look on the other side, to the household side, which is what 
this bill does.
    Mr. Cleaver. Thank you. Mr. Wesbury.
    Mr. Wesbury. Sure, and I would agree with Dr. Blinder that 
it is good politics, or at least it looks that way, but I think 
it is lousy economics. And one of the reasons that I say that 
is that imagine if the whole financial system failed, just went 
away; very, very few people could ever afford a home because 
they would have to put cash down. They couldn't borrow money to 
buy it. They couldn't get insurance on the home. They couldn't 
get mortgage insurance, not fire insurance, not any kind of 
insurance because it is the financial system that provides all 
of that and it allows people to buy little pieces of it over 
time and it makes a great big thing. And then it is easy to 
attack this great, big thing but, in fact, we couldn't live our 
lives as we do today without the financial system in place.
    Mr. Cleaver. But if you are sitting here in Kansas City, 
Missouri, and you are out here watching this huge bailout and 
you have just been ripped off and you are going to get a $300 
check as a stimulus, don't you think you would feel like the 
government always leans towards the corporate level? And are 
you saying that is what it should do, lean toward the corporate 
because if the corporate folk are healthy and happy it always 
rains down on the less fortunate? I mean, your comment just now 
reminded me of the statement--I am going to try to remember the 
statement from Mr. Mellon--I mean, that is kind of what you 
just said and paraphrased.
    Mr. Wesbury. It is not what I said.
    Mr. Cleaver. Okay.
    Mr. Wesbury. What I said is, sure, I can see why people 
might think that. But what I am saying is that you could not 
get mortgage without the financial sector there, and so if the 
Federal Reserve is not--I am not saying that I agree with the 
bailout of Bear Stearns and what they did with J.P. Morgan, 
etc., etc, but in general, helping the financial sector survive 
a hiccup like this, or a mess like this, or a crisis like this, 
is absolutely essential to keep society going like it was. You 
can't get a mortgage without the financial sector. So the 
Federal Reserve's attempt to save the financial sector, if that 
is the way you want to put it, you can phrase it any way you 
want, is actually an attempt to make sure that people can 
continue to get mortgages down the road. So in essence, I can 
understand why people feel that way, but what it tells me is 
they are not thinking very deeply about the issues.
    Mr. Cleaver. Well, I would like to invite you to my town 
hall meeting Saturday and you tell them that they are not 
thinking deeply.
    Mr. Blinder. Congressman, could I just say one sentence? I 
think this bill would do a world of good for the financial 
system as well.
    Mr. Sinai. Congressman, what you said I have to say 
something. I am a citizen of this country, not just an 
economist or somebody who comes here to testify. What you just 
described is what is wrong with America. The instincts of your 
people tell me that if you all do something about it we will 
get back in the track of doing what is right for America. What 
went on is absolutely egregious in the financial system and all 
the things that happened. There is no other way in a 
commonsense way to put it that way, and the way that your 
constituents are seeing is the way most Americans are seeing 
it. The polls say that very clearly.
    The Chairman. Thank you. The gentleman from Colorado--
    Mr. Perlmutter. Thank you, Mr. Chairman. And I appreciate 
the testimony--
    The Chairman. --whose questioning will be greeted with 
great joy, since he is the last questioner.
    Mr. Perlmutter. I appreciate the testimony from all three 
of you because there are parts of things that you have all said 
that I agree with. Mr. Wesbury, I agree with you 
wholeheartedly. I mean, my belief is every 20 years we go 
through something similar to this because people forget the 
lessons of the past. They believe--they get greedy. They get 
stupid. They believe the prices are always going up and, you 
know, the 1980's, you talked about Penn Square, M Bank, 
Continental Illinois, Silverado, with the belief that 
everything was going to go up. And in Colorado it was real 
estate, not just oil. So it isn't just the homeowners and it 
isn't just the lenders. It isn't just the regulators. I mean, 
Congress--one of the things I am angry about is the loosening 
of laws that kept investment banks separate from traditional 
banks, I mean, a lesson we learned in the Depression for 
goodness sakes; all based on greed.
    And I would ask you three as some of the top scholars on 
the subject, this Nation is borrowing a lot of money as 
individuals and as a nation. How does that play into everything 
we are doing here? Let me go back to the chairman's bill before 
I get to waxing eloquently. Mr. Wesbury, under his bill, it is 
voluntary by the lender to take advantage of a carrot, which 
would be the FHA guarantee at 90 percent of the written down-
amount. So what is wrong with that?
    Mr. Wesbury. I think as long as it stays voluntary, we are 
okay with it. I think if we allow the FHA--it does get the 
government more involved, which can always--
    Mr. Perlmutter. But we are going to get involved if we have 
to start helping the FDIC and we have already gotten involved 
when we gave $30 billion to underwrite Bear Stearns because of 
these lousy mortgages. We are already in this deal; big.
    Mr. Wesbury. I understand that. One thing I go back to is 
that I heard the chairman say that if the servicers don't 
voluntarily do something, then we are going to make them do 
something. And I am paraphrasing him. We can go back and look 
at the record. So I hear you when you say voluntary, but very 
often once we do get involved with these things, it quickly 
becomes involuntary.
    Mr. Perlmutter. Okay. So then my question is this: 
Listening to Dr. Sinai and Dr. Blinder, you, too, have 
recognized we are on sort of a precipice here. My question is, 
if we don't do anything, if we let the market sort of work 
itself out, how many foreclosures are we going have, and how 
long is this going to take?
    Mr. Wesbury. No one knows for sure, but I think the worst 
estimates that I have seen in foreclosures is about 2 million 
foreclosures and that is out of 108 million homeowners, 
occupied homes. I am sorry, renters or homeowners. And so that 
is less than 2 percent. Now that's--anybody who has their home 
foreclosed on them, if they actually have resources in it, skin 
in the game, that is a sad thing.
    Mr. Perlmutter. And I recognize that. I have come as a 
bankruptcy lawyer to this, representing lenders. I have been 
there for that. But something 2 or 3 weeks ago ago triggered a 
very dramatic effort by the Federal Reserve to move over to the 
investment banking side because of fear that we were in trouble 
on these mortgage-backed securities.
    Mr. Wesbury. This is very, very similar to Continental 
Bank, which was too big to fail. Bear Stearns had its tentacles 
and counterparty risks throughout the system and the Federal 
Reserve was worried that that would cause systemic problems. I 
don't know whether they were right or not. We won't ever know 
because it is over now. It was similar to Continental Bank.
    What I will say is that we survived, the economy survived, 
the 2000 to 2002 stock market crash where the NASDAQ alone lost 
$4.5 trillion of value. No one is talking about losses even 
close to that, maybe 10 percent of that in the housing market 
over the next couple of years. So our economy can absorb these 
kinds of hits much more readily than many people seem to fear 
today. I think we are much more resilient than people believe. 
And that is what I would hope is that we would believe in our 
economy more, that it can withstand these shocks, that the 
bankruptcy--
    Mr. Perlmutter. Well, and I would have agreed with you but 
for the dramatic action that was taken 3 weeks ago. Over a 
weekend, we are not in session, boom. There was a real fear 
that there was going to be a domino effect on Wall Street and 
here we are doing a voluntary effort to help some homeowners 
and provide lenders a guarantee. I just don't see--compared to 
what we did and the dramatic step that was taken 2 or 3 weeks 
ago, this is helpful. It is nothing like that.
    Mr. Wesbury. As long as it stays voluntary, I think it is a 
very good thing.
    Mr. Perlmutter. Thank you, Mr. Chairman.
    The Chairman. And let me just add that it is voluntary in 
two ways, and there is an error in the Administration talking 
about being forced to take bad loans. It is entirely voluntary 
on the part of the holders of the mortgages. No one is going to 
be coercing them at all. The one coercion that might have 
happened, and I was going to vote for it but it is now a dead 
issue, is a bankruptcy bill. The fear of bankruptcy in the 
primary residence might have been suppressed. I was a sponsor 
of it. It is now clearly dead. So this now entirely voluntary.
    On the other side, nothing we are doing statutorily will 
compel the FHA to accept any loan. We have talked about 
changing the standards. The FHA has beat us to the punch as the 
Commissioner acknowledged. The FHA yesterday announced that 
they are going to waive this requirement of no default. But 
they are doing away with arbitrary restrictions to go to case-
by-case and the FHA will remain committed to doing a study of 
each loan and not accepting a loan if they don't think it can 
be repaid. That one is possible. They may misjudge it and under 
their plan if housing prices drop more precipitously than 
expected, yes, there is some liability there. We would hope 
that wouldn't be happening. But that is it. It is voluntary on 
the part of the servicers. The FHA has the right to say yes or 
no.
    We do believe, and I think it is probably, as I said, the 
economic problem, if I remember my economics class correctly, 
is mainly that there are things that an individual might not do 
himself or herself that he or she would do if you knew that 
other people were doing them as well. And that may be 
encouraging this together could be helpful. That is what this 
is and, again, I want to stress on the auction, which the 
Federal Reserve suggested to us. The auction--there will be a 
Federal mechanism that will accept bundles of loans for the FHA 
guarantee but the FHA will then have the independent authority 
to examine that pool and kick out any that don't meet its 
standards. So there will be no coercion of the FHA on that end. 
I thank the panel, particularly these three panelists for 
staying all day, and adding a kind of perspective that was very 
helpful to us, and the hearing is mercifully adjourned.
    [Whereupon, at 3:32 p.m., the hearing was adjourned.]


                            A P P E N D I X



                             April 9, 2008


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