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



 
TRANSPORTATION AND HOUSING AND URBAN DEVELOPMENT, AND RELATED AGENCIES 
                  APPROPRIATIONS FOR FISCAL YEAR 2008

                              ----------                              


                        THURSDAY, MARCH 15, 2007

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 9:30 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Patty Murray (chairman) presiding.
    Present: Senators Murray and Bond.

              DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

                     Federal Housing Administration

STATEMENT OF HON. BRIAN D. MONTGOMERY, ASSISTANT 
            SECRETARY FOR HOUSING AND FEDERAL HOUSING 
            COMMISSIONER
ACCOMPANIED BY:
        HON. KENNETH M. DONOHUE, INSPECTOR GENERAL, OFFICE OF INSPECTOR 
            GENERAL
        WILLIAM B. SHEAR, DIRECTOR, FINANCIAL MARKETS AND COMMUNITY 
            INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE

               OPENING STATEMENT OF SENATOR PATTY MURRAY

    Senator Murray. This subcommittee will come to order. This 
morning, this subcommittee will hear testimony on the Federal 
Housing Administration. We will discuss the overall solvency of 
its mortgage lending program as well as the administration's 
proposal for reforming the FHA.
    I am pleased that our Federal Housing Commissioner, Brian 
Montgomery, is here. He is joined by HUD Inspector General 
Kenneth Donahue and witnesses from the GAO, Mortgage Bankers 
Association and the National Association of Realtors.
    Over the last 73 years of its existence, the FHA has served 
as a powerful engine to expand home ownership across the 
country. It has played a critical and essential role in 
providing access to capital for low-and-moderate income 
families. Most recently, however, the FHA has come to look more 
and more like an anachronism. Critics have said that they are 
out of touch with the marketplace, their mortgage products are 
outdated, they are a technological dinosaur and they are hard 
to do business with.
    In recent years, the FHA has captured a smaller and smaller 
percentage of the overall mortgage market and its decline has 
been a rapid one. In my State, we have the Washington State 
Housing Finance Commission, whose mission, like the FHA's, is 
to serve low-and-moderate income homebuyers. The Commission's 
Executive Director recently told me that in my State, the FHA's 
role in his efforts have been turned upside down in just the 
last 10 years. A decade ago, FHA covered 80 percent of the loan 
activity in his agency. Today, it only covers 20 percent.
    When you look at all mortgage lending, FHA now represents 
roughly 3 percent of total mortgage volume nationwide. Now, 
some observers like to argue that whenever the private sector 
can replace the government in providing essential services, 
it's a good thing. In this case, I'm not so sure.
    The FHA's loan products have fallen out of favor in part 
because private lenders have aggressively marketed subprime 
loans to high-risk borrowers. Some of these lenders have used 
temporary rate discounts or teaser rates, to push low-income 
borrowers into exotic loans with high fees and penalties that 
they can barely understand, much less afford. Some of these 
lenders have been boosting loan volume by taking credit 
standards to new lows and demanding almost no proof of income 
or credit worthiness.
    As a result, we are now seeing rapidly rising foreclosures 
and some of the most aggressive subprime lenders are shuttering 
their operations. Just 2 days ago, the Mortgage Bankers 
Association released their updated survey on mortgage 
delinquencies. It revealed that foreclosures of subprime 
mortgages had reached a record high. The share of subprime 
borrowers making late payments rose to more than 13.3 percent.
    That same day, the second largest subprime mortgage lender, 
New Century Financial, was de-listed from the New York Stock 
Exchange and announced that it had received criminal inquiries 
from both the Securities and Exchange Commission and State 
regulators. Those announcements sent the stock market into a 
tailspin. By the end of the day, the Dow Jones Industrial 
Average had dropped nearly 250 points or almost 2 percent. 
Financial stocks dropped even faster, falling almost 3.3 
percent for the day.
    The collapse of the subprime mortgage market has elicited 
warnings from Federal Reserve Board Chairman. Some economists 
have even predicted that the ripple effects of this collapse 
could eventually trigger a recession. These dire predictions 
should worry us all but should surprise no one.
    It is estimated that one in five new mortgages written in 
recent years fell into the subprime category--one in five. This 
year alone, some $1.2 trillion in mortgages will have their 
interest rate reset upward. Some borrowers took out these 
adjustable rate loans banking on the fact that they would have 
an opportunity to either refinance their loan or if necessary, 
sell their home. Now the prepayment penalty is built into many 
of these loans as well as the overall downturn in home prices, 
means these opportunities have disappeared.
    Many economists have said that our mortgage markets are in 
for a very rough road ahead. There is concern that this market 
upheaval could trigger a market over-reaction, where the 
availability of mortgage loan capital for working families 
tightens dramatically or just evaporates. If the mortgage 
market overreacts and working families need help, they may have 
to rely on the FHA. That means we need to make sure the FHA is 
strong and effective.
    Today, the FHA's overall financial picture is weak. Absent 
the enactment of reform legislation this year, we are told that 
for the first time in its history, the FHA could require a 
direct appropriation to subsidize loan operations. This 
subcommittee could be required to appropriate $143 million in 
2008, just to keep FHA's loan activities in the black. That is 
$143 million we won't be able to put toward section 8 
recipients, homeless programs and other HUD programs serving 
needy citizens.
    Currently, a growing percentage of the FHA's loan volume is 
not for traditional home mortgages for new homeowners. Rather, 
an increasingly popular FHA product appears to be reverse 
mortgages for elderly homeowners. This is a worthwhile program 
that keeps elderly families with fixed incomes in their homes. 
But getting younger Americans into their first home has always 
been central to FHA's historical mission. And in these 
tumultuous times, I think we need to work to make sure that the 
FHA can once again be relevant in that market.
    This subcommittee continues to receive reports from the 
Government Accountability Office and the Inspector General 
indicating continuing problems with the currency of FHA's data, 
the sufficiency of its underwriting and the agency's 
technological obsolescence. The Bush administration put forward 
a reform proposal for the FHA in the last Congress. We expect 
it to be resubmitted in this Congress. Enactment of this FHA 
reform, we are told, should eliminate the need for any 
appropriated subsidy and make the FHA more competitive with the 
private market.
    But this subcommittee and the rest of Congress need to look 
at these proposals very carefully. We need to make sure that we 
are not encouraging FHA to engage in some of the same high-
risk, high-cost lending practices that are now upsetting the 
markets and putting relatively new homeowners out of their 
homes. The FHA is the taxpayers' mortgage lender. As such, it 
has an obligation to protect consumers. The FHA has specific 
statutory mandates to employ measures to keep families in their 
homes. These are requirements and obligations that private 
lenders do not have.
    If the recent upheaval in mortgage lending means that 
private loan capital dries up for our working class families, 
we must make sure that the FHA is poised to keep the dream of 
home ownership alive. But the FHA must re-establish itself as 
America's mortgage lender, not by imitating the marketing and 
underwriting practices of New Century Financial. Rather, they 
must work to ensure that working families are getting into 
homes with loans that they can fully understand and afford.
    With that, I would like to recognize my ranking member, 
Senator Bond.

            OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND

    Senator Bond. Thank you very much, Madam Chair and a warm 
welcome to our witnesses for this important hearing on the FHA. 
We are focused primarily today on the single-family insured 
programs under the Mutual Mortgage Insurance Fund.
    Madam Chair, you've done a very good job of outlining all 
of the challenges and the problems but since this is the 
Senate, it's not enough that you have said it. I'm going to say 
it, too. So if you'll bear with me.
    As I said, we have a wide cross-section of witnesses who I 
expect can give us their views and positions, which should help 
provide a foundation for meaningful and comprehensive FHA 
reform. FHA has been enormously successful in assisting 
millions of Americans realize the dream of home ownership and I 
credit FHA's professional workforce and its leadership for 
these accomplishments.
    However, FHA's history is also marked by longstanding 
challenges in balancing risk against expanding home ownership, 
especially for low income and first time homebuyers. Not too 
long ago, FHA was operating at record profit levels for the 
Federal Government. Now, FHA is at a serious crossroads and the 
question today is, how do we move forward in the best interests 
of the American taxpayer and those who wish to pursue home 
ownership?
    In fairness, the Appropriations Committee should follow the 
lead of the Banking Committee in addressing FHA. Nevertheless, 
our committee has a substantial interest in the financial 
stability and solvency of FHA, since potential cost savings 
from FHA reform legislation could be used to support funding 
the needs of a number of popular housing programs.
    In fact, the committee has been instrumental in some of the 
most recent significant FHA legislative changes, from raising 
the loan limits in 1988, which this committee did, when I was 
chair and working with Senator Mikulski on the VA/HUD 
Subcommittee, to increasing access to the reverse mortgage 
program and we've been able to reinvest those cost savings from 
the reforms to address other critical housing needs.
    On the other side, if FHA needs an appropriation, that will 
take away from some of our ability to fund other needed housing 
assistance programs. Regardless of the outcome, we have to find 
a way to make these programs work and fund them adequately.
    There are also a number of philosophical and practical 
issues surrounding FHA reform. We must consider to what extent 
FHA is still relevant or needed in the home ownership 
marketplace. If needed and relevant, Congress must consider how 
to ensure it can become and continue to be a viable player in 
the marketplace.
    In addition to its loan products, we should examine changes 
to FHA's structure so it has the tools to operate competitively 
and efficiently as any other large financial institution. For 
example, I'm interested in converting FHA into a quasi-
governmental entity so that it can hire and retain highly 
skilled people and it can keep pace with technological 
advances.
    Finally, we must examine whether FHA can properly balance 
the risks and benefits of home ownership so that the interest 
of the borrower and the American taxpayer are adequately 
protected. It's clear that something must be done, since FHA 
seems to be cracking. In recent years, FHA has been plagued by 
rising default rates, higher than expected program costs and a 
sharp decline in program participation. In fact, the Mortgage 
Bankers Association's most recent survey reported record 
delinquency rates for FHA loans.
    More disturbing is MBA's finding that FHA delinquency rates 
were similar, if not higher, than subprime loans. Further, 
FHA's share of the single-family market dropped by 40 percent 
in fiscal year 2005, with it's overall market share dropping 
from 12 percent in fiscal year 2002 to less than 4 percent in 
2006 and this decline occurred during a period when overall 
home sales were increasing.
    To be blunt, in every HUD budget hearing over the last few 
years, I have raised concerns about the viability and future of 
FHA. Nevertheless, it has been business as usual and Congress 
was advised that the FHA's future was bright. But the facts 
obviously indicate otherwise. The situation is now so dire that 
without any significant changes and reforms, FHA's MMI fund is 
projected to operate at a net loss in 2008, requiring a 
positive credit subsidy--a direct appropriation from this 
committee, for the first time in history.
    This would be tragic, since other HUD programs are already 
being severely squeezed by budget constraints. The budget 
request, however, does not propose any appropriation to cover 
the positive credit subsidy and instead, the FHA Commissioner 
will raise premiums to ensure FHA's solvency. HUD's hope for 
improving FHA's long-term health is tied to the proposed reform 
legislation, which is assumed in the administration's 2008 
budget request. It's always a risky matter to assume that 
Congress will get something done. That's our problem, not 
yours. But it is a problem for all of us.
    HUD expects the legislation will grow FHA's receipts by 
increasing its mortgage loan limits as well as by implementing 
a new risk-based pricing and flexible down payment system. 
HUD's optimism depends on its ability to implement quickly and 
effectively the legislation. As we know, HUD does nothing 
quickly, since most proposals get caught up in an inflexible 
and multi-layered bureaucracy that can take years to act and 
that, again, is demonstrated by past experience.
    To me, the most troubling provision is the zero down 
payment program. This could pose substantial risk to the MMI 
fund because these homebuyers have no financial stakes in their 
homes and have little financial ability to pay for any big 
ticket repair item, such as a failed furnace or a leaky roof. 
Historically, FHA suffered substantial losses in the late 
1980's due to defaults by families with high loan-to-value or 
LTV ratios. Not only did the practice of high LTV loans damage 
the credit-worthiness of families who defaulted on their 
mortgages but equally troubling, as again our former committee 
colleague, Senator Mikulski pointed out, the defaults drove 
down the value of other housing in the neighborhood and 
transformed the neighborhoods into severely distressed and 
blighted areas. Sadly, some of these neighborhoods still suffer 
from those past mistakes.
    Many in Congress support the administration's proposal but 
I question the practical impact of these proposals since they 
do not appear to address adequately the financial solvency of 
FHA or its underlying operational problems. Providing FHA with 
new loan products will have questionable impact since FHA 
continues to struggle in managing risk and ensuring 
accountability for its existing programs.
    But don't just take that from me. Take this from Congress's 
official budget scorekeeper, the Congressional Budget Office. 
CBO last year estimated FHA's legislative reform package would 
result in a cost savings of about $2.3 billion over 5 years. 
However, about $2.2 billion or 95 percent of those savings were 
attributed to what is basically an accounting maneuver. Moving 
the successful FHA program, the home equity conversion mortgage 
or reverse mortgage program, from the GI/SRI fund account to 
the MMI fund account. Now, back when I used to play sports, we 
were always on the lookout for some guy who would change the 
score on the scorebooks when it wasn't that way in the field. 
We used to call that pencil-whipping and I am not a golfer but 
I understand that sometimes occurs in golf. Well, to me, this 
is the equivalent of pencil-whipping in government accounting 
and I have a minimum amount of high enthusiasm for that. That 
does not meet the ``show me'' test for Missouri.
    The key elements of the administration's reform package, 
increasing loan limits and implementing a new risk based 
pricing system, will not significantly increase FHA's business 
and will not result in significant cost savings, according to 
CBO. Preliminary estimates of CBO's updated analysis will show 
almost no cost savings from these provisions. Frankly, we're 
facing a positive credit subsidy mainly due to FHA's self-
inflicted wounds.
    The GAO's testimony indicates that a large factor in the 
FHA recent financial problems is due to high claim and loss 
rates for seller financed down payment assistance loans, many 
of which were financed by nonprofit organizations. Thankfully, 
the Internal Revenue Service issued a ruling last May that may 
stem this practice. IRS is examining 185 of these organizations 
on their 501(c)3 status but I strongly urge FHA to take its own 
actions in addressing this matter.
    I also remind you that this down payment practice is 
similar and is identical in practical impact to the zero down 
payment proposal where the homeowner has no real stake in his 
or her new home. There is a history lesson to be learned here 
and I surely hope we've learned from our mistakes.
    I trust this hearing is just the beginning of a real debate 
on FHA reform. If we do reform and revitalize FHA, we must 
fully understand the financial risks of any legislation as well 
as understand what steps HUD has taken and plans to take to 
reduce the risk of fraud and abuse in its FHA mortgage 
programs.
    I thank you for your tolerance in letting me get it off my 
chest and I return to the chair.
    [The statement follows:]

           Prepared Statement of Senator Christopher S. Bond

    Good morning and thank you, Madame Chair, for calling this 
important hearing on the Department of Housing and Urban Development's 
(HUD) Federal Housing Administration (FHA). Today, we primarily are 
focused on FHA's single-family programs insured under the Mutual 
Mortgage Insurance (MMI) Fund. This is a timely hearing given the 
declining state of FHA and the recent woes in the mortgage market 
driven by the crash of the subprime market.
    We are fortunate to have a broad range of witnesses before us 
today. I expect to hear a wide variety of views and positions, which 
should help provide a foundation for meaningful and comprehensive FHA 
reform.
    FHA has been enormously successful in assisting millions of 
Americans realize the dream of homeownership and I credit FHA's 
professional workforce and its leadership for these accomplishments. 
However, FHA's history also is marked by long-standing challenges in 
balancing risk against expanding homeownership, especially for low-
income and first-time homebuyers. Not too long ago, FHA was operating 
at record profit levels for the Federal Government. Now, FHA is at a 
serious crossroads and the question today is how do we move forward in 
the best interests of the American Taxpayer and those who still wish to 
pursue homeownership?
    In fairness, the Appropriations Committee should follow the lead of 
the Banking Committee in addressing FHA. Nevertheless, our committee 
has substantial interest in the financial stability and solvency of FHA 
since potential cost savings derived from FHA reform legislation could 
be used to support the funding needs of a number of popular housing 
programs. In fact, this committee has been instrumental in some of the 
most recent significant FHA legislative changes--from raising the loan 
limits in 1998, which I did as chair of the VA-HUD Subcommittee, to 
increasing access to the reverse mortgage program--and we have 
reinvested the cost savings from those reforms to address other 
critical housing needs. Regardless of the outcome of FHA reform 
legislation, we must find a way to fund adequately these programs.
    There also are a number of philosophical and practical issues 
surrounding FHA reform. We must consider to what extent FHA is still 
relevant or needed in the homeownership marketplace. If needed and 
relevant, Congress should consider how to ensure it can become and 
continue to be a viable player in the marketplace. In addition to its 
loan products, we should examine changes to FHA's structure so that it 
has the tools to operate competitively and efficiently as any other 
large financial institution. For example, I am interested in converting 
FHA into a quasi-governmental entity so that it can hire and retain 
highly-skilled people and it can keep pace with technological advances. 
Finally, we must examine whether FHA can properly balance the risks and 
benefits of homeownership so that the interests of the borrower and the 
American Taxpayer are adequately protected.
    It is clear that something must be done since the FHA seems to be 
cracking. In recent years, FHA has been plagued by rising default 
rates, higher than expected program costs, and a sharp decline in 
program participation. In fact, the Mortgage Bankers Association's most 
recent survey reported record delinquency rates for FHA loans. More 
disturbing is MBA's finding that FHA delinquency rates were similar if 
not higher than subprime loans! Further, FHA's share of the single 
family market dropped by 40 percent in fiscal year 2005 with its 
overall market share dropping from 12 percent in fiscal year 2002 to 
less than 4 percent in fiscal year 2006. And this decline occurred 
during a period when overall home sales were increasing.
    To be blunt, in every HUD budget hearing over the last few years, I 
have raised concerns about the viability and future of FHA. 
Nevertheless, it has been business as usual and the Congress was 
advised that FHA's future was bright. But the facts obviously indicate 
otherwise. The situation is now so dire that without any significant 
changes and reforms, FHA's MMI Fund is projected to operate at a net 
loss in fiscal year 2008, requiring a positive credit subsidy--meaning 
a direct appropriation--for the first time in history. This would be 
tragic since other HUD programs are already being severely squeezed by 
budget constraints. The budget request, however, does not propose any 
appropriation to cover the positive credit subsidy and instead, the 
Commissioner will raise premiums to ensure FHA's solvency.
    HUD's hope for improving FHA's long-term health is tied to proposed 
reform legislation, which is assumed in the administration's fiscal 
year 2008 budget request. HUD expects this legislation will grow FHA 
receipts by increasing its mortgage loan limits as well as by 
implementing a new risk-based pricing and flexible down-payment system. 
HUD's optimism depends on its ability to implement quickly and 
effectively the legislation. As we know, HUD does nothing quickly since 
most proposals get caught up in an inflexible and multi-layered 
bureaucracy that can take years to act.
    The most troubling provision is a new zero-down-payment program. 
This could pose substantial risks to the MMI Fund because these 
homebuyers have no financial stake in their homes and have little 
financial ability to pay for any big ticket repair item such as a 
failed furnace or a leaky roof. Historically, FHA suffered substantial 
losses in the late 1980s due to defaults by families with high loan-to-
value (LTV) ratios. Not only did the practice of high LTV loans damage 
the creditworthiness of families who defaulted on their mortgages but, 
equally troubling, the defaults drove down the value of other housing 
in the neighborhood and transformed the neighborhoods into severely 
distressed and blighted areas. Sadly, some of these neighborhoods still 
suffer from those past mistakes.
    Many in Congress support the administration's proposals but I 
question the practical impact of these proposals since they do not 
appear to address adequately the financial solvency of FHA or its 
underlying operational problems. Providing FHA with new loan products 
will have questionable impact since FHA continues to struggle in 
managing risk and ensuring accountability for its existing programs. 
But don't just take this from me. Take this from Congress's official 
budget scorekeeper, the Congressional Budget Office (CBO). Last year, 
the CBO estimated FHA's legislative reform package would result in a 
cost savings of about $2.3 billion over 5 years. However, about $2.2 
billion or 95 percent of the savings were attributed to what is 
basically an accounting maneuver--moving the most successful FHA 
program, the Home Equity Conversion Mortgage or ``reverse'' mortgage 
program from the GI/SRI Funds account to the MMI Fund account.
    The key elements of the administration's reform package--increasing 
loan limits and implementing a new risk-based pricing system--will NOT 
significantly increase FHA's business and will NOT result in 
significant cost savings according to CBO. Preliminary estimates of 
CBO's updated analysis will show almost NO cost savings from these 
provisions.
    Frankly, we are facing a positive credit subsidy mainly due to 
FHA's self-inflicted wounds. The GAO's testimony indicates that a large 
factor in FHA's recent financial problems is due to high claim and loss 
rates for seller-financed down-payment assistance loans--many of which 
were financed by non-profit organizations. Thankfully, the Internal 
Revenue Service (IRS) issued a ruling last May that may stem this 
practice. IRS is examining 185 of these organizations on their 
501(c)(3) status but I strongly urge FHA to take its own actions in 
addressing this matter. I also remind you that this downpayment 
practice is similar to the zero down-payment proposal where the 
homeowner has no real stake in his new home. There is a history lesson 
to be learned here and I strongly hope we will have learned from our 
mistakes.
    I trust this hearing is just the beginning of a real debate on FHA 
reform. If we do reform and revitalize the FHA, we must fully 
understand the financial risks of any legislation as well as understand 
what steps HUD has taken and plans to take to reduce the risk of fraud 
and abuse in its FHA mortgage programs.
    Thank you, Senator Murray.

    Senator Murray. Thank you very much, Senator Bond.
    I want to turn to our witnesses. Welcome all of you today. 
Thank you so much for coming and giving us your input today. We 
have in front of us, Brian Montgomery, who is the Assistant 
Secretary for Housing; Kenneth Donohue, the Inspector General 
from the Department of Housing and Urban Development; William 
Shear, who is Director of Financial Markets and Community 
Investment with GAO; JoAnne Poole, with the National 
Association of Realtors; and John Robbins with the Mortgage 
Bankers Association. Welcome, all of you. We would ask that 
each one of you limit your remarks to 5 minutes. I will let you 
know when the time is up. All of your testimony will be 
submitted for the record. We all have it and we will make sure 
all of our committee members have it as well. So we will be 
limiting you to 5 minutes so that we can get to our questions 
and answers today.
    Mr. Montgomery, we will begin with you.

                 STATEMENT OF HON. BRIAN D. MONTGOMERY

    Mr. Montgomery. Thank you, Chairwoman Murray and ranking 
member Bond for inviting me here today. Our hard work on FHA 
reform during the 109th Congress paid off to the tune of 107 
co-sponsors, nearly evenly split from both sides of the aisle, 
I might add in a resounding 415 to 7 vote on the floor of the 
House as well as a separate 412 to 4 vote on the manufactured 
housing reforms.
    Keeping that in mind, I would like to emphasize that our 
priorities for FHA legislation have not significantly changed 
from last year. As was our goal 1 year ago, we are striving to 
provide lower income families safe, secure home ownership 
opportunities. The simplicity lies with our mission, to provide 
underserved Americans a safe housing product at a fair price. 
As this committee is well aware, many first-time and minority 
homebuyers face significant challenges when trying to purchase 
a home. In recent years, such difficulties have resulted in 
many of these individuals assuming risky, adjustable rate, 
subprime loans.
    The impact on African American and Latino borrowers has 
been especially profound. For instance, according to the 2004 
HUMDA data, 40 percent of African Americans and 23 percent of 
Latinos pay an interest rate 3 percentage points higher than 
the market rate. When these homebuyers signed off on their 
loans, the built-in resets and rate increases seemed like a 
lifetime away. Today, however, many of these borrowers face a 
different reality.
    According to mortgage strategists, some $2 trillion of U.S. 
mortgage debt or about a quarter of all mortgage loans are due 
for interest resets in 2007 and 2008. While some borrowers will 
make the higher payments, many will struggle.
    The second component to our approach is that it is 
comprehensive. In light of recent housing market shifts and the 
departure of a strong subprime presence, due in large part to 
the resets I just mentioned, many lending institutions are 
simply turning their backs on lower income borrowers.
    And just as the national housing market is tightening, so 
too are borrower requirements. In order to offset this 
tightening of credit, there needs to be a mortgage alternative, 
which will provide a wide slough of borrowers and 
simultaneously provide them with the loan options they require 
and that is a new and invigorated FHA.
    As I've already mentioned, the changes we are proposing are 
not new. For one, we're proposing to eliminate our complicated 
down payment formula, our 3 percent minimum cash investment and 
before the rest of the market began offering low down payment 
loans, we were the best option for first time homebuyers 
because we required only a minimal down payment. But as many of 
you are aware, the market passed FHA by and as reported by the 
National Association of Realtors, last year 43 percent of first 
time homebuyers purchased their homes with no down payment. Of 
those who did put money down, the majority put down 2 percent 
or less.
    The down payment is the biggest barrier to home ownership 
in this country, especially for lower income families. But we 
have no way to address that barrier without changes to our 
statute. The FHA Modernization Act would permit borrowers to 
choose how much to invest, from almost no money down to 1 or 2 
or even 10 percent. The bill also provides FHA the flexibility 
to set the insurance premiums commensurate with the risk of a 
loan. We would charge lower credit risk borrowers a lower 
premium than they would get today and higher credit risk 
borrowers, many of whom we are unable to reach today, would be 
charged a slightly higher premium. In so doing, we could reach 
deeper into the pool of prospective borrowers while protecting 
the financial soundness of the MMI fund.
    A slightly higher premium would increase a borrower's 
monthly payment only minimally. For example, the average FHA 
loan in 2006 is only $128,000. On a monthly basis, this loan 
would cost the borrower $7.96 at 1 percent, $16 at 2 percent 
and only $24 at 3 percent. Clearly, this high premium is still 
affordable.
    Now, compare this modest premium to the average subprime 
loan made on a $225,000 home purchase and the numbers become 
far more meaningful. On average, subprime borrowers pay an 
interest rate three points higher than conventional borrowers 
and this rate hike translates into an additional $300 per 
month, which is $137,000 over the life of a loan.
    Another piece of the legislation I'd like to mention is the 
proposed increase to our loan limits. By increasing the loan 
limit to 65 percent and 100 percent of the conforming loan 
limit, we would once again be a player in high cost states, 
regions that have previously been out of play, such as the 
entire State of California and most of the Northeast.

                           PREPARED STATEMENT

    What's more, raising the floor to 65 percent of the 
conforming loan limit has the added benefit of again giving 
families better access to newly constructed housing, which is 
on average, more costly.
    I look forward to answering your questions. Thank you.
    [The statement follows:]
             Prepared Statement of Hon. Brian D. Montgomery
    Thank you Chairwoman Murray and Ranking Member Bond for inviting me 
to testify on the administration's proposed FHA Modernization. We plan 
to submit legislation soon that would implement the proposals included 
in the 2008 budget.
    We all worked hard in the 109th Congress with many of you here 
today, and our message was well received. I hope our collaborative 
efforts on behalf of low- and moderate-income families can be a model 
for the 110th Congress.
    As you are all aware, the Federal Housing Administration was 
created in 1934 to serve as an innovator in the mortgage market, to 
meet the needs of citizens otherwise underserved by the private sector, 
to stabilize local and regional housing markets, and to support the 
national economy. This mission is still very relevant, perhaps now more 
so than ever.
    Moreover, the FHA model represents the very best of what a 
government working with the private sector can and should do. Since its 
inception, FHA has helped more than 34 million Americans become 
homeowners. By operating through a private sector distribution network, 
FHA efficiently reaches families in need of safe and affordable home 
financing. Simply put, FHA insurance protects lenders against loss, 
enabling these private sector partners to offer market-rate mortgages 
to homebuyers who would otherwise remain unserved or underserved.
    FHA also protects the homebuyer. FHA offers foreclosure prevention 
alternatives that are unparalleled in the industry. In fiscal year 2006 
more than 75,000 FHA insured borrowers facing serious default were able 
to retain homeownership through FHA's toolbox of foreclosure prevention 
options. In an environment of increasing defaults, FHA's foreclosure 
rate actually decreased last year. This protection against foreclosure 
is good for families and good for communities. It also resulted in $2 
billion in loss avoidance for the Insurance Fund, which illustrates our 
commitment to sound financial management.
    We believe that FHA should continue to play a key role in the 
national mortgage market and I'm here today to make the case for 
changes to the National Housing Act that will permit us to continue to 
fulfill our critical mission.
    Allow me to explain. In recent years, FHA's outdated statutory 
authority has left the agency out of synch with the rest of the lending 
industry. Over the last decade, the mortgage industry transformed 
itself, offering innovative new products, risk-based pricing, and 
faster processing with automated systems. Meanwhile, FHA continued to 
offer the same types of products with the same kinds of pricing, 
becoming less attractive to lenders and borrowers alike.
    As a result, FHA's volume has dropped precipitously in housing 
markets all across the Nation. For example, in Chairwoman's Murray's 
home State of Washington, FHA's volume has dropped from 16,806 loans in 
2000 to 6,477 loans in 2006 (a decline of 61 percent or almost $1.2 
billion). For Ranking Member Bond, during that same time period, FHA's 
volume in Missouri dropped from 15,172 to 8,979 loans (a decline of 41 
percent or $262 million).
    But the most troublesome statistic of all comes from Senator 
Feinstein's home State of California. There, FHA saw its volume drop 
from 109,074 in 2000 to just 2,599 in 2006--an astonishing decline of 
98 percent in just 6 years.
    These statistics suggest that tens of thousands of low- and 
moderate-income families who would have chosen FHA turned to 
alternative methods of mortgage finance. While many of them were well-
served, some were not and turned to expensive and sometimes risky 
exotic loans. We see today the unfortunate outcomes such families 
across the Nation are experiencing.
    To offer a better and more attractive mortgage product, over the 
last 18 months we have made significant administrative changes to FHA, 
streamlining and realigning operating procedures. While these changes 
are good and were long overdue, they are not enough, a point our 
industry partners have clearly conveyed to us and to you. That is why 
last year FHA requested that Congress amend the National Housing Act to 
give it the flexibility it needs to fulfill its original mission in 
today's ever changing marketplace.
    As the dynamic mortgage market passed FHA by, many homebuyers, 
especially those living in higher cost States such as California, New 
York, and Massachusetts, to name a few, purchased mortgage products 
with conditions and terms they would not be able to meet.
    Some homebuyers turned to high-cost financing and nontraditional 
loan products to afford their first homes. While low initial monthly 
payments may have seemed like a good thing at the time, the reset rates 
on some interest-only loans are substantial and many families have been 
and will continue to be unable to keep pace when the payments increase. 
In addition, prepayment penalties often times make refinancing cost-
prohibitive. According to Mortgage Strategist, more than $2 trillion of 
U.S. mortgage debt, or about a quarter of all mortgage loans 
outstanding, is due for interest rate resets in 2007 and 2008. While 
some borrowers will make the higher payments and many others will 
refinance, some will struggle and some will be forced to sell or lose 
their homes to foreclosure. I'm sure it comes as no surprise to the 
people in this room that the foreclosure rate for subprime loans is 
higher than that of FHA loans. And I think we can all agree that 
foreclosures are bad for families, bad for neighborhoods, and bad for 
the economy as a whole.
    In the context of this economic environment, we see FHA 
Modernization as part of the solution. FHA reform is designed to 
restore a choice to homebuyers who can't qualify for prime financing 
and more options for all potential FHA borrowers.
    Moreover, the FHA bill proposes changes that will strengthen FHA's 
financial position, improving FHA's ability to mitigate and compensate 
for risk. The proposed changes would permit FHA to operate like every 
other insurance company in the Nation, pricing its products 
commensurate with the risk, as opposed to having some clients pay too 
much and some too little. Imagine if a car insurance company charged 
all clients the same premium--the 17-year-old teenager and a 40-year-
old adult would pay the same rate. Is that fair? With a blended rate, 
those who know they're paying too much switch to another insurance 
company. That leads to a portfolio that is increasingly lopsided: too 
many riskier borrowers, too few safer borrowers, and collectively poses 
greater risk to an insurance fund. This scenario, known as adverse 
selection is exactly what happened to FHA over the last decade. Those 
who were lower credit risks went elsewhere. The premium changes 
proposed in the administration's proposal will restore balance to the 
FHA funds, providing appropriate levels of revenue to operate in a more 
fiscally sound manner.
    While we are on the topic of the soundness of the insurance fund, I 
am proud to report that the OIG found no material weaknesses in its 
fiscal year 2006 audit of the FHA, and that in January 2007, the GAO 
removed FHA's single family mortgage insurance programs from its high 
risk list. Both of these developments reflected improvements that HUD 
has made in recent years in its management of property disposition 
contractors, its oversight of lenders, its implementation of a mortgage 
scorecard, and its ability to predict claims and estimate credit 
subsidy costs.
    I know my introduction was lengthy, but I want you to understand 
how important FHA reform really is--for FHA, for the homebuyers we 
serve, and for the industry as a whole. FHA's private sector partners--
the lenders, the realtors, the brokers, the home builders--want to tell 
their clients about the FHA alternative. They want low- to moderate-
income homebuyers to have a safer, more affordable financing option. 
They want FHA to be a viable player again.
    Now let me explain a little bit about the simple changes we're 
proposing. For one, we're proposing to eliminate FHA's complicated 
downpayment calculation and 3 percent cash investment requirement. 
Before the rest of the market began offering low downpayment loans, FHA 
was often the best option for first-time homebuyers because it required 
only a minimal downpayment. But, as I said before, the market passed 
FHA by. According to the National Association of Realtors, last year, 
43 percent of first-time homebuyers purchased their homes with no 
downpayment. Of those who did put money down, the majority put down 2 
percent or less.
    The downpayment is the biggest barrier to homeownership in this 
country, but FHA has no way to address the barrier without changes to 
its statute. FHA Modernization would permit borrowers to choose how 
much to invest, from no money down to 1 or 2 or even 10 percent and to 
be charged appropriate premiums for the size of the downpayment they 
make.
    The proposal also provides FHA the flexibility to set the FHA 
insurance premiums commensurate with the risk of the loans. For 
example, no downpayment loans would be priced slightly higher, yet 
appropriately, to give homebuyers a fairly-priced option and to ensure 
that FHA's insurance fund is compensated for taking on the additional 
risk. FHA would also consider the borrower's credit profile when 
setting the insurance premium. FHA would charge lower-credit risk 
borrowers a lower insurance premium than it does today, and higher-
credit risk borrowers would be charged a slightly higher premium. In so 
doing, FHA could reach deeper into the pool of prospective borrowers, 
while protecting the financial soundness of the FHA Fund and creating 
incentives for borrowers to achieve good credit ratings and save for 
downpayments.
    A slightly higher premium would increase a borrower's monthly 
payment only minimally. For example, on a $225,000 loan, a 1 percent 
upfront premium financed into the loan would cost the borrower $13.97 
per month; a 2 percent premium would cost $27.94 and a 3 percent 
premium, $41.90. Clearly, this higher premium is still affordable. 
Moreover, it's a smart investment, because the borrower is paying for 
the FHA insurance to obtain a market rate loan.
    Some say that with a risk-based pricing approach FHA will target 
people who shouldn't be homebuyers and charge them more than they 
should pay. I want to address these concerns directly. Our goal is to 
reach families who are capable of becoming homeowners and to offer them 
a safe and fairly-priced loan option.
    With a risk-based premium structure, FHA can reach hard-working, 
credit-worthy borrowers--store clerks, bus drivers, librarians, social 
workers--who, for a variety of reasons, do not qualify for prime 
financing. Some have poor credit scores due to circumstances beyond 
their control, but have put their lives back together and need a second 
chance. For some, the rapid appreciation in housing prices has simply 
outpaced their incomes. Many renters find it difficult to save for a 
downpayment, but have adequate incomes to make monthly mortgage 
payments and do not pose a significant credit risk. They simply need an 
affordable financing vehicle to get them in the door. FHA can and 
should be there for these families.
    If granted, FHA's new legislative authorities would save homeowners 
a lot of money, because FHA's loan product would carry a lower interest 
rate than a non-prime loan product. The higher premiums that FHA will 
charge some types of borrowers are still substantially lower than they 
would pay for subprime financing. For example, if FHA charged a 3 
percent upfront insurance premium for a $225,000 loan to a credit-
impaired borrower versus that same borrower obtaining a subprime loan 
with an interest rate 3 percent above par, the borrower would pay over 
$300 more in monthly mortgage payments with the subprime loan and over 
$137,000 more over the life of the loan. In addition, FHA borrowers do 
not have to be concerned about teaser rates, unmanageable interest rate 
increases or prepayment penalties.
    Moreover, FHA intends to lower the insurance premium for many 
borrowers. FHA will charge lower-risk borrowers a substantially lower 
premium than these types of borrowers pay today. For example, 
homebuyers with higher credit scores who choose to invest at least 3 
percent in a downpayment may pay as little as .075 of a percent upfront 
premium.
    So while FHA may charge riskier borrowers more (and safer borrowers 
less) than it does today, the benefit is four-fold. First, FHA will be 
able to reach additional borrowers the agency can't serve today. 
Second, many borrowers will pay less with FHA than with a subprime 
loan. Third, the FHA Fund will be managed in a financially sound 
manner, with adequate premium income to cover any expected losses. 
Finally, borrowers will be rewarded for maintaining good household 
financial practices that lead to good credit ratings and higher savings 
for a downpayment.
    Another change proposed in FHA Modernization is to increase FHA's 
loan limits. Members of Congress from high-cost states have repeatedly 
asked FHA to do something about our antiquated loan limits. This 
proposal answers those concerns. FHA's loan limit in high-cost areas 
would rise from 87 to 100 percent of the GSE conforming loan limit; in 
lower-cost areas, the limit would rise from 48 to 65 percent of the 
conforming loan limit. In between high- and lower-cost areas, FHA's 
loan limit will increase from 95 to 100 percent of the local median 
home price. This change is extremely important and crucial in today's 
housing market. In many areas of the country, the existing FHA limits 
are lower than the cost of new construction. Buyers of new homes can't 
choose FHA financing in these markets. In other areas, most notably 
California, FHA has simply been priced out of the market.
    Finally, FHA Modernization offers some changes to the Home Equity 
Conversion Mortgage (HECM) program, which enables senior homeowners, 
aged 62 years or older, to tap into their home equity to live 
comfortably in their golden years. The proposal eliminates the cap on 
the number of loans FHA can insure; it sets a single, national loan 
limit; and it creates a new HECM for Home Purchase product to permit 
seniors to move from the family home to more suitable senior housing 
and convert the purchase loan into a HECM in a single transaction. 
Today, seniors who want to move, but need additional cash flow to pay 
their living expenses, must purchase a new home and take out a HECM in 
two distinct transactions, resulting in two sets of loan fees and 
charges.
    Let me repeat a point I made earlier in the testimony. I want to 
assure you that the changes we are proposing will not impose any 
additional budgetary cost. We are proposing to manage the Fund in a 
financially prudent way, beginning with the change in FHA pricing to 
match premiums with risk. This will avoid FHA being exposed to 
excessive risk, as it is today, because some borrowers who use FHA are 
under-charged for their risk to the Fund while those who are 
overcharged are fleeing from the program. Of course, we will continue 
to monitor the performance of our borrowers very closely, and make 
adjustments to underwriting policies and/or premiums as needed.
    I know I've talked a lot here today, but I want to convey to you 
how passionate I am about the proposed changes. I believe we have an 
opportunity to make a difference in the lives of millions of low- and 
moderate-income Americans. We have a chance to bring FHA back into 
business, to restore the FHA product to its traditional market 
position. To all those families who can buy a home with prime 
conventional financing, I say, ``Go for it!'' They're fortunate and 
they should take full advantage of that product. But for those who 
can't, FHA needs to be a viable option. And when people ask me why we 
are proposing these changes, I tell them these exact words: ``Families 
need a safe deal, at a fair price. Families need a way to take part in 
the American Dream without putting themselves at risk. Families need 
FHA.''
    I want to thank you again for providing me the opportunity to 
testify here today on modernizing the Federal Housing Administration. I 
look forward to working with all of you to make these necessary reforms 
a reality.

    Senator Murray. Thank you very much. Mr. Donohue.

                  STATEMENT OF HON. KENNETH M. DONOHUE

    Mr. Donohue. Chairman Murray, ranking member Bond and the 
members of the subcommittee, thank you for inviting me here to 
testify today. In January, the GAO announced the results of its 
high-risk series review. I want to commend the Department and 
FHA for the removal of its rental housing assistance and the 
single-family mortgage insurance program from the high-risk 
list, which they had been on since 1994.
    This resolution, in part, is a result of ongoing dialogue 
between FHA and the OIG and is an excellent example of good 
government and positive change.
    I come to you today with a note of warning for the FHA. 
There have been a lot of articles lately comparing the fall of 
the subprime lending market to that of the failed savings and 
loan institutions of the 1980's. I spent 7 years of the 
Resolution Trust Corporation uncovering the fraud and abuse 
among directors of failed savings and loans. I have seen first 
hand the damaging results of an unregulated and solely profit 
driven industry, results that ultimately cost the American 
taxpayer billions of dollars.
    Whether we are just starting to see the tip of the iceberg 
today or actually seeing the iceberg in the subprime lending 
market remains to be seen. But unlike the savings and loan 
crisis, it will have a social impact as many honest, 
hardworking individuals may lose their homes. The mortgage 
industry has said they have increased home ownership, however, 
at what cost to the American people?
    Relaxed underwriting practices instituted by unscrupulous 
subprime lenders, the usage of riskier products, like 
adjustable rate and interest only loans, coupled with appraisal 
fraud and lack of understandable disclosure of loan terms have 
made it easier for those who do not quality for prime loans to 
purchase homes but not retain them. In addition, while it might 
have been a splendid idea to help the troubled borrowers with 
low mitigation programs, it is worth remembering that the 
rollover non-performing loans added to the savings and loan 
mess of the 1990's.
    With the current trend of interest rates in flux, the 
resulting payment shock and low home appreciation, due in part, 
to over building, we have seen States such as Colorado and we 
will probably continue to see increased delinquencies and 
foreclosure rates. Further, a number of these borrowers fell 
subject to additional hardship as predatory lenders applied 
aggressive sales tactics and outright fraud to finance the 
subprime loans. I am concerned as to whether FHA is headed in 
the same direction as the subprime market with a seemingly 
continued deregulation and introduction of riskier products as 
part of its proposed reform.
    A chart produced by the Mortgage Bankers Association survey 
shows how closely the FHA delinquency rate follows that of the 
subprime market. We have an industry that is generally profit 
driven. However, with that should come responsibility. Unlike 
the mortgage industry, the FHA is mission driven. The FHA 
Single Family lending has experienced a market drop in 
insurance volume as subprime lending spiked and mortgage 
interest rates increased.
    The numbers are disconcerting. In fiscal year 2006, 
insurance endorse was down 8 percent; new endorsements were off 
17 percent and delinquent and default rates inched upward. 
History will actually reflect that FHA was spared the impact of 
the subprime prices because it did not contain these in its 
portfolio.
    The FHA 2008 budget submission suggests that costs will 
exceed receipts. FHA may really be left with only two choices--
to request a credit subsidy by means of appropriations or to 
increase the premiums to avoid a shortfall. Reform packets, 
which include risk based premiums, zero down payment loans and 
higher mortgage limits seems to be partly directed at high 
income housing markets to the possible detriment of first time 
homebuyers and minority customers.

                           PREPARED STATEMENT

    I also want to stress, the proposed reform bill is silent 
on strengthening controls and enforcement action in preventing 
future fraud. As to our record, over the past 3 years, HUD/OIG 
has issued 190 auto reports to the area of FHA. These are 
reports that identified $1.1 billion in questionable costs and 
funds that could be put to a better use. During the same time 
period, the HUD/OIG had over 1,350 indictments and $1.3 billion 
in court-ordered restitutions. I cannot say the reform 
legislation is the answer and I recognize that some change is 
necessary. There are great challenges confronting the FHA 
programs; nevertheless, aggressive oversight and enforcement is 
crucial to prevent a reoccurrence of what we are witnessing in 
the subprime market today and the savings and loan industry in 
the past year. Clearly, there are lessons to learn from the 
repeat of history. Thank you.
    [The statement follows:]
             Prepared Statement of Hon. Kenneth M. Donohue
    Chairman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for inviting me to testify today.

                               BACKGROUND

    The U.S. Department of Housing and Urban Development (HUD) 
Inspector General is one of the original 12 Inspectors General 
authorized under the Inspector General Act of 1978. The Office of 
Inspector General (OIG) has forged a strong alliance with HUD personnel 
in recommending ways to improve departmental operations and in 
prosecuting program abuses. OIG strives to make a difference in HUD's 
performance and accountability. OIG is committed to its statutory 
mission of detecting and preventing fraud, waste, and abuse and 
promoting the effectiveness and efficiency of government operations. 
While organizationally located within the Department, OIG operates 
independently with separate budget authority. This independence allows 
for clear and objective reporting to the Secretary and the Congress.
    The Department's primary challenge is to find ways to improve 
housing and to expand opportunities for families seeking to improve 
their quality of life. HUD does this through a variety of housing and 
community development programs aimed at helping Americans nationwide 
obtain affordable housing. These programs, which include Federal 
Housing Administration (FHA) mortgage insurance for Single Family and 
Multifamily properties, are funded through a $30+ billion annual budget 
and, in the case of FHA, through mortgage insurance premiums. At the 
end of fiscal year 2006, FHA's outstanding mortgage insurance portfolio 
was about $396 billion.
    Each year in accordance with the Reports Consolidated Act of 2000, 
HUD OIG is required to submit a statement to the Secretary with a 
summary assessment of the most serious challenges facing the 
Department. OIG submitted its latest assessment on October 19, 2006. 
The Department has notably and laudably made progress in its efforts to 
correct its serious challenges. However, continued progression in the 
integration of FHA's financial management systems, and strengthening of 
lender accountability and enforcement against program abusers is still 
needed.
    FHA is the largest mortgage insurer in the world, providing 
coverage to over 34 million home mortgages and 47,205 multifamily 
projects since 1934. FHA insurance protects HUD-approved lenders 
against losses should a homeowner or project owner default on their 
mortgage loans. FHA insures a wide spectrum of loans. Its single family 
programs include insuring mortgage loans to purchase new or existing 
homes, condominiums, manufactured housing, houses needing 
rehabilitation, as well as reverse equity mortgages to elderly 
homeowners. Its multifamily programs provide mortgage insurance to 
facilitate the construction, substantial rehabilitation, purchase and 
refinancing of multifamily housing projects and healthcare facilities.
    On January 31, 2007, the Government Accountability Office (GAO) 
announced the results of its biennial ``high-risk'' series review. We 
commend the Department for the removal of its rental housing assistance 
and the single family mortgage insurance programs, which have been on 
GAO's risk list since 1994.

                             THE CHALLENGE

    Chairman, ranking member, and members of the subcommittee, you have 
probably read or seen a number of articles of late comparing the fall 
of the subprime lending market to that of the failed savings and loan 
institutions of the 1980's. I spent 7 years at the Resolution Trust 
Corporation as Assistant Director for Investigations, uncovering the 
fraud and abuse among directors of the failed savings and loan 
institutions. I have seen first hand the damaging results of a solely 
profit-driven industry, which ultimately cost the American taxpayer 
billions of dollars.
    Whether we are just starting to see the ``tip of the iceberg'' 
today or are actually seeing the iceberg in the subprime lending market 
remains to be seen, but like the savings and loan crisis, it will not 
only have a financial impact but a social impact as many honest, hard 
working individuals may lose their homes. The mortgage industry has 
said they have increased homeownership; however, at what cost to the 
American people?
    The Senate Committee on Banking, Housing and Urban Affairs recently 
held a hearing on subprime lending. The testimony included estimates 
that as many as 2.2 million families may lose their homes to 
foreclosure--foreclosures that were often predictable or avoidable 
through responsible lending. We see this today in the State of 
Colorado, where it is estimated that two out of every five home loans 
is a subprime loan. Colorado has not only ranked among the top States 
for mortgage fraud during the last 2 years, but has held the highest 
foreclosure rate in the Nation for most of 2006.
    Relaxed underwriting practices instituted by unscrupulous subprime 
lenders, the usage of ``riskier'' products (e.g., adjustable-rate and 
interest-only loans)--coupled with appraisal fraud--and lack of 
understandable disclosure of loan terms have made it easier for those 
who do not qualify for prime loans to purchase homes but not retain 
them. With the current trend of rising interest rates and the resulting 
payment shock, and low home appreciation--due in part to overbuilding 
that we have seen in States, such as Colorado--we will probably 
continue to see increasing delinquency and foreclosure rates. Further, 
a number of these borrowers may fall subject to additional hardship as 
their subprime loans are refinanced by predatory lenders who apply 
aggressive sales tactics and outright fraud.
    I am concerned as to whether FHA is headed in the same direction as 
the subprime market with its seemingly continued de-regulation and 
introduction of ``riskier'' products as part of its proposed reform. A 
chart produced by the Mortgage Bankers Association National Delinquency 
Survey shows how closely the FHA delinquency rate--as a loan type--
follows that of the subprime market. To further illustrate in the third 
quarter of 2006, delinquencies for subprime past due loans were at 
12.56 percent (up 7 percent from the second quarter of 2006 and up 17 
percent from the third quarter in 2005), while total delinquencies for 
all past due loans were at 4.67 percent. Ninety-day delinquencies for 
subprime loans stood at 2.96 percent, while all other loans were at 
0.94 percent. Foreclosure starts for subprime loans was at 1.82 
percent, while for all other loans only 0.46 percent began foreclosure 
in the third quarter of 2006.
    We have an industry that is generally profit-driven, and primarily 
concerned with the bottom line; however, with that should come 
responsibility. Unlike the mortgage industry that is primarily profit 
driven, the FHA is mission driven.

                                FHA RISK

    FHA single family lending has experienced a marked drop in 
insurance volume, as subprime lending spiked and mortgage interest 
rates increased. The numbers are disconcerting: in fiscal year 2006 
insurance in force (active mortgages) was down 8 percent, new 
endorsements were off 17 percent, and delinquency and default rates 
inched upward. Does this scenario mean FHA faces a financial crisis? 
Not based on the recent actuarial findings that estimate a capital 
ratio of 6.82 percent for the Mutual Mortgage Insurance (MMI) fund that 
well exceeds the 2 percent capital ratio mandated by the 1990 Cranston-
Gonzalez National Affordable Housing Act. FHA actuaries found the MMI 
fund to be adequately capitalized to defray expected claims cost over 
the next decade including losses from the hard hit Gulf coast region, 
which is estimated at $613 million. Revenue shortfalls from insurance 
premiums were predicted, but they were offset by expected interest 
income from Treasury investments.
    FHA's fiscal year 2008 budget submission casts a somewhat different 
light as it concerns the risk of the MMI fund. It states: ``Because of 
adverse loan performance and improved estimation techniques, the base 
line credit subsidy rate for FHA's single family program--assuming no 
programmatic changes--is positive, meaning that total costs exceed 
receipts on a present value basis, and therefore would require 
appropriations of credit subsidy budget authority to continue 
operation. The 2008 baseline includes no budget authority to cover 
these costs and assumes FHA would use its existing authorities to 
increase premiums to avoid the need for credit subsidy appropriations. 
Under the Budget's proposals, FHA will be able to set premiums that are 
based on risk and are sufficient to avoid the need for credit subsidy 
appropriations.'' (emphasis added)
    Simply, FHA may be really left with only two choices, to request a 
credit subsidy by means of appropriations or increase its premiums to 
avoid an estimated shortfall of $143 million in fiscal year 2008. One 
FHA response to this impending predicament is through the passage of 
``The Expanding American Homeownership Act.'' In his June 20, 2006 
testimony, the FHA Commissioner stated, ``. . . the FHA bill proposes 
changes that will strengthen FHA's financial position, improving FHA's 
ability to mitigate and compensate risk. The proposed changes would 
permit FHA to operate like every other insurance company in the Nation, 
pricing its products commensurate with the risk, as opposed to having 
some clients pay too much and some too little.'' Regardless of whether 
the FHA reforms are enacted, as FHA takes on more risk--as has been the 
trend in recent years--we believe premiums will also need to increase 
or Congress may have to subsidize the program.
    Moreover, I remain somewhat concerned over the proposed 
modernization of FHA and whether the reforms will provide a panacea to 
its ``loss of market'' woes and ensure the future solvency of the MMI 
fund. The reform package--which includes risk-based premiums, zero-
downpayment loans, and higher mortgage limits--seems to be partially 
directed at expanding FHA's reach to the higher income housing market 
to the possible impact on its traditional first-time homebuyer and 
minority customers. These reform package proposals merit further 
discussions, including the following:
Risk-Based Premiums
    Moving to a mixed price premium structure: (1) could by its very 
complexity require increased budget authority to make FHA system 
modifications and impose new administrative/cost burdens on originating 
and servicing lenders; and (2) potentially expose the FHA Single Family 
insurance program to fair housing questions and accusations of ``red-
lining'' unless the decision matrix for pricing is unquestionable.
    FHA customers traditionally have been first-time homebuyers and 
minorities, some with incomplete or flawed credit histories and 
marginal reserves to avoid default when facing financial stress. FHA 
reform will require these higher risk borrowers to pay higher premiums. 
Risk-based pricing, therefore, may increase the mortgage carrying costs 
of FHA borrowers that are the least able to afford them.
Zero Down Payment
    As the actuaries have pointed out, FHA is currently experiencing 
higher default and claim rates on seller-funded nonprofit down payment 
assisted loans, which are effectively zero down payment loans (100 
percent loan-to-value). GAO reported in 2005 the probability of such 
loans resulting in an insurance claim was 76 percent higher than 
comparable loans without such assistance. It is reasonable to conclude 
that zero down payment loans would represent a comparable insurance 
risk. Additionally, in light of current congressional and GSE (Freddie 
Mac and Fannie Mae) concerns over the growth of subprime lending and 
growing default rates, FHA should be wary of inviting future claim 
risks by insuring 100 percent and greater (after financing closing 
costs and insurance premiums) loan-to-value loans.
Higher Mortgage Limits
    FHA should determine mortgage loan limits consistent with its 
mission to serve underserved borrowers and communities, particularly 
first-time homebuyers and minorities. Raising the loan limits to GSE 
conforming maximums may serve to attract borrowers who have access to 
conventional financing, and do not need a government program to acquire 
homeownership.
    Raising FHA area loan limits, especially the high-cost area ones, 
will not necessarily help low- and moderate-income families become 
homeowners. In some markets, raising the base limit would mean that FHA 
would insure homes well above the median house price statewide, further 
distancing FHA from its mission, and potentially exposing the MMI fund 
to increased risk from regional economic downturns. If the limits for 
2-4 unit properties are also included, FHA will be assuming even 
greater financial risk on what are essentially investment properties.
    Unless there is evidence to show otherwise--the reforms may 
actually increase the mortgage burden of the qualified, but less 
creditworthy borrowers and reward those with greater financial 
stability. And one could argue that FHA appears to be strategizing to 
capture some share of the prime market and borrowers already served by 
conventional lending.
    Moreover, the proposed reform is silent on strengthening controls 
and enforcement actions and preventing future fraud. As we have seen 
over the last 2 years, FHA has made changes to its operations, which in 
some instances has included de-regulation--without seemingly proper 
risk analysis--out of concern over retaining market share. However, 
there has been some change; most notably the Deputy Secretary recently 
supported our recommendation that Housing (FHA) rescind the issuance of 
Mortgagee Letter 2005-23, which removed the ``. . . six-month payment 
history requirement for loans submitted late for endorsement.'' Our 
audit found that loans with an unacceptable payment history--within the 
prior 6 months to submission--were at least 3.5 times higher risk of 
claims to the MMI fund.
    The OIG recognizes that there is an important call for action to 
avoid the need for the Congress to subsidize the program; however, the 
introduction of ``riskier'' products through reform must be balanced 
with more effective program fraud controls to mitigate future insurance 
losses and ensure oversight of lenders that violate established 
requirements. For example, our recent audit of the single family 
mortgage insurance claim process determined that, prior to paying 
billions of dollars in single family insurance claims, FHA did not 
independently ascertain whether loans insured under the MMI fund met 
program requirements. Housing disagreed with our recommendations which 
included FHA establishing a risk-based post claim review process and 
seeking recovery or adequate support for final HUD costs for 44 
unsupported claims identified in our sample totaling over $1.3 million 
in losses.
    The private sector has pointed to one remedy to reduce fraud in 
mortgage loan programs. Mortgage bankers are beginning to use 
predictive models that screen loan applications for fraud at pre-
funding. FHA needs to move beyond post endorsement monitoring and 
embrace this new technology through policy and programmatic changes, as 
part of FHA reform.
    Lastly, the actuaries did not evaluate MMI fund solvency, assuming 
the proposed FHA reform became law. It would seem prudent for FHA to 
have its actuaries prepare another study to reflect likely performance 
scenarios before introducing the reforms to the mortgage market.
    In spite of these differences, we are encouraged to work 
collectively with FHA. In 2006, the Mortgage Bankers hosted a fraud 
symposium, which we attended and were an active participant. We hope 
such collaboration can serve as a model for all our future cooperative 
efforts including those with the FHA.

                    CONTINUING OIG AREAS OF CONCERN

    Even though the Department has notably made progress in its efforts 
to correct its serious challenges--supported by recent removal from 
GAO's high-risk list--as GAO cautions, HUD needs to manage new risks 
and accurately estimate the costs of program changes. The following are 
continuing areas of concern that we have identified through our audit 
and investigative efforts over the FHA single family and multifamily 
insurance programs.
Down Payment Assistance
    Until recently, HUD has not been responsive to the universal 
concern that seller-funded nonprofit down payment assistance providers 
inflate real estate prices and increase the risk of default. OIG's 
concerns with down payment assistance from seller-funded nonprofits 
have been long-standing and are consistent with concerns raised by 
others. The FHA was not responsive to our concerns and that of the GAO 
until the Internal Revenue Service issued a revenue ruling making it 
clear that seller funded down payment assistance providers are not 
charities as they do not meet the requirements of 26 U.S.C.  
501(c)(3). This ruling enabled us to convince the Department to compel 
FHA to issue a rule that will establish specific standards regarding 
borrower investments in a mortgage property when a gift is provided by 
a nonprofit organization.
    The Department has committed to a schedule that will result in a 
final rule being issued next summer. However, it is important to note 
that until this rule is issued, the status quo remains the same and 
nonprofit down payment assisted loans will continue to have a negative 
impact on the economic value of the MMI fund.
Loan Case Binder Access
    FHA has adopted an ill-advised policy that permits those with the 
potential to perpetrate fraud upon the insurance fund to maintain the 
original records/certifications associated with their fraud. Through 
the issuance of Mortgage Letter 2005-36, the Lender Insurance (LI) 
Program enables certain FHA-approved Direct Endorsement lenders to 
endorse FHA loans without a pre-endorsement review and generally 
relieves LI lenders from the responsibility of submitting loan 
originations case binders to FHA.
    We expressed our concerns over the various LI Program provisions 
that may adversely impact the ability to investigate and prosecute 
fraud perpetrated upon FHA. Also, we obtained a letter of opposition 
from the FBI, alerted OMB to the issuance of the mortgagee letter, 
apprised Senate and House oversight staff, and gained support of the 
Office of General Counsel (OGC). In spite of the best efforts of many, 
FHA implemented the program; with assurances to the OGC and us that it 
would collaborate with interested parties to make technical corrections 
once the program was implemented. More than 1 year later, FHA has yet 
to schedule the first meeting to discuss needed technical corrections.
Single Family Fraud
    In my experience, over 99 percent of people are honest, while less 
than 1 percent is intent on defrauding others. Their impact can be, 
however, quite detrimental. Organized groups or individuals driven by 
the bottom line are defrauding consumers and FHA, at the same time that 
FHA is seemingly pursuing a policy of de-regulation. We continue to 
compile evidence through our audit and investigative activities of 
organized groups and individuals who conspire to take advantage of 
first-time homebuyers and minority customers. These groups and 
individuals conspire, with or without the borrowers' knowledge, to 
provide materially false applications, documents and statements to 
obscure information that would otherwise demonstrate that borrowers do 
not qualify for the loans they seek or that the property in question 
does not meet FHA insurance guidelines.
    OIG is also seeing a trend with organized groups in some parts of 
the country recruiting illegal aliens to purchase FHA-insured homes. 
Illegal aliens are not qualified to purchase FHA-insured homes due to 
their immigration status. As a result, this group is often preyed upon 
by unscrupulous mortgage professionals who assist illegal aliens in 
obtaining fraudulent and stolen social security numbers, tax documents, 
and employment documents. All too frequently these borrowers soon 
realize that they are unable to bear the periodic costs associated with 
homeownership and default on their loan. In turn, these ever increasing 
defaults degrade entire communities where the organized groups target 
their efforts. As a result of FHA's continued pattern of de-regulation 
or inconsistent enforcement of established regulations, single family 
loans remain vulnerable to fraud.
Multifamily Fraud
    FHA does not have adequate controls to prohibit equity skimming in 
nursing homes. In consideration for endorsement for insurance by FHA, 
prospective nursing home mortgagor/owners are required to execute a 
regulatory agreement. The regulatory agreement is FHA's chief vehicle 
to protect its financial and programmatic interests in the mortgaged 
property. Typically, the mortgagor/owner does not ``operate'' the 
nursing home and leases the property to a lessee/operator that executes 
a separate and less comprehensive regulatory agreement. Numerous OIG 
audits have determined that FHA does not have adequate controls in 
place to ensure program objectives are accomplished.
    Among the significant control weaknesses identified by the OIG is 
that the regulatory agreement used for the lessee/operator-managed 
nursing homes lacks certain requirements contained in the regulatory 
agreement applicable to mortgagor/owner-managed nursing homes. The 
regulatory agreement used for lessee/operator-managed nursing homes 
does not preclude the lessee/operator from diverting all or any portion 
of the income generated by the property to non-property purposes to the 
detriment of the elderly tenants, and HUD who is subject to the payment 
of an insurance claim to the lender due to the mortgagor/owner's 
default on the FHA-insured loan.
Gulf Coast
    Congress estimates that damage to residential structures will range 
from $17 to $33 billion. In the Presidentially Declared Disaster Areas, 
HUD's FHA single family insurance fund insured more than 328,000 
mortgages having an unpaid principal balance of $23 billion. FHA's 
multifamily program in the Presidentially Declared Disaster Areas 
insured 528 projects with an amortized principal balance of $3 billion. 
Of these, 112 or 21 percent sustained more than minor damage, resulting 
in significant potential losses. Further, the actuaries have estimated 
the expected claim losses caused by the hurricanes to be $613 million.
    The devastation caused by Hurricanes Katrina and Rita, and more 
importantly the unprecedented volume of Federal assistance provided in 
reaction to the hurricanes, has created an environment ripe for fraud. 
OIG will continue to focus, to the greatest extent possible, on the 
ultimate disposition and accountability of these funds.

                               THE RECORD

    Pursuant to goal number 1 of HUD-OIG's Strategic Plan, to help HUD 
resolve its major management challenges by being a relevant and 
problem-solving advisor to the Department, we continue to focus our 
audit and investigative efforts on FHA to include both single family 
and multifamily insurance programs. Over the past 3 years, HUD OIG has 
issued 190 audit reports in the area of FHA. These FHA-related audit 
reports identified over $1.1 billion in questioned costs and funds that 
could be put to better use. During the same time period, the HUD OIG 
had 1,078 cases opened. The following are examples of our audit and 
investigative activities.
Office of Audit
            Single Family
    We audited a San Antonio, Texas financial firm because of an 
unusually high ratio of defaults. We found that 47 percent of its 
defaults involved one seller, who owned 50 percent of the lender. OIG 
reviewed 51 of the defaulted loans that involved the seller. The lender 
approved mortgages on overvalued properties because the lender allowed 
an identity-of-interest seller to add ineligible and unsupported 
construction costs and inadequately reviewed the appraisals. Also, the 
lender did not adequately document analyses of borrowers' credit. 
Further, the lender's processing had technical difficulties. 
Consequently, HUD and the borrowers unnecessarily incurred increased 
risks through higher insurance exposure and higher mortgage payments as 
evidenced by the borrowers defaulting on their mortgages.
    HUD OIG audited a Miamisburg, Ohio lender approved to originate, 
underwrite, and submit insurance endorsement requests under HUD's 
single family direct endorsement program. We selected it for audit 
because of its high late endorsement rate. This lender submitted 2,071 
late requests for endorsement out of 68,730 loans tested. The loans 
were either delinquent or otherwise did not meet HUD's requirement of 
six consecutive timely payments after delinquency but before submission 
to HUD. It also incorrectly certified that both the mortgage and escrow 
accounts for 133 loans and the escrow account for taxes, hazard 
insurance premiums, and mortgage insurance premiums for 497 loans were 
current.
    HUD OIG audited a Phoenix, Arizona mortgage company's insured loan 
originations due to high default and claim rates. It did not originate 
the 19 loans reviewed in compliance with HUD requirements or prudent 
lending practices. All 19 loans involved origination deficiencies that 
should have precluded their approval, including false employment data, 
overstated income, understated liabilities, unacceptable credit 
histories, improper treatment of downpayment gifts and/or interest rate 
buydowns resulting in over insured mortgages, inaccurate or excessive 
qualifying ratios without compensating factors, and borrower 
overcharges for unsupported or unallowed fees. As a result, it placed 
HUD's single family insurance fund at risk for 19 unacceptable loans 
with original mortgages totaling more than $2.5 million, and borrowers 
were overcharged $9,400. HUD remains at risk and/or has incurred losses 
totaling more than $1.2 million related to 15 of the 19 loans.
            Multifamily
    HUD OIG audited six housing projects in Los Angeles, California, to 
assess HUD's concerns over inappropriate disbursements and determine 
whether the projects were administered in compliance with HUD 
requirements. The owner and identity-of-interest management agent used 
project funds to pay more than $2.6 million in ineligible and 
unsupported costs, including excessive and unreasonable charges by an 
identity-of-interest maintenance contractor, excessive charges for the 
management agent's president, unsupported rent charges and capital 
improvement expenses for the management agent's office, and ineligible 
ownership expenses. OIG anticipates similar additional questionable 
costs continued after the end of the audit period that could cost the 
projects another $457,000. OIG's building inspections identified more 
than 240 health or safety violations, which resulted in more than 
$561,000 in housing assistance payments for units and buildings that 
were not decent, safe, and sanitary. In addition, the owner and 
identity-of-interest management agent did not effectively manage the 
projects, to include not accurately calculating, reporting, and 
resolving more than $655,000 in project liabilities.
    In Bethany, Oklahoma we audited a HUD-insured nursing home to 
determine whether it complied with the regulatory agreement and HUD 
requirements when disbursing project funds. We found its officials used 
$2.3 million for ineligible costs, such as loan repayments and late 
fees, and could not support $4.5 million in expenditures. Further, 
these officials did not provide documentation to support the use of 
revenue amounting to nearly $12 million. This ultimately resulted in 
mortgage default and closure of the nursing home.
    We completed an audit of a rehabilitation center in Carmichael, 
California. We found that the owner incorporated the project in its 
petition for bankruptcy and then defaulted on the project's mortgage. 
In addition, the owner disbursed $3.7 million in project funds through 
ineligible cash distributions and expenses. These activities resulted 
in increased risk to HUD, the assignment of the mortgage note to HUD, 
and HUD's resulting loss of $323,000 on the sale of the note.
Office of Investigation
            Single Family
    Seven Charlotte, NC residents were indicted by a Federal grand jury 
on 66 counts alleging conspiracy, wire fraud, bank fraud, making false 
statements and entries, and money laundering. The Defendants owned and 
operated a mortgage brokerage corporation. The scheme entailed 
defrauding HUD and the Government National Mortgage Association (GNMA) 
whose mission is to support affordable home ownership in America by 
providing an efficient government secondary market vehicle to link the 
capital and Federal housing markets. A bundle of loans, usually 
totaling $1 million, is packaged by a lender and sold to investors as a 
pool for which it is required that an actual existing dwelling is 
constructed and that a homeowner is submitting monthly mortgage 
payments. GNMA is the final guarantor of the loan pools and mortgage-
backed securities and will fully reimburse the investors should the 
need arise.
    The Defendants are alleged to have devised and executed an 
elaborate mortgage fraud scheme to generate over 100 loans that were 
purported to be FHA-insured loans on nonexistent properties that were 
ultimately resold to investors in mortgage pools backed by GNMA, as 
well as the Federal National Mortgage Association (FNMA). GNMA was 
required to make the investors whole when the fraud was discovered. The 
defendants would recruit strawbuyers to secure fraudulent FHA-insured 
home loans through a builder and these loans, in most cases, were 
secured by properties that were vacant lots or for homes belonging to 
legitimate homeowners. The Defendants allegedly received the loan 
proceeds and used the money for their personal benefit and to advance 
the fraud scheme.
    As a result of the fraud, the Defendants obtained more than $5 
million from FNMA and more than $26 million from GNMA. The 
investigation was initiated based on GNMA having discovered 
irregularities during an audit of the builder. The GNMA losses are 
based on the cost to repurchase each fraudulent loan from GNMA 
investors. The defendants also fraudulently obtained a $5 million line 
of credit with a banking and trust company by submitting straw 
mortgages and false documents. This investigation has resulted in the 
seizure of assets worth $8 million.
    OIG investigated a large mortgage company in Detroit, Michigan and 
confirmed that it submitted to FHA as many as 28,000 loans with 
underwriter's certifications purportedly signed by one of two FHA-
approved underwriters. In actuality, however, these loans had been 
underwritten by other staff, who had not received FHA-approval and who 
merely signed the FHA-approved underwriters' names on the 
certifications. OIG referred the matter to the United States Attorney's 
Office for the Eastern District of Michigan, which entered into a civil 
settlement valued at in excess of $40 million. This figure covered 
FHA's experienced and forecast losses on the loans, and included a 
penalty.
    Four defendants were charged in a scheme in Colorado for assisting 
unqualified and undocumented immigrants in obtaining more than 300 FHA-
insured loans valued in excess of $61 million. As a result of 
foreclosures, HUD realized losses of $2.3 million.
            Multifamily
    The owner of a mortgage company and four HUD-insured nursing homes 
located in Rhode Island and the administrator of the nursing homes, and 
others, illegally diverted income or funds from the nursing homes to 
themselves or identity-of-interest companies authorizing payments for 
unwarranted services while the properties were in a non-surplus-cash 
position, a violation of their HUD regulatory agreement. As a result of 
their actions, HUD realized a loss of $14 million when the owner 
defaulted on the HUD-insured mortgages for 2 of the nursing homes. For 
the remaining 2 nursing homes, HUD continues litigation over the $13 
million insurance payment of one nursing home and continues operations 
of the other--which is listed for sale--with a $9.7 million FHA-insured 
mortgage. In addition, the portfolio contains approximately 57 FHA-
insured loans estimated at $314.3 million, all of which are considered 
at risk.

                           CONTINUED SUPPORT

    We continue to support the Department and FHA's mission and will 
also continue to increase our efforts to ensure the administrative 
health and vitality of HUD's programs and activities. I know that with 
the hard work of staff, we will persist in a pattern of improved 
oversight and enforcement and I look forward to working with the 
Department to come up with common and workable solutions. I would like 
to mention the notable remarks made by the Secretary in recent 
testimony on March 1, 2007, that borrowers should be paying a portion 
of the downpayment when obtaining an FHA-insured loan. As we know, 
without a financial stake in a home, borrowers have less incentive to 
be responsible homeowners making it easier to default and walk away.
    That is where HUD comes in, to ensure Americans are given the 
opportunity to obtain and retain affordable housing. However, this 
cannot be driven solely by the Federal Government, but must also be 
done through a collective effort that combines the expertise of the 
housing industry of both the public and private sector.
    I cannot say that the reform legislation is the answer and I 
recognize that some change is necessary. There are great challenges 
confronting FHA programs. Nevertheless, aggressive oversight and 
enforcement is crucial to prevent a recurrence of what we are 
witnessing in the subprime market today and the savings and loan 
industry in years past. Clearly, there are lessons learned from repeats 
of history.

                               CONCLUSION

    That concludes my testimony and I thank the subcommittee for 
holding this hearing and I look forward to answering questions that 
members may have.

    Senator Murray. Mr. Shear.

                     STATEMENT OF WILLIAM B. SHEAR

    Mr. Shear. Thank you. Madam Chairman, Senator Bond and 
members of the subcommittee, it is a pleasure to be here this 
morning to share information and perspectives as the committee 
examines issues concerning the financial performance of FHA.
    Although the program currently operates with a negative 
subsidy, the risks FHA faces in today's mortgage market are 
growing. Because of the worsening performance of the mortgages 
it insures, FHA has estimated that the program would require a 
positive subsidy--that is, an appropriation of budget 
authority--in fiscal year 2008 if no program changes were made.
    To help FHA adapt to market changes, HUD has proposed a 
number of changes to the National Housing Act that would 
provide FHA flexibilities. A major theme of our testimony today 
is that whether under its existing authority or using any 
additional flexibility that Congress may grant, FHA's ability 
to manage both risk and program changes will affect the 
financial performance of the insurance program.
    Our testimony discusses four reports that we have issued 
since 2005, plus some related information from ongoing work 
we're conducting at the request of Senators Allard and Shelby.
    In summary, our work identified a number of weaknesses in 
FHA's ability to estimate and manage risk that may affect the 
financial performance of the insurance program.
    First, FHA has not developed sufficient standards and 
controls to manage risks associated with a substantial 
proportion of loans with down payment assistance, including 
assistance from nonprofit organizations funded by home sellers. 
According to FHA, high claim and loss rates for loans with such 
assistance were major reasons for the estimated positive 
subsidy cost for fiscal year 2008, absent any program changes.
    Second, FHA has not consistently implemented practices, 
such as stricter underwriting or piloting used by other 
mortgage institutions to help manage the risks associated with 
new product offerings. Although FHA has indicated that it would 
impose stricter underwriting standards for a no-down-payment 
mortgage if the legislative changes were enacted, it does not 
plan to pilot the product.
    Third, the way that FHA developed its mortgage scorecard, 
while generally reasonable, limits how effectively it assesses 
the default risk of borrowers. With increased competition from 
conventional mortgage providers, limitations in its scorecard 
could cause FHA to insure mortgages that are relatively more 
risky. Our ongoing work indicates that FHA plans to use the 
scorecard to help set insurance premiums if legislative changes 
are enacted. Accordingly, any limitations in the scorecard's 
ability to predict defaults could result in FHA mispricing its 
products.
    Fourth, although FHA has improved its ability to estimate 
the subsidy costs for its single-family insurance program, it 
generally has underestimated these costs. Increases in the 
expected level of claims were a major cause of a particularly 
large re-estimate that FHA submitted as of the end of fiscal 
year 2003.
    We have made several recommendations in our recent reports, 
including that FHA: (1) incorporate the risk posed by down 
payment assistance into its scorecard; (2) study and report on 
the impact of variables not in its loan performance models that 
have been found to influence credit risk; and (3) consider 
piloting new products.

                           PREPARED STATEMENT

    FHA has taken actions in response to our recommendations, 
but continued focus on risk management will be necessary for 
FHA to operate in a financially sound manner in the face of 
market and program changes.
    Madam Chairman, I would be happy to answer any questions at 
this time.
    [The statement follows:]

                 Prepared Statement of William B. Shear

    Madam Chairman and members of the subcommittee, I am pleased to 
have the opportunity to share information and perspectives with the 
committee as it examines issues concerning the financial performance of 
the Department of Housing and Urban Development's (HUD) Federal Housing 
Administration (FHA). FHA provides insurance for single-family home 
mortgages made by private lenders. In fiscal year 2006, it insured 
about 426,000 mortgages, representing $55 billion in mortgage 
insurance. According to FHA's estimates, the insurance program 
currently operates with a negative subsidy, meaning that the present 
value of estimated cash inflows (such as borrower premiums) to FHA's 
Mutual Mortgage Insurance Fund (Fund) exceeds the present value of 
estimated cash outflows (such as claims).
    But, the risks FHA faces in today's mortgage market are growing. 
For example, the agency has seen increased competition from 
conventional mortgage and insurance providers, many of which offer low- 
and no-down-payment products, and that may be better able than FHA to 
identify and approve relatively low-risk borrowers. Additionally, 
because of the worsening performance of the mortgages it insures, FHA 
has estimated that the program would require a positive subsidy--that 
is, an appropriation of budget authority--in fiscal year 2008 if no 
program changes were made.
    To help FHA adapt to market changes, HUD has proposed a number of 
changes to the National Housing Act that, among other things, would 
give FHA flexibility to set insurance premiums based on the credit risk 
of borrowers and reduce down-payment requirements from the current 3 
percent to potentially zero. Whether under its existing authority or 
using any additional flexibility that Congress may grant, FHA's ability 
to manage risks and program changes will affect the financial 
performance of the insurance program.
    My testimony today discusses 4 reports that we have issued since 
2005 on different aspects of FHA's risk management, as well as ongoing 
work we are conducting on FHA's proposed legislative changes and the 
tools and resources it would use to implement them, if passed. This 
body of work addresses a number of issues relevant to FHA's financial 
performance. Specifically, I will discuss: (1) weaknesses in how FHA 
has managed the risks of loans with down-payment assistance; (2) 
practices that could be instructive for FHA in managing the risks of 
new mortgage products; (3) FHA's development and use of a mortgage 
scorecard; and (4) FHA's estimation of subsidy costs for its single-
family insurance program.
    In conducting this work, we reviewed and analyzed information 
concerning the standards and controls FHA uses to manage the risks of 
loans with down-payment assistance; steps mortgage industry 
participants take to design and implement low- and no-down-payment 
mortgage products; FHA's approach to developing its mortgage scorecard 
and the scorecard's benefits and limitations; FHA's estimates of 
program costs and the factors underlying the agency's cost reestimates; 
and FHA's plans and resources for implementing its proposed legislative 
changes. We interviewed officials from FHA, the U.S. Department of 
Agriculture, and U.S. Department of Veterans Affairs; and staff at 
selected private mortgage providers and insurers, Fannie Mae, Freddie 
Mac, the Office of Federal Housing Enterprise Oversight, selected State 
housing finance agencies, and nonprofit down-payment assistance 
providers. We conducted this work from January 2004 to March 2007 in 
accordance with generally accepted government auditing standards.
    In summary, our work identified a number of weaknesses in FHA's 
ability to estimate and manage risk that may affect the financial 
performance of the insurance program:
    FHA has not developed sufficient standards and controls to manage 
risks associated with the substantial proportion of loans with down-
payment assistance. Unlike other mortgage industry participants, FHA 
does not restrict homebuyers' use of down-payment assistance from 
nonprofit organizations that receive part of their funding from home 
sellers. However, our analysis of a national sample of FHA-insured 
loans found that the probability of loans with this type of down-
payment assistance resulting in an insurance claim was 76 percent 
higher than comparable loans without such assistance. Additionally, the 
financial risks of these loans recently have been realized in effects 
on the credit subsidy estimates. According to FHA, high claim and loss 
rates for loans with this type of down-payment assistance were major 
reasons why the estimated credit subsidy rate--the expected cost--for 
the single-family insurance program would be positive, or less 
favorable, in fiscal year 2008 (absent any program changes).
    Some of the practices of other mortgage institutions offer a 
framework that could help FHA manage the risks associated with new 
products such as no-down-payment mortgages. For example, mortgage 
institutions may limit the volume of new products issued--that is, 
pilot a product--and sometimes require stricter underwriting on these 
products. While FHA has utilized pilots or demonstrations when making 
changes to its single-family mortgage insurance, it generally has done 
so in response to a legislative requirement and not on its own 
initiative. Moreover, FHA officials have questioned the circumstances 
under which pilot programs were needed and also said that they lacked 
sufficient resources to appropriately manage a pilot. However, FHA 
officials have indicated that they would institute stricter 
underwriting standards for any no-down-payment mortgage authorized by 
their legislative proposal.
    While generally reasonable, the way that FHA developed its mortgage 
scorecard--an automated tool that evaluates the default risk of 
borrowers--limits the scorecard's effectiveness. More specifically, FHA 
and its contractor used variables that reflected borrower and loan 
characteristics to create the scorecard and an accepted modeling 
process to test the variables' accuracy in predicting default. But, the 
data used to develop the scorecard were 12 years old by the time that 
FHA began using the scorecard in 2004, and the market has changed 
significantly since then. In addition, the scorecard does not include 
all the important variables that could help explain expected loan 
performance such as the source of the down payment. With competition 
from conventional providers, limitations in the scorecard could cause 
FHA to insure mortgages that are relatively more risky. Our ongoing 
work indicates that FHA plans to use the scorecard to help set 
insurance premiums if legislative changes are enacted. Accordingly, any 
limitations in the scorecard's ability to predict defaults could result 
in FHA mispricing its products.
    Although FHA has improved its ability to estimate the subsidy costs 
for its single-family insurance program, it generally has 
underestimated these costs. To meet Federal requirements, FHA annually 
reestimates subsidy costs for each loan cohort.\1\ The current 
reestimated subsidy costs for all except the fiscal year 1992 and 1993 
cohorts are less favorable--that is, higher--than originally estimated. 
Increases in the expected level of insurance claims--potentially 
stemming from changes in underwriting guidelines, among other factors--
were a major cause of a particularly large reestimate that FHA 
submitted as of the end of fiscal year 2003.
---------------------------------------------------------------------------
    \1\ Essentially, a cohort includes the loans insured in a given 
year.
---------------------------------------------------------------------------
    On the basis of our findings from the reports I have summarized, we 
made several recommendations designed to improve FHA's risk management. 
For example, to improve its assessment of borrowers' default risk, we 
recommended that FHA develop policies for updating the scorecard, 
incorporate the risks posed by down-payment assistance into the 
scorecard, and explore additional uses for this tool. To more reliably 
estimate program costs, we recommended that FHA study and report in the 
annual actuarial review of the Fund the impact of variables not in the 
agency's loan performance models (the results of which are used in 
estimating and reestimating program costs) that have been found in 
other studies to influence credit risk.\2\
---------------------------------------------------------------------------
    \2\ Since 1990, the National Housing Act has required an annual and 
independent actuarial analysis of the economic net worth and soundness 
of the Fund. 12 U.S.C. section 1711(g).
---------------------------------------------------------------------------
    FHA has taken actions in response to some of our findings and 
recommendations. For example, FHA has developed and begun putting in 
place policies for annually updating the scorecard and testing 
additional predictive variables. To more reliably assess program costs, 
an FHA contractor incorporated the source of down-payment assistance 
and borrower credit scores in recent actuarial reviews of the Fund.
    While these actions represent improvements in FHA's risk 
management, sustained management attention to the issues that we have 
identified and continued congressional oversight of FHA will play an 
important role in ensuring that FHA is able to expand homeownership 
opportunities for low- and middle-income families while operating in a 
manner that is financially sound.

                               BACKGROUND

    Congress established FHA in 1934 under the National Housing Act 
(Public Law 73-479) to broaden homeownership, protect lending 
institutions, and stimulate employment in the building industry. FHA's 
single-family programs insure private lenders against losses (up to 
almost 100 percent of the loan amount) from borrower defaults on 
mortgages that meet FHA criteria. In 2005, more than three-quarters of 
the loans that FHA insured went to first-time homebuyers, and about 
one-third of these loans went to minorities. From 2001 through 2005, 
FHA insured about 5 million mortgages with a total value of about $590 
billion. However, FHA's loan volume fell sharply over that period, and 
in 2005 FHA-insured loans accounted for about 5 percent of single-
family home purchase mortgages, compared with about 19 percent in 
2001.\3\ Additionally, default rates for FHA-insured mortgages have 
risen steeply over the past several years, a period during which home 
prices have generally appreciated rapidly.
---------------------------------------------------------------------------
    \3\ These figures represent mortgages for owner-occupied homes 
only.
---------------------------------------------------------------------------
    FHA determines the expected cost of its insurance program, known as 
the credit subsidy cost, by estimating the program's future 
performance.\4\ Similar to other agencies, FHA is required to 
reestimate credit subsidy costs annually to reflect actual loan 
performance and expected changes in estimates of future loan 
performance. FHA has estimated negative credit subsidies for the Fund 
from 1992, when Federal credit reform became effective, through 2007. 
However, FHA has estimated that, assuming no program changes, the loans 
it expects to insure in fiscal year 2008 would require a positive 
subsidy, meaning that the present value of estimated cash inflows would 
be less than the present value of estimated cash outflows. The economic 
value, or net worth, of the Fund that supports FHA's insurance depends 
on the relative size of cash outflows and inflows over time. Cash flows 
out of the Fund for payments associated with claims on defaulted loans 
and refunds of up-front premiums on prepaid mortgages. To cover these 
outflows, FHA receives cash inflows from borrowers' insurance premiums 
and net proceeds from recoveries on defaulted loans. An independent 
contractor's actuarial review of the Fund for fiscal year 2006 
estimated that the Fund's capital ratio--the economic value divided by 
the insurance-in-force--is 6.82 percent, well above the mandated 2 
percent minimum.\5\ If the Fund were to be exhausted, the U.S. Treasury 
would have to cover lenders' claims directly.
---------------------------------------------------------------------------
    \4\ Pursuant to the Federal Credit Reform Act of 1990, HUD must 
annually estimate the credit subsidy cost for its mortgage insurance 
programs. Credit subsidy costs are the net present value of estimated 
payments HUD makes less the estimated amounts it receives, excluding 
administrative costs.
    \5\ In fiscal year 2006, the Fund's estimated economic value was 
$22 billion and the unamortized insurance-in-force was $323 billion.
---------------------------------------------------------------------------
    Two major trends in the conventional mortgage market have 
significantly affected FHA.\6\ First, in recent years, members of the 
conventional mortgage market (such as private mortgage insurers, Fannie 
Mae, and Freddie Mac) increasingly have been active in supporting low- 
and even no-down-payment mortgages, increasing consumer choices for 
borrowers who may have previously chosen an FHA-insured loan. Second, 
to help assess the default risk of borrowers, particularly those with 
high loan-to-value ratios (loan amount divided by sales price or 
appraised value), the mortgage industry has increasingly used mortgage 
scoring and automated underwriting systems.\7\ Mortgage scoring is a 
technology-based tool that relies on the statistical analysis of 
millions of previously originated mortgage loans to determine how key 
attributes such as the borrower's credit history, property 
characteristics, and terms of the mortgage affect future loan 
performance. As a result of such tools, the mortgage industry is able 
to process loan applications more quickly and consistently than in the 
past. In 2004, FHA implemented a mortgage scoring tool, called the FHA 
Technology Open to Approved Lenders (TOTAL) Scorecard, to be used in 
conjunction with existing automated underwriting systems.
---------------------------------------------------------------------------
    \6\ Conventional mortgages do not carry government insurance or 
guarantees.
    \7\ Underwriting refers to a risk analysis that uses information 
collected during the origination process to decide whether to approve a 
loan.
---------------------------------------------------------------------------
    Partly in response to changes in the mortgage market, HUD has 
proposed legislation intended to modernize FHA. Provisions in the 
proposal would authorize FHA to change the way it sets insurance 
premiums and reduce down-payment requirements. The proposed legislation 
would enable FHA to depart from its current, essentially flat, premium 
structure and charge a wider range of premiums based on individual 
borrowers' risk of default. Currently, FHA also requires homebuyers to 
make a 3 percent contribution toward the purchase of the property. 
HUD's proposal would eliminate this contribution requirement and enable 
FHA to offer some borrowers a no-down-payment product.

  FHA HAS NOT IMPLEMENTED SUFFICIENT STANDARDS AND CONTROLS TO MANAGE 
         FINANCIAL RISKS OF LOANS WITH DOWN-PAYMENT ASSISTANCE

    In our November 2005 report examining FHA's actions to manage the 
new risks associated with the growing proportion of loans with down-
payment assistance, we found that the agency did not implement 
sufficient standards and controls to manage the risks posed by these 
loans.\8\ Unlike other mortgage industry participants, FHA does not 
restrict homebuyers' use of down-payment assistance from nonprofit 
organizations that receive part of their funding from home sellers. 
According to FHA, high claim and loss rates for loans with this type of 
down-payment assistance were major reasons for changing the estimated 
credit subsidy rate from negative to positive for fiscal year 2008 (in 
the absence of any program changes). Furthermore, incorporating the 
impact of such loans into the actuarial study of the Fund for fiscal 
year 2005 resulted in almost a $2 billion (7 percent) decrease in the 
Fund's estimated economic value.
---------------------------------------------------------------------------
    \8\ GAO, Mortgage Financing: Additional Action Needed to Manage 
Risks of FHA-Insured Loans with Down Payment Assistance, GAO-06-24 
(Washington, DC: Nov. 9, 2005).
---------------------------------------------------------------------------
Loans With Down-Payment Assistance Are a Substantial Portion of FHA's 
        Portfolio and Pose Greater Financial Risks Than Similar Loans 
        Without Assistance
    Homebuyers who receive FHA-insured mortgages often have limited 
funds and, to meet the 3 percent borrower investment FHA currently 
requires, may obtain down-payment assistance from a third party, such 
as a relative or a charitable organization (nonprofit) that is funded 
by the property sellers. The proportion of FHA-insured loans that are 
financed in part by down-payment assistance from various sources has 
increased substantially in the last few years, while the overall number 
of loans that FHA insures has fallen dramatically. Money from 
nonprofits funded by seller contributions has accounted for a growing 
percentage of that assistance. From 2000 to 2004, the total proportion 
of FHA-insured purchase loans that had a loan-to-value ratio greater 
than 95 percent and that also involved down-payment assistance, from 
any source, grew from 35 percent to nearly 50 percent. Approximately 6 
percent of FHA-insured purchase loans in 2000 received down-payment 
assistance from nonprofits (the large majority of which were funded by 
property sellers), but by 2004 nonprofit assistance grew to about 30 
percent. The corresponding percentages for 2005 and 2006 were about the 
same.
    We and others have found that loans with down-payment assistance do 
not perform as well as loans without down-payment assistance. We 
analyzed loan performance by source of down-payment assistance, using 
two samples of FHA-insured purchase loans from 2000, 2001, and 2002--a 
national sample and a sample from three metropolitan statistical areas 
(MSA) with high rates of down-payment assistance.\9\ Holding other 
variables constant, our analysis indicated that FHA-insured loans with 
down-payment assistance had higher delinquency and claim rates than 
similar loans without such assistance. For example, we found that the 
probability that loans with nonseller-funded sources of down-payment 
assistance (e.g., gifts from relatives) would result in insurance 
claims was 49 percent higher in the national sample and 45 percent 
higher in the MSA sample than it was for comparable loans without 
assistance. Similarly, the probability that loans with nonprofit 
seller-funded down-payment assistance would result in insurance claims 
was 76 percent higher in the national sample and 166 percent higher in 
the MSA sample than it was for comparable loans without assistance. 
This difference in performance may be explained, in part, by the higher 
sales prices of comparable homes bought with seller-funded down-payment 
assistance. Our analysis indicated that FHA-insured homes bought with 
seller-funded nonprofit assistance were appraised and sold for about 2 
to 3 percent more than comparable homes bought without such assistance. 
The difference in performance also may be partially explained by the 
homebuyer having less equity in the transaction.
---------------------------------------------------------------------------
    \9\ The data (current as of June 30, 2005) consisted of purchase 
loans insured by FHA's 203(b) program, its main single-family program, 
and its 234(c), condominium program. The three MSAs were Atlanta, 
Indianapolis, and Salt Lake City.
---------------------------------------------------------------------------
Stricter Standards and Additional Controls Could Help FHA Manage the 
        Risks Posed by Loans With Down-Payment Assistance
    FHA has implemented some standards and internal controls to manage 
the risks associated with loans with down-payment assistance, but 
stricter standards and additional controls could help FHA better manage 
the financial risks posed by these loans while meeting its mission of 
expanding homeownership opportunities. Like other mortgage industry 
participants, FHA generally applies the same underwriting standards to 
loans with down-payment assistance that it applies to loans without 
such assistance. One important exception is that FHA, unlike others, 
does not limit the use of down-payment assistance from seller-funded 
nonprofits. Some mortgage industry participants view assistance from 
seller-funded nonprofits as a seller inducement to the sale and, 
therefore, either restrict or prohibit its use. FHA has not treated 
such assistance as a seller inducement and, therefore, does not subject 
this assistance to the limits it otherwise places on contributions from 
sellers.
    Concerns about loans with nonprofit seller-funded down-payment 
assistance have prompted FHA and IRS to initiate steps that could curb 
their use. For example, FHA has begun drafting a proposed rule that, as 
described by FHA, would appear to prohibit down-payment assistance from 
seller-funded nonprofits. FHA's legislative proposal could also 
eliminate the need for such assistance by allowing some FHA borrowers 
to make no down payments for an FHA-insured loan. Finally, in May 2006, 
IRS issued a ruling stating that organizations that provide seller-
funded down-payment assistance to home buyers do not qualify as tax-
exempt charities. FHA permitted these organizations to provide down-
payment assistance because they qualified as charities. Accordingly, 
the ruling could significantly reduce the number of FHA-insured loans 
with seller-funded down payments. However, FHA officials told us that 
as of March 2007, they were not aware of IRS rescinding the charitable 
status of any of these organizations.
    Our report made several recommendations designed to better manage 
the risks of loans with down-payment assistance generally, and more 
specifically from seller-funded nonprofits. Overall, we recommended 
that in considering the costs and benefits of its policy permitting 
down-payment assistance, FHA also consider risk-mitigation techniques 
such as including down-payment assistance as a factor when underwriting 
loans or more closely monitoring loans with such assistance. For down-
payment assistance providers that receive funding from property 
sellers, we recommended that FHA take additional steps to mitigate the 
risks of these loans, such as treating such assistance as a seller 
contribution and, therefore, subject to existing limits on seller 
contributions. In response, FHA agreed to improve its oversight of 
down-payment assistance lending by: (1) modifying its information 
systems to document assistance from seller-funded nonprofits; and, (2) 
more routinely monitoring the performance of loans with down-payment 
assistance. Also, as previously noted, HUD has initiated steps to curb 
and provide alternatives to seller-funded down-payment assistance.

 PRACTICES THAT OTHER MORTGAGE INSTITUTIONS USE COULD HELP FHA MANAGE 
              RISKS FROM LOW- OR NO-DOWN-PAYMENT PRODUCTS

    If Congress authorized FHA to insure mortgages with smaller or no 
down payments, practices that other mortgage institutions use could 
help FHA to design and manage the financial risks of these new 
products. In a February 2005 report, we identified steps that mortgage 
institutions take when introducing new products.\10\ Specifically, 
mortgage institutions often utilize special requirements when 
introducing new products, such as requiring additional credit 
enhancements (mechanisms for transferring risk from one party to 
another) or implementing stricter underwriting requirements, and 
limiting how widely they make available a new product. By adopting such 
practices, FHA could reduce the potential for higher claims on products 
whose risks may not be well understood.
---------------------------------------------------------------------------
    \10\ GAO, Mortgage Financing: Actions Needed to Help FHA Manage 
Risks from New Mortgage Loan Products, GAO-05-194 (Washington, DC: Feb. 
11, 2005).
---------------------------------------------------------------------------
Mortgage Institutions Require Additional Credit Enhancements, Stricter 
        Underwriting, and Higher Premiums for Low- and No-Down-Payment 
        Products
    Some mortgage institutions require additional credit enhancements 
on low- and no-down payment products, which generally are riskier 
because they have higher loan-to-value ratios than loans with larger 
down payments. For example, Fannie Mae and Freddie Mac mitigate the 
risk of low- and no-down payment products by requiring additional 
credit enhancements such as higher mortgage insurance coverage. 
Although FHA is required to provide up to 100 percent coverage of the 
loans it insures, FHA may engage in co-insurance of its single-family 
loans. Under co-insurance, FHA could require lenders to share in the 
risks of insuring mortgages by assuming some percentage of the losses 
on the loans that they originated (lenders would generally use private 
mortgage insurance for risk sharing).
    Mortgage institutions also can mitigate the risk of low- and no-
down-payment products through stricter underwriting. Institutions can 
do this in a number of ways, including requiring a higher credit score 
threshold for certain products, requiring greater borrower reserves, or 
requiring more documentation of income or assets from the borrower. 
Although the changes FHA could make are limited by statutory standards, 
it could benefit from similar approaches. The HUD Secretary has 
latitude within statutory limitations to change underwriting 
requirements for new and existing products and has done so many times. 
For example, FHA expanded its definition of what could be included as 
borrower's effective income when calculating payment-to-income ratios. 
In commenting on our February 2005 report, FHA officials told us that 
they were unlikely to mandate a credit score threshold or borrower 
reserve requirements for a no-down-payment product because the product 
was intended to serve borrowers who were underserved by the 
conventional market, including those who lacked credit scores and had 
little wealth or personal savings. However, in the course of our 
ongoing work on FHA's legislative proposal, FHA officials indicated 
that they would likely set a credit score threshold for any no-down-
payment product.
    Finally, mortgage institutions can increase fees or charge higher 
premiums to help offset the potential costs of products that are 
believed to have greater risk. For example, Fannie Mae officials stated 
that they would charge higher guarantee fees on low- and no-down 
payment loans if they were not able to require higher insurance 
coverage.\11\ Our ongoing work indicates that FHA, if authorized to 
implement risk-based pricing, would charge higher premiums for loans 
with higher loan-to-value ratios, all other things being equal.
---------------------------------------------------------------------------
    \11\ Fannie Mae and Freddie Mac charge fees for guaranteeing timely 
payment on mortgage-backed securities they issue. The fees are based, 
in part, on the credit risk they face.
---------------------------------------------------------------------------
    We recommended that if FHA implemented a no-down-payment mortgage 
product or other new products about which the risks were not well 
understood, the agency should: (1) consider incorporating stricter 
underwriting criteria such as appropriate credit score thresholds or 
borrower reserve requirements; and, (2) utilize other techniques for 
mitigating risks, including the use of credit enhancements. In 
response, FHA said it agreed that these techniques should be evaluated 
when considering or proposing a new FHA product.
Before Fully Implementing New Products, Some Mortgage Institutions May 
        Limit Availability
    Some mortgage institutions initially may offer new products on a 
limited basis. For example, Fannie Mae and Freddie Mac sometimes use 
pilots, or limited offerings of new products, to build experience with 
a new product type. Fannie Mae and Freddie Mac also sometimes set 
volume limits for the percentage of their business that could be low- 
and no-down-payment lending. FHA has utilized pilots or demonstrations 
when making changes to its single-family mortgage insurance but 
generally has done so in response to legislative requirement rather 
than on its own initiative. For example, FHA's Home Equity Conversion 
Mortgage insurance program started as a pilot that authorized FHA to 
insure 2,500 reverse mortgages.\12\ Additionally, some mortgage 
institutions may limit the origination and servicing of new products to 
their better lenders and servicers. Fannie Mae and Freddie Mac both 
reported that these were important steps in introducing a new product.
---------------------------------------------------------------------------
    \12\ Under this program, homeowners borrow against equity in their 
home and receive payments from their lenders.
---------------------------------------------------------------------------
    We recommended that when FHA releases new products or makes 
significant changes to existing products, it consider similar steps to 
limit the initial availability of these products. FHA officials agreed 
that they could, under certain circumstances, envision piloting or 
limiting the ways in which a new product would be available, but 
pointed to the practical limitations of doing so. For example, FHA 
officials told us that administering the Home Equity Conversion 
Mortgage pilot program was difficult because of the challenges of 
equitably selecting a limited number of lenders and borrowers. FHA 
generally offers products on a national basis and, if they did not, 
specific regions of the county or lenders might question why they were 
not able to receive the same benefit. FHA officials told us they have 
conducted pilot programs when Congress has authorized them, but they 
questioned the circumstances under which pilot programs were needed, 
and also said that they lacked sufficient resources to appropriately 
manage a pilot. Consistent with these views, FHA officials told us more 
recently that they would not limit the initial availability of any 
products authorized by its legislative proposal. However, if FHA does 
not limit the availability of new or changed products, the agency runs 
the risk of facing higher claims from products whose risks may not be 
well understood.

  THE WAY FHA DEVELOPED TOTAL LIMITS THE SCORECARD'S EFFECTIVENESS IN 
                ASSESSING THE DEFAULT RISK OF BORROWERS

    A primary tool that FHA uses to assess the default risk of 
borrowers who apply for FHA-insured mortgages is its TOTAL scorecard. 
TOTAL's capabilities are important, because to the extent that 
conventional mortgage lenders and insurers are better able than FHA to 
use mortgage scoring to identify and approve relatively low-risk 
borrowers and charge fees based on default risk, FHA may face adverse 
selection. That is, conventional providers may approve lower-risk 
borrowers in FHA's traditional market segment, leaving relatively high-
risk borrowers for FHA. Accordingly, the greater the effectiveness of 
TOTAL, the greater the likelihood that FHA will be able to effectively 
manage the risks posed by borrowers and operate in a financially sound 
manner.
    In reports we issued in November 2005 and April 2006, we noted that 
while FHA's process for developing TOTAL generally was reasonable, some 
of the choices FHA made in the development process could limit the 
scorecard's effectiveness.\13\ FHA and its contractor used variables 
that reflected borrower and loan characteristics to create TOTAL, as 
well as an accepted modeling process to test the variables' accuracy in 
predicting default. However, we also found that:
---------------------------------------------------------------------------
    \13\ GAO, Mortgage Financing: HUD Could Realize Additional Benefits 
from its Mortgage Scorecard, GAO-06-435 (Washington, DC: Apr. 13, 2006) 
and GAO-06-24.
---------------------------------------------------------------------------
    The data used to develop TOTAL were 12 years old by the time FHA 
implemented the scorecard. Specifically, when FHA began developing 
TOTAL in 1998, the agency chose to use 1992 loan data, which would be 
old enough to provide a sufficient number of defaults that could be 
attributed to a borrower's poor creditworthiness. However, FHA did not 
implement TOTAL until 2004 and has not subsequently updated the data 
used in the scorecard. Best practices of private-sector organizations 
call for scorecards to be based on data that are representative of the 
current mortgage market--specifically, relevant data that are no more 
than several years old. In the past 12 years, significant changes--
growth in the use of down-payment assistance, for example--have 
occurred in the mortgage market that have affected the characteristics 
of those applying for FHA-insured loans. As a result, the relationships 
between borrower and loan characteristics and the likelihood of default 
also may have changed.
    TOTAL does not include certain key variables that could help 
explain expected loan performance. For example, TOTAL does not include 
a variable for the source of the down payment. However, FHA 
contractors, HUD's Inspector General, and our work have all identified 
the source of a down payment as an important indicator of risk, and the 
use of down-payment assistance in the FHA program has grown rapidly 
over the last 5 years. Further, TOTAL does not include other important 
variables--such as a variable for generally riskier adjustable rate 
loans--included in other scorecards used by private-sector entities.
    Although FHA had a contract to update TOTAL, the agency did not 
develop a formal plan for updating TOTAL on a regular basis. Best 
practices in the private sector, also reflected in bank regulator 
guidance, call for having formal policies to ensure that scorecards are 
routinely updated. Without policies and procedures for routinely 
updating TOTAL, the scorecard may become less reliable and, therefore, 
less effective at predicting the likelihood of default.
    To improve TOTAL's effectiveness, we recommended, among other 
things, that HUD develop policies and procedures for regularly updating 
TOTAL and more fully consider the risks posed by down-payment 
assistance when underwriting loans, such as including the presence and 
source of down-payment assistance as a loan variable in the scorecard. 
In response, FHA has developed and begun putting in place policies and 
procedures that call for annual: (1) monitoring of the scorecard's 
ability to predict loan default; (2) testing of additional predictive 
variables to include in the scorecard; and, (3) updating the scorecard 
with recent loan performance data.
    We also recommended that HUD explore additional uses for TOTAL, 
including using it to implement risk-based pricing of mortgage 
insurance and to develop new products. These actions could enhance 
FHA's ability to effectively compete in the mortgage market and avoid 
adverse selection. Our ongoing work indicates that FHA plans to use 
borrowers' TOTAL scores to help set insurance premiums. Accordingly, 
any limitations in TOTAL's ability to predict defaults could result in 
FHA mispricing its products.

 FHA'S CURRENT REESTIMATED SUBSIDY COSTS ARE GENERALLY LESS FAVORABLE 
                      THAN ITS ORIGINAL ESTIMATES

    As previously noted, FHA, like other Federal agencies, is required 
to reestimate credit subsidy costs annually to reflect actual loan 
performance and expected changes in estimates of future loan 
performance. In doing so, FHA reestimates subsidy costs for each loan 
cohort.
    As we reported in September 2005, FHA's subsidy reestimates 
generally have been less favorable (i.e., higher) than the original 
estimates since Federal credit reform became effective in 1992.\14\ The 
current reestimated subsidy costs for all except the fiscal year 1992 
and 1993 cohorts are higher than the original estimates. For example, 
the current reestimated cost for the fiscal year 2006 cohort is about 
$800 million less favorable than originally estimated.
---------------------------------------------------------------------------
    \14\ GAO, Mortgage Financing: FHA's $7 Billion Reestimate Reflects 
Higher Claims and Changing Loan Performance Estimates, GAO-05-875 
(Washington, DC: Sep. 2, 2005).
---------------------------------------------------------------------------
    With respect to reestimates across cohorts, our report examined 
factors contributing to an unusually large $7 billion reestimate (more 
than twice the size of other recent reestimates) that FHA submitted as 
of the end of fiscal year 2003 for the fiscal year 1992 through 2003 
cohorts. These factors included increases in estimated claims and 
prepayments (the payment of a loan before its maturity date). Several 
policy changes and trends may have contributed to changes in the 
expected claims. For example:
    Revised underwriting guidelines made it easier for borrowers who 
were more susceptible to changes in economic conditions--and therefore 
more likely to default on their mortgages--to obtain an FHA-insured 
loan.
    Competition from conventional mortgage providers could have 
resulted in FHA insuring more risky borrowers.
    FHA insured an increasing number of loans with down-payment 
assistance, which generally have a greater risk of default.
    FHA's loan performance models did not include key variables that 
help estimate loan performance, such as credit scores, and as of 
September 2005, the source of down payment.
    The major factors underlying the surge in prepayment activity were 
declining interest rates and rapid appreciation of housing prices. 
These trends created incentives and opportunities for borrowers to 
refinance using conventional loans.
    To more reliably estimate program costs, we recommended that FHA 
study and report on how variables found to influence credit risk, such 
as payment-to-income ratios, credit scores, and down-payment assistance 
would affect the forecasting ability of its loan performance models. We 
also recommended that when changing the definitions of key variables, 
FHA report the impact of such changes on the models' forecasting 
ability. In response, HUD indicated that its contractor was considering 
the specific variables that we had recommended FHA include in its 
annual actuarial review of the Fund. The contractor subsequently 
incorporated the source of down-payment assistance in the fiscal year 
2005 actuarial review and borrower credit scores in the fiscal year 
2006 review.
    Madam Chairman, this concludes my prepared statement. I would be 
happy to answer any questions at this time.

    Senator Murray. Thank you very much. Ms. Poole.

STATEMENT OF JOANNE POOLE, COMMITTEE LIAISON, NATIONAL 
            ASSOCIATION OF REALTORS
    Ms. Poole. Good morning, Madam Chairman and Ranking Member 
Bond and members of the subcommittee. I am the broker/owner of 
Poole Realty, located in Glen Burnie, Maryland. I have been a 
realtor for 21--sorry.
    I am the broker/owner of Poole Realty in Glen Burnie, 
Maryland and I have been a realtor for 21 years and I am 
currently part of the National Association of Realtors' 
Enlarged Leadership Team. I am here today to present the views 
of the National Association of Realtors' 1.3 million realtor 
members on the need to reform the FHA program.
    The current increase in foreclosures is troubling to all of 
us. Predatory lending, exotic mortgages and a dramatic rise in 
subprime lending, coupled with the slowing of the home price 
appreciation, have all contributed to this crisis.
    In 1934, the Federal Housing Administration was established 
to provide consumers an alternative during a similar lending 
crisis. At that time, short term, interest only and balloon 
loans were prevalent. As conventional and subprime lenders have 
expanded their repertoire of loan products, FHA has remained 
stagnant. As a result, a growing number of homebuyers have 
turned to subprime and nontraditional mortgages. While subprime 
loans have a very important role for certain borrowers, there 
are many consumers who have taken out subprime loans when they 
would have easily qualified for FHA at a lower overall cost.
    More troubling are the families who have explored 
nontraditional mortgages such as interest-only and option ARMs. 
For some of these borrowers, monthly payments will become 
impossible as payments increase by as much as 50 percent or 
more when the introductory periods end or when their loan 
balances get larger and larger each month instead of smaller.
    To enhance FHA's viability, the administration has proposed 
a number of important reforms to the FHA Single Family 
Insurance program that NAR believes will greatly benefit 
homebuyers by improving access to FHA's safe and affordable 
credit.
    As an example, the National Association of Realtors 
projects that in Washington State, where less than 6,500 
homeowners used FHA for financing in 2005, the reforms proposed 
could increase the number of FHA homebuyers by more than 62 
percent, saving those borrowers $20.9 million over what they 
would have paid with a subprime loan. Also based on NAR's 
research, we believe that in Missouri, the FHA borrowers would 
have increased by 50 percent for a savings of $18.1 million.
    Eliminating the statutory 3 percent minimum cash investment 
in down payment calculation will provide consumers a safe 
option away from the nontraditional products. Differing 
premiums based on the risk of the borrower, would allow FHA a 
balanced risk. Risk based pricing is accepted practice in the 
private market; it should be for FHA as well.
    The administration also proposes combining all Single 
Family programs into the Mutual Mortgage Insurance fund. It 
simply makes good business sense to combine these programs. The 
administration also proposes increasing FHA's loan limits, not 
in just high cost areas but nationwide. Such increases are 
critical to FHA to assist homebuyers in places like California 
but also areas where home prices exceed the current maximum of 
$200,160 but are not defined as high cost areas, such as 
Washington, Pennsylvania and Colorado.
    The universal and consistent availability of FHA loan 
products is the principle hallmark of the program that has made 
mortgage insurance available to individuals regardless of their 
racial, ethnic or social characteristics during periods of 
economic prosperity and economic depression. This will be 
especially important today.
    By offering access to prime rate financing, FHA provides 
borrowers a means to achieve lower monthly payments without 
relying on interest only or optional payment schemes. FHA 
products are fairly priced without resorting to teaser rates or 
negative amortization but provides safe and appropriate 
underwriting and loss mitigation programs.
    FHA's loss mitigation program authorizes lenders to assist 
borrowers in default. In the year 2004 alone, more than 78,000 
borrowers were able to retain their home through FHA's loss 
mitigation program and 2 years later, nearly 90 percent of 
those borrowers are still in their homes.
    By encouraging lenders to participate in loss mitigation 
efforts and penalizing those who don't, FHA has successfully 
helped homeowners keep their homes and reduce the level of 
losses to FHA fraud.

                           PREPARED STATEMENT

    FHA is often criticized--yes. Without the reforms to the 
FHA program first time homebuyers, minorities and homebuyers 
with less than perfect credit will continue to see fewer and 
fewer safe, affordable mortgage options. The National 
Association of Realtors really believe that this is a program 
that needs to be revamped and have partnered with the Federal 
Housing Administration to produce a booklet, which I would ask 
be admitted into testimony, FHA Improvement Benefits to You and 
the Homeowner.
    [The information follows:]

                   Prepared Statement of JoAnne Poole

    Madam Chairman, Ranking Member Bond, thank you for this opportunity 
to testify before you. My name is JoAnne Poole and I am the broker/
owner of Poole Realty in Glen Burnie, Maryland. I have been a realtor 
for 21 years, and am currently part of NAR's Enlarged Leadership Team, 
and serve as a 2007 Liaison.
    I am here to testify on behalf of 1.3 million members of the 
National Association of REALTORS. We thank you for the opportunity to 
present our view on the FHA program and the need for reform. NAR 
represents a wide variety of housing industry professionals committed 
to the development and preservation of the Nation's housing stock and 
making it available to the widest range of potential homebuyers. The 
Association has a long tradition of support for innovative and 
effective Federal housing programs and we have worked diligently with 
the Congress to fashion housing policies that ensure Federal housing 
programs meet their mission responsibly and efficiently.

                              NEED FOR FHA

    The current increase in foreclosures is troubling to all of us. In 
2006, 1.2 million families entered into foreclosure, 42 percent more 
than in 2005.\1\ Predatory lending, exotic mortgages and a dramatic 
rise in sub-prime lending--coupled with slowing home price 
appreciation--have all contributed to this crisis.
---------------------------------------------------------------------------
    \1\ A Flood of Foreclosures, But Should You Invest?, Market Watch, 
February 18, 2007.
---------------------------------------------------------------------------
    In 1934 the Federal Housing Administration was established to 
provide consumers an alternative during a similar lending crisis. At 
that time, short-term, interest-only and balloon loans were prevalent. 
Since its inception, FHA has insured more than 34 million properties. 
However, because it hasn't evolved, FHA's market share has been 
dropping. In the 1990's FHA loans were about 12 percent of the market. 
Today, that rate is less than 3 percent. This statistic is unfortunate 
given that FHA is needed now as much as it was in 1934. At the same 
time, the sub-prime market has skyrocketed. In 2003, the sub-prime 
market share was 8.5 percent by 2005 it was at 20 percent. In 2006, 
FHA/VA market share dropped 37.8 percent; conventional loans dropped 
9.8 percent; while sub-prime loans increased another 15.7 percent.
    When formed, FHA was a pioneer of mortgage products. FHA was the 
first to offer 30-year fixed-rate financing in a time when loans were 
generally for less than 5 years. Unfortunately, FHA has not changed 
with the times. Where they were once the innovator, FHA has become the 
lender of last resort. As conventional and sub-prime lenders have 
expanded their repertoire of loan products, FHA has remained stagnant. 
As a result, a growing number of homebuyers are deciding to use one of 
several new types of non-traditional mortgages that let them 
``stretch'' their income so they can qualify for a larger loan.
    Non-traditional mortgages often begin with a low introductory 
interest rate and payment--a ``teaser''--but the monthly mortgage 
payments are likely to increase significantly in the future. Some of 
these loans are ``low documentation'' mortgages that provide easier 
standards for qualifying, but also feature higher interest rates or 
higher fees. Mortgages such as interest-only and option ARMs can often 
be risky propositions for some borrowers. These products pose severe 
risk for consumers who may be unable to afford their mortgage payments 
when monthly payments increase by as much as 50 percent or more when 
the introductory periods end, or when their loan balances get larger 
each month instead of smaller. Mortgage experts estimate that 
approximately $1.5 trillion worth of adjustable mortgages will reset by 
the end of 2007.\2\ While some borrowers may be able to make the new 
higher payments, many will find it difficult, if not impossible.
---------------------------------------------------------------------------
    \2\ Homeowners Brace For ARMs' New Rates, The Seattle Times, 
February 17, 2007.
---------------------------------------------------------------------------
    As the market has changed, FHA must also change to reflect consumer 
needs and demands. If FHA is enhanced to conform to today's mortgage 
environment, many borrowers would have available to them a safer 
alternative to the riskier products that are currently marketed to 
them.

                          FHA REFORM PROPOSALS

    To enhance FHA's viability, the administration has proposed a 
number of important reforms to the FHA single-family insurance program 
that NAR believes will greatly benefit homebuyers by improving access 
to FHA's safe and affordable credit. By way of an example, NAR projects 
that in Washington State, where less than 6,500 homeowners used FHA for 
financing in 2005, the reforms proposed could increase the number of 
FHA homebuyers by more than 62 percent, saving those borrowers $20.9 
million over what they would pay for a sub-prime loan.
    FHA is proposing to eliminate the statutory 3 percent minimum cash 
investment and downpayment calculation, allow FHA flexibility to 
provide risk-based pricing, move the condo program into the 203(b) 
fund, and increase the loan limits. The National Association of 
REALTORS strongly supports these reform provisions.
    Down Payment Flexibility.--The ability to afford the downpayment 
and settlement costs associated with buying a home remains the most 
challenging hurdle for many homebuyers. Eliminating the statutory 3 
percent minimum downpayment will provide FHA flexibility to offer 
varying downpayment terms to different borrowers. Although housing 
remains strong in our Nation's economy and has helped to increase our 
Nation's homeownership rate to a record 69 percent, many deserving 
American families continue to face obstacles in their quest for the 
American dream of owning a home. Providing flexible downpayment 
products for FHA will go a long way to addressing this problem.
    In 2005, 43 percent of first-time homebuyers financed 100 percent 
of their home. NAR research indicates that if FHA were allowed to offer 
this option, 1.6 million families could benefit. According to NAR's 
Profile of Homebuyers, 55 percent of homebuyers who financed with a 
zero-downpayment loan in 2005, had incomes less than $65,000; 24 
percent of those who used a zero-downpayment product were minorities; 
and 52 percent of people who financed 100 percent of their home 
purchased homes priced at less than $150,000. It is important to note 
that FHA will require borrowers to have some cash investment in the 
home. This investment can be in the form of payment of the up-front 
premium or closing costs. No loan will be made for more than 103 
percent the value of the home.
    Loan Limits.--FHA mortgages are used most often by first-time 
homebuyers, minority buyers, and other buyers who cannot qualify for 
conventional mortgages because they are unable to meet the lender's 
stringent underwriting standards. Despite its successes as a 
homeownership tool, FHA is not a useful product in high cost areas of 
the country because its maximum mortgage limits have lagged far behind 
the median home price in many communities. As a result, working 
families such as teachers, police officers and firefighters are unable 
to buy a home in the communities where they work. Even in your home 
State of Washington, Madam Chairman, the median home price exceeds 
FHA's current limit of $200,160.
    This is why NAR strongly supports proposals to change the FHA loan 
limits. Under the administration's plan, FHA's limits for single unit 
homes in high cost areas would increase from $362,790 to the 2006 
conforming loan limit of $417,000. In non-high cost areas, the FHA 
limit (floor) would increase from $200,160 to $271,050 for single unit 
homes. This increase will enhance FHA's ability to assist homebuyers in 
areas not defined as high-cost, but where home prices still exceed the 
current maximum of $200,160. This includes States like Arizona, 
Colorado, Florida, Georgia, Illinois, Maine, Minnesota, Nevada, North 
Carolina, Ohio, Oregon, Pennsylvania, Utah, Vermont, and Washington. 
While none of these States is generally considered ``high cost'', all 
have median home prices higher than the current FHA loan limit.
    Risk-based Pricing.--Another key component of the administration's 
proposal is to provide FHA with the ability to charge borrowers 
different premiums based on differing credit scores and payment 
histories. Risk-based pricing of the interest rate, fees and/or 
mortgage insurance is used in the conventional and sub-prime markets to 
manage risk and appropriately price products based on an individual's 
financial circumstances. Currently, all FHA borrowers, regardless of 
risk, pay virtually the same premiums and receive the same interest 
rate.
    The legislation will allow FHA to differentiate premiums based on 
the risk of the product (e.g. amount of cash investment) and the credit 
profile of the borrower. These changes will enable FHA to offer all 
borrowers choices in the type of premium charged (e.g. annual, upfront 
or a hybrid). In addition it will permit FHA to reach higher risk 
borrowers (by charging them a premium amount commensurate with risk), 
while continuing to attract the better credit risks, by charging them 
less. FHA financing, with risk-based premium pricing, will still be a 
much better deal for borrowers with higher risk characteristics than is 
currently available in the ``near prime'' or sub-prime markets. Risk-
based pricing makes total sense to the private market, and should for 
FHA as well.
    It is also important to note that, while FHA has had the authority 
to charge premiums up to 2.25 percent, they have not done so. FHA 
currently charges 1.5 percent. The FHA Fund is strong and has continued 
to have excess revenue, so there has not been a need to increase the 
premiums. However, due to its markedly decreased market share, FHA may 
have to increase premiums on borrowers in 2007 and in future years. 
Unless the program is reformed to make it more consumer-friendly, FHA 
will need to generate more revenue to cover its losses.
    Giving FHA the flexibility to charge different borrowers different 
premiums based on risk will allow FHA to increase their pool of 
borrowers. If FHA is also given authority to provide lower downpayment 
mortgages, premium levels will need to reflect the added risk of such 
loans (as is done in the private market) to protect the FHA fund.
    Changes to the Fund Structures.--The administration also proposes 
to combine all single-family programs into the Mutual Mortgage 
Insurance Fund. The FHA program has four funds with which it insures 
its mortgages. The Mutual Mortgage Insurance (MMI) Fund is the 
principal funding account that insures traditional section 203b single-
family mortgages. The Fund receives upfront and annual premiums 
collected from borrowers as well as net proceeds from the sale of 
foreclosed homes. It is self-sufficient and has not required taxpayer 
bailouts.
    The Cooperative Management Housing Insurance Fund (CMHI), which is 
linked to the MMI Fund, finances the Cooperative Housing Insurance 
program (section 213) which provides mortgage insurance for cooperative 
housing projects of more than 5 units that are occupied by members of a 
cooperative housing corporation.
    FHA also operates Special Risk Insurance (SRI) and General 
Insurance (GI) Funds, insuring loans used for the development, 
construction, rehabilitation, purchase, and refinancing of multifamily 
housing and healthcare facilities as well as loans for disaster 
victims, cooperatives and seniors housing. Currently, the FHA 
condominium loan guarantee program and 203k purchase/rehabilitation 
loan guarantee program are operated under the GI/SRI Fund.
    NAR strongly supports inclusion of the FHA condominium loan 
guarantee program and the 203k purchase/rehabilitation loan guarantee 
program in the MMIF. Both of these programs provide financing for 
single family units and have little in common with multifamily and 
health facilitates programs covered by the SRI and GI funds. In recent 
years programs operating under the GI/SRI funds have experienced 
disruptions and suspensions due to funding commitment limitations. 
Maintaining the single family condo and purchase/rehabilitation 
programs under the GI/SRI funds exposes these programs to possible 
future disruptions. Thus, from a conceptual an accounting standpoint, 
it makes sound business sense to place all single-family programs under 
the MMIF.
    Program Enhancements.--As well as combining the 203(k) and 
condominium programs under the MMIF, NAR also recommends key 
enhancements to increase the programs' appeal and viability. 
Specifically, NAR recommends that HUD be directed to restore investor 
participation in the 203(k) program. In blighted areas, homeowners are 
often wary of the burdens associated with buying and rehabilitating a 
home themselves. However, investors are often better equipped and 
prepared to handle the responsibilities related to renovating and 
repairing homes. Investors can be very helpful in revitalizing areas 
where homeowners are nervous about taking on such a project.
    We also recommend that HUD lift the current owner-occupied 
requirement of 51 percent before individual condominium units can 
qualify for FHA-insured mortgages. The policy is too restrictive 
because it limits sales and homeownership opportunities, particularly 
in market areas comprised of significant condominium developments and 
first-time homebuyers. In addition, the inspection requirements on 
condominiums are burdensome. HUD has indicated that it would provide 
more flexibility to the condo program under the MMIF. We strongly 
support loosening restrictions on FHA condo sales and 203k loans to 
provide more housing opportunities to homebuyers nationwide.

                        BORROWER BENEFITS OF FHA

    The universal and consistent availability of FHA loan products is 
the principal hallmark of the program that has made mortgage insurance 
available to individuals regardless of their racial, ethnic, or social 
characteristics during periods of economic prosperity and economic 
depression.
    The FHA program makes it possible for higher-risk, yet credit-
worthy borrowers to get prime financing. According to a recent Federal 
Reserve Bank review,\3\ the average credit score for sub-prime 
borrowers was 651. This is higher than FHA's median credit score 
borrower, which demonstrates that these borrowers are likely paying 
more than they need to pay. By offering access to prime rate financing, 
FHA provides borrowers a means to achieve lower monthly payments--
without relying to interest-only or ``optional'' payment schemes. FHA 
products are safe, thanks to appropriate underwriting and loss-
mitigation programs, and fairly priced without resorting to teaser 
rates or negative amortization.
---------------------------------------------------------------------------
    \3\ Federal Reserve Bank of St. Louis Review--January-February 
2006.
---------------------------------------------------------------------------
    When the housing market was in turmoil during the 1980s, FHA 
continued to insure loans when others left the market; following 9/11, 
FHA devised a special loan forbearance program for those who 
temporarily lost their jobs due to the attack; after Hurricanes Katrina 
and Rita, FHA provided a foreclosure moratorium for borrowers who were 
unable to pay their mortgages while recovering from the disaster. FHA's 
universal availability has helped to stabilize housing markets when 
private mortgage insurance has been nonexistent or regional economies 
have faltered. FHA is the only national mortgage insurance program that 
provides financing to all markets at all times. Simply put, FHA has 
been there for borrowers.
    Now, more than ever, FHA needs to be strengthened to continue to be 
available to borrowers. In just the past few months, at least 25 sub-
prime lenders have exited the business, declared bankruptcy, announced 
significant losses, or put themselves up for sale.\4\ After making 
record profits, these lenders are simply bailing as the bad loans they 
made begin to fail. FHA, who is more careful with its underwriting 
standards, can be a safe alternative for buyers who have been lured 
into unnecessary sub-prime loans.
---------------------------------------------------------------------------
    \4\ The Mortgage Mess Spreads, BusinessWeek.com, March 7, 2007.
---------------------------------------------------------------------------
    FHA is a leader in preventing foreclosures. FHA's loss mitigation 
program authorizes lenders to assist borrowers in default. The program 
includes mortgage modification and partial claim options. Mortgage 
modification allows borrowers to change the terms of their mortgage so 
that they can afford to stay in the home. Changes can include extension 
of the length of the mortgage or changes in the interest rate. Under 
the partial claim program, FHA lends the borrower money to cure the 
loan default. This no-interest loan is not due until the property is 
sold or paid off. In the year 2004 alone, more than 78,000 borrowers 
were able to retain their home through FHA's loss mitigation program; 
and 2 years later, nearly 90 percent of these borrowers are still in 
their homes. By encouraging lenders to participate in these loss 
mitigation efforts and penalizing those who don't, FHA has successfully 
helped homeowners keep their homes and reduced the level of losses to 
the FHA fund.

                      SOLVENCY AND STRENGTH OF FHA

    Critics of the reform proposals have argued that FHA isn't 
positioned to handle changes to the program. We respectfully disagree. 
Despite FHA's falling market share, the FHA fund is healthy and strong. 
Congress has mandated that FHA have a capitalization ratio of 2 percent 
to insure fiscal solvency. In 2006, the FHA cap ratio was far above 
that figure at 6.82 percent--despite being the lender of last resort in 
today's marketplace. FHA's current economic value is over $22 billion. 
In simple terms, this indicates that if the MMIF stopped operations 
today, the current portfolio would be expected to generate $22 billion 
dollars over the remaining life of the loans in the portfolio above 
what it would pay out in claims. Since its inception in 1934, FHA has 
never needed a Federal bailout, and has been completely self-
sufficient. In fact, FHA has contributed a significant amount of money 
to the Federal Treasury each year. However, due to the dramatic loss in 
volume, FHA has estimated that it will need to increase premiums if 
reforms are not implemented that increase usage of FHA.
    If FHA is allowed to adjust premiums based on risk, it will operate 
even more soundly than it does today. If FHA is to thrive and fully 
perform its intended function, a change to risk-based pricing is 
necessary. Average pricing in the portion of the credit spectrum where 
FHA operates is crucial if FHA is to sustain its operations in a 
financially solvent manner. Absent risk-based premiums, the risk 
profile FHA borrowers can decrease, causing either an increase in the 
average price or an ultimate shortfall in the insurance fund. This is 
why FHA has estimated that it will need to increase premiums if reforms 
are not implemented that increase usage of FHA.
    FHA is often criticized for its default and foreclosure rate. That 
criticism is unwarranted, as FHA's mission is to serve people that 
aren't served by the conventional market, and therefore are more risky. 
However, FHA's foreclosure rate is substantially better than the sub-
prime market, where many FHA-eligible borrowers currently have loans. A 
recent study by the Center for Responsible Lender reported that ``FHA 
and sub-prime loans have quite different foreclosure rates. For 
example, sub-prime loans originated in 2000 in our sample had a 12.9 
percent foreclosure rate within 5 years. In contrast, . . . FHA loans 
originated in 2000 had a 6.29 percent foreclosure rate by year-end 
2005.'' \5\
---------------------------------------------------------------------------
    \5\ Losing Ground:Foreclosures in the Subprime Market and Their 
Cost to Homeowners, Center for Responsible Lending, December 2006, page 
26.
---------------------------------------------------------------------------
    When FHA has seen problems with their default rates, they have 
tried to remedy them. FHA noticed that loans which utilized a gift 
downpayment had a higher default rate. These gifts included seller-
funded downpayment assistance. FHA attempted to eliminate this program 
and faced legal challenges. At that time Congress supported downpayment 
gift providers, and challenged HUD's attempt to shut them down. Studies 
done by the Government Accountability Office and others determined that 
this form of downpayment assistance in fact drove up the costs of 
homeownership, and generally made the loan a bigger risk. Although the 
IRS recently ruled that many seller-funded downpayment programs would 
lose their charitable tax status, they have yet to change the status of 
any organization. To avoid further delay, FHA announced plans to 
publish a notice prohibiting gift downpayment loans from FHA 
eligibility. Such a prohibition should greatly improve FHA's default 
rate. It has been estimated that 29 percent of FHA borrowers in 2005 
used seller-funded downpayment assistance.
    Instead, by providing FHA the ability to offer flexible down 
payments, homeowners won't bear the increased home price costs and the 
loans will be safer. Allowing FHA to price low downpayment loans 
according to risk, they would be more in line with the conventional 
market. This will greatly increase FHA's default rate.
    Furthermore, FHA's operations have improved dramatically in the 
last several years. In 1994, HUD was designated as ``high risk'' by the 
Government Accountability Office, a longtime critic of the Department. 
Last month, that designation was removed. GAO said that ``HUD had 
improved its oversight of lenders and appraisers and issues or proposed 
regulations to strengthen lender accountability and combat predatory 
lending practices.'' \6\ HUD has also demonstrated their ability to 
estimate program costs and oversight for mortgage underwriting.
---------------------------------------------------------------------------
    \6\ GAO, High Risk Series: An Update, GAO-07-310 (Washington, DC.: 
January, 2007)
---------------------------------------------------------------------------

                               CONCLUSION

    Thank you again for the opportunity to testify on this important 
issue. Now is the time when the country needs FHA. As sub-prime loans 
reset and real estate markets are no longer experiencing double digit 
appreciation; a reformed FHA would be perfectly positioned to offer 
borrowers a safer mortgage alternative and bring stability to local 
markets and local economies. The National Association of REALTORS 
stands ready to work with the Congress on passage of FHA reform.
                                 ______
                                 
                      Attachment 1.--FHA Brochure
         Shopping for a Mortgage? FHA Improvements Benefit You
FHA Insured Mortgages
Realtors and FHA: Partners in Homeownership

REALTORS AND FHA--WORKING TOGETHER TO HELP PEOPLE FULFILL THE AMERICAN 
                                 DREAM

    REALTORS and the Federal Housing Administration (FHA), which is 
part of the U.S. Department of Housing and Urban Development (HUD), 
have been partners in creating homeownership opportunities for more 
than 70 years. Since FHA was created in 1934, it has helped more than 
34 million families become homeowners, many by working with their 
REALTORS to achieve their dream of homeownership.
    This brochure illustrates improvements in FHA programs that will 
benefit you. Many aspects of the FHA mortgage application process have 
been streamlined to make the process more user-friendly and efficient. 
Upon reading this brochure, you will see that FHA programs are a 
valuable asset to REALTORS, other real estate professionals, and most 
importantly, those seeking to own a home.
    Backed by the full faith and credit of the Federal government, FHA-
insured mortgages are one of the safest and most affordable types of 
mortgages available to homebuyers. Working together, REALTORS and FHA 
help millions of families come home.

                    WHAT IS FHA MORTGAGE INSURANCE?

    The Federal Housing Administration (FHA) insures mortgages offered 
by banks, savings associations, and other financial institutions. An 
FHA-insured mortgage is backed by the full faith and credit of the 
United States government. While FHA does not make loans, it benefits 
the homebuyer by providing mortgage insurance which encourages 
financial institutions to make affordable financing available.

               WHAT ARE THE BENEFITS OF AN FHA MORTGAGE?

    FHA offers low down payment options, eligibility with less than 
perfect credit, a loan at a reasonable cost, and help if there is ever 
trouble making the mortgage payment. Because an FHA mortgage insures 
the lender against loss, an FHA mortgage typically has an interest rate 
that is competitive with the best in your market and lower than the 
rates charged for subprime and other non-prime mortgages.
    FHA not only helps people buy a home, but helps them keep it as 
well. In return for protecting lenders against loss, FHA requires 
financial institutions to offer assistance to borrowers experiencing 
difficulty making mortgage payments.

                        WHAT ABOUT ELIGIBILITY?

    In order to be eligible for an FHA-insured mortgage, a borrower 
must:
  --Occupy the property as the principal residence;
  --Possess a valid Social Security Number;
  --Have a two-year employment history;
    --School and military service count towards this two-year 
            requirement.
  --Not be delinquent on any Federal debt such as a student loan or 
        other FHA-insured mortgage; and
  --Meet flexible credit requirements.

  THERE ARE SEVERAL OTHER FEATURES WORTH KNOWING ABOUT AN FHA-INSURED 
                               MORTGAGE:

  --FHA adopted the industry appraisal standards permitting the use of 
        the Fannie Mae appraisal forms with no additional specialized 
        documentation, no Valuation Conditions form or Homebuyer 
        Summary.
  --FHA has eliminated unnecessary requirements to make minor repairs.
  --The homebuyer and the seller, individually or jointly, can pay 
        closing costs as agreed to in the sales contract. FHA no longer 
        limits what closing costs the homebuyer is permitted to pay.
  --Caps on payment and debt-to-income ratios are more generous than 
        most standard conforming mortgage products. The payment-to-
        income ratio may not exceed 31 percent and the debt-to-income 
        ratio may not exceed 43 percent.
  --A minimum credit score is not required. In fact, one may not be 
        turned down for an FHA mortgage solely for lack of credit 
        history.
  --The buyer's entire cash investment--as little as three percent--can 
        be a gift from a family member, employer, charitable 
        organization or local government entity.
  --The seller can contribute up to 6 percent of the home's price 
        toward closing costs through a seller's concession.
  --There are no prepayment penalties on FHA-insured mortgages.
  --U.S. citizenship is not required but, for those who are not 
        citizens, they must be lawful permanent or non-permanent 
        resident aliens with a valid Social Security Number.
          how else can fha assist in achieving homeownership?
    In addition to its standard Section 203(b) Mortgage Insurance 
Program, FHA has a number of other valuable programs designed to 
facilitate homeownership.
FHA Adjustable Rate Mortgage (ARM) Products
  --FHA offers a standard 1-year adjustable rate mortgage (ARM) as well 
        as 3, 5, 7, and 10-year ARM options.
  --ARM products may be good options for those who plan to own the home 
        for only a few years, expect an increase in future earnings, or 
        expect a decrease in interest rates.
FHA's Limited Repair Program
  --FHA's Section 203(k) Limited Repair Program is an excellent 
        financing option for you whether buying or selling homes--
        especially when repairs are identified during a home inspection 
        or appraisal--because it gives buyers the ability to make 
        repairs after closing.
  --Buyers can finance up to an additional $35,000 into their mortgage 
        to pay for minor remodeling such as replacing flooring, 
        installing new appliances, and painting the interior and/or 
        exterior of the home.

     IN ADDITION TO FHA, THE U.S. DEPARTMENT OF HOUSING AND URBAN 
               DEVELOPMENT (HUD) OFFERS THESE RESOURCES:

HUD Homes
    The Department has single-family homes in hundreds of communities 
available for sale to the public. How do you benefit from purchasing a 
HUD Home?
  --Many HUD homes are available with FHA financing, making it easier 
        to purchase a home.
  --The Department pays the real estate commission, if it is included 
        in the contract.
  --Only a real estate professional licensed by the state and 
        registered with HUD can sell HUD homes.
    For more information on available HUD homes, please visit: 
www.homesales.gov.
    For more information on selling HUD homes, please visit: 
www.hud.gov/groups/brokers.cfm.
HUD-Approved Housing Counseling Agencies
    Homebuyers often have a lot of questions about getting an FHA-
insured mortgage and about the home buying process in general. HUD-
approved Housing Counseling Agencies provide buyers the opportunity to 
get the answers they need by meeting with a housing counselor at a HUD-
approved agency in their community. These agencies offer homeownership 
counseling and financial literacy training at little or no cost. To 
find a counselor in your neighborhood, call 1-800-569-4287 or visit 
http://www.hud.gov/buying/index.cfm and click on ``find a housing 
counselor'' on the right under ``counseling and education.''
    To learn more about these products or to find out if there are 
homeownership programs sponsored by your state or local governments and 
other community organizations, please visit FHA's website at 
www.fha.gov or call 1.800 CALL FHA.
    For more information about the National Association of REALTORS 
and how we work with you, visit our website at www.REALTOR.org.
    The National Association of REALTORS, ``The Voice for Real 
Estate,'' is America's largest trade association, representing more 
than 1.3 million members involved in all aspects of the residential and 
commercial real estate industries. For more information, please visit 
www.REALTOR.org.
    The Federal Housing Administration (FHA)--which is part of the U.S. 
Department of Housing and Urban Development--has been helping people 
become homeowners since 1934. FHA insures the loan, so lenders can 
offer you a better deal. FHA offers loans with low down payments that 
are easier to qualify for, and can cost less than conventional loans. 
For more information, please visit www.fha.gov.
    October 2006, Item# 126-128. National Association of REALTORS, 500 
New Jersey Avenue, NW, Washington, DC, 20001. Federal Housing 
Administration, U.S. Department of Housing and Urban Development, 451 
7th Street, SW, Washington, DC, 20410.

    Senator Murray. Thank you very much. Mr. Robbins.

STATEMENT OF JOHN M. ROBBINS, CHAIRMAN, MORTGAGE 
            BANKERS ASSOCIATION
    Mr. Robbins. Good morning, Chairwoman Murray and Ranking 
Member Bond. Thank you for holding this hearing and inviting me 
to share MBA's views on reforming the FHA.
    I have spent over 36 years working with FHA and I have made 
billions of dollars in loan originations to families who have 
achieved the dream of home ownership through FHA's programs. 
When I started in the mortgage business, FHA programs helped us 
serve many borrowers who otherwise would not get a loan.
    Today, the story is very different. In 2003, FHA made up 
approximately 16 percent of my company's overall production. 
Last year, only a little more than 1 percent of our business 
went to FHA.
    While the mortgage market has grown significantly, our use 
of the FHA program has dropped precipitously. Lenders have 
progressed, reacting to quickly changing and efficient 
technology. Unfortunately, FHA has not. While the needs of low-
and-moderate income homebuyers, first time homebuyers and of 
senior homeowners have changed, FHA has not followed its 
historic path of adopting to meet borrowers' changing needs.
    MBA strongly supports FHA and believes it still plays a 
critical role in today's marketplace. Most of FHA's business is 
directed toward low-and-moderate income and minority borrowers, 
the very strata that is most challenged to be part of the 
American dream. At the same time, we have watched with growing 
concern as FHA has steadily lost market share over the past 
decade, potentially threatening its long-term ability to help 
underserved borrowers.
    As the market continues to evolve around FHA, the great 
fear is that many aspiring homeowners will either be left 
behind or forced into higher cost alternatives.
    MBA notes with great concern that the administration's 
fiscal year 2008 budget proposal estimates the FHA Mortgage 
Insurance Fund will go into the red next year unless changes to 
the existing program are made or additional appropriations are 
provided. MBA agrees with the administration that FHA's Mutual 
Mortgage Insurance Fund would run in the black with little or 
no premium increase necessary if FHA reform proposals were 
passed this year.
    In fact, in casual calculation--back of the envelope--not 
at this point supported by MBA institutional research, I 
suggest if FHA were to regain its market share back to its 1990 
level of 10 percent, the U.S. Treasury would receive an 
additional $3 billion a year in revenue from expanded use of 
this program. We believe Congress should empower FHA to allow 
it to meet today's needs and anticipate tomorrow's.
    MBA believes changes should be made in three areas. FHA 
needs more flexibility to introduce innovative new products, 
invest in new technology and manage their human resources. MBA 
supports changes to FHA's loan limits. FHA's down payment 
requirements, including the elimination of the complicated down 
payment formula and down payment flexibility. The down payment 
is one of the primary obstacles for first-time minority and 
low-income borrowers.
    Finally, MBA also supports changes to the Home Equity 
Conversion Mortgage Program. MBA's surveys show that FHA's 
hack' em-up product comprises 95 percent of all reverse 
mortgages and is thus, tremendously important for our senior 
homeowners.
    In conclusion, FHA has an important role to play in the 
market, in the expanding, affordable home ownership 
opportunities for the underserved and addressing the home 
ownership gap. For low-and-moderate income families, FHA should 
be the financing considered first because it has the lowest 
rate and provides borrowers the best opportunity to become a 
successful homeowner.

                           PREPARED STATEMENT

    However, the current loss of market presence means we are 
losing FHA's impact. The result is that some families are 
either turning to more expensive financing or giving up. I urge 
Congress to enact legislation to reform FHA, to increase its 
availability to homebuyers, promote consumer choice and ensure 
its ability to continue serving American families. MBA stands 
ready to work with you on this important issue.
    [The statement follows:]

                 Prepared Statement of John M. Robbins

    Thank you for holding this hearing and inviting the Mortgage 
Bankers Association (MBA) \1\ to share its views with the subcommittee 
on the solvency and reform proposals for the Federal Housing 
Administration (FHA). My name is John Robbins and I am Co-Head and 
Special Counsel of American Mortgage Network, and Chairman of the 
Mortgage Bankers Association (MBA). Formerly, I was Chief Executive 
Officer of American Mortgage Network (AmNet), a wholesale mortgage bank 
I co-founded which is based in San Diego. AmNet was bought by Wachovia 
Bank in 2005. I am here today because MBA believes Congress must act to 
make important legislative changes to the National Housing Act if the 
Federal Housing Administration (FHA) is to continue to be a financially 
sound tool for lenders to use in serving the housing needs of American 
families who are unserved or underserved by conventional markets.
---------------------------------------------------------------------------
    \1\ The Mortgage Bankers Association (MBA) is the national 
association representing the real estate finance industry, an industry 
that employs more than 500,000 people in virtually every community in 
the country. Headquartered in Washington, DC, the association works to 
ensure the continued strength of the Nation's residential and 
commercial real estate markets; to expand homeownership and extend 
access to affordable housing to all Americans. MBA promotes fair and 
ethical lending practices and fosters professional excellence among 
real estate finance employees through a wide range of educational 
programs and a variety of publications. Its membership of over 3,000 
companies includes all elements of real estate finance: mortgage 
companies, mortgage brokers, commercial banks, thrifts, Wall Street 
conduits, life insurance companies and others in the mortgage lending 
field. For additional information, visit MBA's Web site: 
www.mortgagebankers.org.
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    When I started in the mortgage business, the programs of FHA were 
invaluable in enabling us to serve families who otherwise would have no 
other affordable alternative for financing their home. I spent over 36 
years working with FHA and have made millions of dollars in loan 
originations to families who have become homeowners as a result of 
FHA's programs. We worked hard to be a good partner with FHA in 
administering its programs and, together, FHA and AmNet enabled 
thousands of families to purchase their first home.
    Today, though, the story is very different. While AmNet has grown 
significantly, our ability to use the FHA program has declined 
precipitously. In 2003, FHA made up approximately 16 percent of our 
overall production. Last year, however, only a little more than 1 
percent of our business went to FHA.
    While AmNet has been able to adapt to changes in the mortgage 
markets, FHA has been prevented from doing so. The needs of low- and 
moderate-income homebuyers, of first-time homebuyers, of minority 
homebuyers, and of senior homeowners have changed. FHA's programs 
though, have not followed their historic path of adaptation to meet 
these borrowers' changing needs.
    The numbers are troublesome. In 1990, 13 percent of total 
originations in the United States were FHA-insured mortgages. 
Currently, that number has dropped to under 3 percent.\2\ More 
importantly, in 1990, 28 percent of new home sales (which are typically 
a large first-time homebuyer market) were financed through programs at 
FHA or the Department of Veterans Affairs (VA); today that number has 
dropped to under 12 percent.
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    \2\ Source: Inside Mortgage Finance, March 2, 2007.
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    MBA cites these numbers not because we believe that there is a 
certain market share that FHA should retain, but rather because these 
numbers are consistent with many lenders' views that FHA has not kept 
up with changes in the market. These numbers point to a decline, not 
just in market share, but in FHA's potential to positively impact 
homeownership. This loss of impact does not stem from the fact that FHA 
is no longer relevant, but rather that statutory constraints prohibit 
FHA from adapting its relevance to consumer needs today.
    A recent anecdote illustrates this point very well. A story ran in 
RealtyTimes almost 2 years ago, on June 21, 2005, in which a 
Baltimore, MD real estate agent unabashedly advises homebuyers to avoid 
FHA financing. The agent states: ``Approved FHA loan recipients, same 
notice to you, don't bother bringing it to the table during a sellers 
market. More times than not, your offer will be rejected. We know that 
VA and FHA loans allow you the means of purchasing more home for the 
mortgage, but it only works if you are the only game in town.'' His 
advice was based on the often true notion that FHA-insured financing is 
slower and more laborious than conventional financing, which means 
FHA's valuable programs are not reaching the people they should.

                             FHA BACKGROUND

    FHA was created as an independent entity by the National Housing 
Act on June 27, 1934, to encourage improvement in housing standards and 
conditions, to provide an adequate home financing system by insurance 
of housing mortgages and credit and to exert a stabilizing influence on 
the mortgage market. FHA was incorporated into the newly formed U.S. 
Department of Housing and Urban Development (HUD) in 1965. Over the 
years, FHA has facilitated the availability of capital for the Nation's 
multifamily and single-family housing market by providing government-
insured financing on a loan-by-loan basis.
    FHA offers multifamily and single-family insurance programs that 
work through private lenders to extend financing for homes. FHA has 
historically been an innovator. Over the past several decades, the 
mission of FHA's single-family programs have increasingly focused on 
expanding homeownership for those families who would otherwise either 
be unable to obtain financing or obtain financing with affordable 
terms. FHA's multifamily programs have allowed projects to be developed 
in areas that otherwise would be difficult to finance and provides 
needed rental housing to families that might otherwise be priced out of 
a community.
    Additionally, the FHA program has been a stabilizing influence on 
the Nation's housing markets due to the fact that it is consistently 
available under the same terms at all times and in all places. FHA does 
not withdraw from markets.

                  THE NEED FOR FHA TODAY AND TOMORROW

    The FHA single-family programs are vital to many homebuyers who 
desire to own a home but cannot find affordable financing to realize 
this dream. While the FHA has had a number of roles throughout its 
history, its most important role today is to give first-time homebuyers 
the ability to climb onto the first rung of the homeownership ladder 
and to act as a vehicle for closing the homeownership gap for 
minorities and low- and moderate-income families.
    Despite this country's recent record high levels of homeownership, 
not all families share in this dream equally. As of the first quarter 
of 2006, the national homeownership rate stood at 68.5 percent, but 
only 51 percent of minorities owned their own home. Only 48 percent of 
African-Americans and 49.4 percent of Latinos owned their own homes. 
This compares with 75.5 percent of non-Hispanic white households.
    By the end of 2005, 84.3 percent of families earning more than the 
median income owned their own home, while only 53.1 percent of families 
below the median income owned their own home.
    These discrepancies are tragic because homeownership remains the 
most effective wealth-building tool available to the average American 
family.

                              FHA'S RECORD

    More than any other nationally available program, during the 1990s, 
FHA's impact focused on the needs of first-time, minority, and/or low- 
and moderate-income borrowers.
    In 1990, 64 percent of FHA borrowers using FHA to purchase a home 
were first-time homebuyers. Today, that rate has climbed to about 80 
percent. In 1992, about 1-in-5 FHA-insured purchase loans went to 
minority homebuyers. That number in recent years has grown to more than 
one-in-three. Minorities make up a greater percentage of FHA borrowers 
than they do conventional market borrowers.
    FHA is particularly important to those minority populations 
experiencing the largest homeownership gaps. Home Mortgage Disclosure 
Act (HMDA) data reveal that in 2004, 14.2 percent of FHA borrowers were 
African-Americans, compared with 5.4 percent of conventional borrowers. 
Hispanic borrowers made up 15.3 percent of FHA loans, while they only 
were 8.9 percent of the conventional market. Combined, African-American 
and Hispanic borrowers constituted 29.5 percent of FHA loans, doubling 
the conventional market's rate of 14.3 percent. In fact, in 2004, FHA 
insured nearly as many purchase loans to African-American and Hispanic 
families as were purchased by Fannie Mae and Freddie Mac combined.
    The same data demonstrates FHA's tremendous service to those 
American families earning near or below the national median income. 
Over 57 percent of FHA borrowers earned less than $50,000, which is 
more than double the rate of the conventional market, where fewer than 
28 percent of borrowers earned less than $50,000.
    Ironically, as the above numbers reveal, FHA's mission to serve 
underserved populations has become increasingly focused during the same 
period as the decline in FHA's presence in the market. FHA's impact is 
being lost at the very time when it is needed most. The result is that 
American families are either turning to more expensive financing or 
giving up.
    It is crucial that FHA keep pace with changes in the U.S. mortgage 
markets. While FHA programs can be the best and most cost-effective way 
of expanding lending to underserved communities, we have yet to unleash 
the full potential of these programs to help this country achieve 
important societal goals.
    To be effective in the 21st century, FHA should be empowered to 
allow it to develop products and programs to meet the needs of today's 
homebuyers and anticipate the needs of tomorrow's mortgage markets, 
while at the same time being fully accountable for the results it 
achieves and the impact of its programs.
    Under the strong leadership of its current Commissioner, Brian 
Montgomery, FHA has undertaken significant changes to its regulations 
and operations in a very short time. In just a little more than 1 year, 
FHA has streamlined the insurance endorsement process, improved 
appraisal requirements and removed some unnecessary regulations. By 
doing so, Commissioner Montgomery has also instilled a spirit of change 
and a bias for action within FHA.
    MBA compliments the Commissioner on his significant accomplishments 
to date, though we recognize that more work lies ahead. Lenders still 
report that FHA is difficult to work with and that oversight activities 
often focus on minor compliance deficiencies in a loan file rather than 
focusing on issues of true risk to FHA's insurance funds. FHA is 
designed to serve higher risk borrowers and MBA believes that those 
auditing FHA lenders must understand this and be able to differentiate 
this aspect of the program from intentional abuse.
    MBA is confident in the Commissioner's ability to address these and 
other issues that are within his control. There is much though, that is 
beyond FHA's control and needs Congressional action.
    Single-family FHA-insured mortgages are made by private lenders, 
such as mortgage companies, banks and thrifts. FHA insures single-
family mortgages with more flexible underwriting requirements than 
might otherwise be available. Approved FHA mortgage lenders process, 
underwrite and close FHA-insured mortgages without prior FHA approval. 
As an incentive to reach into harder-to-serve populations, FHA insures 
100 percent of the loan balance as long as the loan is properly 
underwritten.
    FHA has a strong history of innovating mortgage products to serve 
an increasing number of homebuyers. FHA was the first nationwide 
mortgage program; the first to offer 20-year, 25-year, and finally 30-
year amortizing mortgages; and the first to lower downpayment 
requirements from 20 percent to 10 percent to 5 percent to 3 percent. 
FHA has always performed a market stabilizing function by ensuring that 
mortgage lending continued after local economic collapses or regional 
natural disasters when many other lenders and mortgage insurers pulled 
out of these markets.
    FHA's primary single-family program is funded through the Mutual 
Mortgage Insurance Fund (MMIF), which operates similar to a trust fund 
and has been completely self-sufficient. This allows FHA to accomplish 
its mission at little or no cost to the government. In fact, FHA's 
operations transfer funds to the U.S. Treasury each year, thereby 
reducing the Federal deficit. FHA has always accomplished its mission 
without cost to the taxpayer. At no time in FHA's history has the U.S. 
Treasury ever had to ``bail out'' the MMIF or the FHA.

                    THE FHA BUDGET FORECAST FOR 2008

    The Federal assistance that FHA provides to low- and moderate-
income households provides critical support for extending homeownership 
possibilities that the private market cannot fully address. MBA notes 
with great concern the administration's fiscal year 2008 budget 
proposal released last month which estimates that the FHA mortgage 
insurance fund will go into the red in fiscal year 2008 unless changes 
to the existing program are made or budget authority to provide 
additional credit subsidy is given to the Agency. Since no additional 
budget authority to cover these costs were included in the budget, the 
FHA would need to either raise premiums, curtail credit to some 
borrowers who today could get loans, or some combination.
    To cover the expected increased costs associated with higher 
defaults and lower originations, the administration projects increases 
in the up-front mortgage insurance premium (MIP) from 150 basis points 
(1.5 percent) to 166 basis points will be needed. In addition, the 
annual MIP is assumed to increase from 50 basis points to 55 basis 
points. On a $200,000 loan, this is an extra $320 (from $3,000 to 
$3,321) due at the closing table and an additional $100 (from $1,000 to 
$1,100) the borrower must pay each year for the same loan. This may not 
seem like a lot of money, but for your typical FHA borrower--who is 
likely to be trying to get in their first home and may not have much in 
the way of a savings--this could be the difference between owning a 
home or continuing to sit on the sidelines of homeownership.
    MBA agrees with the administration that the FHA's mutual mortgage 
insurance fund would run in the black, and little or no premium 
increases would be necessary, if FHA reform proposals were passed in 
Congress this year. MBA believes unlocking FHA's potential in the 
marketplace is the right solution in the face of the Agency's systemic 
inability to modernize itself, and now faces the prospect of raising 
fees to maintain its diminished presence in the marketplace. We urge 
Congress to consider solutions that will enable FHA to serve more 
potential homeowners.

                       UNLEASHING FHA'S POTENTIAL

    In reviewing the status of FHA over the past decade, MBA has come 
to the conclusion that FHA faces severe challenges in managing its 
resources and programs in a quickly changing mortgage market. These 
challenges have already diminished FHA's ability to serve its public 
purposes and have also made it susceptible to fraud, waste, and abuse. 
Unaddressed, these issues will cause FHA to become less relevant, and 
will leave families served by its programs with no alternative for 
homeownership or affordable rental housing.
    In the fall of 2004, MBA formed a FHA Empowerment Task Force 
comprising of MBA member companies experienced in originating single-
family and multifamily FHA loans. The Task Force discussed the long-
term issues confronting FHA with the goal of developing legislative 
proposals that would empower it to manage its programs and policies 
more effectively.
    The Task Force identified FHA's higher costs of originations, 
lessening prominence in the market, out-dated technology, adverse 
selection, and the inability to efficiently develop products as 
problems for FHA. Per the Task Force's recommendations, MBA proposed 
the following three steps to unleash FHA from overly burdensome 
statutory processes and restrictions, and to empower FHA to adopt 
important private sector efficiencies:
  --FHA needs the ability to use a portion of the revenues generated by 
        its operations to invest in the upgrade and maintenance of 
        technology to adequately manage its portfolios and interface 
        with lenders.
  --FHA needs greater flexibility to recruit, manage and compensate 
        employees if it is to keep pace with a changing financial 
        landscape and ensure appropriate staffing to the task of 
        managing $450+ billion insurance funds.
  --FHA needs greater autonomy to make changes to their programs and to 
        develop new products that will better serve those who are not 
        being adequately served by others in the mortgage market.
Ability to Invest Revenues in Technology
    Technology's impact on mortgage markets over the past 15 years 
cannot be overstated. Technology has allowed the mortgage industry to 
lower the cost of homeownership, streamline the origination process, 
and has allowed more borrowers to qualify for financing. The creation 
of automated underwriting systems, sophisticated credit score modeling, 
and business-to-business electronic commerce are but a few examples of 
technology's impact.
    FHA has been detrimentally slow to move from a paper-based process, 
and it cannot electronically interface with its business customers in 
the same manner as the private sector. During 2004 and 2005, over 1.5 
million paper loan files were mailed back and forth between FHA and its 
approved lenders and manually reviewed during the endorsement process. 
Despite the fact that FHA published regulations in 1997 authorizing 
electronic endorsement of loans, FHA was not able to implement this 
regulation until this past January, 8 years later. This delay occurred 
despite the fact that over the same 8 years, FHA's operations generated 
billions of dollars in excess of program costs that was transferred to 
the U.S. Treasury.
    MBA believes FHA cannot create and implement technological 
improvements because it lacks sufficient authority to use the revenues 
it generates to invest in technology.
    MBA proposes the creation of a separate fund specifically for FHA 
technology, funded by revenues generated by the operation of the MMIF. 
MBA suggests the establishment of a revenue and a capital ratio 
benchmark for FHA, wherein, if both are exceeded, FHA be authorized by 
Congress to use a portion of the excess revenue generated to invest in 
its technology. Such a mechanism would allow FHA to invest in 
technology upgrades, without requiring additional appropriations from 
Congress.
    Improvements to FHA's technology will allow it to improve 
management of its portfolio, garner efficiencies and lower operational 
costs, which will allow it to reach farther down the risk spectrum to 
borrowers currently unable to achieve homeownership. MBA believes that 
such an investment would yield cost savings to FHA operations far in 
excess of the investment amount.
Greater Control in Managing Human Resources
    FHA is restricted in its ability to effectively manage its human 
resources at a time when the sophistication of the mortgage markets 
demands market participants to be experienced, knowledgeable, flexible, 
and innovative. To fulfill its mission, FHA needs to be able to attract 
the best and brightest. Other Federal agencies, such as the Federal 
Deposit Insurance Corporation (FDIC), that interface with and oversee 
the financial services sector are given greater authority to manage and 
incentivize their human resources. MBA believes that FHA should have 
similar authority if it is to remain relevant in providing 
homeownership opportunities to those families underserved by the 
private markets. FHA should have more flexibility in its personnel 
structure than that which is provided under the regular Federal civil 
service rules. With greater freedom, FHA could operate more efficiently 
and effectively at a lower cost. Further, improvements to FHA's ability 
to manage its human capital will allow FHA to attract and manage the 
talent necessary to develop and implement the strategies that will 
provide opportunities for homeownership to underserved segments of the 
market.
Flexibility to Create Products and Make Program Changes
    FHA programs are slow to adapt to changing needs within the 
mortgage markets. Whether it is small technical issues or larger 
program needs, it often takes many years and the expenditure of great 
resources to implement changes. This process overly burdens FHA from 
efficiently making changes that will serve homebuyers and renters 
better and protect FHA's insurance funds. Today's mortgage markets 
require agencies that are empowered to implement changes quickly and to 
roll-out or test new programs to address underserved segments of the 
market.
    A prime example of this problem can be found in the recent 
experience of FHA in offering hybrid Adjustable Rate Mortgage (ARM) 
products. A hybrid ARM is a mortgage product which offers borrowers a 
fixed interest rate for a specified period of time, after which the 
rate adjusts periodically at a certain margin over an agreed upon 
index. Lenders are typically able to offer a lower initial interest 
rate on a 30-year hybrid ARM than on a 30-year fixed rate mortgage. 
During the late 1990's, hybrid ARMs grew in popularity in the 
conventional market due to the fact that they offer borrowers a 
compromise between the lower rates associated with ARM products and the 
benefits of a fixed rate period.
    In order for FHA to offer this product to the homebuyers it serves, 
legislative approval was required. After several years of advocacy 
efforts, such approval was granted with the passage of Public Law 107-
73 in November 2001. Unfortunately, this authority was not fully 
implemented until the Spring of 2005.
    The problem began when Public Law 107-73 included an interest rate 
cap structure for the 5/1 hybrid ARMs that was not viable in the 
marketplace. The 5/1 hybrid ARM has been the most popular hybrid ARM in 
the conventional market. As FHA began the rulemaking process for 
implementing the new program, they had no choice but to issue a 
proposed rule for comment with a 5/1 cap structure as dictated in 
legislation. By the time MBA submitted its comment letter on the 
proposed rule to FHA, we had already supported efforts within Congress 
to have legislation introduced that would amend the statute to change 
the cap structure. MBA's comments urged that, if passed prior to final 
rulemaking, the 5/1 cap fix be included in the final rule.
    On December 16, 2003, Public Law 108-186 was signed into law 
amending the hybrid ARM statutes to make the required technical fix to 
the interest rate cap structure affecting the 5/1 hybrid ARM product. 
At this point, FHA was ready to publish a final rule. Regardless of the 
passage of Public Law 108-186, FHA was forced to go through additional 
rulemaking in order to incorporate the fix into regulation. Thus, on 
March 10, 2004, FHA issued a Final Rule authorizing the hybrid ARM 
program, with a cap structure that made FHA's 5/1 hybrid ARM unworkable 
in the marketplace. It was not until March 29, 2005 that FHA was able 
to complete rulemaking on the amendment and implement the new cap 
structure for the 5/1 hybrid ARM product.
    The hybrid ARM story demonstrates well the statutory straitjacket 
under which the FHA operates. A 4-to-6-year lag in introducing program 
changes is simply unacceptable in today's market. Every month that a 
new program is delayed or a rule is held up, means that families who 
could otherwise be served by the program are prevented from realizing 
the dream of homeownership or securing affordable rental housing.
    MBA believes the above three changes will allow FHA to become an 
organization that can effectively manage risk and self-adapt to 
shifting mortgage market conditions while meeting the housing needs of 
those families who continue to be unserved or underserved today.

               LEGISLATIVE ACTIVITY IN THE 109TH CONGRESS

    MBA supported much of the legislation before the last Congress, and 
I would like to take a moment to offer our perspective on various 
provisions.
    MBA supported the Expanding American Homeownership Act of 2006, 
H.R. 5121, a bipartisan bill which marked the first time FHA was looked 
at by Congress in a comprehensive way in over 10 years. In general, 
H.R. 5121 would have significantly streamlined and modernized the 
National Housing Act and unleashed FHA from a 74-year-old statutory 
regime that constricts its effectiveness.
    Among other things, H.R. 5121 would have provided for flexible down 
payments, flexible risk-based premiums, an increase in mortgage limits, 
an extension of mortgage terms, reform of FHA's condominium program, 
and changes to the Home Equity Conversion Mortgage (HECM) program. MBA 
would like to review a number of provisions that were a part of that 
legislation.
Downpayment Requirements
    MBA supports the elimination of the complicated formula for 
determining the downpayment that is currently detailed in statute. The 
calculation is outdated and unnecessarily complex. The calculation of 
the downpayment alone is often cited by loan officers as a reason for 
not offering the FHA product.
    MBA supports improving FHA's products with downpayment flexibility. 
Independent studies have demonstrated two important facts: first, the 
downpayment is one of the primary obstacles for first-time homebuyers, 
minorities, and low- and moderate-income homebuyers. Second, the 
downpayment itself, in many cases, is not as important a factor in 
determining risk as are other factors. Many borrowers will be in a 
better financial position if they keep the funds they would have 
expended for a large downpayment as a cash reserve for unexpected 
homeownership costs or life events.
    We believe that FHA should be empowered to establish policies that 
would allow borrowers to qualify for FHA insurance with flexible 
downpayment requirements and decide the amount of the cash investment 
they would like to make in purchasing a home.
Adjusting Mortgage Insurance Premiums for Loan Level Risk
    MBA believes that FHA would be able to serve more borrowers, and do 
so with lower risk to the MMIF, if they are able to adjust premiums 
based on the risk of each mortgage they insure. A flexible premium 
structure could also give borrowers greater choice in how they utilize 
the FHA program.
    It is a fact that some borrowers and loans will pose a greater risk 
to FHA than others. At some level, FHA should have the authority to 
adjust premiums based upon some borrower or loan factors that add risk. 
Such adjustment for risk need not be a complicated formula. MBA 
believes FHA could significantly mitigate the risk to the MMIF by 
selecting a small number of risk factors that would cause an adjustment 
from a base mortgage insurance premium (MIP).
    A current example of this would be the fact that borrowers 
receiving a gift of the downpayment on a FHA-insured mortgage is 
charged the same premium as a borrower who puts down 3 percent of their 
own funds, despite the fact that the former represents a higher risk 
loan. FHA could better address such a risk in the MMIF by charging a 
higher MIP to offset some of the additional risk that such a borrower 
poses. In this manner, while a borrower receiving a gift of funds for 
the downpayment will still receive the benefits of FHA financing, they 
themselves would share some of the risk, rather than having the risk 
born solely by those making a 3 percent downpayment.
    Creating a risk-based premium structure will only be beneficial to 
consumers, though, if FHA considers lowering current premiums to less 
risky loans. We would not support simply raising current premiums for 
higher risk borrowers.
Raising Maximum Mortgage Limits for High Cost Areas
    MBA supports the proposal to raise FHA's maximum mortgage limits to 
100 percent of an area's median home price (currently pegged at 95 
percent) and to raise the ceiling to 100 percent of the GSEs' 
conforming loan limits (currently limited to 87 percent) and the floor 
to 65 percent (currently 48 percent). There is a strong need for FHA 
financing to be relevant in areas with high home prices. MBA believes 
raising the limits to the GSEs' conforming limits in these areas 
strikes a good balance between allowing FHA to serve a greater number 
of borrowers without taking on additional risk.
    Additionally, in many low cost areas, FHA's loan limits are not 
sufficient to cover the costs of new construction. New construction 
targeted to first-time homebuyers has historically been a part of the 
market in which FHA has had a large presence. MBA believes raising the 
floor will improve the ability of first-time homebuyers to purchase 
modest newly constructed homes in low-cost areas since they will be 
able to use FHA-insured financing.
Lengthening Mortgage Term
    MBA supports authorizing FHA to develop products with mortgage 
terms up to 40 years. Currently, FHA is generally limited to products 
with terms of no more than 30 years. Stretching out the term will lower 
the monthly mortgage payment and allow more borrowers to qualify for a 
loan while remaining in a product that continues to amortize. We 
believe FHA should have the ability to test products with these 
features, and then, based on performance and homebuyer needs, to 
improve or remove such a product.
Improvements to FHA Condominium Financing
    MBA supports changes to FHA's condominium program that will 
streamline the process for obtaining project approval and allow for 
greater use of this program. It is unfortunate to note that FHA 
insurance on condominium units has dropped at a higher rate than the 
overall decline in FHA's originations. This decline contradicts the 
fact that in costly markets, condominium units are typically the 
primary type of housing for first-time homebuyers. FHA should have a 
much bigger presence in the condominium market.
Improvements to the Reverse Mortgage Program
    MBA unequivocally supports all proposals to change the FHA's Home 
Equity Conversion Mortgage (HECM) program: the permanent removal of the 
current 250,000 loan cap, the authorization of HECMs for home purchase 
and on properties less than 1 year old, and the creation of a single, 
national loan limit for the HECM program.
    The HECM program has proven itself to be an important financing 
product for this country's senior homeowners, allowing them to access 
the equity in their homes without having to worry about making mortgage 
payments until they move out. The program has allowed tens of thousands 
of senior homeowners to pay for items that have given them greater 
freedom, such as improvements to their homes that have allowed them to 
age in place, or to meet monthly living expenses without having to move 
out of the family home.
    MBA believes it is time to remove the program's cap because the cap 
threatens to limit the HECM program at a time when more and more 
seniors are turning to reverse mortgages as a means to provide 
necessary funds for their daily lives. MBA further believes that the 
HECM program has earned the right to be on par with other FHA programs 
that are subject only to FHA's overall insurance fund caps. 
Additionally, removing the program cap will serve to lower costs as 
more lenders will be encouraged to enter the reverse mortgage market.
    Additionally, authorizing the HECM program for home purchase will 
improve housing options for seniors. In a HECM for purchase 
transaction, a senior homeowner might sell a property they own to move 
to be near family. The proceeds of the sale could be combined with a 
reverse mortgage, originated at closing and paid in a lump sum, to 
allow a senior to purchase the home without the future responsibility 
of monthly mortgage payments. Alternatively, a senior homeowner may 
wish to take out a reverse mortgage on a property that is less than 1 
year old, defined as ``new construction'' by FHA.
    Finally, the HECM program should have a single, national loan limit 
equal to the conforming loan limit. Currently, the HECM program is 
subject to the same county-by-county loan limits as FHA's forward 
programs. HECM borrowers are disadvantaged under this system because 
they are not able to access the full value of the equity they have 
built up over the years by making their mortgage payments. A senior 
homeowner living in a high-cost area will be able to access more equity 
than a senior living in a lower cost area, despite the fact that their 
homes may be worth the same and they have the same amount of equity 
built up. Reverse mortgages are different than forward mortgages and 
the reasons for loan limits are different, too. FHA needs the 
flexibility to implement different policies, especially concerning loan 
limits.
    MBA also supported a bill Senator Hillary Clinton (D-NY) introduced 
in the 109th Congress, the ``21st Century Housing Act.'' The bill 
contained the following positive provisions:
Investment in FHA Infrastructure--Human Resources
    MBA supported authorizing the Secretary of HUD to appoint and fix 
the compensation of FHA employees and officers. The bill would have 
called on the Secretary to consult with, and maintain comparability 
with, the compensation of officers and employees of the Federal Deposit 
Insurance Corporation. This provision can be carried out by excess 
revenue derived from the operation of FHA's insurance funds, beyond 
that which was estimated in the Federal budget for any given year. 
While MBA had some questions as to the funding mechanism detailed in 
the bill for this provision, we firmly believe that giving FHA greater 
flexibility in investing in its human capital is critical if it is to 
attract and retain the talent it needs to become a stronger and more 
effective program serving the needs of our Nation's homeowners and 
renters.
Investment in FHA Infrastructure--Information Technology
    MBA strongly supported this provision which would have funded 
investment in FHA's information technology. This provision contemplated 
that excess funding derived from the operation of FHA's insurance 
funds, beyond that which was estimated in the Federal budget for any 
given year, would be used to carry out this provision. While MBA had 
some questions as to the funding mechanism detailed in the bill for 
this provision, MBA believes that upgrading FHA's technology is 
critical to improving FHA's management of its portfolio and lowering 
its operational costs. MBA also believes that such an investment will 
allow FHA to reach farther down the risk spectrum to borrowers 
currently unable to achieve homeownership.

      OTHER FHA ISSUE--TREATMENT OF FHA NON-CONVEYABLE PROPERTIES

    The Federal Housing Administration (FHA) provides credit insurance 
against the risk of foreclosure losses associated with loans originated 
according to FHA standards. FHA generally pays an insurance claim when 
it takes title (conveyance) to a property as a result of foreclosure. 
To convey a property and receive insurance benefits, however, FHA 
requires that the property be in ``conveyance condition'' (i.e., 
repaired and saleable condition). Properties that have sustained damage 
attributable to fire, flood, earthquake, tornado, hurricane, boiler 
explosion (for condominiums), or the lender's failure to preserve and 
protect the property are not eligible for insurance benefits unless 
they are repaired prior to conveyance of the property to the FHA. While 
HUD has in the past accepted properties in ``as is'' (damaged) 
condition on a case-by-case basis, this is rarely done. Moreover, HUD 
will deduct from the ``as is'' claim the estimated cost of repair. HUD 
should accept conveyance of damaged properties and not adjust the claim 
for the cost of repair when there was no failure on the part of the 
servicer to obtain hazard or flood insurance pursuant to Federal law. 
In addition, to the extent that a property is not conveyable or has 
other problems (i.e., condemned, demolished by local, State, or Federal 
Government or there is concern about environmental issues that preclude 
a private servicer from taking title to the property), HUD should be 
permitted to pay the full claim without the servicer taking conveyance 
of the property or HUD taking conveyance of the property. At this time, 
MBA does not believe HUD has the statutory authority to manage claims 
in this manner.

                        FHA MULTIFAMILY PROGRAMS

    While this hearing is to focus attention on FHA's single-family 
programs, it is important to underscore the critical role of FHA's 
multifamily programs in providing decent, affordable rental housing to 
many Americans. Approximately 30 percent of families and elderly 
citizens either prefer to rent or cannot afford to own their own homes. 
FHA's insurance of multifamily mortgages provides a cost-effective 
means of generating new construction or rehabilitation of rental 
housing across the Nation. As well, FHA is one of the primary 
generators of capital for healthcare facilities, particularly nursing 
homes.
    While the FHA has implemented a number of significant improvements 
to its single-family program over the last year, the same focus needs 
to be applied to improving the multifamily programs. MBA hopes that 
process improvements on the multifamily side of FHA will soon be 
discussed and implemented.
    Additionally, I must voice MBA's strong opposition to the proposal 
in the administration's 2008 budget proposal to increase the insurance 
premiums on multifamily projects far above that necessary to operate a 
financially sound program. The net effect of this proposal will be to 
cause many affordable rental properties not to be built or 
rehabilitated and to raise rents on those families and elderly 
households on the projects that still go through.
    There is no rationale for this fee increase except to generate 
additional revenue for the Federal Government as these programs are 
already priced to cover their costs in accordance with the Federal 
Credit Reform Act of 1990. We urge the committee to prohibit FHA from 
implementing this fee increase.

                               CONCLUSION

    FHA's presence in the single-family marketplace is smaller than it 
has been in the past and its impact is diminishing. Many MBA members, 
who have been traditionally strong FHA lenders, have seen their 
production of FHA loans drop significantly. This belies the fact that 
FHA's purposes are still relevant and its potential to help borrowers 
is still necessary.
    I would like to conclude my testimony by highlighting two issues 
which make passing FHA legislation particularly urgent this year. 
First, hurricane season will again be soon upon us. The disasters of 
Hurricanes Katrina and Rita point to the need for a financially solvent 
FHA that is not restricted by onerous processes and procedures. The FHA 
program must be ready to assist homeowners and renters who lost 
everything amid the destruction of the hurricanes. It must have the 
necessary wherewithal to step in and help work out the existing 
mortgages in disaster areas. FHA must have the programs necessary to 
meaningfully assist in the rebuilding effort. Giving FHA the mechanisms 
to fund adequate technology improvements, flexibilities in managing 
human resources, and greater authority to introduce products will 
ensure FHA can step in to help communities when disasters occur.
    Secondly, without congressional action this year, many families 
face a serious risk of being unable to access FHA financing due to a 
recent ruling passed down by the Internal Revenue Service (IRS). On May 
4, 2006, the IRS released Revenue Ruling 2006-27, which may lead the 
IRS to rescind the nonprofit status of a large number of nonprofits who 
receive funding from property sellers in providing downpayment 
assistance to FHA borrowers. FHA regulations require that nonprofits 
providing a downpayment gift have an IRS nonprofit exempt status. Due 
to the ruling, the IRS has indicated that it is investigating 185 
organizations which provide downpayment assistance.
    MBA expects this ruling to have a dramatic effect on FHA's purchase 
production. Before the ruling, more than one-third of FHA purchase 
loans had some type of downpayment assistance. Such programs currently 
serve tens of thousands of FHA's primary clientele: first-time 
homebuyers, low- and moderate-income families and minorities.
    Clearly, congressional action on FHA reform this year is vital.
    On behalf of MBA, I would like to thank the subcommittee for the 
opportunity to present our views on the important programs offered by 
FHA. MBA looks forward to working with Congress and HUD to improve 
FHA's long-standing mission and ability to serve aspiring homeowners 
and those seeking affordable rental housing.

    Senator Murray. Thank you very much. And thank you to all 
of you for your testimony. It will all be placed in the record 
of this committee and all members will receive a copy.
    Mr. Montgomery, let me start with you. The rising defaults 
and foreclosures in the subprime market did not just start this 
past Tuesday. The foreclosure data that was released by Mr. 
Robbins' association on Tuesday just indicated to us that the 
situation is worsening. For a great many years, the subprime 
market was taking market share away from the FHA. Do you think 
the recent upset in the markets is likely to reverse that 
trend?
    Mr. Montgomery. Thank you very much for your question. We 
did an historical analysis, looking at the HUMDA data and why 
FHA was losing market share and you can look at how our market 
went down and look how the subprime market went up. It became 
very obvious to us that we were losing a lot of our traditional 
borrowers, if you will, to a subprime product.
    Yes, we are very concerned about the delinquency, the 
serious delinquency rates that were released yesterday relative 
to the subprime. Speaking for FHA, yes, we are concerned about 
that but I do want to note that during that timeframe--this is 
the most recent data just released yesterday--that our 
foreclosure rate actually went down, which it hadn't done in 
several months and the foreclosure rate for the subprime market 
is about twice that of FHA. While our 30-day delinquency number 
did go up, our 90-day delinquency number did go down as well. 
And that's about 30 percent below that of the subprime market.
    So yes, we are concerned about the rise of the subprime 
market, what's been happening there but in many cases, a lot of 
those borrowers would have faired much better had they had an 
FHA loan and this is one of the things that we've been talking 
about at great length at FHA for the 18 months that I've been 
there, saying we need a reinvigorated FHA to be there for 
families who have a couple of blemishes on their credit and 
perhaps don't have a lot of money for a down payment.
    Senator Murray. Well, HUD has made a claim for over 1 year 
that if the reform package is enacted by Congress, that the FHA 
market share will double in 2012. That will bring your market 
share from 3 percent to 6 percent. Given the recent market 
uncertainties, do you believe that your market share might grow 
beyond your 6 percent target?
    Mr. Montgomery. Well, let me answer that this way. We're--
we're not a private corporation so the degree of our success is 
not necessarily market share. I do want to get that point out. 
However, it is important that a reinvigorated, modern FHA be 
there for lenders and brokers--we're not a bank, as you know, 
so that they can best decide which is the product that fits a 
particular family's situation.
    For a long time, FHA did not necessarily, as we know, fill 
that void for the reasons that we've all gone into today. So 
yes, we think a new reinvigorated FHA would make us a better 
product and we think that as a result of that, more lenders, 
more realtors, will be inclined to recommend us to their 
clients.
    If I could add one other point to that, I can't stress 
enough, when I first got there and talking to all the trade 
association members and even some other groups, that we were--
and still are--a tough place to deal with. We were the slowest 
game in town. Our IT systems remain antiquated, although we've 
made some improvements and these are some of the same things I 
mentioned last year and some of our processes were outdated. We 
were one of the last organizations to electronically submit 
loan documents. By the way, this is something our sister 
agency, VA, had been doing since 1999. Some of our appraisal 
requirements just didn't make sense so we needed, before we 
even looked at improving the products that we had to improve 
our processes as well, to make us a product that our partners 
out in the field would want to use.
    Senator Murray. Mr. Montgomery, you gave a speech last 
month before the National Association of Homebuilders and 
indicated that you thought the FHA could provide cheaper loan 
rates to the very same borrowers that are currently loaded into 
subprime mortgages. Is this the state of affairs today or will 
this only be the case if FHA reform legislation is enacted?
    Mr. Montgomery. It's a key distinction to make. Just 
because we serve many of the same types of borrowers as the 
subprime market, we are not a subprime product. We don't have 
any teaser rates. We don't have any prepayment penalties. We 
are basically a 30-year, fixed rate product. There are no 
surprises at the end of an ARM period. Even the ARM that we 
have is indexed at a much lower rate so that families avoid 
balloon payments. So there is really no comparison between the 
two types of products.
    But let me also say that there is nothing, from our 
standpoint, to prevent some current subprime borrowers from 
refinancing perhaps into an FHA loan. Our eligibility criteria, 
though, they have to meet. That will not change with these 
improvements and yes, we do think that some subprime borrowers 
could and will fare better with an FHA product.
    Senator Murray. So if the FHA has the ability to provide 
these borrowers with better rates today, why are these 
borrowers going elsewhere?
    Mr. Montgomery. Well, that's a tough one, Senator. I would 
say in many cases, what I've read, what I've been told, some 
subprime borrowers, not all, totally blurred the line between a 
conventional loan and a subprime loan. There have been court 
settlements involved with lenders that we're all aware of, 
where there were cases--in one case, some 750,000 cases of 
perhaps predatory lending involved.
    So I--many times when I talk about why some families went 
subprime, I use the term, steered toward, because I think 
that's exactly what happened and way too many families were 
taken advantage of. All the while, you have a slow to adapt, 
less than nimble FHA sitting there, going what about us? We had 
no money to make people aware of our product, no money for 
consumer awareness. So it was kind of a perfect storm of a 
treading in the water FHA and large subprime lenders with a lot 
of marketing dollars coming in there and in many cases--not 
all--there is a place for the subprime product--but in many 
cases, totally blurring that line. And now, I think, 
unfortunately for many families, we are seeing what is going to 
happen as a result of some of those decisions.
    Senator Murray. Do you have any idea what percentage of 
current subprime borrowers you believe would be found 
creditworthy under FHA's criteria?
    Mr. Montgomery. It's a hard number to quantify, Senator but 
some of our internal discussions, we think it would be in 
probably the hundreds of thousands.
    Senator Murray. Ms. Poole and Mr. Robbins, do you think the 
rising foreclosures in the subprime market will necessarily 
have an impact on the business that is handled by FHA? Mr. 
Robbins.
    Mr. Robbins. Let me take you through a couple of 
statistics, which would outline the foreclosure issue and in 
the subprime market. The U.S. population of mortgages is about 
$50 million in total. The subprime represents about 13.5 
percent of that number or $6,750,000. Currently, the MBA 
announced that loans in foreclosure were about 4.53 percent in 
the subprime, which is actually half of its peak, which was in 
the year 2000, when it hit 9.35 percent at that time.
    Of that group of loans, through loss mitigation techniques, 
about half don't complete the foreclosure process. So that 
would leave about 335,000 loans that would ultimately face 
foreclosure that had been in the subprime area. We note with 
great interest that FHA's foreclosure ratio is less than half 
of the subprime because--again, because of outstanding loss 
mitigation techniques that are employed by the Federal Housing 
Administration versus those of subprime companies.
    It's the MBA's feeling that without question, that vast 
numbers of subprime borrowers would benefit significantly from 
FHA financing. In the past, it takes approximately 70 percent 
longer to process and underwrite a FHA loan versus a subprime 
loan. The market moved toward the efficient alternative, 
inappropriately in some cases, using very lax underwriting. We 
feel, with FHA modernization, that they could be a formidable 
competitor in the low to moderate income lending world. They 
could restore their market share relatively quickly because of 
the fact that with the full faith in credit of the United 
States Government in the guarantee portion of that, that the 
lowest interest rate would induce a significant number of 
borrowers and a short time processing frame, bridge the 
efficiency gap that was created. So we feel that these changes 
have an enormous and a very positive effect on future 
homeowners.
    Senator Murray. Ms. Poole, do you care to comment?
    Ms. Poole. Yes. One of the things I'd like to make sure we 
note is that many more homebuyers could have been and could, in 
the future, use the FHA product. But one of the things that 
should be noted is the loan limits that are attached to the FHA 
product, which puts a lot of borrowers out of the market and 
sends them into the subprime and exotic mortgages.
    I, as a practitioner, am actually facing a lot of borrowers 
who are now homeowners, who are facing possible foreclosures, 
simply from purchasing over the last couple of years and they 
are in upside down mortgages that they did not know they were 
in. As a practitioner, when talking with a lender, I was 
sometimes not actually given all the information the borrower 
was given because the borrower and lender work together.
    So when you get to a point of saying, I don't know how this 
happened, the fact is, it happened. And so I'm looking at it 
saying, you know, if there had been a FHA product that would 
have been available for the price range that they were 
purchasing in, it would have given me an opportunity to help 
them that way. But without it being there and no matter who you 
are, what you want to do in the market that I work, is to own a 
home. So all the promises and pie in the sky seem okay because 
I can afford the monthly payment but not looking at the long-
term effect.
    Senator Murray. Thank you very much. Senator Bond.
    Senator Bond. Thank you, Madam Chair. Commissioner 
Montgomery, you have certain authorities to ensure the FHA MMI 
fund is solvent and doesn't require a bailout from Congress and 
in fact, the administration's 2008 budget request assumes that.
    No. 1, can you give us your personal and the 
administration's commitment that you will not allow MMI fund's 
credit subsidy to go positive in 2008 and second, GAO's 
testimony states that high claim and loss rates for loans with 
down payment assistance financing were major reasons why the 
estimated credit subsidy rate for MMI is projected to be 
positive. If that statement is accurate, why do you continue to 
insure these high-risk loans that may jeopardize the health of 
FHA?
    Then I'll ask Mr. Donohue and Mr. Shear to comment on that, 
please.
    Mr. Montgomery. Do you want me to go first, Senator?
    Senator Bond. Yes. I want you to lay it out and then we'll 
slice it.
    Mr. Montgomery. I just wanted to confirm that, sir. Sir, 
yes, while I am FHA Commissioner, the MMI fund will not go to a 
positive credit subsidy. We have a fallback position. We're 
working very hard to get FHA modernization and if you look at 
how we think volume would increase and thus, receipts and that 
would keep the credit subsidy negative, which as we all know in 
government, is a good thing.
    However, let me just reiterate, while I am Commissioner, 
our fallback position would be to raise the upfront premiums 
modestly from 1.5 to 1.66, .016 of a percentage and a small 
increase in the annuals to keep that from happening.
    Second, sir, on the gift down payment programs, we have 
worked with the Internal Revenue Service, starting gosh, 
probably about 1 year, year and a half ago, when they 
approached us about some of their concerns. I don't want to 
speak for the IRS but just summarizing some of their concerns, 
whether some--not all--of the seller funded gift down payment 
programs met through detached and disinterested clause for bona 
fide 501(c)3s. And there are some 185 or so, sir, that we're 
aware of. They had a revenue ruling as we're all aware of, in 
May of last year, saying--putting on notice, seller funded down 
payment programs that if you don't meet these criteria then you 
could be in jeopardy of losing that status.
    Now, I don't want to speak ill of the IRS for a number of 
reasons but as we all know----
    Senator Bond. During that time when we're all subject to 
them----
    Mr. Montgomery. Yes, sir. But I know they have their hands 
full and they are moving a little slower than we anticipated in 
this area. So HUD also is and has moved toward rulemaking in 
this area and the rule currently is over at the Office of 
Management and Budget for their review.
    But yes sir, the FHA guidelines state that as long as 
someone is a 501(c)3, because you have to be a nonprofit to 
participate in the down payment programs, then we have to 
continue accepting them. We are not in the business of making 
the determination as to who is a 501(c)3; that is the IRS's 
purview.
    Senator Bond. Well, I agree with the fact that the 501(c)3 
determination is properly the jurisdiction of the IRS. What I'm 
concerned about is the impact of these gift down payments on 
the exposure of FHA. That's why we expect to see something and 
I'd like to hear Mr. Donohue and Mr. Shear talk about that.
    Mr. Donohue. I'm sorry, mention about the reduction of FHA 
lower--at least, in part, the foreclosure is partly due to loss 
mitigation and also, I believe, the foreclosure--moratorium in 
the gulf--but I want to get back, sir, to your question. I mean 
it, I get nervous when I hear things about efficiency and 
modernization, even though I support it. I really do. In my 
opinion, a lot of money was made here the last couple of years 
and what I do is I see where enforcement and oversight is not 
applied in cases.
    Senator, you mentioned about this pencil-whipping. Where I 
come from, they talk about a three-card Monty. This seller down 
payment assistance, I saw first hand several years ago and as 
far as I'm concerned is a three-card Monty, the way it was 
designed. Going back and giving money from the builder back to 
the lender to come up with the down payment and then what 
happened? It had direct results--it caused spec house--the 
increase in value unofficially. The next thing you know, those 
owners would come back and get hit with a tax bill when the 
land was re-evaluated and insurance and so many of them move 
out of the house.
    I took that to the FHA and I brought this attention to them 
and there was great reluctance on their part. In fact, my guess 
is, I probably upset a lot of the Mortgage Bankers 
Associations. When I first came on 5 years ago, I used to get 
invited to a lot of their functions. That seems to have dropped 
off significantly the last couple of years.
    But I think this--when the Commissioner speaks about 
modernization, I'm drawn upon to a particular matter we dealt 
with and this had to do with loan binders. Loan binders are the 
files that are kept with regard to loans executed by FHA. There 
was a modernization designed for those binders to be retained 
by the lending organizations. I have concern about that. I went 
to the FBI and asked them their opinion and they supported me 
with regard to the very concern is simple. I was in 
investigations for 31 years. I get real nervous when I'm going 
back and talking to a particular lender that might have done 
wrong and the very information I have, the investigation file 
that I have to recover to look at is maintained by them. I'd 
hate to think what they might do with if they really are 
fraudulently aggressive.
    But the fact is, this was a situation that I had to 
challenge and the FHA Commissioner went ahead anyway and 
administered that modernization plan. I think it's all about 
aggressive enforcement over sites served.
    Senator Bond. Then Mr. Shear and then I'm going to have, 
since we've mentioned Mortgage Banking Associations, I'm sure 
that Mr. Robbins may have a view on that. So let me hear from 
Mr. Shear.
    Mr. Shear. Thank you, Senator Bond. First, you said 
something about the subsidy rates and whether a positive 
subsidy would be required. Over the last few years, part of the 
improvements that we have noted with FHA is their ability to 
improve their models for estimation purposes. At the same time, 
we're trained to be skeptical, and when you see underestimated 
costs year after year, we still have a reason for some pause. 
But by the same token, these models have improved. I would 
expect as the Commissioner has said, with an increase in 
premiums under current statutory authority, that the program 
can be made a negative subsidy program in fiscal year 2008.
    On the second issue of down-payment assistance, even though 
we have monitored developments at the IRS, we haven't conducted 
audits of IRS. Our audit has been of FHA and we have 
recommended that the seller-funded down payment assistance that 
has become such a major share of FHA's portfolio, be treated as 
a seller inducement. At the time we made that recommendation, 
the response from FHA was that FHA was bound by a HUD Office of 
General Counsel legal opinion that said that this couldn't be 
treated as a seller inducement. We don't have a legal opinion 
about the legal opinion but as a matter of policy, we continue 
to believe FHA has to take action to deal with seller-funded 
down payment assistance.
    Senator Bond. Mr. Robbins.
    Mr. Robbins. The down payment assistance program makes up 
about a third of FHA's current business and its our position 
that allowing a flexible down payment will effectively do away 
with abuses in the program and so the answer to that is a more 
flexible down payment program.
    Senator Bond. Tell me how that--what do you mean by a 
flexible down payment program? I don't really understand what 
that flexible----
    Mr. Robbins. Doing away with the formula driven down 
payment program that is today providing a real zero down 
program that we can introduce to borrowers. We're not in the 
business of developing down payment assistance programs, the 
Mortgage Bankers Association is not. And we are in the business 
of opining that we want a safe and sound and healthy Federal 
Housing Administration and support proposals that keep it 
actuarially sound. But we also are aware that the FHA down 
payment assistance or the down payment assistance program is 
being used, principally by low-income and minority buyers in 
order to get into their house and what we have found is you 
have seen in traditional marketplace--43 percent of first time 
homebuyers last year used a zero down payment program. If we 
were able to adopt a similar kind of program through FHA on a 
direct program, it would do a lot to go to--to curb the abuses 
in the DAP program that you see today.
    Senator Bond. The public policy goal of getting people into 
first time houses is extremely important but I am very much 
concerned about the historical evidence that we've seen that 
when you don't have skin in the game, when you haven't put 
something up, when there is no equity value in the home, this 
puts the homeowner too often in a squeeze where something comes 
along, a furnace breaks down, a roof leaks, there is no 
headroom in it. So is this not a problem?
    Mr. Robbins. You know, to me, it depends on how the 
borrower is underwritten and there is nothing that takes the 
place of good old common sense. I mean, there are situations 
where 100 percent loan to value program is fine for a borrower, 
properly underwritten. There are some cases where the borrower, 
with a no-down product is not ready for home ownership yet. And 
my belief is that a well applied underwriting program adopted 
by the FHA under that program with the appropriate risk pricing 
behind that, would go a long way to benefit the homeowners who 
need that kind of financing and in fact, quality for it versus 
them using a subprime alternative.
    Senator Bond. Ms. Poole, did you want to comment on that?
    Ms. Poole. I sure would. There are a couple of things that 
I think come into play. One of things is that with the seller 
funded down payment assistance, it really increases home 
prices, which start to price people, especially first time 
homebuyers, out of the market. So we have to keep that in mind.
    Flexible down payment would not have the same impact. But 
flexible down payments are based on credit scores, it's based 
on credit histories and how a person handles themselves credit-
wise.
    So the zero down is not something that is even being talked 
about for everyone. It's on a sliding scale, depending upon 
where you are and what you're doing. Again, as a practitioner, 
I work with mostly first time homebuyers and I would say that 
every time they make a monthly payment, to them, they have 
invested into that home. Rather they didn't put it all in 
upfront or with the 3 percent or whether they are doing 80/20, 
it's when they make that first payment that they feel as though 
I have vested interest in how this works.
    One of the most important things that I think has to be 
talked about and has to be considered is the education portion 
that comes into play when people, first time homebuyers buy 
homes. Without the education piece, sometimes people can get in 
to situations that they are not prepared for and as for the 
National Association of Realtors, we are 100 percent in 
agreement that people need to be educated in the home-buying 
process long before they decide to make that first home 
purchase.
    Senator Bond. Thank you very much. Madam Chair, I will have 
other questions for the record but I have another commitment.
    Senator Murray. Okay, very good.
    Senator Bond. I thank the witnesses and you've given some 
enlightenment and a little bit of confusion on a very important 
subject and we appreciate your efforts to help us straighten it 
out.
    Senator Murray. Thank you very much, Senator Bond. We will 
make sure your questions get submitted to the record and ask 
that everyone give their responses back to us.
    I do have a few more questions I want to ask and I'll start 
with you, Mr. Montgomery. Two weeks ago, Secretary Jackson 
testified before the House Appropriations Committee and said 
that HUD had changed its position about allowing FHA to offer 
mortgages with a zero down payment and he went on to say he was 
not opposed to requiring a 1 or 2 percent down payment 
requirement. But since that hearing, now HUD has indicated you 
do not intend to change your reform proposal and zero down 
payment mortgages will still be permitted. What exactly is the 
administration's position on this?
    Mr. Montgomery. Right now we have a standard minimum 3 
percent cash requirement and that can take many different 
shapes and forms. We are asking and we haven't transmitted a 
bill but again, it will look very similar to last year's bill, 
the ability to do away with the requirement of the 3 percent. 
Now that may mean that either through closing costs assistance 
or the person finances the upfront mortgage insurance premium 
and puts some money down that there is some cash in the game. 
It may be at 99.95 LTV loan but there will be some minimum cash 
investment on the part of the borrower. It may be that the down 
payment is a very small number but their cash contribution 
comes from elsewhere.
    Senator Murray. But will you be asking for authority for 
zero down payment mortgages?
    Mr. Montgomery. We will be asking authority for flexibility 
in the cash requirement to include the down payment assistance, 
to include other cash participation the borrower may do. I also 
want to say that we do need some flexibility in that area 
because it's just too difficult. There are a lot of borrowers 
who would qualify but just don't have the cash and they are 
creditworthy low-income borrowers and for many of them, they 
turn to the subprime product, many of them turn to the gift 
down payment programs. So yes, we do need some flexibility in 
that requirement.
    Senator Murray. Well, Ms. Poole, in her formal testimony, 
said that 43 percent of all mortgages to first time homebuyers 
in 2005 involved no down payment. And now we're seeing this 
alarming increase in delinquencies and foreclosures in the 
subprime market that involve these no down payments. So the 
administration's FHA reform proposal that would essentially 
allow no down payments, zero down payments, how are you going 
to ensure, under this proposal if you move toward that, it 
won't suffer the same fate as the subprime?
    Mr. Montgomery. I can't speak for the subprime but I can 
speak for FHA and no, ma'am, it will not. Our eligibility 
criteria will not change. If anything, when a borrower chooses 
to put less cash down in the transaction, the eligibility 
criteria will strengthen. I have an obligation to this 
committee, to this body, to the taxpayers, to make sure the FHA 
fund is operated in a financially sound manner. So as a result 
of that, we will not change that criteria. It is not our intent 
to make homeowners out of families who are not ready to become 
homeowners. But I would submit that there are working families 
out there, whether they are social workers, librarians or 
mechanics, who save a little here and there for a down payment. 
They are good, creditworthy, hardworking families but they have 
a little bump in the road, the transmission goes out on the 
car. You name it and there goes the cash savings. I would 
submit that there are tens if not hundreds of thousands of 
families like that, who don't want a handout. They just need a 
hand, because they pay for this premium. It's not a Government 
handout. So those are those hardworking, creditworthy, low-
income borrowers that we are trying to reach.
    Senator Murray. Have you done a thorough analysis that will 
tell us that we'll be able to guarantee these zero down 
payments that you could share with the committee?
    Mr. Montgomery. We have done actuarial reviews of all our 
products and since we haven't transmitted the bill yet, we have 
a whole pricing structure that we're still reviewing. But bare 
in mind, we would price the product with FHA reform, 
commensurate with the risk. So any borrower again, who might be 
a higher risk and is choosing to put lower down, will pay for 
that privilege, if you will. But look at what they get in 
return. They get a fixed rate loan over a longer period. They 
have no teaser rates that they have in the subprime, which for 
many of them, is their only option today and they have no 
prepayment penalties. The FHA is a fully amortizing product. So 
I would say it is a far, far better option for many of those 
families.
    Senator Murray. Mr. Shear and Mr. Robbins, do you have any 
comments on that?
    Mr. Shear. On the zero-down product, one of the things that 
we found from our work, which is consistent with other 
research, is that a zero-down product does carry higher risk, 
higher risk of default. And while it is a congressional 
prerogative whether to allow FHA to have a zero-down product, 
we believe it should be provided on a pilot basis. When you 
look at other mortgage providers, when they offer a zero- or 
low-down product, they always pilot the program because it is 
very risky to go into an activity if you don't understand the 
risks of that activity and pilot programs allow that 
understanding to occur.
    So that is basically our position. It isn't one of whether 
to allow zero down or not, but if Congress were going to allow 
it, it should be a pilot program.
    Senator Murray. Dr. Donohue?
    Mr. Donohue. Senator, the seller down payment is twice the 
default rate and I look forward to hearing more from FHA with 
regard to how they can ensure that will not have an adverse 
effect on the FHA.
    But I want to say one last thing and that's the fact is, my 
concern remains with the relationship between FHA and the 
lenders. I think without aggressive enforcement and I'm 
concerned about what I've seen, aggressive enforcement, I 
think--that's where I think a lot of problems might exist with 
regard to what I see in the future. Thank you.
    Senator Murray. Mr. Robbins.
    Mr. Robbins. A couple of comments. The lower down payment 
program would be offset by higher risk premiums that are 
charged. I don't think you can compare a subprime, no income, 
no asset loan to a fully documented FHA loan. The underwriting 
process is completely different and a substantial amount of the 
loss mitigation would be seen under an FHA program because they 
are really documenting every aspect of a borrower's assets and 
income, where obviously, under a subprime, no income, no asset 
loan, that responsibility would be abdicated.
    Here is my basic concern, being a lender and having been 
one for many, many years and having experienced and done 
literally billions of dollars of first time homebuyer loans. 
We're looking at a market that will grow from $10 trillion in 
outstanding mortgage debt today to $20 trillion estimated 
within the next two decades, in less than two decades. 
Harvard's Joint Center for Housing Studies has said that during 
that period of time, because of the changing demographics of 
this country, that 66\2/3\ percent of first time homebuyers 
will be minority Americans buying their first house. We have to 
have programs that meet that demand. We have a tidal wave of 
opportunity that is occurring in this country, to convert 
people and give them their share of the American dream and let 
them put their stake in the ground in home ownership. We have 
to have the programs to meet that demand and a well-founded FHA 
with solid underwriting is going to allow us to do that.
    Senator Murray. Thank you very much. I do have one other 
question. Senator Bond put language in our 2007 appropriations 
bill that would clamp down on fraudulent gift down payment 
assistance programs. Mr. Donohue and Mr. Shear, do you think 
that language--I don't know if you're familiar with it but do 
you think that would adequately get at the crooked actors 
without harming the real nonprofits that are trying to get 
people into homes?
    Mr. Donohue. Senator, I support that. I think that 
currently, with the best intentions and the review that is 
underway, the seller down payment assistance program is still 
going on. And I'd like to see it end as quickly as possible so 
I support any notion of that type.
    Senator Murray. Mr. Shear.
    Mr. Shear. I'm not familiar with the provisions related to 
this but certainly, it sounds promising and for us, again, the 
reason we think FHA should treat it as a seller inducement is 
because, for all practical purposes, it is. And just to make 
clear, even though we found that loans with more traditional--
what I'll call the old fashioned kind of down payment 
assistance, where it comes from a charity, from a foundation, 
where there is real equity created in a home because of the 
down payment assistance--even though the performance of those 
loans wasn't quite as good as other loans, our concern isn't 
with the more traditional down payment assistance. It's with 
this particular mechanism of seller-funded assistance that has 
become such a large share of FHA's portfolio.
    Senator Murray. Mr. Montgomery.
    Mr. Montgomery. I just want to make sure that we understand 
there is a wide difference between a seller-funded gift down 
payment and a zero-down product. In many cases, the cost of the 
down payment, if you will, for the seller funded, the 
charitable one, if you will, is put on at the end of the loan 
and along with other costs that a borrower may have, they could 
be in a higher than 100 percent LTV posture, whereas a 
traditional down payment, you don't have that. It's not a loan 
you're paying back. You are putting some money in the game so 
there is a big difference between the two products.
    But again, just to reiterate the point I made earlier, we 
have been working with the IRS. We have been working on a rule 
and I understand Mr. Donohue's frustration with that but we've 
moved closer to that point than probably any previous 
Commissioner and these are not new products. These gift down 
payments have been around since the late 1990's.
    Senator Murray. And do you have a comment on Senator Bond's 
language in the appropriations bill?
    Mr. Montgomery. I think if that is what it gets to, then 
that's the way we would go but I would add again, that the IRS 
has a revenue ruling out. HUD is moving, FHA may be moving a 
rule and is currently at OMB.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Murray. That is all the questions I have at this 
point. I believe we have some questions from other members that 
we will submit for the record. If you would respond back, I 
would appreciate it.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]
            Questions Submitted to Hon. Brian D. Montgomery
           Questions Submitted by Senator Christopher S. Bond

                      DOWNPAYMENT ASSISTANCE LOANS

    Question. Do you support the elimination of these loans? Are you 
committed to implementing the GAO's recommendations and stopping the 
practice of insuring these types of high-risk loans? When do you expect 
your proposed ruling to be implemented?
    Answer. Last year HUD published a rule that would eliminate these 
high-risk loans, however implementation has been delayed due to 
litigation. We are currently awaiting a court ruling on how to proceed.
    Question. Would you support a legislative provision in the THUD 
appropriations bill that prohibits FHA from engaging in this activity?
    Answer. The fiscal year 2009 budget proposes new risk categories 
for these high risk loans. This risk category bears a positive subsidy 
rate of 6.35 percent. Should Congress wish FHA to continue to insure 
these loans, we will require an appropriation to cover the very 
substantial anticipated cost to the Government of such loan guarantees.

                            FHA'S STRUCTURE

    Question. It is my belief that FHA reform be comprehensive and 
address some of the structural issues that have impeded FHA's ability 
to manage effectively the risk of its insured mortgages. I believe 
having some flexibility in hiring (possibly similar to the FDIC and 
other quasi-governmental entities) and purchasing authority can help 
the FHA function more like a business.
    Can you comment on how the current structure impacts FHA's 
operations and what types of flexibility you need to ensure FHA can be 
more responsive and accountable? In terms of your workforce, are you 
currently facing a large number of retirements like the rest of the 
Federal Government and how will that impact FHA?
    Answer. For now, we believe that flexibility to increase the FHA 
funding used for information technology systems would help. We are also 
attempting to bring new employees on board so they can be trained 
before experienced staff retires. We do believe these measures will 
allow us to meet both the challenges of implementing the new 
legislation and to deal with the very dynamic home mortgage market.

                       ASSET CONTROL AREA PROGRAM

    Question. In the fiscal year 1999 VA-HUD Appropriations Act, the 
Congress created the Asset Control Areas (ACA) to address the growing 
number of FHA-foreclosed homes in distressed communities and to promote 
homeownership to stabilize these neighborhoods. Our intent was for HUD 
to work with nonprofits and local governments in implementing this 
program.
    Can you give me an update on the program, in terms of how many new 
contracts have been approved in the last year? How long does it 
typically take HUD to approve these contracts?
    Answer. In fiscal year 2007 one new agreement was approved and one 
was renewed. Once the ACA participant submits a completed package and 
accepts the terms of the model agreement, the package is approved 
within 30-45 days.

                       IMPACT OF SUBPRIME MARKET

    Question. There has been a lot of attention to the subprime market 
and its recent problems as thousands of subprime loans are going into 
default and foreclosure. The Federal Reserve chairman recently 
suggested that the subprime problems could have broader economic 
consequences and some on Wall Street fear that it will spread to the 
prime market and to corporate credit.
    How has the subprime market affected FHA's business and market-
share over the past several years? In other words, did the subprime 
market attract borrowers who would have traditionally been served by 
FHA? Second, looking forward, since the subprime market is imploding, 
will many borrowers return to FHA? Do you see an increase in business 
happening? Lastly, with many of the subprime mortgages likely to end up 
in foreclosure, will it cause a domino effect on homes insured by FHA?
    Answer. Subprime lenders attracted a significant number of 
borrowers who would have qualified for, and likely used, FHA. Many of 
these borrowers are expecting to refinance out of their subprime loans 
before they reset to a higher interest rate. As with the FHA Secure 
initiative announced last year, we are exploring ways to assist these 
families, so we do expect an increase in business. Our borrowers 
continue to be required to meet FHA's underwriting standards before any 
loan is insured. Consequently, with the exception of the gift 
downpayment loans, we do not expect an increase in claims.

                             MANAGING RISK

    Question. The GAO has raised several concerns with FHA's ability to 
manage risk and that it could impact its ability to manage new products 
such as the proposed no down-payment mortgage product.
    Given the GAO and IG's concerns, the downturn in the housing 
market, and the record delinquency rate of FHA loans, what safeguards 
or limitations would FHA place on its risk-based premium and low to 
zero down-payment products? How will you ensure that borrowers will not 
be put at risk of owing more than the value of the home? What are your 
thoughts on piloting a program as suggested by the GAO?
    Answer. With the exception of seller financed gift downpayment 
loans, we do not anticipate large numbers of FHA borrowers being put in 
a position of owing more than their homes are worth, aside from 
widespread declines in market values that adversely affect all 
borrowers. We believe the serious problems confronting the housing 
market as a whole are not appropriate for a limited demonstration, but 
rather require a program available to all who need it and who qualify.

            COSTS OF IMPLEMENTING RISK-BASED PRICING SYSTEM

    Question. The IG's testimony states that moving to a risk-based 
premium pricing structure could require additional budget authority 
funding to make FHA system modifications. Further, this new pricing 
system could impose new administrative/cost burdens on originating and 
servicing lenders, according to the IG.
    Does your budget request include funding to address the system 
modifications suggested by the IG? If so, how much would it cost in 
fiscal year 2008 and in the out years? Have you analyzed the potential 
administrative/cost impact of the proposed risk-based pricing structure 
on lenders?
    Answer. The modifications to FHA systems have been completed. We 
don't anticipate increased annual requirements solely because of the 
implementation of risk-based pricing. At the same time, however, FHA 
systems are as much as 27 years old. They all need to be upgraded or 
replaced.

             FAIR HOUSING CONCERNS WITH RISK-BASED PRICING

    Question. The IG's testimony raises fair housing and red-lining 
concerns with the administration's risk-based pricing proposal. How are 
you addressing these concerns?
    Answer. The Department does not believe that the risk-based pricing 
will have a discriminatory effect on minority households or 
neighborhoods. Quite to the contrary, risk-based pricing will allow FHA 
to more effectively carry out its mission of promoting home ownership 
by lower income families, especially minorities and first-time 
homebuyers. With greater pricing flexibility, FHA will be able to reach 
more families and offer more financing options at more affordable cost.

                               FHA FRAUD

    Question. The IG's testimony listed a number of areas of continuing 
concern related to FHA fraud. One area of concern was FHA's adoption of 
a new policy dealing with the Lender Insurance Program. FHA implemented 
the new policy to this program despite opposition from the FBI and 
HUD's OGC but committed to making technical corrections to the new 
policy after implementation. What sort of progress have you made in 
making technical corrections to this program?
    Answer. The Lender Insurance (LI) program is a process that allows 
for insurance of loans by lenders without prior review by HUD staff. LI 
loans are subject to the same Direct Endorsement standards with the 
exception of those requirements that are unique to the LI process. Risk 
management controls for all Direct Endorsement loans include Social 
Security Number validation, property flip check of all purchase 
mortgage loans, electronic review of all insuring data prior to 
endorsement, analysis of all closed loans to select high risk loans for 
review, analysis of all lenders to identify the high risk lenders for 
review, electronic monitoring of each lender's claim and default rates 
in Neighborhood Watch to determine compliance with FHA approval 
standards and termination of a lender's origination or underwriting 
approval for poor performance under Credit Watch Termination.
    FHA is working with Regulation Division attorneys on two revisions 
to current HUD single-family regulations. The first revision would 
revise the regulations to provide a definition of the term 
``origination'' and clarify that LI is a process and that loans insured 
under this process are subject to the current Direct Endorsement 
statutes, regulations and policies.
    FHA, under existing regulatory authority to hold program 
participants fully accountable for their actions, has adopted 
procedures for dealing with any LI lender that fails to produce a case 
binder when requested, which is the major source of OIG's concern. The 
second revision would revise the regulations to require that lenders 
indemnify HUD for failure to submit a case binder when requested or for 
failure to submit a case binder with sufficient documentation to 
determine eligibility of Federal Housing Administration (FHA) mortgage 
insurance. This revision enhances existing regulatory authority and 
procedures for dealing with a LI lender who fails to produce a case 
binder when requested.
    FHA would also like to point out that, despite OIG's concerns, 
those lenders making loans under the LI program have a better record of 
loan performance than do those lenders that still submit binders to FHA 
for insuring purposes. LI is a privilege and not a right and LI lenders 
are abiding by FHA's requirements.

                              RESPA REFORM

    Question. A few years ago, the administration proposed reforms to 
the Real Estate Settlement Procedures Act (RESPA) to simplify the 
mortgage process and to provide certainty to borrowers about their 
costs. The proposed rule, however, was withdrawn. Does the 
administration have any plans to reform RESPA?
    Answer. Yes, the Department looks forward to publication of the 
rule and public comment very soon. The Department will work with 
Congress on this very important rule. The goals are to simplify and 
improve the disclosure requirements for mortgage settlement costs under 
RESPA, and to protect consumers by making it possible for consumers to 
shop for the loan and settlement services that best meet their needs.
                                 ______
                                 
              Questions Submitted by Senator Arlen Spector

                           RISK-BASED PRICING

    Question. Risk-based pricing may increase the mortgage carrying 
costs of those FHA borrowers that are least able to afford them and 
there is a greater risk of default on zero downpayment loans. How do 
you plan to prepare for and protect against these risks and ensure that 
low-income families are not led to greater financial instability?
    Answer. FHA will continue to use its very effective underwriting 
process to ensure that families qualify for and can afford the 
mortgages they are seeking.

                            FHA LOAN LIMITS

    Question. Raising FHA area loan limits could distance FHA from the 
lower-income families it was established to serve. How will raising the 
loan limits help the lowest-income families who have the fewest 
alternative options?
    Answer. We have effectively been eliminated as an option for low-
income families in high cost areas such as California and New York. 
Raising the limits will allow FHA to once again serve low-income and 
first-time homebuyers in these areas.
                                 ______
                                 
             Questions Submitted to Hon. Kenneth M. Donohue
           Questions Submitted by Senator Christopher S. Bond

                               FHA FRAUD

    Question. Your testimony listed a number of areas of continuing 
concern related to FHA fraud. One area of concern was FHA's adoption of 
a new policy dealing with the Lender Insurance Program.
    What is the significance of this problem?
    Answer. The Lender Insurance Program allows certain FHA-approved 
direct endorsement lenders to endorse FHA insured loans without a pre-
endorsement review and generally relieves the submission of loan 
origination case binders to FHA. OIG expressed concern that relieving 
Lender Insurance Program lenders from the responsibility of submitting 
loan origination case binders to FHA may adversely impact the ability 
to investigate and prosecute fraud perpetrated upon FHA.

                            FHA'S STRUCTURE

    Question. As I stated in my opening statement, I strongly believe 
that FHA reform should address some of the structural issues with FHA 
that has impeded its ability to manage effectively the risk of its 
insured mortgages. I believe having some flexibility in hiring 
(possibly similar to the FDIC and other quasi-governmental entities) 
and purchasing authority can help the FHA function more like a 
business.
    Do you believe that FHA's current structure impedes their ability 
to perform their mission in a sound and effective manner?
    Answer. The OIG has not independently assessed whether FHA's 
current structure impedes its ability to perform its mission in a sound 
and effective manner. However, based on our audit and investigative 
activities we are concerned with the ability of FHA's staff and its 
current systems (i.e., reliability) to implement and manage the various 
new programs/products proposed as part of FHA reform.
    Since fiscal year 1991, we have reported annually on the 
Department's lack of an integrated financial system in compliance with 
all Federal financial management systems requirements, including the 
need to enhance FHA's management controls over its various insurance 
and other financial systems. Organizational changes and human capital 
management have not only been a challenge to FHA, but the Department as 
a whole for many years. As such, FHA has contracted out a number of its 
functions that are essential to the accomplishment of its overall 
mission.
    The Department has made progress in implementing a new financial 
system at FHA, but continued progression in the integration of FHA's 
financial management systems, and strengthening of lender 
accountability and enforcement against program abuses is still needed.

                        HIGH-RISK STATUS OF FHA

    Question. The GAO recently removed the high-risk designation for 
FHA's single-family programs because of the agency's progress in 
addressing its long-standing problems. However, the GAO warns that 
FHA's proposed changes to raise its loan limits, implement a new risk-
based premium system, and reduce down-payment requirements, could 
introduce new risks and oversight challenges to FHA.
    Despite the removal of GAO's high-risk designation, is FHA still 
vulnerable to waste, fraud, and abuse?
    Answer. The Department has made progress in its efforts to correct 
some of its challenges and we commend the removal of FHA's single-
family programs from GAO's high-risk list. However, FHA is still 
vulnerable to waste, fraud, and abuse, especially with the changes 
proposed as part of FHA reform.
    We are concerned with the soundness of the front-end risk 
assessments performed by or on behalf of the Department for the various 
proposed operational and programmatic changes that are part of or 
related to FHA reform. Therefore, we have begun an audit of FHA's 
control structure, which includes a review of its front-end risk 
assessment process, to ensure cost/performance effective actions are 
taken to minimize undesired outcomes and maximize the likelihood of 
desired outcomes.
    Additional risk is inherent with the introduction of any new 
program/product and it must be balanced with a commensurate increase in 
oversight and enforcement, which was lacking from the various FHA 
reform proposals. Without such protections to mitigate future insurance 
losses one cannot ensure the effectiveness of FHA in meeting its 
overall mission, which includes maintaining and expanding 
homeownership. The OIG is committed to continuing its work with the 
Department to ensure the integrity of FHA's single-family insurance 
programs.
                                 ______
                                 
                Questions Submitted to William B. Shear
           Questions Submitted by Senator Christopher S. Bond

    Question. The GAO recently removed the high-risk designation for 
FHA's single-family programs because of the agency's progress in 
addressing its long-standing problems. However, the GAO warns that 
FHA's proposed changes to raise its loan limits, implement a new risk-
based premium system, and reduce down-payment requirements, could 
introduce new risks and oversight challenges to FHA.
    Despite the removal of GAO's high-risk designation, do you believe 
FHA is still vulnerable to waste, fraud, and abuse? Will FHA's proposed 
new loan products potentially expose FHA to more risk and if not 
managed adequately, is it possible for FHA to be placed back on the 
high-risk list?
    Answer. We removed the high-risk designation in January 2007 
because of the progress FHA had made in addressing weaknesses we had 
identified in its risk management, including improvements in lender 
oversight and loan performance modeling.\1\ Because of this progress, 
we believe that FHA is less vulnerable than it has been in the past to 
risks that could undermine the efficiency and effectiveness of its 
single-family mortgage insurance programs. However, as we noted in our 
High-Risk Update and our June 2007 report on FHA's modernization 
efforts, some of FHA's proposed program changes could introduce new 
risks and challenges.\2\ FHA's proposal to offer products with lower 
down-payment requirements is of particular concern given the greater 
default risk of low-down-payment loans, housing market conditions that 
could put borrowers with such loans in a negative equity position, and 
the difficulty of setting prices for new products whose risks may not 
be well understood. Due partly to these risks and challenges, we 
included FHA's single-family insurance programs on a list of suggested 
areas for oversight that we provided to Congress in November 2006.\3\ 
To make any future decisions about the high-risk status of this program 
area, we would use published criteria that encompass a number of 
quantitative and qualitative factors.\4\ Additionally, we would review 
a wide range of data and documentation, including information on FHA's 
ability to manage the risks of any new mortgage products it is 
authorized to offer.
---------------------------------------------------------------------------
    \1\ GAO, High-Risk Series: An Update, GAO-07-310 (Washington, DC: 
January 2007).
    \2\ GAO, Federal Housing Administration: Modernization Proposals 
Would Have Program and Budget Implications and Require Continued 
Improvements in Risk Management, GAO-07-708 (Washington, DC: June 29, 
2007).
    \3\ GAO, Suggested Areas for Oversight for the 110th Congress, GAO-
07-235R (Washington, DC: Nov. 17, 2006).
    \4\ GAO, Determining Performance and Accountability Challenges and 
High Risks, GAO-01-159SP (Washington, DC: November 2000).
---------------------------------------------------------------------------
    Question. In your testimony, you state that high claim and loss 
rates for loans with down-payment assistance financing were major 
reasons why the estimated credit subsidy rate for the FHA MMI Fund is 
projected to be positive for fiscal year 2008. HUD has recently 
developed a proposed rule to address these types of loans.
    Can you elaborate on why these types of loans perform so poorly and 
what specific recommendations you have made to address these problems? 
How do these loans perform compared to subprime loans? Do you believe 
HUD's proposed rule adequately addresses your concerns and 
recommendations?
    Answer. Our testimony focused specifically on the high claim and 
loss rates for loans with down-payment assistance from nonprofit 
organizations that received at least part of their funding from 
property sellers (seller-funded nonprofits). These loans are 
problematic because property sellers that provide down-payment 
assistance through nonprofits often raise the sales prices of the homes 
involved in order to recover the required payments to the nonprofits. 
For example, in November 2005, we reported that FHA-insured homes 
bought with seller-funded nonprofit assistance appraised at and sold 
for about 2 to 3 percent more than comparable homes bought without such 
assistance.\5\ The weaker performance of loans with seller-funded down-
payment assistance may be explained, in part, by the higher sales 
prices and the homebuyer having less equity in the transaction. Seller-
funded down-payment assistance effectively undercuts FHA requirements 
that help to ensure that FHA homebuyers obtain a certain amount of 
``instant equity'' at closing. That is, when the sales price represents 
the fair market value of the house, and the homebuyer contributes 3 
percent of the sales price at the closing, the loan-to-value ratio 
(i.e., the ratio of the amount of the mortgage loan to the value of the 
home) is less than 100 percent. But when a seller raises the sales 
price of a property to accommodate a contribution to a nonprofit that 
provides down-payment assistance to the buyer, the buyer's mortgage may 
represent 100 percent or more of the property's true market value. In 
prior work, we found that, controlling for other factors, high loan-to-
value ratios lead to increased insurance claims.
---------------------------------------------------------------------------
    \5\ GAO, Mortgage Financing: Additional Action Needed to Manage 
Risks of FHA-Insured Loans with Down Payment Assistance, GAO-06-24 
(Washington, DC: Nov. 9, 2005).
---------------------------------------------------------------------------
    Our 2005 report made recommendations designed to better manage the 
risks of loans with down-payment assistance generally and from seller-
funded nonprofits specifically. We recommended that FHA consider risk 
mitigation techniques such as including down-payment assistance as a 
factor when underwriting loans. We also recommended that FHA take 
additional steps to mitigate the risk associated with loans with 
seller-funded down-payment assistance, such as treating such assistance 
as a seller inducement and therefore subject to the prohibition against 
using seller contributions to meet the 3 percent borrower contribution 
requirement. Consistent with the first recommendation, FHA is testing 
additional predictive variables, including source of the down payment, 
for inclusion in its mortgage scorecard (an automated tool that 
evaluates the default risk of borrowers). HUD's proposed rule to 
prohibit seller-funded down-payment assistance is responsive to the 
second recommendation.
    It is difficult to compare the performance of FHA-insured loans 
with seller-funded down-payment assistance to subprime loans because of 
differences in the way performance data are reported. (For example, FHA 
measures the percentage of loans, by origination year, that completed 
the foreclosure process and resulted in an insurance claim. In 
contrast, the Mortgage Bankers Association's National Delinquency 
Survey--which provides data on prime, subprime, and government-insured 
loans--measures the percentage of loans being serviced, regardless of 
origination year, that were in any stage of the foreclosure process.) 
FHA has reported that, as of January 2007, 15.6 percent of fiscal year 
2000 loans with down-payment assistance from nonprofits (the large 
majority of which received funding from property sellers) had resulted 
in an insurance claim. For this and more recent books of business, the 
claim rates for loans with this type of assistance were at least twice 
as high as the claim rates for all FHA-insured purchase loans.
    Question. As I stated in my opening statement, I strongly believe 
that FHA reform should address some of the structural issues with FHA 
that has impeded its ability to manage effectively the risk of its 
insured mortgages. I believe having some flexibility in hiring 
(possibly similar to the FDIC and other quasi-governmental entities) 
and purchasing authority can help the FHA function more like a 
business.
    Do you believe that FHA's current structure impedes their ability 
to perform their mission in a sound and effective manner?
    Answer. In our June 2007 report on FHA's modernization efforts, we 
discussed options that FHA and Congress could consider to help FHA 
adapt to changes in the mortgage market and the pros and cons of these 
options.\6\ Some of these options could help the agency perform its 
mission more effectively by increasing its operational flexibility. For 
example, we noted that mortgage industry participants and researchers 
had indicated that Congress could consider granting FHA additional 
authorities to invest in staff and technology. Specifically, Congress 
could allow FHA to manage its employees outside of Federal pay scales. 
Some Federal agencies, such as the Securities and Exchange Commission, 
the Office of Thrift Supervision, and the Federal Deposit Insurance 
Corporation, are permitted to pay salaries above normal Federal pay 
scales in recognition of the special skills demanded by sophisticated 
financial market operations. The Millennial Housing Commission and 
mortgage industry officials have suggested that FHA be given similar 
authority.\7\ This option could help FHA to recruit experienced staff 
to help the agency adapt to market changes and could be funded with the 
Mutual Mortgage Insurance Fund's current resources--that is, negative 
subsidies that accrue in the Fund's reserves. However, the Fund is 
required by law to operate on an actuarially sound basis. Because the 
soundness of the Fund is measured by an estimate of its economic 
value--an estimate that is subject to inherent uncertainty and 
professional judgment--the Fund's current resources should be used with 
caution. Spending the Fund's current resources would lower the Fund's 
reserves, which in turn would lower the economic value of the Fund. As 
a result, the Fund's ability to withstand severe economic conditions 
could be diminished. Also, using the Fund's current resources would 
increase the Federal budget deficit unless accompanied by corresponding 
reductions in other government spending or an increase in receipts.
---------------------------------------------------------------------------
    \6\ GAO-07-708.
    \7\ The Millennial Housing Commission, established by Congress in 
2000, studied the Federal role in meeting the Nation's housing 
challenges and issued a report in 2002, which included recommendations 
for a variety of reforms to Federal housing programs. See Meeting Our 
Nation's Housing Challenges: Report of the Bipartisan Millennial 
Housing Commission (Washington, DC: May 30, 2002).
---------------------------------------------------------------------------
    Question. The GAO has raised several concerns with FHA's ability to 
manage risk and that it could impact its ability to manage new products 
such as the proposed no down-payment mortgage product. And now, the 
delinquency rate for FHA loans are at a new record level according to 
the latest Mortgage Bankers Association's Delinquency Survey. In fact, 
MBA's data seems to indicate that FHA loans are as risky, if not more 
risky, than subprime loans.
    Given FHA's track record in managing its existing portfolio of 
loans and risky loans such as those with high loan-to-value ratios, 
should we be concerned about FHA's ability to manage effectively its 
proposed no- or low-down-payment loan programs?
    Answer. In our June 2007 report on FHA's modernization efforts, we 
expressed concerns about the proposal to lower down-payment 
requirements potentially to zero given the greater default risk of 
loans with high loan-to-value ratios, policies that could result in 
effective loan-to-value ratios of over 100 percent, and housing market 
conditions that could leave borrowers with such loans with negative 
equity.\8\ We noted that sound management of very low or no-down-
payment products would be necessary to help ensure that FHA and 
borrowers do not experience financial losses. Piloting or otherwise 
limiting the availability of new products would allow FHA the time to 
learn more about the performance of these loans and could help avoid 
unanticipated insurance claims. Despite the potential benefits of this 
practice, FHA generally has not implemented pilots, unless directed to 
do so by Congress. We have previously indicated that, if Congress 
authorizes FHA to insure new products, Congress and FHA should consider 
a number of means, including limiting their initial availability, to 
mitigate the additional risks these loans may pose. We continue to 
believe that piloting would be a prudent approach to introducing the 
products authorized by FHA's legislative proposal.
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    \8\ GAO-07-708. Loans with low or no down payments carry greater 
risk because of the direct relationship that exists between the amount 
of equity borrowers have in their homes and the risk of default. The 
higher the loan-to-value ratio, the less cash borrowers will have 
invested in their homes and the more likely it is that they may default 
on mortgage obligations, especially during times of economic hardship 
or price depreciation in the housing market.
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    Question. Your testimony notes that FHA has generally 
underestimated the subsidy costs for its single-family program based on 
the annual re-estimates it conducts. In fact, FHA had a $7 billion re-
estimate in 2003 due to various reasons.
    Given this history, what level of confidence do you have that FHA's 
credit subsidy estimate for fiscal year 2008 is accurate? Is it 
unreasonable to assume that the credit subsidy situation is worse than 
projected by FHA? Do you believe that the credit subsidy estimate for 
fiscal year 2007 may change?
    Answer. Although credit subsidy estimates by their nature have a 
degree of uncertainty, FHA's estimates, including those for fiscal year 
2008, should be viewed with particular caution given the agency's track 
record. In recent years, FHA has taken a number of steps to improve its 
subsidy estimates such as including the source of down payment and 
borrower credit scores in its loan performance models (the results of 
which are used to estimate credit subsidy costs). However, FHA's 
current reestimates of subsidy costs are generally less favorable than 
the original estimates, even for recent books of business. For example, 
the current reestimated cost for the fiscal year 2006 book of business 
is about $800 million higher than originally estimated.
    Annual estimates of a program's lifetime credit subsidy costs can 
change from year to year as a result of changes in estimation 
methodology, economic assumptions, and program policies. Furthermore, 
each additional year provides more historical data on loan performance 
that may influence subsidy estimates. As a result, it is likely that 
FHA's credit subsidy estimate for fiscal year 2007 (and for other 
years) will change to some degree. However, it is difficult to predict 
the size and direction of those changes.
                                 ______
                                 
              Question Submitted by Senator Arlen Specter

    Question. According to GAO's analyses, will FHA's modernization 
proposals make FHA more financially sound? What is the most crucial 
change for FHA to implement to improve its risk management?
    Answer. As we reported in June 2007, FHA has estimated that its 
three major legislative proposals (instituting risk-based pricing, 
raising loan limits, and lowering down-payment requirements) would have 
a beneficial impact on HUD's budget due to higher estimated negative 
subsidies.\9\ According to the President's fiscal year 2008 budget, the 
credit subsidy rate for FHA's Mutual Mortgage Insurance Fund (which 
supports FHA's single-family insurance programs) would be more 
favorable if the legislative proposals were enacted. Absent any program 
changes, FHA estimates that the Fund would require an appropriation of 
credit subsidy budget authority of approximately $143 million. If the 
legislative proposals were not enacted, FHA would consider raising 
premiums to avoid the need for appropriations. If the major legislative 
proposals were passed, FHA estimates that the Fund would generate $342 
million in negative subsidies. Although credit subsidy estimates by 
their nature have a degree of uncertainty, FHA's estimates, including 
those for fiscal year 2008, should be viewed with particular caution 
given the agency's track record. FHA's current reestimates of subsidy 
costs are generally less favorable than the original estimates, even 
for recent books of business. For example, the current reestimated cost 
for the fiscal year 2006 book of business is about $800 million higher 
than originally estimated.
---------------------------------------------------------------------------
    \9\ GAO, Federal Housing Administration: Modernization Proposals 
Would Have Program and Budget Implications and Require Continued 
Improvements in Risk Management, GAO-07-708 (Washington, DC: June 29, 
2007).
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    A major reason why FHA has estimated a need for appropriations in 
fiscal year 2008 (absent program changes) is the poor performance of 
loans with down-payment assistance from nonprofits that receive funding 
from property sellers. Accordingly, we believe it is critical that FHA 
develop sufficient standards and controls to manage the risks 
associated with these loans. These loans are problematic because 
property sellers that provide down-payment assistance through 
nonprofits often raise the sales prices of the homes involved in order 
to recover the required payments to the nonprofits. For example, in 
November 2005, we reported that FHA-insured homes bought with seller-
funded nonprofit assistance appraised at and sold for about 2 to 3 
percent more than comparable homes bought without such assistance.\10\ 
The weaker performance of loans with seller-funded down-payment 
assistance may be explained, in part, by the higher sales prices and 
the homebuyer having less equity in the transaction.
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    \10\ GAO, Mortgage Financing: Additional Action Needed to Manage 
Risks of FHA-Insured Loans with Down Payment Assistance, GAO-06-24 
(Washington, DC: Nov. 9, 2005).
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    Our 2005 report made recommendations designed to better manage the 
risks of loans with down-payment assistance generally and from seller-
funded nonprofits specifically. We recommended that FHA consider risk 
mitigation techniques such as including down-payment assistance as a 
factor when underwriting loans. We also recommended that FHA take 
additional steps to mitigate the risk associated with loans with 
seller-funded down-payment assistance, such as treating such assistance 
as a seller inducement and therefore subject to the prohibition against 
using seller contributions to meet the 3 percent borrower contribution 
requirement. Consistent with the first recommendation, FHA is testing 
additional predictive variables, including source of the down payment, 
for inclusion in its mortgage scorecard (an automated tool that 
evaluates the default risk of borrowers). Additionally, HUD has 
proposed a rule to prohibit seller-funded down-payment assistance. 
However, implementation of the rule has been delayed due to a legal 
challenge from certain nonprofit down-payment assistance providers.

                          SUBCOMMITTEE RECESS

    Senator Murray. Thank you to all of you for coming forward 
today and your testimony. It's been very helpful to this 
committee. With that, this subcommittee will stand in recess, 
subject to the call of the Chair.
    [Whereupon, at 10:50 a.m., Thursday, March 15, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
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