[Senate Hearing 110-978]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-978


    TURMOIL IN U.S. CREDIT MARKETS: EXAMINING PROPOSALS TO MITIGATE 
                             FORECLOSURES 
                     AND RESTORE LIQUIDITY TO THE 
                            MORTGAGE MARKETS

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

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

THE HOPE FOR HOMEOWNERS ACT AND OTHER PROPOSALS TO ADDRESS THE ONGOING 
     TURMOIL IN THE CREDIT AND MORTGAGE MARKETS WITH FOCUS ON THE 
 IMPLEMENTATION OF VARIOUS PROPOSALS TO ADDRESS THE FORECLOSURE CRISIS


                               __________

                       WEDNESDAY, APRIL 16, 2008

                               __________

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


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




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania        MEL MARTINEZ, Florida
JON TESTER, Montana                  BOB CORKER, Tennessee

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel

                      Amy S. Friend, Chief Counsel
                  Jonathan Miller, Professional Staff
                       Aaron D. Klein, Economist
          Julie Y. Chon, International Economic Policy Adviser
                Didem Nisanci, Professional Staff Member
                 Chuck Jones, Professional Staff Member
                  Megan Bartley, Legislative Assistant

                    Mark Osterle, Republican Counsel
                    Jim Johnson, Republican Counsel
     Mark A. Calabria, Republican Senior Professional Staff Member
         Tewana Wilkerson, Republican Professional Staff Member
         Gregg A. Richard, Republican Professional Staff Member
          Courtney Geduldig, Republican Legislative Assistant

                       Dawn Ratliff, Chief Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor










                            C O N T E N T S

                              ----------                              

                       WEDNESDAY, APRIL 16, 2008

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Reed.................................................     6
    Senator Allard...............................................     7
    Senator Carper...............................................     7
    Senator Menendez.............................................     8
    Senator Corker...............................................     9
    Senator Tester...............................................    10

                               WITNESSES

Brian D. Montgomery, Assistant Secretary for Housing, and Federal 
  Housing Commissioner, Department of Housing and Urban 
  Development....................................................    11
    Prepared statement...........................................    45
    Response to written questions of:
        Chairman Dodd............................................    88
Arthur J. Murton, Director, Division of Insurance and Research, 
  Federal Deposit Insurance Corporation..........................    13
    Prepared statement...........................................    52
Scott M. Polakoff, Senior Deputy Director and Chief Operating 
  Officer, Office of Thrift Supervision..........................    14
    Prepared statement...........................................    75

 
    TURMOIL IN U.S. CREDIT MARKETS: EXAMINING PROPOSALS TO MITIGATE 
       FORECLOSURES AND RESTORE LIQUIDITY TO THE MORTGAGE MARKETS

                              ----------                              


                       WEDNESDAY, APRIL 16, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Let me thank our witnesses this morning and 
those who have gathered in the Committee room to be here for 
our hearing this morning entitled ``Turmoil in the U.S. Credit 
Markets: Examining Proposals to Mitigate Foreclosures and 
Restore Liquidity to the Mortgage Markets.'' And, again, I want 
to thank everyone for their participation over the last several 
weeks. We have had a very busy Committee activity, and it will 
continue as such. We have an awful lot on our plate, obviously, 
and so yesterday's hearing was, I thought, a very good one, and 
I appreciate immensely the participation of as many Members.
    I know everyone has conflicting schedules as well, with 
other Committee assignments and responsibilities, but the fact 
that we have had as much participation by the Committee as we 
have had I think is an indication of how seriously every Member 
of this Committee takes these issues that we have in front of 
us. And I am particularly grateful to Senator Shelby and his 
staff, as well as my own, obviously, for the tremendous work 
being done and the effort made a week or so ago as we spent a 
good deal of time on the floor of the Senate grappling with at 
least our first efforts on trying to deal with the foreclosure 
issues. And while it was not everything that Senator Shelby 
wanted or I wanted or even things that are in there that we 
would not have necessarily written on our own, I think it was a 
major step in the right direction, and I am grateful to every 
Member of this Committee for their support in that effort.
    This morning, we will continue that discussion, obviously, 
as we examine further the questions of how can we mitigate 
foreclosures, how can we really help unleash the pent-up 
capital that is out there. I mentioned to Senator Shelby that 
yesterday morning I had the privilege of meeting with a large 
group of people involved in commercial mortgage-backed 
securities and heard an earful about their problems. Last year, 
I think that business did some $230 billion worth of business 
in 2007. As of the middle of April, they have done $5 billion 
worth of business this year. It is just frozen up entirely.
    We heard that about 15 percent of lenders are no longer 
involved in the business of student loans, and those numbers 
could continue to skyrocket over the next several weeks and 
months. So any debate about whether or not there is a 
contagious effect in this issue I think has been obviously 
debunked by anyone who is listening to anybody else in various 
other sectors of our economy and how this is affecting us.
    So whether or not we can do something to play a worthwhile 
and responsible role in trying to bring this to a halt and move 
in a different direction is the critical question before us--
the liquidity, transparency, and, most of all, confidence in 
our markets.
    So this morning, the Senate Banking Committee is meeting to 
hold its second hearing on the Hope for Homeownership Act and 
other plans to address the historic levels of foreclosures the 
American people are experiencing. This is Wednesday of this 
week. By the end of business today, another 24,000 people in 
this country will have filed for foreclosure, and roughly 1,000 
a day will be in foreclosure. And every day that we move 
forward without addressing that underlying question, those 
problems will continue to grow.
    There is a growing consensus that the Federal Government 
needs to get more aggressively involved in helping American 
families keep their homes. In addition to my legislation, the 
Office of Thrift Supervision has put forward a plan. HUD has 
proposed a plan. Senator McCain ha a plan. And these plans 
embrace the key concepts, I would point out, in the legislation 
that I have circulated, that Barney Frank and the House side 
has also been working on and holding hearings on, including use 
of the existing FHA platform to refinance distressed homeowners 
into new loans.
    It is my hope that we can work collectively to bring 
together the best features of these various ideas and move 
legislation quickly before we watch any more people have to 
suffer the loss of losing the most important investment they 
are ever going to have in their lives. Our failure to act 
earlier has made the problems we now face more severe.
    Mark Zandi, a well-known housing economist, put it this 
way, and let me quote him. He said, ``Policymakers' initial 
response to last summer's subprime financial shock was very 
tentative as they misjudged its severity and the extent of its 
economic fallout. Financial markets and the economy 
subsequently eroded. Only if more homeowners are able to retain 
or remain in their homes will the negative cycle of 
foreclosures begetting house price declines begetting more 
foreclosures be short-circuited. This in turn is necessary to 
ending the down draft in the housing market that is weighing so 
heavily on the economy and the financial system.''
    Briefly, the legislation that I have proposed creates a new 
fund at the FHA to insure new affordable mortgages for 
distressed homeowners. These FHA mortgages would refinance the 
old troubled loans at significant discount. The new loans would 
be no larger than the borrowers could afford to pay and no more 
than 90 percent of the current value of the home. This formula 
is very similar to the one laid out by Federal Reserve Chairman 
Bernanke in his speech several weeks ago when he noted that 
creating new equity for underwater borrowers may be a more 
effective way to prevent foreclosures. The administration has 
also embraced the concept. Under my proposal, no one--I repeat, 
no one--gets what would be described as a bailout. Lenders and 
investors will have to take a serious haircut to participate in 
the program. But, in return, they will receive more than they 
would recover through foreclosure. Borrowers get to keep their 
homes, but they must pay for the FHA insurance and share the 
newly created equity and future appreciation with the FHA 
program to help offset any possible losses. Only owner-
occupiers would be eligible for this new program, and only 
those who clearly cannot afford their current mortgages.
    There will be no speculators or investors allowed in this 
program. Not only would this initiative help deserving 
homeowners and the communities in which they live, this program 
would help stabilize capital markets, put a floor on excessive 
downward spiral of housing prices, and get capital flowing once 
again, which is absolutely critical, in my view.
    In addition to the witnesses we heard from last week's 
hearing, the staff has been consulting widely with investors, 
lenders, servicers, economists, securitizers, regulators, and 
other Senate offices to improve the draft legislation. And we 
continue to seek input in order to make this product as strong 
as possible and move it forward as soon as possible. It is 
increasingly difficult to explain to the American people why it 
is that their government can act so quickly to put taxpayer 
dollars at risk to bail out, if you will, large financial 
institutions on Wall Street without making a more robust effort 
to help Americans keep their homes. In my own view, these 
efforts must go hand in hand. Before financial institutions can 
really get back on a steady course, we need to address the 
subprime and nontraditional mortgages underlying the alphabet 
soup of complex securities. While not a silver bullet, the Hope 
for Homeownership Act would, I think, help to do so.
    The need for action continues to be acute. Yesterday, 
RealtyTrac released new data which showed that foreclosures 
filings jumped 57 percent in March from a year ago. This marks 
the 27th consecutive month of year-over-year increases in 
national foreclosure filings. And as I said a moment ago, 
another 8,000 families today in America will file for 
foreclosure; 8,000, roughly, did yesterday, the day before, and 
will tomorrow. At some point we have to step up and decide we 
are going to try and do something about that, and allowing it 
just to hemorrhage day after day after day is not an answer. 
Inaction is not an answer. And failure is not an answer.
    So today we are gathering once again to try and think about 
ways in which we can make a difference. In America, in our 
America, this should not be acceptable. If we do not take 
effective action, we risk being forced to take more dramatic 
and costlier action to respond to more dire consequences down 
the road. That is what happened with Bear Stearns, obviously.
    As I said last week, I understand that some people oppose 
this kind of program on the ground that we should not reward 
people who, in their view, acted irresponsibly. Let me respond 
by quoting Scott Stern, who testified last week on this very 
subject matter. To remind my colleagues, Mr. Stern is the CEO 
of Lenders One, a coalition of 110 small and medium-sized 
mortgage lenders. Mr. Stern explained that he feels that the 
``condemnation of borrowers that took out risky loans is 
misplaced because of the growing practice of pushing high-risk 
loans on borrowers who had no reasonable expectation of being 
able to repay the mortgage.'' Mr. Stern called this ``mortgage 
malpractice.'' He went on to say, ``In our industry, we have 
frankly seen too much mortgage malpractice. Curing a loan that 
had a high risk of failure creates no moral hazard. Just the 
opposite. Modifying a loan which probably should not have been 
made in the first place is the kind of action that can help 
restore integrity and trust in the mortgage market.''
    Of course, some borrowers who might benefit from this 
program might not be deserving, according to some. But if we do 
nothing, we know for certain that hundreds of thousands of 
homeowners who need and deserve our help will lose their homes. 
That is why I believe we should act, and I look forward to 
working with my colleagues to craft the best possible solution 
to this problem.
    And, again, I want to thank Senator Shelby immensely for 
supporting the idea of these hearings for us to listen to 
people who can offer some sound advice and counsel on how we 
move forward, and with that, let me turn to the Ranking Member.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    As we continue our examination of the mortgage market and 
various proposals for further Government intervention, I 
believe we must ensure that our actions do not reward, and 
thereby facilitate, imprudent financial decisionmaking. As this 
Committee heard in testimony last week, many areas of this 
country are likely to experience further price declines. In 
States such as California, a mortgage writedown of 10 or even 
20 percent could likely still leave borrowers with negative 
equity in just a year or two. Encouraging a family with no real 
equity to remain in a depreciating asset may not make sense.
    Mr. Chairman, I believe there is widespread agreement that 
many families, particularly those receiving subprime loans, 
were not quite ready for homeownership. If these same families 
were not ready for homeownership in a booming market, it is not 
clear to me how they become ready in a declining market. This, 
of course, begs the question. Who should qualify for taxpayer-
backed assistance?
    We continue to hear that over 2 million homeowners may be 
facing foreclosure. The pressure to act in the face of such a 
dire prediction can be overwhelming. But before we act, Mr. 
Chairman, I believe there needs to be a frank discussion about 
equity and moral hazard. If the Government is going to step in 
and prevent foreclosures, who will qualify for this taxpayer-
backed borrowing? Are all these borrowers deserving? If not, 
which ones are and why? What do we know about the households 
facing foreclosure? What information is relevant and what is 
not? The answers to these questions should drive our policy 
choices because we will undoubtedly be rewarding some while 
penalizing others.
    Mr. Chairman, I believe there is a consensus that we should 
not be bailing out investors or speculators, but there are 
other important questions that need answers here. How many of 
these households made minimal or no downpayments on the 
properties they hold? How many of these households did a cash-
out refinance on the same property and now face difficulty 
paying the higher mortgage cost? How many of these households 
have poor credit scores and have significant credit card debt? 
How many of these households face foreclosure because of an 
income decrease due to a voluntary job loss? Yes, how many 
homebuyers used exotic mortgage products, gambling on the 
ability to refinance in future years?
    What do we tell the family that waited and made prudent 
financial decisions when we bail out the people who 
overreached? When did we decide that the overextended homebuyer 
is more deserving than the potential homebuyer who can now take 
advantage of declining home prices? What is the FHA's current 
financial condition? What impact would another significant 
expansion of the FHA have on the mutual mortgage insurance 
fund?
    Mr. Chairman, I hope we can get answers to some of these 
questions at today's hearing. If we do not, I would encourage 
the Committee to continue exploring thoroughly all facets of 
your proposal before we act. I would also urge the Committee to 
expand significantly its examination of the in-time mortgage 
cycle.
    Mr. Chairman, we are facing one of the most significant 
economic events in decades, and I believe we have a 
responsibility to understand how we got there, who is at fault, 
and whether we can prevent it from ever happening again. I 
believe the Committee needs to examine comprehensively the 
reasons behind the ongoing liquidity crisis and the downturn in 
the housing market. The examination, Mr. Chairman, I believe 
should start with the origination of home loans and proceed 
through the securitization process that you referenced to the 
ultimate holders of such loans. It should examine the role 
played by all market participants, including commercial banks, 
investment banks, credit rating agencies, mortgage brokers, 
realtors, home builders, finance companies, and Federal and 
State regulators.
    I believe we should also examine the secondary effects of 
the downturn in the housing market, including the impact on the 
municipal credit markets, the availability of credit, and the 
condition of our financial institutions. The examination here 
should aim to provide, to the extent possible, an empirical 
basis for any conclusions reached so that any actions the 
Committee decides to take in the future are grounded in fact 
and not anecdotal evidence.
    Among the topics that should be examined, I believe, Mr. 
Chairman, are: Who were the largest underwriters of structured 
finance products? Did investment banks conduct proper due 
diligence when structuring asset-backed securities? Were 
underwriters aware of the poor quality of many of the loans 
they were securitizing? And if so, did they properly disclose 
the risk to investors? Was the Securities and Exchange 
Commission properly overseeing the activities of investment 
banks and ensuring that the disclosures of structured finance 
products were accurate?
    Were bank regulators properly monitoring the structured 
finance and derivatives activities of financial institutions? 
What role did bank capital requirements play in encouraging 
banks to move assets off their balance sheets through the use 
of securitization? And will the new Basel II capital 
requirements eliminate or reduce the incentives banks have for 
securitizing assets merely to avoid capital requirements?
    What benefit did structured finance products provide? Did 
out-of-date accounting standards lead to structured finance 
products being reported in an inaccurate or misleading manner 
on financial statements? Have accounting standards kept pace 
with innovations in financial products to ensure that the value 
of the new products is accurately reflected on balance sheets?
    Further questions: How often was securitization used for 
regulatory arbitrage purposes, such as avoiding capital 
requirements, reducing taxes, or securing beneficial accounting 
treatment? And who were the largest investors in structured 
finance products? Were they conducting proper due diligence on 
the products they were buying? And is there any evidence of 
widespread misleading or fraudulent sales practices of 
structured products to investors? And why have the credit 
rating agencies downgraded so many structured finance products? 
And to what extent did foreign investment or the Federal 
Reserve's monetary policy fuel the sharp increase in housing 
prices? Did our current regulatory structure fail? If so, did 
it fail because it was not restrictive enough? Or did it fail 
because it was too restrictive, providing a false sense of 
security to market participants? And how significant was the 
role of real estate speculators in the run-up of housing 
prices? And to what extent did the practice of mortgage 
brokers, realtors, and home builders fuel the frenzy? And how 
often did buyers simply reach beyond their means when they 
purchased a home?
    Mr. Chairman, after a thorough examination of the full 
spectrum that I have gone through of the collapsing mortgage 
market, the Committee, I believe, should examine potential 
reforms to restore confidence in and improve the operation of 
our financial markets. Mr. Chairman, as you do, I believe the 
responsibility of understanding what happened rests solely with 
this Committee. We are uniquely positioned on this Committee to 
inform the American people, and it is incumbent upon us to do 
so.
    Thank you.
    Chairman Dodd. I thank you very much. Certainly we have 
been doing that, and we are going to act as well, I hope.
    Let me ask if any other members here would like to be heard 
before we start. All your opening statements will be included 
in the record, but does anyone want to be heard? Tom. Jack.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Just briefly, Mr. Chairman. Again, I want to 
commend you and Senator Shelby for holding the hearing and for 
your comments.
    The fundamental assumption that most people on Wall Street 
had and most people around the kitchen tables of America had 
was that housing prices would not go down, and for the last 
decade or more, they had been formulating their economic 
strategies based on that assumption. And that assumption is not 
valid, and as long as they feel that there is no floor on 
housing prices, I think both decisionmakers on Wall Street and 
Americans across the country will not get their financial 
traction, will not start spending again, will not start feeling 
comfortable about the future. And we have to act, I think, 
promptly to restore a floor.
    There are various proposals. I think we can do an analysis, 
we must do an analysis, but we have to act. And, to date, the 
voluntary efforts of the administration have been modest at 
best in terms of reaching people who are in danger of 
foreclosure, and also reaching people who are paying their 
mortgages but they are underwater. Their mortgage is much 
greater than the value of their home. And that means they are 
not going to go out and take money out to send children to 
college; they are not going to go out and take money out to buy 
something. And, again, this is all adding to a recession that 
is upon us.
    So I think we have to act, and I hope this hearing will 
give us insights for prompt and timely action. Thank you, Mr. 
Chairman.
    Chairman Dodd. Thank you very much.
    I would remind the Committee we are going to have Chairman 
Cox here next week to be talking about the role of the SEC and 
the credit agencies. We have had a series of hearings, and we 
will continue. Obviously, as Senator Shelby points out very 
accurately here, we have an obligation to know how this all 
happened, and certainly that is an important role and an 
ongoing one.
    I would also suggest we have a commensurate responsibility, 
of course, to act to make sure this problem does not grow 
worse. And my concern is it is. We had Larry Summers the other 
day talking about--I think, Jack, to pick up on your point--
some 15 million homes now are underwater; that is, debt exceeds 
equity, and those numbers are growing. And, obviously, you go 
back to what values were before, Bob Corker likes to point out, 
and rightly so, that, you know, we are looking at values today 
versus where they were a few years ago in terms of reality and 
all of that. In the meantime, obviously, a lot of wealth is 
being lost.
    So we have two roles: one, to find out what happened; and, 
two, to make sure we take steps to see to it that we short-
circuit this problem before it gets completely out of hand.
    Wayne, do you want to----

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I would like to just say that 
both you and Senator Shelby are bringing up some very credible 
questions that we need to continue to work on finding the 
answers on.
    I do have some reservations on taking FHA, which has a 
troubled past, and adding more risk to a newly recovering 
agency which would put taxpayers on the hook. So I hope we can 
be cautious about that.
    Chairman Dodd. Thanks very much for that.
    Anyone else want to be heard? Tom.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. I am happy today to welcome our witnesses, 
and I look forward to your testimony. Some of you have already 
given us plenty of food for thought.
    I would just remind my colleagues as we approach this 
hearing, we had the opportunity during the debate on the 
Housing Recovery Act, which we passed by a wide margin a week 
or so ago, and I applaud the Chairman and Ranking Member and 
others who helped to make that happen.
    You will recall that we had an opportunity to consider a 
proposal by Senator Durbin to empower a bankruptcy judge to 
modify the amount of principal that is owed in a primary 
mortgage, and we decided, by a fairly wide margin, that we are 
not going to do that. That was one effort to try to address the 
problem here that the Chairman would have us consider, and that 
is, where people owe more money on their home than their home 
is worth, and the value of the home might still be dropping.
    I am not interested in rewarding bad behavior. I am not 
interested in rewarding bad behavior on the part of borrowers 
or lenders or investors. I do not think any of us are 
interested in doing that. But I know that if Bob Menendez and I 
were neighbors and my home goes into foreclosure, there is a 
problem certainly for my family, but there is also a problem 
for him and his family and other people who live in my 
neighborhood because the value of their homes are going to go 
down as my home in foreclosure decays and is deteriorated.
    There are a number of good, constructive ideas of how to 
move forward on this. I think the Chairman's proposal is 
certainly that. I think Congressman Frank has that. OTS has 
suggested a good idea. FHASecure is a good idea. Somewhere in 
the mix of all that is, I think, very good public policy that 
will help address the problem, the dilemma that is faced not 
just by the folks that are going into foreclosure, but also by 
the people who live in those neighborhoods, and to do it in a 
way that does not put taxpayers needlessly at risk.
    There is a way to do this, and I am very hopeful that we 
will find that way.
    Chairman Dodd. I hope so as well.
    Anyone else want to be heard on this? Bob.

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you, Mr. Chairman. I only wish I 
could live next to Senator Carper. I just cannot afford it.
    [Laughter.]
    Senator Carper. We would have to change the Constitution. 
There would be three Senators from Delaware.
    Senator Menendez. It would be a pleasure to live next door 
to him. But I just want to say I appreciate you continuing this 
series of hearings. You know, I have to be honest with you, Mr. 
Chairman. The terms of the administration's proposals, both 
past and present, I am somewhat at a loss for words. I do not 
know what else Members of the Committee can say or the 
economists can say or the consumers can say that presents and 
convinces the administration the size of the crisis that we are 
facing. And I think a serious crisis deserves a serious and 
significant committed solution. So I am glad that the 
administration is on board with the idea of an expanded FHA 
plan, but I think your plan, Mr. Chairman, does a lot more to 
help a wider range of homeowners than some of what the 
administration is talking about.
    And I will just take a moment just to remind us again about 
what Senator Carper was saying. This is far beyond the 
individual. It is about all of us. At the end of the day, it is 
about all of us. We had an economy that lost 80,000 jobs in 
March; the unemployment rate rose to 5.1 percent; the housing 
crisis has already subtracted 1.2 percent from the GDP growth; 
and home prices declined for the first year since the Great 
Depression. The first year since the Great Depression.
    We have $460 billion in adjustable rate mortgages scheduled 
to reset this year, which means that the number of padlocks on 
doors are only going to grow. And there were 8,000 filings for 
foreclosure per day in the month of February; 3 million 
mortgage loans are expected to default this year and next; and 
of these, 2 million are expected to result in foreclosures.
    And, finally, yesterday RealtyTrac reported that there was 
a 5-percent increase in foreclosure filings last month and a 
57-percent increase from last year. And their report shows that 
one in every 538 American households received a foreclosure 
filing last month. One out of 538.
    Mr. Chairman, we need to do everything that Senator Shelby 
and you have talked about in terms of protecting so that we do 
not find ourselves in this circumstance again. But the urgency 
of the moment is now, and I hope that, you know, we can 
convince the administration to move quickly and more 
significantly than it has talked about today, and we look 
forward to hearing the panel.
    Chairman Dodd. Thank you.
    Senator Corker.

                STATEMENT OF SENATOR BOB CORKER

    Senator Corker. I typically do not make opening comments, 
but there has been so much, I will just follow up on Senator 
Menendez and say that I agree with him. I think his last 
sentence was dead on, that the administration does have a plan, 
and I hope that they will move quickly to implement it. I read 
it last night. It actually makes a lot of sense.
    I just would say that, in general, our efforts so far have 
been incredibly clumsy. We have spent $168 billion with our 
first stimulus package, which is a boon for Walmart and Sears 
and others, but not for the economy in general. And this last 
effort, to me, while I applaud the bipartisan efforts, it was, 
again, incredibly clumsy, and we are spending lots of money 
doing things that have nothing to do with the problem. And I 
applaud you today for having a hearing that is surgically 
focused on the actual problem. But I hope as we move through 
this we remember how clumsy our efforts can be legislatively 
and that we encourage efforts by the administration that can 
move swiftly and actually do things hopefully that make more 
sense and do not have long-term lingering problems for others 
to pay for down the road.
    So this is a surgical meeting. I thank you for this. 
Yesterday's hearing to me was outstanding, and I look forward 
to some good discussion today. But I hope we will keep in mind 
and look back at what we have done over the last couple months 
knowing that we have not even come close to hitting the target, 
and sometimes when we do things legislatively, that is what 
occurs.
    Chairman Dodd. Well, I could not agree more. We certainly 
have been trying to hit that target, and it is awfully 
difficult sometimes to get all the players aiming in the same 
direction.
    Senator Tester, any comments.

                STATEMENT OF SENATOR JON TESTER

    Senator Tester. Yes, well, thank you, Mr. Chairman. The 
questions that Senator Shelby asked are good questions. I hope 
you submit them so we can get answers for them.
    Truthfully, I know some of them are global and some may not 
be able to be answered, but the truth is that for that 2 or 3 
minutes you asked questions, they are all critically important, 
and they are questions I want to know, too.
    I think it is interesting because, you know, we talk about 
folks, if they can afford to get into a home, and then you have 
got bankers that allow them to get into a home on an interest-
only loan with no down. So who is really at fault here? And I 
really revert back to personal experience.
    When I moved here 16 months ago and we were looking to buy 
a house instead of renting, for obvious reasons, I was offered 
a no-down, interest-only loan, and I was very tempted. If I had 
been 20 years old, I would have probably jumped on it. It is 
goofy. It is goofy that they would offer that. And it is also 
goofy that you get checks in the mail for 5,000 bucks and you 
just go put them in the bank and you have got money. And if you 
are hard up, you do it.
    There are people that are responsible for this, and I want 
to--and I do not think the administration has done any kind of 
job at all over the last few years, having any oversight of 
what is going on in the industry. And it is very disturbing to 
me. And I do not know if what we have done is clumsy or not. I 
have not been totally happy with it either, Senator Corker, but 
the fact is that when Bear Stearns got into trouble, it took 3 
days. And I just wonder how much due diligence was done there.
    Thank you, Mr. Chairman.
    Chairman Dodd. Great question. Ninety-six hours, moved 
pretty fast, put $29 billion right on the block pretty fast, 
and no collateral last, except hoping the assets there are 
going to turn out to be worth something down the road. And here 
we are 1 year later, having sat in this very room with all the 
stakeholders, trying to get them to do something on this damn 
thing, and nothing happened. According to Moody's, 1 percent 
may be workouts. Nothing. And the administration sat back in 
August, and all they wanted to talk about was the debt ceiling 
when we had the meeting on this issue. And using their 
language, it was ``contained.''
    So clumsy is what I am getting from the administration in 
not responding to this because we are failing to address what 
is going on here, and it is getting worse, daily getting worse. 
So my hope is--and we are going to be able to act fairly soon 
on some of these ideas, and simultaneously obviously go back 
and try and figure out as much as we can about what happened. 
And that is clearly an important function of the Committee. But 
that is not going to be--we are not going to be judged 
historically by just examining what happened if, in fact, in 
the process we do not do something to short-circuit this. And 
if we do not do that, then history will indict us if we end up 
with an economic mess on our hands that takes a generation to 
correct. And I am worried that is going to be the case.
    So, with that, we welcome our witnesses this morning. We 
are delighted to welcome the Honorable Brian Montgomery, 
Assistant Secretary for Housing, Federal Housing Commissioner. 
Mr. Montgomery formerly served as Deputy Assistant to the 
President in the Cabinet of the Secretary before coming to HUD. 
His duties included oversight of FHA's $400 billion insurance 
portfolio and HUD's various regulatory responsibilities.
    Arthur Murton is Director of the Division of Insurance and 
Research for the Federal Deposit Insurance Corporation. Mr. 
Murton has a Ph.D. in Economics from the University of 
Virginia, served at the FDIC since 1986--22 years. The Division 
of Insurance and Research directs the FDIC's efforts in banking 
research and policy development, and let me just say Sheila 
Bair wanted to be here, but there has been a death in her 
family, and we extend, all of us do, our deepest sympathies to 
Sheila. She has been a wonderful public servant, has been 
before this Committee many, many times. We welcome you here 
today, Mr. Murton, but please extend our condolences to Sheila.
    Mr. Murton. Thank you. I will do that.
    Chairman Dodd. Scott Polakoff is the Senior Deputy Director 
and Chief Operating Officer of the Office of Thrift 
Supervision. He joined OTS in 2005 after serving the FDIC for 
over two decades. The OTS is the primary regulator of Federal 
and State chartered savings associations.
    We thank all three of you for being here this morning, and 
we will begin with you, Brian. Thanks for coming before the 
Committee.

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

    Mr. Montgomery. Thank you very much, Mr. Chairman and 
Ranking Member Shelby, for this invitation, and I want to say I 
think the time is now for some clear vision and some wise 
policy as we go forward.
    I do want to say I am confident that we can find some 
common ground to address this housing crisis, given our mutual 
interest in breaking the cycle of foreclosure. You and I agree 
that what the Nation needs is a solution that restores 
desperately needed liquidity for the credit markets and some 
price stability to the local real estate markets, and I know 
that we all want to find a way for FHA to help hundreds of 
thousands of Americans keep their homes and certainly avoid 
foreclosure.
    I believe we must help responsible families and communities 
in need without transferring risks and costs that should be 
borne by the private sector to the taxpayers. In fact, I 
believe most Americans want to protect homeowners who play by 
the rules. They don't want to have to pay for the risky 
financial behavior of others, and they don't want to make the 
Federal Government the lender of last resort, with the private 
sector dumping bad paper on FHA and on the taxpayers.
    The taxpayers do not want us to Federalize the housing 
market, which would be unwise economically. I believe FHA 
should remain true to its mission. And we must not harm our 
economy through solutions that, however well intentioned, 
further erode the foundation of the nation's housing market, 
hurt homeowners who are meeting their mortgage obligations, or 
even perhaps prolong the correction.
    I will say this. For more than 2 years, the administration 
has suggested legislative ways to improve the agency's ability 
to fulfill its mission to help low- and moderate-income and 
also first-time home buyers who are not served by the 
conventional mortgage market. The administration continues to 
urge Congress to reach agreement on a bill to modernize FHA so 
that the President can sign it into law.
    Mr. Chairman, in the meantime, FHA has been able to use its 
administrative authority to help hundreds of thousands of 
Americans refinance their home loan. In August of last year, 
the President introduced an effort known as FHASecure to help 
more Americans facing foreclosure refinance into a safer, more 
secure FHA-insured loan. Since then, close to 160,000 families 
have been able to refinance with FHA. We have always said that 
we are open to further expansion of FHASecure, but done so in a 
responsible way.
    Thus, last week at a hearing before a House Financial 
Services Committee, I announced some further administrative 
steps that will extend FHA opportunities to more homeowners 
that will help break the cycle of foreclosure. These efforts, 
using current regulatory authority, are targeted to distressed 
homeowners struggling to make their current mortgage payments 
and have no place to turn to refinance their homes as they 
continue to lose value.
    And our efforts will not create an unacceptable level of 
financial risk for FHA. I believe that some of the 
Congressional approaches often have unforseen consequences. For 
example, we believe mandatory write-offs of all existing 
mortgage debt will severely limit participation by existing 
lien holders. In addition, home buyers who speculated with a 
high-risk, high-leverage product would under this bill be 
rewarded with the deed to an upper-end house for a cost well 
below its long-term value. They can live in this house and 
later sell it for a substantial profit at the expense of the 
investors, who will take the write-down losses. The proposal 
does create significant inequity for the neighbors of such 
speculators.
    Also, the equity-sharing arrangements in this bill, we 
think are wrongly directed. The equity arrangements to prevent 
windfall profits to homeowners should not benefit the Federal 
Government, but the existing lien holder to minimize their 
losses. To be blunt, this is not our money.
    As well, creation of a new fund and board to expand the 
existing cap is redundant and, we believe, unnecessary because 
the existing FHA framework could achieve the same goal and much 
faster.
    Finally, Mr. Chairman, establishment of new GSE and 
suspension of the existing goals should be handled by HUD 
alone, the agency most familiar with the process. We believe 
adding extra cooks to that kitchen will unnecessarily 
complicate a process that we believe is currently working.
    I should add that the administration opposes any provision 
which will provide billions of dollars in loans or grants to 
States and local governments, whether through the CDBG program 
or other programs, for the purchase and rehab of vacant 
foreclosed homes. We believe in addition to being extremely 
costly, such a program would constitute a taxpayer bail-out of 
lenders and speculators while doing little to help keep 
struggling families in their homes.
    These are my initial thoughts about the bill. Let me say in 
closing, I will reiterate that. We do have some common ground 
to explore here and I want to say I look forward to working 
with you and the entire committee to do just that. There is a 
lot riding on this, Senator and Mr. Chairman. Thank you.
    Chairman Dodd. Thank you very much, Brian, for that, and we 
look forward to your ideas and thoughts in exploring some of 
the differences.
    Mr. Murton.

 STATEMENT OF ART MURTON, DIRECTOR, DIVISION OF INSURANCE AND 
          RESEARCH, FEDERAL DEPOSIT INSURANCE COMPANY

    Mr. Murton. Chairman Dodd, Ranking Member Shelby, Members 
of the Committee, I appreciate the opportunity to testify today 
on behalf of the FDIC.
    The problems we face in the housing and credit markets were 
caused by a complex set of interrelated concerns. The FDIC is 
concerned that we face a continuing cycle of default, 
foreclosures, declining home prices, and uncertainty, thus 
leading to potential for further losses, preventing recovery of 
the credit markets, and impairing the performance of the U.S. 
economy. Avoiding this result will require well-designed 
approaches to help distressed borrowers and to restore 
secondary market liquidity.
    No single solution can fully address the circumstances 
confronting us. Proposals addressing the current problems in 
the mortgage markets will raise issues of fairness, especially 
on the part of borrowers who have remained timely on their 
mortgage payments. However, properly structured proposals will 
provide benefits beyond the immediate participants by 
preventing a large number of foreclosures that would adversely 
affect other homeowners, other communities, and the broader 
economy.
    The FDIC has advocated systematic voluntary loan 
modifications to deal with poorly underwritten and unaffordable 
loans, particularly in the subprime market. While some progress 
has been made, the pace has been too slow to achieve the 
results that we were hoping for and to contain the broader harm 
to our communities and the economy. As Chairman Bair has 
stated, we are at a point where we need more intervention and 
it probably will cost some money.
    In the remaining time, I would like to make a few comments 
about the Hope for Home Owners Act of 2008. The proposal by 
Chairman Dodd addresses many of the principles the FDIC 
considers necessary for an effective program. It restructures 
troubled mortgages into loans that should be affordable and 
sustainable over the long term. It requires that investors 
recognize current losses while preventing borrowers from being 
unduly enriched if home prices appreciate. It uses existing 
government and market structures, which should allow the 
program to be implemented quickly. And it includes a financial 
cushion to help insulate the FHA and the taxpayers from losses.
    Still, there are some specific issues that need to be 
addressed. A major obstacle to refinancing many troubled first 
mortgages is that a significant number of them are subject to 
second liens. Resolving this issue is essential.
    A second concern is whether the FHA in the short-term will 
have the capacity to run the program.
    Third, there is the potential for adverse selection. The 
concern here is that investors will have economic incentives to 
cherry-pick the better loans and push the weaker loans into the 
FHA program, thereby increasing the cost.
    A final issue relates to the lack of financial incentive 
for servicers to modify loans.
    In addition, my prepared testimony contains a few 
suggestions that go beyond the scope of the bill before the 
committee.
    So in conclusion, the FDIC supports long-term solutions 
that fairly share the costs and risks of modifying or 
restructuring loans, that use existing government and market 
structures, and that mitigate the potential exposure to 
taxpayers. The FDIC is committed to working with Congress and 
others on solutions that address the immediate problems and 
that look to the future.
    Thank you, and I would welcome any questions the committee 
would have.
    Chairman Dodd. Thank you very much, Mr. Murton.
    Mr. Polakoff.

  STATEMENT OF SCOTT M. POLAKOFF, SENIOR DEPUTY DIRECTOR AND 
     CHIEF OPERATING OFFICER, OFFICE OF THRIFT SUPERVISION

    Mr. Polakoff. Good morning, Chairman Dodd, Ranking Member 
Shelby, and Members of the Committee. Thank you for inviting me 
here today to testify on behalf of OTS on preventing home 
foreclosures in America.
    We are in the midst of a stressed real estate environment. 
Home sales have deteriorated sharply, with sales down by 36 
percent since 2006, resulting in nearly a 10-month inventory. 
An increasing number of borrowers are having difficulty making 
their mortgage payments. Of the $11 trillion in mortgage loans 
outstanding, approximately $1 trillion are subprime loans. As 
of January 2008, 21 percent of subprime borrowers are 
delinquent, compared to 14 percent 1 year ago.
    Foreclosure data suggests an increasing number of home 
owners are losing their homes, as the rate of foreclosure on 
all mortgage loans has doubled in the past 2 years and for 
subprime loans has risen to 9 percent from 4 percent in the 12 
months ending January 2008.
    Adding to the problem is the unprecedented home price 
depreciation. With home prices down 10 percent from their peak 
in 2006, approximately nine million home owners are expected to 
have no or negative equity in their homes. Our observation is 
that numerous borrowers who would benefit from refinancing 
their mortgages can no longer qualify, as the equity has 
disintegrated over the past years.
    I should point out that a significant concentration of 
these non-performing loans resides in private-label 
securitizations. A private-label securitization has many 
stakeholders. The borrower, the investor, trustee, and the 
servicer all play critical roles in this secondary market 
funding vehicle. Any proposal to help prevent avoidable 
foreclosures should consider the interests of each of these 
components and opportunities to align various interests for the 
good of our housing economy.
    As you know, OTS announced its foreclosure prevention 
proposal in February of this year. Since then, we have been 
meeting with other financial regulators, major mortgage 
servicers, the American Securitization Forum, and other 
industry experts in an attempt to refine our proposal to assist 
with these efforts. These meetings, particularly with the 
servicers and investors, have given us insight into what I 
consider to be the key question at hand, and that is how to 
provide the right incentives to all of the stakeholders.
    If the proposal is too rich to borrowers, then we risk 
moral hazard. If the proposal ignores the interest of 
investors, then we risk inactivity by servicers. And if we 
ignore the legal documents, specifically the pooling and 
servicing agreements, then we risk excessive litigation and 
potentially impair future liquidity in the secondary market. 
But if we don't create an effective tool, then foreclosures 
will continue and the negative impact on neighborhoods and 
communities will be severe.
    As you know, the OTS plan has a good deal in common with 
the Chairman's bill. Both seek to prevent foreclosures by 
refinancing the mortgages of distressed borrowers with loans 
guaranteed by the FHA. Both proposals suggest a conservative 
loan-to-value ratio based on the home's current fair market 
value. We recognize that this current fair market value may be 
less than the principal owed on a loan due to home price 
depreciation. Under the OTS plan, the holder of the original 
loan would sustain a loss and receive a negative equity 
certificate for a sizable portion of the difference between the 
outstanding loan amount and the short refinance amount. The 
original loan holder could recover an amount up to the full 
value of the negative equity certificate when the home is 
eventually sold.
    I should point out that we have refined our proposal to 
allow the home owner to share in this negative equity interest 
as an incentive to stay in the home, maintain it, and perhaps 
even make improvements to get the best possible price upon 
resale. This borrower incentive is another important part in 
searching for the proper equilibrium of interests.
    Recently, we have heard stories where the second mortgage 
holder has prevented a borrower from entering a short refinance 
by refusing to subordinate its lien interest. It seems worthy 
to explore the possibility that such second mortgage holders 
could also share to some small degree in the negative equity 
certificate as an incentive to subordinate their position for a 
refinance opportunity.
    Last, there are two key components of our proposal that 
deserve mention. First, this vehicle would apply only to 
situations where default is reasonably foreseeable. While it 
has the ability to assist borrowers who may be underwater in 
their mortgage, it is not intended to aid borrowers who have 
the ability to repay but lack the willingness to repay.
    Second, this model is intended to help owner-occupied 
borrowers, not investors.
    We recognize that there are multiple causes for real estate 
stress and there need to be multiple tools available to work 
through this crisis.
    Thank you for having me here today, Mr. Chairman, and I 
look forward to answering your questions.
    Chairman Dodd. Thank you very, very much, and I thank all 
three of you for your comments. I should have said at the 
outset, if I didn't, any supporting data, materials you want 
the committee to have as a part of the testimony we will 
certainly include as part of the record.
    I will put 7 minutes on here and see if we can't hold to 
that so we give everyone who is here a chance to raise some of 
these very important questions that members have.
    Let me, if I can, just start out quickly with you, Mr. 
Montgomery, obviously to try to get as much information as we 
can about what is working and what is not working. And again, I 
want to emphasize the point, I know a lot of people are trying 
to figure out what best to do in all of this, and I welcome 
that and I am deeply appreciative of the various ideas that 
have been surfaced.
    Let me state as clearly as I can, there is no ideological 
position here. I am trying to be as practical as I can as to 
what can work, make a difference. And so I am less interested 
in people's ideological framework than recognizing there are 
moments when an intervention is necessary. Ideally, I don't 
like it. I would like the market to work. And if the market can 
work, there is no reason for us to act. But when the market is 
not working, then it becomes incumbent upon us, I think, to try 
and figure out a responsible way to intervene intelligently, 
thoughtfully, and responsibly, obviously understanding at the 
time you are never quite sure what is going to happen, but you 
hope you are smart enough that you are going to be a positive 
influence on it.
    But to do that, you have got to know what the data is. I am 
looking at an article that was entitled, ``HUD Acknowledges 
Inability to Help Many Borrowers.'' This was an article that 
appeared about a month ago, and the Director of FHA's Office of 
Single-Family Program Development said that there had been only 
1,500 FHA-secured financings. From March 1 to the 15th, HUD 
reported that just 242 loans were made for delinquent 
borrowers, or just 17 loans per day.
    I mentioned earlier we are getting some, according to Track 
Realty, in the neighborhood of 7,000 to 8,000 filings a day and 
as many as 1,000 of those 7,000 or 8,000 are actually going 
into foreclosure. At least those are the numbers we are getting 
on all of this.
    So instead of 17 a day, as opposed to the numbers we are 
looking at--let me ask, first of all, the two other witnesses. 
Do you agree with that general overview here, that the program 
is not--FHASecure, while it is a good idea, it is not 
addressing the magnitude of the problem. Is that your 
conclusion, as well, as you have looked at this issue?
    Mr. Polakoff. Mr. Chairman, I wouldn't be prepared to say 
that at this point. As we reach out to the servicers, we 
understand that the servicers themselves are modifying a number 
of loans in an attempt to do the right thing. Borrowers are 
using FHASecure as a vehicle. There still seems to be an 
incredible difficulty to reach a number of borrowers as they 
approach default and a foreclosure situation, sir.
    Chairman Dodd. How about you, Mr. Murton?
    Mr. Murton. Well, I think as I said in my statement, I 
think as Chairman Bair said, we are at the point where we do 
think more steps are needed. We think the efforts so far have 
been important, but we do think that more may be needed.
    Chairman Dodd. Well, in your testimony, Mr. Montgomery, you 
state that FHASecure and HOPE NOW initiatives have together 
helped more than 1.3 million home owners. I would like to get 
that data, if I can, or the committee would, for the record 
that breaks out exactly how many borrowers are getting 
repayment loans and modifications, what kind of repayment plans 
and modifications they are getting. All of us hear, I think, 
that too many loans are being reclassified as modifications 
where no long-term interest rate freezes are involved or other 
considerations. The word ``modification'' is being rather used 
loosely, and it would be very helpful if we could at your 
earliest convenience here to get us the data that supports that 
conclusion of 1.3 million.
    Do you want to add any comments here in terms of the 
concerns I have about them?
    Mr. Montgomery. Yes. Absolutely, Mr. Chairman. Thank you. 
When we announced FHASecure on August 31----
    Chairman Dodd. I point out, by the way, the industry itself 
has raised some concerns in the press about what they call 
cooking the books on these numbers, so----
    Mr. Montgomery. Anybody can look at our books who want to, 
sir, any time, any day. Let me just say that when we rolled out 
FHASecure, again, we are an insurance company. We needed to 
have a measure of response backing our actuarial soundness. But 
we did say going forward that we would make improvements as we 
saw fit.
    There have been 163,000 mostly subprime borrowers who are 
heading toward the slippery slope of delinquency--we know this 
because they tell us--who had never even heard of the FHA. 
Remember, for many years, and your staff will attest to this, 
FHA, I think a lot of people thought we were the Federal 
Highway Administration. We are almost an afterthought for many 
borrowers. A lot of publicity around the announcement. Again, 
borrowers tell us this. They thought they had no other option.
    So I will say this. We way overestimated the number who 
would come in delinquent, and I will get to that in a second. 
We way underestimated the numbers that would come in current. 
By the end of the fiscal year, we believe we will have 400,000 
borrowers--remember, these were not FHA borrowers--that will 
refinance through a safe and secure FHA loan.
    Now let me fast-forward to last week. Moving forward, we 
wanted to make some more improvements to FHASecure, again 
coming at it from the sense of delinquencies, keeping our debt-
to-income ratios and the like. We think we will add another 
100,000 to that number. Remember, a lot of these folks were 
never going to qualify anyway. They had no document loans. They 
had stripped out a lot of the equity in their homes. So going 
forward, I think a lot of those families who refinance will 
disagree that they have not been helped.
    Chairman Dodd. Well, again, I think getting the data here 
would help us get a better picture on all of this.
    One of the things being raised, a concern about it, is, of 
course, that we are protecting taxpayers. Obviously, all of us 
want to do that. When this program or something similar was 
tried years ago, it actually produced a modest amount of income 
for the Federal Government in those days, in 1920s, 1930s 
dollars. We are not looking to make money off this, but 
obviously we want to avoid having great exposure for the 
American taxpayer, as well, that has been raised by many, 
including Senator Shelby and others.
    And one of the ways we try to protect the taxpayer in this 
plan--the three ways we try to do it, I would like to know how 
you feel about these and if there are any other ideas you would 
have that we ought to include as part of the proposal.
    One, it increases the maximum up-front and annual premiums 
in the proposal. It calls for FHA to share in future 
appreciation. So you are getting resources back to the program. 
And it limits the maximum loan-to-value of the new loan to 90 
percent of the current value of the property, something Mr. 
Polakoff addressed.
    Do any of you have any other additional factors or 
reactions to these ideas and is there anything else you would 
add? How about you, Mr. Montgomery?
    Mr. Montgomery. I would say on the LTV, again, sir, there 
is some common ground here. I can't stress that enough.
    Chairman Dodd. Yes.
    Mr. Montgomery. We think there needs to be an incentive for 
the current lien holder as part of those agreements that were 
referenced earlier to want to do the write-off down to some 
certain number. I think a mandatory complete write-off, where 
the FHA refinance is accepted as payment in full, I don't know 
that you will get the participation that you are looking. We 
think by coming at it a little differently that FHA steps in, 
there is a second lien for a part of that charge-off, we think 
is a more prudent approach. Ninety percent LTV loans perform 
very well for FHA.
    I would also say on the debt-to-income, I know that you 
give that authority to a board----
    Chairman Dodd. Yes.
    Mr. Montgomery [continuing]. Which again we, speaking for 
our excellent career staff at FHA, believe strongly we have 
that expertise. But we feel very secure in keeping those debt-
to-income ratios the same, and I know you would have this board 
do that, 31 being the front end, 43 being the back end.
    Chairman Dodd. Right.
    Mr. Montgomery. On the shared equity component, again, as I 
mentioned in my oral statement and the written, we were not 
party to that original transaction. This is not FHA's money.
    Chairman Dodd. Yes.
    Mr. Montgomery. I think we share in the goal that we want 
to keep that borrower in the home so they don't experience some 
windfall profit. We think the 90 percent with the soft second 
supports that. But we could also have some sort of recapture 
provision, some sort of resell restriction to perhaps 
accomplish the same thing.
    Chairman Dodd. I agree with that. That is not a bad idea.
    Mr. Murton.
    Mr. Murton. Yes. In our written testimony, we did mention 
that perhaps increasing the fee from 3 percent to 5 percent, or 
in that direction, may be important. We are concerned about 
making sure that the government is protected to the extent 
possible. So I think there may be room for discussion on that. 
We do recognize that you do have to provide incentives for the 
investors to participate.
    Chairman Dodd. Right. Exactly.
    Mr. Polakoff. Mr. Chairman, we would urge very strongly 
consideration that the negative equity certificate or the 
potential of sharing upside appreciation reside with the 
original loan holder, potentially also with the second and with 
the borrower. Whether 90 percent LTV, whether that 10 percent 
cushion is the right amount, the key here for these FHA 
refinance, we believe, is insured financial institutions are 
going to be the ones that underwrite these loans. It should be 
fully documented, properly underwritten, with a 10-percent 
margin. We believe they should be safe and sound loans.
    Chairman Dodd. Yes. Well, in fact, on the incentive idea, I 
think there is some real value in that, as well, striking that 
balance, because this is voluntary, and to the extent you want 
both the investor and obviously the borrower--the incentive of 
the borrower is there. You get to stay in your home. But the 
incentive for the investor to step up and say, I am willing to 
take that haircut and do this, I think you have got to have a 
proper incentive in there. It gets to the issue rather well of 
the safe harbor provisions, which I will come back in a later 
round since we have already gone over the time here. But I 
appreciate your comments on that.
    Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Montgomery, you stated in your testimony that some 
ideas stretch FHA beyond its role or ability to serve the 
American people appropriately. Today, I will ask you, does FHA 
have the institutional capacity in terms of expertise, staff 
numbers, available funding, among other things, to be able to 
handle the proposed increases in its activities?
    Mr. Montgomery. Well, not to get sideways with the budget 
folks, I guess the only good news in the fact that we are still 
waiting for FHA modernization is we have been able to take 2 
years----
    Senator Shelby. Some of us serve on the Appropriations 
Committee, too, so if you wouldn't mind----
    Mr. Montgomery. Sorry, Senator. That we have been able to 
upgrade our systems, even though their average age is about 18 
years. So yes, we do need some systems upgrades.
    Senator Shelby. Which is going to cost money, that 
capacity.
    Mr. Montgomery. Yes, sir.
    Senator Shelby. OK. Would you explain to the committee what 
you believe constitutes underwriting flexibility? As some might 
say, underwriting flexibility is a euphemism for the loose 
underwriting standards that led many to present difficulties in 
the mortgage markets. What do you mean by underwriting 
flexibility?
    Mr. Montgomery. Well, I will agree with some of what 
Senator Tester mentioned before. It was almost free money, 
these no docs, income-stated asset. Remember, FHA----
    Senator Shelby. That is asking for trouble, isn't it?
    Mr. Montgomery. Absolutely, sir. That is part of why we are 
in this predicament we are in, and FHA doesn't do that. We have 
this crazy notion you have to prove your job history. You have 
to verify your income. We have rigid debt-to-income ratios that 
we are not going to change.
    Senator Shelby. Mr. Murton, some have suggested that 
Congress should set up a board to oversee an expansion of FHA. 
On that board, some would say, should sit the FDIC, the 
Treasury, and Housing and Urban Development Secretary. Would 
you tell the committee here or in writing later what unique 
expertise the FDIC posses in the area of mortgage insurance? I 
know that is part of your portfolio, a big part. Go ahead.
    Mr. Murton. Yes. I would be happy to provide a fuller 
answer in writing, but I think that when you look at our 
experience as safety and soundness supervisors, as supervisors 
for consumer protection, I think we have experience, a great 
deal of experience in the mortgage markets. And then in our 
capacity as the receiver of failed institutions, we have people 
who have dealt with these problems, who have tried to work out 
loans with borrowers, who have tried to avoid foreclosures and 
who have seen the effects of these kind of problems on 
communities and the economy.
    Senator Shelby. Mr. Murton, you also mentioned in your 
testimony that one of the first principles for solutions is 
that the solution be sustained over the long term. In other 
words, doing something just for expediency generally won't 
work. Do you believe that it is a sustainable solution to write 
down a mortgage and refinance it when many housing markets are 
likely to see future price declines of ten, 15, 20 percent? In 
other words, where is the bottom? Are we rushing too soon? 
Where are we?
    Mr. Murton. I don't know that anyone knows when we will get 
to the bottom. I think that we have borrowers who are not in 
affordable mortgages and I think they are facing the decision 
of whether to end up in a foreclosure, and I think that needs 
to be addressed and that we need to address that sooner rather 
than later is our perspective.
    Senator Shelby. Mr. Montgomery, appraisal controls. A 
critical component of all of the write-down plans that have 
been presented is the integrity of the appraisal process. 
Lenders still will have a strong and clear incentive for 
properties to be over-appraised in order to shift as much risk 
as possible to the government. HUD's Inspector General recently 
reported that FHA did not have adequate internal controls over 
its appraiser roster. What steps, Mr. Montgomery, is FHA 
planning to take to minimize the adverse impact of inflated 
appraisals on the Mutual Mortgage Insurance Fund? I think it is 
very important that we get realistic, honest appraisals.
    Mr. Montgomery. Absolutely, Senator. I agree 100 percent on 
that. We have had roughly 1,400 or so sanctions against 
appraisers in the last 3 years, and, in fact, stood up a 
program that would help using a risk analysis identify 
appraisers that we were getting high default rates, things of 
that nature.
    Back to your question. On the stimulus package, the 
increased loan limits for FHA, for that jumbo FHA product, as 
some are calling it, we just put out guidance a week-and-a-half 
ago that we are going to require two appraisals for those. 
Although remember, an appraisal is just an opinion of value. We 
are considering doing the same going forward on this FHASecure 
expansion.
    Senator Shelby. Mr. Montgomery, were FHA to lower its 
underwriting standards in order to serve more borrowers, the 
most likely result is an increase in losses to the Federal 
Housing Administration, which could ultimately be borne by the 
taxpayer. What level of delinquencies and losses are you 
projecting for your planned expansion of the FHASecure program?
    Mr. Montgomery. Well, by doing----
    Senator Shelby. Have you done some modeling there?
    Mr. Montgomery. Well, sir, we have done modeling and more 
modeling. But there is about a five-legged stool here, and in 
the interest of time, I will be very brief.
    Senator Shelby. That is OK.
    Mr. Montgomery. We need to do some sensible risk-based 
pricing, and this is something that was in the original FHA 
bill a year ago--excuse me, 2 years ago. The seller-funded 
downpayment assistance, which I know the Senate has included 
prohibitions on that twice, that is, as you know, a lot in the 
predicament that we are in, long-term financial solvency. But 
remember, on our proposal for the delinquencies, if you have 
one 90-day or three 30-day delinquencies, that now has a 90-
percent LTV requirement. That is a tighter restriction, because 
our existing product is only 97 LTV. And, again, historically, 
those 90-percent LTV products perform very well for us from an 
actuarial standpoint.
    Senator Shelby. Mr. Chairman, I just want to wrap this up, 
if I can, in a few seconds. In my opening statement, I asked 
several questions that I believe this Committee--the Committee 
on Banking, Housing, and Urban Affairs--needs to have answered, 
and I commend the Chairman for his comprehensive approach to 
this. Before we can proceed to crafting good legislation--and I 
am going to go over this again--how many of these households 
made minimal or no downpayments on the properties they hold? 
That is something we need to find out, and perhaps some of you 
can help us with. How many of these households did a cash-out 
refinance on that same property and now face difficulty paying 
the higher mortgage costs? How many of the households have poor 
credit scores and have significant credit card debt--in other 
words, are overburdened? How many homeowners used exotic 
mortgage products, gambling on the ability to refinance in 
future years? You know, betting on the ever rising stuff out 
there. I do not know the answer to that, but I think that is 
all part and parcel of our dilemma here facing that. Do you 
disagree with that, Mr. Montgomery?
    Mr. Montgomery. No, sir. I agree with that statement.
    Senator Shelby. Mr. Murton.
    Mr. Murton. I agree with that.
    Senator Shelby. Do you agree?
    Mr. Polakoff. Yes, sir. It is the question as to whether 
the borrower was a victim or an accomplice.
    Senator Shelby. And sometimes a victim, sometimes right in 
there with them?
    Mr. Polakoff. Yes, sir.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator Shelby. And, 
again, I have said over and over again that I think if you 
break these borrowers down to three groups of people, you have 
got those that were speculators, and there is nothing that I am 
proposing that is designed to provide any relief for the 
speculator. I feel badly for them, but they are not included. 
This has to be owner-occupied so you are not sitting there 
buying properties that you do not live in that you are just 
trying to make a buck off of.
    The second group of people that, frankly, never would 
qualify under any restructuring you could provide for would not 
be able to fit into this, and we cannot, tragically--maybe 
there are some other ideas that people have on how to help 
those people, but I cannot see how we can necessarily fit them 
into this idea we are talking about. What we are talking about 
is that constituency, those groups of people who are in 
situations that they can afford to stay in there with a 
workout, that will allow the investor to get something back so 
they do not lose everything, so that neighbors will not be 
adversely affected by foreclosed properties in the 
neighborhood. They may have, you know, chosen or should have 
chosen a wiser course to follow but, nonetheless, are in the 
situation they are in, and the moral hazard is not only--should 
not only be focused on whether or not that individual should 
have been more conscious of the kind of problems they could get 
into, but also the moral hazard is to the other people that 
will be adversely affected if we do not act and do something 
about this as well. And that is really the target audience we 
are trying to get at. The benefit is obviously to keep people 
in their homes where we can. The added benefit is, of course, 
that enough transactions will occur that you can actually 
determine what the floor and the bottom is. That may be the 
more important point from a macroeconomic standpoint so that 
the credit crisis begins to lessen and capital begins to flow 
and the problems begin to address themselves not only in this 
area but in other areas of the economy that are feeling this as 
a result of this particular problem. That is the idea behind 
this more than anything else, and getting at it.
    So I--and we know from the Wall Street Journal study, which 
I do not know how accurate it was, but there were some 60 
percent of these borrowers that would have qualified for prime 
loans at a lot less cost to them than these subprime deals that 
they were talked into. And, again, you know, it is the relation 
of doctor and patient. I mean, I probably should ask all the 
right questions of my doctor before he operates on me. But, 
candidly, I am not a doctor. And I am sitting there and I am 
relying on someone across that table from me in a sense who is 
holding themselves out as a financial adviser to--probably I am 
anticipating more than I should, but when a doctor does not do 
their job, there is something called medical malpractice, and 
we do not turn to the patient and say, ``You should have asked 
better questions before you got into this.'' In a sense, that 
same analogy can apply to some degree here; when you are 
sitting across that table, it is not exactly a level playing 
field in many ways. And I think to sort of suggest as such is 
to misunderstand what occurs when people are trying to get into 
a home, trying to stay afloat. Most of these are second 
mortgages, as we know, not first-time homebuyers. And people 
are underwater financially. There are two or three incomes. 
They are using credit cards. The Chairman is absolutely 
correct. We know now--what is it? I think something--I was 
stunned yesterday that a quarter of students are paying for 
their student loans through credit cards. The average is almost 
close to $10,000 per household in credit card debt and 
obligation. So it is a mounting problem, the consumer debt 
issue, and that is not going to go away here, and I do not know 
if we are ever going to find the exact numbers of the economic 
profile of that individual caught in that situation that today 
is finding themselves facing foreclosure and moving out of 
their homes.
    So I want to make clear that is what we are targeting, 
trying to get to that audience that has the benefit, obviously, 
of keeping their family there, stabilizing that neighborhood, 
property taxes coming in, as well as not allowing this problem 
to spread throughout that neighborhood and getting the 
spiraling effect where foreclosures beget more problems beget 
more foreclosures, and you get that spiraling down problem, and 
the problem gets a lot worse and a lot more costly in many 
ways.
    And, again, anyone who claims they have cornered the wisdom 
on all of this or knows exactly the right thing to do, you 
ought to be immediately suspicious of them. I certainly do not. 
I am relying on smart people who have been through this and 
understand it, trying to come up with a formulation here that 
could make some sense and work for us. That is my job here, the 
practical applications of trying to short-circuit a problem 
that is growing worse.
    Senator Menendez.
    Senator Menendez. Mr. Chairman, I think Senator Carper is 
next.
    Chairman Dodd. I am sorry. I apologize. You are exactly 
right. My apologies.
    Senator Carper. Thank you, my colleague and neighbor.
    Chairman Dodd. You have moved in already. That was pretty 
quick.
    [Laughter.]
    Senator Menendez. Just a summer home.
    Chairman Dodd. Just a summer home, OK.
    Senator Carper. Again, we appreciate your being here and 
your testimony today.
    Mr. Montgomery, right at the end of your testimony, you 
said these words. You said, ``In conclusion, these are our 
initial thoughts about the bill. I again stress that there is a 
lot of common ground here given our shared interest in using 
FHA to help many Americans.''
    I am going to ask each of you to talk about the common 
ground.
    Mr. Montgomery. Do you want me to go first?
    Senator Carper. Why don't you go first?
    Mr. Montgomery. I would say first and foremost I think we 
agree a lot of folks are in the right house but the wrong 
mortgage. No one is promised instant equity when they buy their 
home. There is also no doubt that we have not had a nationwide, 
almost, with some small exceptions, decline in home prices like 
we have seen recently.
    Going forward--and I agree with the Chairman and the 
Ranking Member. I think we all agree on who we want to help and 
who we do not want to help, as unfortunate as those other 
circumstances may be. So we think going forward if there is 
some sort of writedown to a number with a new appraisal, 
perhaps two appraisals, that FHA--and there is a reason we have 
an FHA, and this is a good one, I think--can insure a portion 
of that loan, recognizing that this does not happen in a 
vacuum. There are servicing agreements, pooling agreements. 
There are investors. There are these second liens, which a lot 
of these were piggyback loans. Everybody has a stake in this if 
we are going to do the ultimate thing, and that is, keep the 
home and the borrower out of foreclosure.
    So that is why we think, as well intentioned as doing this 
mandatory write-off is, I would just question how many lenders 
and servicers would want to participate versus what we want to 
do is put that option that exists today to have that soft 
second. It does not accumulate interest. There are no payments 
made on it. But it is out there so that some portion of that 
debt is resolved when the home is refinanced or sold, and 
ultimately we will turn this corner, whenever that may be, and 
prices go back up. And I think that is something we all--maybe 
not to the pace that we just saw recently, but I would say that 
is certainly some common ground. We shared this with House 
Financial Services Committee as well.
    Senator Carper. All right. Thank you.
    Mr. Murton, where do you see the common ground?
    Mr. Murton. Well, I think in our testimony we laid out four 
principles that we would like to see that people----
    Senator Carper. Go ahead and restate those. I saw those in 
your testimony. State them again.
    Mr. Murton. That people be put in sustainable mortgages; 
people who can be in those should be in sustainable mortgages. 
The burden should be shared appropriately, that parties should 
take--third parties are going to have to take losses, and the 
burden will have to be shared.
    Senator Carper. Who would you include among those third 
parties?
    Mr. Murton. Can I come back to that in a minute, please?
    Senator Carper. Sure.
    Mr. Murton. Just let me get through--I am sorry. We would 
like to see it use existing structures, market and Government 
structures, so it can be done quickly. And we would like to 
make sure that we limit the liability to the Government, and I 
think there is common ground on most of those.
    And I think going back to the second one, that is where 
there may be more work to be done, because the burden sharing 
of this is quite complicated to figure out. It is absolutely 
clear that you need to provide the appropriate incentives so 
that investors will encourage the participation on their behalf 
by servicers. That is absolutely critical. It is also critical 
that you protect the Government's interest in this if the 
Government is going to provide funding. And I think finding the 
right sharing of those arrangements is one of the trickier 
issues.
    And then, finally, I think there is common ground or 
agreement that dealing with the question of second liens is 
going to be a complex problem, and we need to figure that out.
    Senator Carper. All right. Thank you.
    Mr. Polakoff.
    Mr. Polakoff. Senator, we have to find ways to prevent 
avoidable foreclosures. Not all foreclosures are avoidable. 
There are multiple tools right now for servicers to consider. 
This bill offers another tool.
    I would say that our conversations with servicers suggests 
that servicers are trying to do the right thing, trying to 
reach out to the borrowers who are in financial distress right 
now. The common elements along those lines I think fit with 
much of what I heard today.
    I go back to the discussion that I think is very worthy of 
if a servicer is going to take a significant write-off in 
allowing the borrower, the distressed borrower, to be able to 
refinance, whether it is with an FHA guaranteed product. I also 
think there is a benefit to talk about the role of private 
mortgage insurance with loans underwritten at 90 percent with 
insured financial institutions. But the question that I would 
submit, the topic that deserves more discussion potentially is 
who can benefit from the home price appreciation, which will 
return at some point.
    Senator Carper. I was talking with one of our leading 
bankers in our State, and we were talking about, among other 
things, the amount of money that a mortgage servicer is paid. 
And he suggested to me that their take, if you will, is 25 
basis points in most situations, but in a foreclosure, the 
mortgage servicer can realize as much as 6 times that income.
    Can you confirm or correct that for me, anybody?
    Mr. Polakoff. Well, I cannot confirm it. I certainly would 
not be so bold as to correct it. But I would submit that 
typically a servicer in a subprime portfolio gets 50 basis 
points for servicing that portfolio, and typically in a 
foreclosure process, the servicer gets--or the servicer 
receives any out-of-pocket costs associated with the 
foreclosure. All of our investigation with servicers does not 
reveal that a servicer benefits going through a foreclosure 
process.
    Senator Carper. Could anyone else comment on that?
    Mr. Murton. I am not an expert on those numbers. As I 
understand it, they are compensated at a higher rate in a 
foreclosure, but there are offsetting costs and so forth so 
that it may not be profitable. But the concern that we have or 
the point we have made is they are paid some administrative 
expenses to compensate for those costs in foreclosures. It is 
not clear they are incented to do the same for modifications 
and other solutions that may be preferable.
    Senator Carper. All right. Share with us your best thoughts 
of how we should deal with second liens or second mortgages. 
Everybody agrees that this may be among the stickiest wickets.
    Mr. Montgomery. Well, and you have probably heard some of 
the same concerns that we have from the investor and the lender 
community out there. But, yes, they absolutely have a stake 
going forward, and I think a lot of them will tell you there is 
no way they think they are going to get 70 cents on the dollar, 
80, 50, 40, whatever. But the fact that there would be a 
mandatory discharge of all of that I think might be what would 
keep this from going forward.
    Senator Carper. All right. Thank you.
    Mr. Murton.
    Mr. Murton. I think that we agree that most of these 
seconds are not worth very much. Nevertheless, they have some 
power over taking the loans out of the mortgage--out of the 
pools and restructuring them. So one thought that we had is 
whether we can look at ways, some other solutions that might 
involve working with loans in the pools under other 
circumstances and finding arrangements that might work there, 
because you may have less of an issue on the second there. But 
it is--we wish we could have come with an answer there, but we 
would like to explore that.
    Senator Carper. Mr. Polakoff.
    Mr. Polakoff. Senator, if I could offer a thought with the 
seconds, because we have heard these stories, I would submit 
that for loan modification purposes, the seconds are irrelevant 
from a power perspective. And certainly they are relevant if a 
borrower is going to pursue an FHA loan, a refinance. But 
everything that we are talking about with an FHA refinance a 
servicer can do with a modification, and by doing so eliminates 
the power of the second.
    So I would suggest very important to address from a 
refinance perspective, not necessary to address from a 
modification perspective.
    Senator Carper. All right. Thank you.
    I think, Mr. Chairman, in your bill one other issue is the 
issue of a safe harbor for mortgage servicers, as I recall, 
that is in your bill, is it not?
    Chairman Dodd. It is in our bill.
    Senator Carper. Let me just ask, if I could on that, the 
inclusion of safe harbor as a part of what we do going forward, 
I think, to incentivize the--or at least to take away 
disincentive for the servicers to enter into these agreements. 
How important do you think safe harbor is?
    Mr. Polakoff. Well, I would offer that there is a real 
important element of the safe harbor. The servicer must abide 
by the pooling and servicing agreement, which obviously has a 
couple very important effects. One of them is maximizing 
proceeds. The other is for REMIC tax purposes. In order to 
define a reasonable, foreseeable default, we have to be sure 
that whatever we submit does encounter an IRS ruling for REMIC 
purposes.
    So I think there are a lot of very important elements to 
discuss with that.
    Senator Carper. All right. Thanks.
    Mr. Murton.
    Mr. Murton. Chairman Bair held a number of roundtables last 
year to explore the complicated issues in this, and it is 
pretty clear that the contracts allow the servicer to act on 
behalf of all the investors in the group. And I think that 
anything that reinforces that we are very supportive of.
    Senator Carper. All right. Mr. Montgomery.
    Mr. Montgomery. That is a little out of FHA's realm. We are 
not a banking regulator.
    Senator Carper. OK. I understand.
    Mr. Montgomery. But I would concur with their comments.
    Senator Carper. All right. Thanks.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Corker.
    Senator Corker. Mr. Chairman, thank you. I am going to 
follow along the same line of questions as Senator Carper, and 
statements. I think that there is a lot of common ground. By 
the way, my ``not neighbor.'' As a matter of fact, sitting 
where I sit over here, I wonder if I am part of the continental 
United States sometimes.
    [Laughter.]
    Chairman Dodd. We have all been there.
    Senator Corker. I understand. I understand.
    Chairman Dodd. You sometimes think you are part of the 
press corps over there.
    Senator Corker. Well, I know these cameramen very well.
    Chairman Dodd. They are slipping you notes all the time, I 
think.
    Senator Corker. You know, I think that line of questioning 
was actually very good, and I know that I have shown my bias in 
regards to what we have done thus far on the economic stimulus 
efforts that have taken place. I think it has actually been my 
most discouraging moments here to see how we sometimes try to 
wrestle with issues and then come to conclusions that do not 
even really address the issue.
    This meeting to me, much like yesterday's where I thought 
we had an opportunity and think we do to basically try to push 
the FFB into doing some things that would really solve the 
problem, I think has some of the same ingredients. And I think 
it has been an excellent hearing. And I think that sometimes 
the most productive things we do legislatively are not to 
legislate necessarily, but to place a marker out there that 
causes other organizations that exist to move toward that. And 
I think in many ways that is what you have done with your 
proposal, is to lay a marker out there that addresses a 
problem.
    I think there are a lot of commonalities in the approach 
between the administration, the witnesses today, and yours, and 
I think that, you know, keeping ownership is certainly a goal 
that has been laid out.
    It seems to me that the negative equity certificates are a 
very elegant way, if you will, of dealing with writing a loan 
down and getting a mortgage into a position that somebody can 
actually pay for it. And yet it does not create all those other 
issues of joint ownership. Many people have referred this bill 
to be something--referred to this bill in a way to make it 
similar to what happened with RTC. But it is not. It is very 
different, because in that case there was a severance of 
ownership. The people no longer owned the property. In this 
case, they are actually going to be in the property. And I 
thought testimony we have had over the last few days where 
people were concerned about what do you do about home 
appreciation that occurs by somebody actually investing in 
their property, improving their kitchen, adding a garage. How 
do you deal with that? And then how do you deal with the 
possibility of the neighbor issue that was referred to earlier 
where one neighbor keeps their loan, the other neighbor does 
what is proposed in this bill and has a quick sale and actually 
benefits from doing the writedown? I think that in many ways 
these negative equity certificates really do deal with the 
issue far more elegantly and, again, keep us out of dealing 
with it.
    So the biggest issue--and it seems to me that Chairman 
Dodd's bill also builds upon the FHA to actually do this. Is 
that correct? I mean, it is within the FHA, a new organization, 
a new entity inside the FHA per this bill, per his bill would 
actually carry out the efforts proposed in this bill. Is that 
correct?
    Mr. Montgomery. As I understand, there is a board that is 
created that would set, you know, debt-to-income ratios, things 
of that nature. We would just submit, since time is of the 
essence here, that we have that existing----
    Senator Corker. So it seems to me also if this bill becomes 
law that there actually has to be an appropriations process to 
actually fund it. And it seems to me that everything that the 
bill lays out can be done within the FHA today. And it seems 
that the negative equity certificates are a much more elegant 
way of making sure we have no moral hazard.
    In addition, I guess the whole issue of debt forgiveness 
creates income, does it not?
    Mr. Montgomery. Well, in our case, there would be some debt 
forgiveness. I think a lot of lenders and others are looking to 
see, to the Chairman's point, where the floor is. But, you 
know, once it is written down to an appraised value, we come in 
and insure 90 percent of that. That other equity is held as a 
soft second.
    Senator Corker. But since it is held as a soft second, the 
borrower, who already has financial issues, does not owe the 
IRS money; whereas, if there is debt forgiveness, my 
understanding is that is income. It always has been income in 
the past. Is that not an issue that would have to be dealt 
with?
    Mr. Murton. I believe that was taken care of in recent 
legislation.
    Senator Corker. For a short window of time.
    Chairman Dodd. It was taken care of.
    Mr. Polakoff. Senator, I believe there is a 2-year window, 
I think, for debt forgiveness not being considered income to 
the borrower.
    Senator Corker. OK. And I would just say that it seems to 
me, then, on that note, though, that this is something that is 
set up to actually go forward, per the administration, for a 
longer period of time. We are only about a third of the way 
through resets at this moment in time. Is that correct? We 
still have tremendous numbers of resets to be dealt with. So it 
seems to me that the issue is urgent, that the FHA is set up at 
this point to deal with it, that it, in fact, takes no 
appropriations process for this to occur. And I guess the big 
question comes back to a question Senator Menendez offered in 
his opening statements. But is the FHA set up to plunge into 
this and deal with this plan in a way that would alleviate the 
need for any legislation of the type that is being discussed 
today?
    Mr. Montgomery. The only difference being that we have a 
2.25-percent premium cap right now to expand the fence line out 
a little further. We would need some flexibility in that 
premium structure since we are a self-sustaining entity that 
does not take taxpayer funds. Again, we are coming at it from a 
delinquency standpoint, things of that nature.
    So, yes, we are doing a lot of this now. We think in the 
interest of time the best thing is to let the Federal Housing 
Administration, perhaps with some legislative fixes, move 
forward.
    Senator Corker. And could you be very specific about what 
those legislative fixes would need to be to cause us to move 
forward immediately in a way that appears to me to really be at 
no taxpayer expense?
    Mr. Montgomery. Well, on the risk-based pricing, we have 
this guiding principle that we do not want to raise premiums on 
some family in Alabama or Texas who today is saving their money 
to buy a home in October, that we do not want to pay for this 
by raising their premiums and we want to wall them off from 
this. The only way that we can do that is to have some flexible 
pricing in that premium, recognizing the differences between 
the highest and lowest premiums. You know, our average borrower 
has a $50,000 income, buys $140,000 home. Those are very subtle 
dollar amounts, but they help our actuarial soundness, because 
we do not want to be back here later this year going to the 
appropriators saying we need money to keep our doors open, 
which I know seems almost counterintuitive because right now us 
and the GSEs are about the only game in town, so to speak. Our 
volume is up significantly. But, you know, we continue to have 
a drag on us with these seller-funded gift downpayments, and I 
cannot overstate that enough. And, again, this body has been 
great to address that.
    Chairman Dodd. Bob, can I just add, you know--here is what 
I am thinking. We have asked, by the way, CBO to score this, 
because obviously that is an important issue. And we do not 
know, but we believe that between the annual and the up-front 
premiums that we are talking about and the shared equity 
component that you have addressed here, we believe there is a 
real possibility that in terms of exposure, it would be 
minimal, and the tax provisions we think we have--the idea is 
to have a short window on this. Partly the idea of not setting 
up a whole new operation is exactly the point you are making. 
To go through that would be--we have an organization that knows 
how to do this in a way, and we are giving it a window of time. 
And you are right, we have resets coming. But if we can limit 
this in time and sunset this whole thing so you are in that 
window we are talking about on tax and we can avoid some of the 
very issues. I just offer that as a thought. But we are asking 
CBO to score it.
    Senator Corker. Well, you are addressing the specific 
legislative issues. You addressed one, and I think--I know my 
time is up, and I know we are probably going to have another 
round. But I will defer to Senator Menendez and come back and 
follow back up.
    Chairman Dodd. Bob.
    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Secretary, a lot of questions have been raised here, 
and I appreciate the definitions of where there is common 
ground on the legislation and where there might be some 
differences. But I think some overarching questions were raised 
that we need to deal with as well, so let me go to the very 
beginning of your opening statement.
    You said, ``Yesterday, Americans paid their taxes. That 
payment is a responsible action by each citizen, a necessary 
duty to pay for the services provided by the Government. Our 
citizens expect us to spend that money wisely, carefully, 
judiciously. After all, it is their money. They don't want us 
to use tax dollars to reward risky behavior or irresponsible 
lending or to create moral hazard. We all have a duty to be 
good fiscal stewards.'' And I cannot think of anyone on the 
Committee who would disagree with you. But that should be 
across a spectrum, should it not?
    Mr. Montgomery. Absolutely.
    Senator Menendez. So when we gave $29 billion to JPMorgan 
to buy Bear Stearns, did we create a moral hazard?
    Mr. Montgomery. Sir, that is a little out of my lane. I am 
the Federal Housing Commissioner.
    Senator Menendez. I understand that, but I think you have 
some sense of it. I mean, we had the Chairman of the Federal 
Reserve here, and I asked him questions about, well, what is 
the liability to American taxpayers, couldn't define it for the 
Committee. Twenty-nine billion dollars in record time.
    Now, what message does that send to Wall Street about 
responsible behavior? See, if we are going to have a standard, 
which I think is an exemplary standard, then it has to be a 
standard across the spectrum. It is very hard for American 
homeowners--and, you know, I understand--Senator Shelby, whom I 
have a great deal of respect for, raised a question. Who is a 
victim? Who is an accomplice?
    Well, let me ask you, gentlemen: In a score of 1 to 100, 
with 100 being the best score, what would you say is the 
average American's financial literacy score? Anyone want to 
venture to give us a sense of it?
    Mr. Montgomery. I would--rather than giving you an exact 
score, I would say probably not very high, sadly.
    Senator Menendez. Would you all agree that would be the 
case?
    Mr. Murton. I would agree.
    Mr. Polakoff. Yes, sir, I would agree.
    Senator Menendez. And that is one of our great challenges, 
because the reality is, having practiced real estate law for a 
fair amount of time before I came to the Congress, I have to 
tell you that I had many hard-working people who I had to go to 
great pains to describe what their mortgage commitment was and 
what they were getting into, because they had absolutely no 
sense whatsoever. And the reality is that they were trying to 
reach for their dream, and they were trying to do it 
responsibly.
    And what I am saying here is, you know, the financial 
literacy is something I hope the Committee will increasingly 
pursue, Mr. Chairman, something I know I am personally 
interested in and have some initiatives on. The reality is this 
is a critical component because at the end of the day, whether 
someone is a victim or an accomplice, you know, depends upon in 
part what is their financial literacy. And I would venture to 
say that a great number of people--I have read from my own case 
files, individuals, including people who had standard mortgages 
for a long period of time, and, in fact, were good credit 
scores and had been responsible payers, and then were lured 
because they were told, ``You are paying too much on your 
fixed-rate mortgage. You can actually get this lower rate,'' 
and were told a whole series of things that led them to 
believe, they thought responsibly that, in fact, making that 
move made sense, and now they find themselves retired with 
their income stream fixed, and in the process of losing a home 
they otherwise would have kept just by continuing to pay their 
conventional rate mortgage. And I have got a whole bunch of 
stories like that.
    So moral hazard, you know, I have a problem with $29 
billion to JPMorgan for Bear Stearns where the Chairman of the 
Federal Reserve cannot tell me what American taxpayers who paid 
their taxes yesterday liability is, and yet we can say to our 
millions of homeowners in this country that are going to affect 
our economy, all of our economy, that we think that 3 percent 
in the latest report from the Center for Responsible Lending 
still has that the industry plan reaches only 3 percent of at-
risk homes. That means a 97-percent correction rate. Are we 
willing to take a 97-percent correction rate in the 
marketplace, not just for those millions of Americans who will 
lose their homes but the consequence to the rest of us? That is 
the essence here, Mr. Chairman, of how we look at the issue. 
And I think it is very important how we look at the issue.
    You know, why did we go ahead and do that for Bear 
Stearns--or for JPMorgan to purchase Bear Stearns? Because 
there was a general consensus that there is a consequence to 
the broader economy if we did not, right? Isn't that basically 
what was the argument? Well, there is a consequence to the 
economy of what happens if we do not do something significant 
about these mortgages?
    So where is the difference between the moral dilemma, the 
duty to be good stewards, and rewarding risky behavior? And, by 
the way, where are the regulators who have the power to stop or 
intercede in a whole host of these instruments that, in fact, 
would not have brought us to the point we are? Where is their 
responsibility? Where is the risky behavior, good fiscal 
stewards standard for them?
    So as we apply these standards that we want to say this 
about homeowners whose, admittedly, financial literacy rate is 
on the lower side, and say we go to rescue Bear Stearns, and we 
say to the regulators, oh, well, we are the clean-up brigade 
versus the preventers of what is happening, let's apply that 
across the spectrum, and then I think it will be fair. But if 
we are only going to apply that to the spectrum of those people 
who made decisions that largely are victims, I have a real 
problem with that.
    Last, Mr. Chairman, I just want to ask one substantive 
question in addition to making--because I think the broader 
statement, if we are going to move forward on this, we have to 
have the parameters of what is, you know, good for the goose is 
good for the gander, so to speak here, and knowing what the 
standards are that we are going to apply across the board.
    But I want to ask you, Mr. Montgomery, I have heard reports 
that the FHA is no longer accepting borrowers without a credit 
score. Is that the case?
    Mr. Montgomery. Well, FHA is about the only entity that 
does not base a decision solely on the credit score. That has 
been one of the hallmarks of FHA for generations.
    Senator Menendez. Is that still your standard?
    Mr. Montgomery. Yes, that still is.
    Senator Menendez. So you are accepting individuals who do 
not necessary have a credit score?
    Mr. Montgomery. Yes. They are a very, very small portion of 
our portfolio, less than 1 percent, probably.
    Senator Menendez. Because there is a fair number of 
borrowers who do not have a credit score, but who use payment 
history such as rent, utilities, and other bills that are well 
documented or solid, responsible payers that, in fact, can hit 
a 620 score, FICO score, and are well within the FHA 
parameters. Those people are not being eliminated at this 
point?
    Mr. Montgomery. No, sir. As a matter of fact, we support 
the provision in the Senate bill that would--assuming it is 
still in there on a pilot program going forward for non-
traditional----
    Senator Menendez. Is the secondary market changing their 
standards in that respect?
    Mr. Montgomery. Well, a lot of the pricing from private 
mortgage insurance companies, certainly from Fannie and 
Freddie, we are seeing a lot of cutoff points on FICO scores, 
absolutely, and certainly a repricing if not a retreat from the 
higher LTV/lower FICO score market.
    Senator Menendez. Well, we look to see what exactly is 
happening there. You know, 22 percent of Latinos in this 
country have no credit score whatsoever. But yet they, in fact, 
have some great records of establishing due payments on time, 
long periods of time that would give them access to an 
opportunity to be considered. If we start eliminating that 
without looking at the substance of their abilities to pay, we 
are going to deny a whole host of people in the rush to now 
respond to some of what has happened before.
    So we have to be, you know, cautious, but at the same time 
we do not want to just eliminate opportunities for people 
across the spectrum who otherwise can be responsible lenders 
and good payees.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Reed.
    Senator Reed. Well, thank you, Mr. Chairman. And thank you, 
gentlemen.
    Mr. Montgomery, all these different proposals anticipate an 
expanded role for the FHA and raise several issues, but two 
major categories: first, financial capacity and, second, 
managerial capacity.
    With respect to financial capacity, it was reported 
recently that for the first time in the 74-year history of FHA, 
you might be running a deficit with respect to your portfolio. 
Can you comment on that, how it would affect you going forward 
or what steps you are taking to reverse that troubling trend?
    Mr. Montgomery. And I have commented extensively on this 
and met with a good bit of the staff that is sitting behind you 
who have been very supportive in this. That is the irony here, 
as FHA's volume continues to grow, that we continue to have a 
drag on our solvency because of the proliferation of seller-
funded downpayment assistance. Six, 7 years ago, it was barely 
5, 7 percent of our portfolio. It is as high as 33 percent 
overall, and in some States--Texas--it is about 45 percent of 
our FHA portfolio.
    The IRS has put these organizations on notice that circular 
financial arrangements, things of that nature, it is clearly an 
inducement by all parties that you do not see in any other 
501(c)(3). We could be the largest mortgage insurance entity in 
the world, but as long as we have that large a percentage of 
loans that use that sort of assistance--we are the only 
customer, by the way--then we will continue to have the drag on 
our financial solvency. And I have been sounding those alarms 
now for some time.
    Senator Reed. Now, let us talk about managerial capacity, 
which is the resources, and many times, I suspect, you know, in 
comparison to a major mortgage lender and insurance company, 
your software, your hardware, your employee base is not as 
robust as you would like it to be, I suspect. Can you comment 
on that also?
    Mr. Montgomery. You are absolutely correct, Senator. I 
mean, we have made some improvements to our existing systems--
the average age of which, by the way, is about 18 years. And we 
can handle it. But I will say going forward we need a long-term 
fix to our information technology.
    The good thing about HUD is we have a very, very 
experienced and hard-working, dedicated career staff. But they 
have been there many, many years, and a lot of them are 
retiring. Just this year, I have to hire 400 people. That is 
just to keep even to where I was last year. And it is a problem 
we have been trying to address.
    The good news is--I guess the bad news is while there have 
been a lot of layoffs in this industry, we are getting a lot of 
high-quality candidates.
    Senator Reed. Right. I mean, one of the unfortunate 
consequences of the economic climate and the meltdown of 
several major mortgage entities is that there are very talented 
people out there, unfortunately, that might be available. But I 
think this goes to part of the effort of reform to reauthorize 
FHA is that there has to be, I think, both the authorization of 
resources to modernize your information systems, to make sure 
you have appropriate staff, and also, I think, going back to 
the point about the seller-financed downpayments, did you have 
any discretion with respect to those products? Can you limit it 
within your portfolio? Or the other question would be it grew 
from 5 percent to 35 percent. Just in the general portfolio of 
management, having an asset like that becomes so large so 
quickly it would raise questions. Can you comment?
    Mr. Montgomery. Well, it would certainly raise questions. 
Obviously, we are bound by the Administrative Procedures Act. 
That process, as you know, can be quite time-consuming. I will 
briefly summarize here. We have put out a proposed rule. It 
went out for public comment. We put out a rule that was going 
to basically eliminate that sort of assistance. We were sued. 
There are various movants and intervenors within those cases, 
and the judge--it is the Eastern District Court of California, 
the Federal District Court of Washington. Both ruled against 
us. They enjoined us from implementing the rule.
    I will say this: If you read both of those decisions, I do 
not think the judges attacked us on the merits of the case, the 
evidence of the case, but they certainly hit us on the 
Administrative Procedures Act. And I will say this: They gave 
us a good road map to get it right.
    Senator Reed. OK.
    Mr. Montgomery. It was not good enough for us to be 97 
percent right in their mind. We have to be 100 percent right. 
And we will continue to move forward.
    Senator Reed. Thank you. Just let me raise another general 
question or a comment for the panel. I was listening intently 
to Senator Tester, who I think made a very profound point about 
these types of arrangements where people could buy a home 
without any money down. I had to buy a home, too, and, you 
know, we put down money because one thing we wanted to do is 
avoid paying mortgage insurance. So we put 20 percent down, 
and, you know, fortunately, we had it. But the whole mortgage 
insurance market is not there to help out now for some of these 
defaults because of the second mortgages which are issued 
simultaneously.
    It suggests to me that a lot of this was--the people who 
were writing not just the first mortgage, but also encouraging 
the borrower to take a second mortgage for a 100-percent 
financed house with zero down and also not looking carefully at 
the income capacity of the borrower, I mean, it goes back to 
the point the Chairman made. That seems to be mortgage 
malpractice, writ large. And, you know, one of the issues that 
struck me here is that, you know, a lot--in the old days, and I 
will date myself, if you--you know, you had to put the money 
down or you had to have mortgage insurance. If the mortgage 
went bad, you know, you lost the house, but the financial 
system recouped the mortgage.
    Any comments in terms of this problem, or reactions? Mr. 
Murton or Mr. Polakoff.
    Mr. Murton. Well, perhaps it goes back to the point I think 
you made earlier, Senator, that people believed housing prices 
would always go up, and I think we got ourselves into that 
mind-set starting with the low interest rates, and then 
following that the unsustainable credit expansion.
    Mr. Polakoff. Senator, I agree that there was much 
irresponsible lending by mortgage companies and mortgage 
brokers, and I do believe that there were some poor decisions 
made by some borrowers who should have known better and were 
taking advantage of the system as well.
    Senator Reed. I mean, one of the things pointed out to me 
is that, you know, if you have a stable income stream, getting 
a second could be a financially shrewd move because you avoid 
the monthly mortgage fees and mortgage payments, et cetera. But 
in the case of so many of these borrowers, particularly the 
subprime, where they did not have those assets, did not have 
those income streams, and getting into a second and being--and 
having someone underwriting that mortgage, that first mortgage, 
knowing that there was no equity, was a serious, I think, lapse 
of judgment.
    But, Mr. Chairman, again, thank you for this hearing. I 
have learned much. Thank you.
    Chairman Dodd. Thank you very much, Senator.
    Just picking up on Senator Reed's point, I think, you know, 
what was the underlying thinking of people in all of this? And 
one is a sense of optimism. I mean, you could say that they 
should have had better judgment in some cases, but that sense 
of optimism and confidence about their country, about 
themselves, about their futures is a valuable and tangible 
asset in all of this. And why are people doing this? Why were 
they taking that second? And you go back and you realize what 
tremendous economic pressure people have been under.
    I cite these statistics, and when I do, every time I say 
them I find myself questioning, and I go back and confirm them 
again. Between 2000 and 2006, if you exclude supervisory jobs 
in the country and speak only about 124 million Americans in 
non-supervisory jobs, their wages went up $1.60 in 6 years--
$1.60. Not a year, not an hour. That was the total wage 
increase for 124 million people. That is $200 million in wage 
increases in that 6-year period of time. I might point out the 
five investment banks gave bonuses of $35 billion in that same 
6-year period, by the way. And so when people have that limited 
income growth--and you are looking at energy, health, food, 
other matters going up--this idea of taking that second 
mortgage and doing--it was not out of greed. They are doing so 
because they are trying to stay afloat. That is why there are 
second family jobs, that third job, that fourth job. That is 
why credit cards in many cases people are financing these 
things. It is not just irresponsible behavior. It is people 
trying to keep their families together in very difficult 
economic times for a lot of them. And there are other things 
they probably should not be doing. I am not trying to create 
some image of a person who has been absolutely perfect, but the 
motivations here are not just about greed. They are about 
surviving in many cases. And they are about optimism, and it is 
about confidence about their futures.
    I think before we just decry all of this, we ought to 
understand the framework and the understanding of what 
motivated people in those moments to do what they did, the idea 
of having a home, raising a family in a place you call your 
own. I am a provider. I take care of my family. My wife and my 
children would love to have their own house. And that has been 
a strong emotion in our country from the founding days of this 
republic. Today, we find ourselves at a lot of risk of all of 
this.
    So just this idea of indicting people out there because 
they got themselves into bad deals, as we heard a minute ago, 
we have had people talking them into this stuff. I mean, I 
still go back--every time I look at that website of the brokers 
that the first rule is, hold yourself out as the financial 
advisor of the borrower. A complete lie, because you are being 
paid based on yield spread premiums that reward you for how 
high a rate you can convince that borrower to take. And when 
you are looking across the table at someone who is a borrower 
who believes this person is their advisor, you know, there 
isn't exactly a level playing field in that sense, either.
    Let me address, before I turn to Senator Corker, I know 
Senator Corker has some questions, Bob asked some very good 
questions. He asked about is there new legislation required 
here, and I asked my staff to kind of do a quick run-down here 
and let me share some thoughts we have on this and whether new 
legislation is needed.
    HUD is claiming--and Brian, you are correct on this--that 
it will serve up to 500,000 people with the new expanded 
FHASecure program. At least that is the number I have been 
given. Is that right?
    Mr. Montgomery. Yes. With this expanded FHASecure, by the 
end of the calendar year----
    Chairman Dodd. Right. OK. And I think Senator Corker raised 
a very good point earlier, and I appreciate it, as well. I 
mean, I don't know how we are going to do with this bill. I am 
going to try and move this idea. But I know in the process, we 
are also moving people probably to do some things they weren't 
going to do in the absence of suggesting some ideas here, as 
well. So to some extent, I guess I ought to be taking a degree 
of satisfaction in that people are moving in a direction that I 
am not sure they would have been moving in had we not been 
proposing some of these ideas.
    But the administration was very slow to acknowledge the 
mortgage problem, as I mentioned at the outset of my remarks, 
and I say this respectfully, but there was just a failure going 
back more than a year ago. I might add, by the way, when I took 
over the Chairmanship of this committee a year and 2 months ago 
and my staff met with Federal Reserve Board staff, stunningly, 
they told us, the staff, they were aware of this problem 
emerging at that point, three-and-a-half years earlier.
    And so when we talk about this problem popping up last 
year, in fact, knowledgeable people claim they were beginning 
to get concerned about this issue, broadly, some time before 
then, and I just share that with you this morning.
    Congressman Frank and I have been talking about a larger 
scale and a more aggressive government program to assist home 
owners since late January, and last week, April 9, the 
administration announced its plan to expand FHASecure. We 
welcome that. I am just pointing out, this was a year and a 
month after we have been raising the issue. It is good to get 
it, but if you won't mind me saying, I wish we had had a little 
earlier reaction to all of this. And in short, by pushing the 
Hope for Home Owners Act, I think we have been helping the 
administration move in the right direction.
    The Dodd bill expands the universe of eligible borrowers 
beyond the recent expansion of FHASecure. It gives the 
authority to FHA to raise fees beyond the current level, which 
I think is a benefit. I appreciate your point, Brian, that the 
levels are where they are, but we think by going a little 
higher, we actually address some of the underlying questions 
about taxpayer exposure and the like and making sure that 
borrower is going to have some skin in this so that they are 
going to get covered, as well. So giving HUD the authority to 
charge more will allow it to expand the universe of eligible 
borrowers.
    In our discussions with servicers and lenders, there is a 
strong sense that our program could be effective even for 
borrowers who are more than 90 days delinquent. The HUD program 
would not extend to those borrowers, which is a limitation. I 
don't know if that requires new legislation or not, but that is 
one of the things we are talking about.
    Third, the legislation also creates a safe harbor for 
servicers so they will be more willing to participate. That 
requires legislation because that doesn't exist.
    And fourth, our plan creates a board, as you have been 
pointing out and talking about, that doesn't exist, obviously, 
that includes Treasury, FDIC, as well as HUD, and we provide 
for lending of staff from other Federal agencies to help 
implement the program, one of the things we don't do enough 
around here, because while this isn't the only universe to deal 
with, we understand there are others that can come into this 
process that could be helpful and we do that. I don't know 
whether you need to do that by regulation or legislatively, but 
it is one of the things we include legislatively to try and 
cover some of those questions that I think you properly raise. 
Do we need more authority under law to allow us to do some of 
the things we are doing?
    I have a lot of faith in FHA to be able to do this. I think 
you run a great shop. I think you make a huge difference for 
people. I think the modernization effort is going to be a major 
step in the right direction. And I don't think you have to go 
out and recreate some agency to do this. I have a lot of 
confidence you and the wonderful staff you have can handle this 
idea, and as long as CBO gives us a mark here we can work with, 
then we may not even need to go through an appropriation 
process.
    So the last thing I want to do is go out and start some 
whole new ballgame here in town that you never get rid of. The 
old axiom in Washington was, you create something new, it never 
goes away. And the last thing we want to do is create something 
new that won't go away. So just to address a couple of those 
questions.
    With that, let me turn to Senator Corker.
    Senator Corker. Well, thank you for those comments. I think 
they are very helpful, and actually, I was confused, I guess, 
at the end of my last questioning as to what did need to happen 
to allow FHA to do what it has proposed through this Secure 
program. My understanding is if we were to pass the FHA 
Modernization Act, that that covers all the things that need to 
occur to handle the portions that you have described, not the 
additional portions Senator Dodd has described, is that 
correct?
    Mr. Montgomery. That is correct. But to go above the 
premium structure, we would need--to do risk-based pricing, we 
would need some----
    Senator Corker. But we already have legislation that moved 
a little ways and is now bogged down. But, in fact, if FHA 
modernization passes, you have the frames you need to continue 
on with this aggressive effort you have laid out?
    Mr. Montgomery. By and large, yes.
    Senator Corker. OK. So just to gain again more common 
ground, I would like for you to address what our Chairman has 
laid out regarding expanding the program in the means that he 
has talked about and then give a little bit of an explanation 
regarding this safe harbor component that he also has laid out 
in his legislation.
    Mr. Montgomery. I will just say that the safe harbor, we 
can expand more on in writing. It is a little out of my area 
and more to the gentleman to my left.
    Again, going forward, I would just say, I think in concept 
we agree. A lot of families are in the right house with the 
wrong mortgage. There are some issues of predatory lending, 
too, where there is no doubt a lot of people were steered 
toward higher-cost loans. But trying to thread the needle, 
there are some very good things in the Frank proposal, there 
are some very good things in this proposal. I say personally 
there are some very good things in our proposal. But just going 
forward with the things the gentleman to my left had mentioned, 
there are a lot of players. There are a lot of legs on the 
stool and how can we make sure, whether it is a piggy-back loan 
that the Senator over here discussed, there are a lot of 
players here that can bollix the whole thing up, so to speak.
    So going forward, we think doing the 90 percent LTV is good 
with a subordinate lien, but it will do us no good if whoever 
is holding the second on that piggy-back loan right now doesn't 
want to go forward with it. And so that is why I think 
extinguishing those loans with a mandatory write-down, I think 
may limit the ability of this program to go forward.
    Senator Corker. But that issue exists under the Dodd 
proposal and your proposal, is that correct?
    Mr. Montgomery. Well, in ours, we would allow--certainly 
people could do write-offs today, by the way. I think the point 
was made earlier, a lot of people are waiting to see where the 
floor is. There is no mystery there are a lot of proposals 
floating out there. But in our proposal, FHA would only insure 
90 percent of whatever the appraised value is, so that 10 
percent equity would be in the soft second with a note, due-on-
sale clause, something of that nature. Now, certainly the 
lender could put all that in a soft second. Eventually, home 
prices will go up. Again, I would just say we are trying to get 
to the same thing here but just a little differently.
    I would also say I think we need some rigid debt-to-income 
ratios for underwriting. We don't want FHA to throw the baby 
out with the bath water here. We need, I think, to insert some 
fairly rigid debt-to-income ratios in there, as well.
    Chairman Dodd. Can I bump just on this, because this piggy-
back loan issue, and I should have mentioned this earlier, sort 
of make this more free-wheeling, is we required in the 
legislation that that second lien be extinguished. That 
requires a negotiation between the first lien holder and the 
second to work that out, because it is not going to happen if 
it doesn't. So there is no fancy I know of how to deal with 
this other than require that before you can participate in the 
program, if you want to, you have got to negotiate that out, 
and----
    Senator Corker. But that is on a voluntary basis.
    Chairman Dodd. That is a voluntary basis, yes. Otherwise, 
it can't work, obviously. You have got a huge problem there. So 
the law says, in effect, resolve that before you step up. Now, 
I realize there may be those who can't, so that is going to 
strike out a certain number. But otherwise, it wouldn't work. I 
don't know how you resolve the problem otherwise.
    Senator Corker. Since we are in this free-wheeling mode, 
the negative equity certificate notion does seem to do away 
with the issue of moral hazard. In other words, the debt is 
still there. It has no interest that is being borne on that 
debt. But at any time in the future should the home sell, that 
debt is repaid and so you do away with the moral hazard issue. 
I would just be curious what your response to that is----
    Chairman Dodd. I welcome that idea. I think that idea has 
value. That is the carrot. I have got to get that investor to 
come up to the plate here. Obviously, the borrower wants to be 
here, although he is going to pay insurance, he is going to 
have to share back. The question is, can I get those piggy-back 
loans worked out. That is no small hurdle to get over, but let 
us assume he can do that.
    And then I have got to get that investor to do what 
culturally they have never been inclined to do. It is almost a 
cultural problem, in my view, and that is culturally, 
experience has told you in the past, get him out of the house. 
We do better under those circumstances than fooling around with 
a delinquent mortgage holder, or payer, rather, in this case he 
is. So there has got to be an incentive for that person to come 
forward.
    So I find that idea very appealing as a way of drawing in, 
for less of a moral hazard reason than I am--if I don't get 
people to participate, this is just a lot of paper----
    Senator Corker. But it is also more streamlined in that you 
basically keep the arrangement between the lenders and the home 
owner instead of having a third party that is benefiting 
somehow from the sale or the value down the road and then 
figuring out who made it worth more. Was it things the 
homeowner did? It seems like to me, it is just a more elegant 
way of dealing with that particular cumbersome sort of problem 
there.
    Chairman Dodd. And I want to, again, I don't want to 
overstate a case to you in how you work that out, but I like 
the idea because some of that is involved. I will leave it 
there.
    Mr. Montgomery. I would just say, we allow that under 
FHASecure, depending on whether they want to do a write-off, 
because they know they will certainly take a larger hit if it 
goes to foreclosure. But again, you couldn't put it on the part 
of the soft second because the prices will go up and you will 
make some of this moral hazard that they had this windfall, so 
to speak.
    Senator Corker. So I will summarize. I know Senator Carper 
is here, too. But it seems to me that actually, there is 
tremendous agreement here. In essence, it is a voluntary 
program.
    Chairman Dodd. Right.
    Senator Corker. It is one that the lenders participate in 
with their own desire. They have to work out things with the 
second and third or fourth and fifth mortgage holders, as they 
may be. They have to work it out with them.
    Chairman Dodd. Right.
    Senator Corker. What is----
    Chairman Dodd. Owner-occupied.
    Senator Corker. Owner-occupied. The fact is that it gets 
the person in the home in a position, again, on a voluntary 
basis by the lender, that allows them to actually make mortgage 
payments, OK----
    Chairman Dodd. They can afford.
    Senator Corker. Ones that they can afford. There is no 
moral hazard if, in fact, we adopt this principle because there 
is a negative equity certificate, so the value of the home has 
to come back up at least to where the indebtedness was before 
there is any profit made by the home owner. And it just seems 
to me there is a lot of mutuality that we somehow ought to 
figure out a way to do, hopefully without legislation. I know 
you are talking to your staff. This is the part I wanted you to 
hear. Hopefully, without legislation. But it sounds like there 
may be some tweaking someplace.
    I would love for you all, if you would, at least to our 
staff and hopefully everyone, get back with us on the two 
issues, I guess, that Senator Dodd has brought up that I am not 
sure that I still fully understand how we would deal with the 
expansion piece and the safe harbor piece. But it seems to me 
we have had 2 days of streamlined surgical-type approaches to 
problems that really affect people.
    Chairman Dodd. The bill hasn't changed in the last month.
    Senator Corker. Well, I think the issue of sharing--I think 
that sharing issue is a major, major--I think that is a major 
issue, and I think bringing in a third party to be involved in 
that is just something that is very troubling and very 
cumbersome, just for what it is worth. But I think that laying 
that marker out has caused other people to think about it in a 
different way and I think all these things are good.
    Chairman Dodd. Thank you very much.
    Senator Carper.
    Senator Carper. Thank you. On the issue of the negative 
equity contract, or negative equity certificate, when I first 
heard about it, I thought that this sounds like an elegant 
solution. In fact, those were my words, too.
    Let me just ask. Is there some precedent in the last decade 
or two where something like a negative equity certificate was 
used in another day and another way, maybe with the S&L crisis? 
Is there a precedent for that so we can actually look back and 
see how it was used and if it was to good effect or not? For 
some reason, in the back of my mind, I am thinking that there 
may have been a precedent for this that we can learn from.
    Mr. Murton. Well, it may not be an exact analogy, but 
certainly the FDIC and the RTC when they resolved failed 
institutions and had to pay off the insured depositors and took 
assets and we had people work those assets, we had arrangements 
where on day one you didn't know the value of it, but if it 
turned out that the properties we realized more value from, or 
the person working it for us realized higher value, we shared 
in that. So we have worked out a number of different sharing 
arrangements when values are uncertain and they worked quite 
well for us, I would say.
    Senator Carper. OK.
    Chairman Dodd. I might say, Tom, on the Bear Stearns-J.P. 
Morgan Chase, I wish we had had some warrants coming back. We 
did that with Chrysler.
    Senator Carper. We did that with Chrysler.
    Chairman Dodd. We didn't get anything out of that thing. 
You talk about these certificates coming back, the people 
putting a lot of skin in the game are the very people we are 
worried about here right now. We have got virtually nothing 
coming back on it except the hope. So I believe it will work 
out, but very little protection.
    Senator Carper. Yes. Mr. Polakoff.
    Mr. Polakoff. Senator, if I could dive down to the weeds 
for a moment without boring you----
    Senator Carper. Go ahead. We will try to go with you.
    Mr. Polakoff. The concept from an OTS perspective allows 
the servicer in the securitization to literally write down the 
amount of the loan to the negative equity aspect of it, 
subordinated to the first, which would be an FHA-guaranteed 
first. So while the term negative equity certificate has gained 
a lot of traction, really what we are talking about is writing 
down the principal to that amount and then subordinating it to 
the first, making it non-interest bearing, changing the terms 
so that the maturity would either align with the current terms 
of the note or when the borrower sold the home.
    Senator Carper. All right. I think I understood most of 
that. Thank you. An elegant explanation.
    I had an interesting conversation. The Chairman and I and 
some of our colleagues were able to discuss issues of the 
economy, some of the housing issues that were before us this 
past weekend. One of the folks who was there with us was the 
former, I think, Chief of President Clinton's Council of 
Economic Advisors, Laura Tyson, and we talked a little bit 
about the issue of how do we--the sharing, if you will, after a 
second mortgage note, after a mortgage is reworked and you have 
a foreclosure avoided and then you have an appreciation over a 
period of time, to what extent does the borrower share in that 
and to what extent would FHA. If FHA is involved, to what 
extent would they share in it.
    I think Chairman Frank has a proposal that would say the 
first year, FHA, I think, would get 100 percent of the uptake, 
and that would be phased out over 5 years until FHA would get 
zero. I think I am on the right track here. I believe in 
Chairman Dodd's mark that it is a little different take. Say 
the first year, FHA would get maybe 100 percent, 90 percent the 
second year, and then down to 50 percent, and for an indefinite 
period of time beyond that, it would be split 50-50 between the 
borrower and FHA. There are a variety of different proposals.
    Ms. Tyson suggested to me--I guess it is Dr. Tyson 
suggested that maybe a better approach, she said, you need more 
than 5 years, and she was talking to Chairman Frank's idea. She 
said, you need more than 5 years, maybe 10 years. So the first 
year would be 100 percent FHA and then down and by the tenth 
year be 10 percent FHA and then the home owner would realize 
the entire amount.
    But there are different ideas here. Which of these 
approaches makes most sense to our panelists?
    Mr. Polakoff. Well, I would offer that what makes most 
sense is for the servicer in the securitization who is taking 
the write-down, and in this case taking a write-down beyond the 
current fair market value to 87 percent of the fair market 
value, deserves the upside potential of a negative equity 
certificate to be shared with the borrower. The borrower needs 
to have an incentive to stay in the house, improve the house, 
look to eventually, if he or she wishes, sell the house, and I 
think we should at least discuss the benefits of some sort of 
interest for the second lien holder to once again be willing to 
subordinate their position.
    Chairman Dodd. That is a very good point, by the way, and 
one that Ben Bernanke has made, as well, in talking about that.
    Senator Carper. OK. Good. Mr. Murton.
    Mr. Murton. I think I agree that the negative equity 
certificates help address some of the moral hazard problem, and 
then I think the question is who do you share it with, the FHA 
or the investor, and I think there are arguments on both sides 
and maybe you can work out some arrangement where if the 
government is taken care of, maybe then it goes to the 
investor. There are lots of ways to structure things like that.
    On the issue of 5 years versus 10 years, perhaps Dr. Tyson 
was thinking that in the past, it has taken quite a while for 
home values to recover and the longer horizon may add value to 
that and that is a legitimate point.
    Senator Carper. OK, thanks. Mr. Montgomery, a quick 
comment?
    Mr. Montgomery. Just real quickly. There is not a lot of 
difference between the negative equity certificate and what we 
are proposing and rolled out last week with FHASecure, just we 
would put it in the form of a second subordinate lien. I just 
want to make that valid point.
    Also, I do want to say that on principal, we weren't a 
party, FHA wasn't a party to the original transaction. I am not 
so sure we should be sharing in equity, so to speak. If a 
borrower today buys a home with FHA insurance and 10 years from 
now they have a profit from it, we don't come back saying, hey, 
we need a cut of that. That is why they pay premiums, up-front 
premiums and annual premiums. I think we can accomplish the 
same thing.
    I think we all agree, yes, owner-occupied homes. We want to 
keep that borrower in the home so they will realize some 
profit. We just would maybe do a re-sell restriction, due on-
sale clause, something of that nature.
    Senator Carper. All right. Just a closing thought on this, 
Mr. Chairman. I am looking here at this glass of water. Some 
people would look at this glass of water and say it is half-
empty. I think in terms of actually finding common ground and 
moving legislation, the glass is half-full and I think we have 
an obligation to work very hard to find the middle ground in 
some of these areas. To the extent that some legislation is 
needed to complement what FHA is doing on their own and others, 
so be it. But I am encouraged.
    Chairman Dodd. Senator Corker.
    Senator Corker. Unless you need to go to lunch or 
something, I will ask one more question. When I was mentioning 
third party earlier, I really meant FHA playing a role in 
equity sharing, which I think was just addressed. I don't think 
that is an appropriate thing, but yet maybe having the interest 
payments due to the second mortgage holders at some point down 
in the future, maybe that does make sense, and I think we all 
nod our head in that regard.
    Getting back, though, to the debt forgiveness issue that I 
brought up earlier, and I realize our first stimulus package 
addressed that for a period of time, whether it is a second 
mortgage, as was just laid out by Mr. Montgomery, or whether it 
is a negative equity certificate, those do address the loan 
forgiveness issues in different ways. I assume if it was second 
mortgage, as you have laid out, there is no debt forgiveness, 
and so that is not triggered. If it is a negative equity 
certificate, I guess there would be a question, is that like a 
financial instrument that is a lien and is there still debt or 
not?
    But I think that while we are all here and while you all 
are all here, since something may happen soon, it would be 
interesting again just to sort of revisit the issue of debt 
forgiveness and how that ought to be addressed and I would love 
to hear from all three of you.
    Mr. Polakoff. Senator, I would say that under the negative 
equity certificate, if the borrower sells the home for an 
amount less than the negative equity certificate, then there 
could very well be--there would be a portion of debt 
forgiveness associated with that, yes, sir.
    Senator Corker. And that would occur, like, way down the 
road?
    Mr. Polakoff. Potentially, but----
    Senator Corker. And I am just wondering if that is 
something we actually addressed appropriately, if you will, in 
the first economic stimulus package. But that is something that 
could happen 8 years from now, is that correct?
    Mr. Polakoff. Yes, sir, though one would hope in 8 years 
there is much home appreciation.
    Senator Corker. Do you want to address that, Mr. 
Montgomery? I mean, there are two different approaches. It 
seems that yours, you never forgive the debt, is that correct?
    Mr. Montgomery. Well, whoever the existing servicer and 
lender is, I mean, there may be a charge-off going on. The home 
is worth--there is a $120,000 mortgage and the home is only 
worth $100,000. We insure 90 percent of it. They could put that 
delta, all of it in the form of a soft second, recognizing that 
prices ultimately go back up. They may decide going forward 
with an agreement there is a charge-off of $20,000 of that 
$120,000 and there is just 10 percent in----
    Senator Corker. And again, that is a voluntary decision----
    Mr. Montgomery. Yes, absolutely. So there are a lot of ways 
to come at it. I mean, there are circumstances that will be 
unique for a lot of borrowers. They will be unique regionally. 
I think getting all the players involved to agree that they may 
ultimately--the current lien holders get something out of this, 
maybe the second lien holder is five cents on the dollar, I 
think is probably all they are looking for, 10 percent, maybe 
more. But we think going at it a little differently, I think we 
seem to be moving in the right direction.
    Senator Corker. Thank you very much.
    Chairman Dodd. And that point, as well. I appreciate 
Senator Carper raising the issue earlier. Again, obviously 
getting the investor, but also you want that borrower to feel 
not only they are getting their home, but that this is also--
that home represents a secure economic future, as well. And so 
that incentive--and there will be those who may turn around and 
say, look, you are far better if I just walk away from this 
whole thing. So we want to make sure that we are incentivizing 
that in ways that keeps both parties to the conclusion that it 
is in your neighbor's interest and your interest and there is a 
financial reward for taking on this responsibility, and also 
from the investor side.
    So striking that balance is probably never going to be 
absolutely perfect, but you try to keep that in mind, as well, 
as we go forward.
    This has been very productive and very helpful, and great 
witnesses. I appreciate it very much.
    We are going to try and move at some point here, I just 
say, on this. There is a sense of urgency about all of this. 
And again, Senator Shelby had to move on to another hearing he 
had to go to, and I appreciate his opening statement and 
talking about the very legitimate questions which this 
committee is raising at every aspect we can while 
simultaneously trying to come up with some answers. So we are 
going to continue to explore what happened. We have got some 
legislation dealing with the practices that got us to this 
point which have to be addressed. But if I had to prioritize 
what our agenda ought to be, it is trying to step up and doing 
something that hits the target and how do we short-circuit this 
problem from getting worse. Obviously, it is important to make 
sure we shut the door so it doesn't ever happen again, but if 
you had to choose which of those two is deserving more of this 
committee's time and attention, it is the first one. It is 
dealing with the problem, and so we are going to try and deal 
with that, also as well as focus on the other questions of how 
we got into this mess and what steps we ought to be taking to 
make sure we don't repeat it.
    I thank everyone very much. The committee stands adjourned.
    [Whereupon, at 12:18 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
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   RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM BRIAN 
                           MONTGOMERY

Q.1. There have been a variety of reports regarding the number 
of loans made under the original FHA Secure program. That 
program was designed to provide FHA-insured loans to borrowers 
who became delinquent because of interest rate resets. 
According to the press report I quoted in the hearing, HUD 
officials have said that this program has insured only 1,500 
loans. In fact, according to a HUD report on FHA activity, 
``just 242'' loans were made for delinquent borrowers (the key 
parameter of the original FHA Secure program) in the two-week 
period of March 1 to March 15. Exactly how many loans have been 
made to date that meet the original parameters of the 
FHASecure?

A.1. As of May 13, 2008, there have been 3,068 endorsements of 
loans to borrowers who became delinquent because of mortgage 
resets and refinanced through FHASecure.

Q.2. In your testimony, you state that the FHASecure and HOPE 
NOW initiatives have together helped more than 1.3 million 
homeowners. Please provide the HOPE NOW data that breaks out 
exactly how many borrowers are getting repayment plans and 
modifications, and what kind of repayment plans and 
modifications they are getting.

A.2. As of February, 27 servicers were part of the HOPE NOW 
Alliance, representing more than 90 percent of all subprime 
loans and a substantial percentage of all mortgage loans. 
Results of the HOPE NOW Alliance include:

      An estimated 1,035,000 homeowners were helped to 
avoid foreclosure from July 2007 through January 2008. This 
includes 758,000 formal repayment plans and 278,000 
modifications. Subprime modifications increased from 19 percent 
of total workouts in the 3rd quarter and 35 percent in the 4th 
quarter to nearly 50 percent in January from 19% of total 
workouts in the 3rd quarter of 2007.

      Since November 2007, HOPE NOW servicers have sent 
over one million outreach letters to at-risk borrowers who have 
not previously been in contact with their servicer.

      16 percent responded in November.

      21 percent responded in December.

      When servicers send similar letters to their 
borrowers, the normal response rate is 2-3 percent.

      Homeowner calls have increased to 5,000 per day 
through the Homeownership Preservation Foundation's Homeowner's 
HOPE Hotline. Over 37,000 counseling sessions were completed 
through the Homeowner's HOPE Hotline in the 4th quarter of 
2007. To date, the HOPE Hotline has received 456,243 calls, 
which led to counseling for 165,755 homeowners. Nearly half of 
those counseled have avoided foreclosure by working out new 
loan terms or by selling their home.

Q.3. How many people do you expect the expanded FHASecure 
program to serve? I have seen estimates that range between 
100,000 and 500,000. Please provide the analysis that explains 
how you reached your estimate.

A.3. Our estimate is 500,000 by December 31, 2008. The analysis 
is based on True Standings data on the mortgage characteristics 
of current and upcoming mortgage resets of nonprime loans.

Q.4. If I understand your new proposal, the FHASecure program 
would allow subordinate liens to remain on the homes, leading 
to combined loan-to-value ratios after the first mortgage is 
written down and receives FHA insurance of 100% or more. Is 
this correct? What kind of performance do you expect these 
loans to exhibit? Please explain the basis for this analysis.

A.4. Allowance for the re-subordination of junior liens has 
always been FHA policy on refinance loans. There have not been 
any performance problems associated with that policy. What is 
new here is to permit the holder of the original first-lien 
mortgage to create a second-lien position from any excess 
indebtedness, over what is permissible in a new, FHA-insured 
first-lien. HUD's performance expectations start with 
experience with re-performing loans in the FHA portfolio. They 
are loans that were seriously delinquent (three or more months 
delinquent) and received loss mitigation work-out assistance. 
Some of that assistance involved creating second liens on the 
borrowers' extended arrearages, after HUD brought the loan 
current via a ``partial'' claim. HUD expects an 18 percent 
ultimate claim rate on those re-performing loans, based upon 
experience to date. Because of the uncertainty surrounding the 
new loans that will be insured under the expansion of 
FHASecure, the Administration has decided to score these loans 
for budget purposes with a 24 percent ultimate claim rate 
potential. That reflects uncertainties surrounding house price 
and economic stability in the short run, which is tempered by 
an expectation that borrower monthly payments will be lower 
after they refinance--even with a bifurcated mortgage--than 
they were on the original mortgage.
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