[Senate Hearing 111-394]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-394
 
  ROLE OF THE FEDERAL HOUSING ADMINISTRATION (FHA) IN ADDRESSING THE 
                             HOUSING CRISIS

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

                                HEARING

                                before a

                          SUBCOMMITTEE OF THE

            COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                            SPECIAL HEARING

                     APRIL 2, 2009--WASHINGTON, DC

                               __________

         Printed for the use of the Committee on Appropriations


  Available via the World Wide Web: http://www.gpoaccess.gov/congress/
                               index.html



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                               __________
                      COMMITTEE ON APPROPRIATIONS

                   DANIEL K. INOUYE, Hawaii, Chairman
ROBERT C. BYRD, West Virginia        THAD COCHRAN, Mississippi
PATRICK J. LEAHY, Vermont            CHRISTOPHER S. BOND, Missouri
TOM HARKIN, Iowa                     MITCH McCONNELL, Kentucky
BARBARA A. MIKULSKI, Maryland        RICHARD C. SHELBY, Alabama
HERB KOHL, Wisconsin                 JUDD GREGG, New Hampshire
PATTY MURRAY, Washington             ROBERT F. BENNETT, Utah
BYRON L. DORGAN, North Dakota        KAY BAILEY HUTCHISON, Texas
DIANNE FEINSTEIN, California         SAM BROWNBACK, Kansas
RICHARD J. DURBIN, Illinois          LAMAR ALEXANDER, Tennessee
TIM JOHNSON, South Dakota            SUSAN COLLINS, Maine
MARY L. LANDRIEU, Louisiana          GEORGE V. VOINOVICH, Ohio
JACK REED, Rhode Island              LISA MURKOWSKI, Alaska
FRANK R. LAUTENBERG, New Jersey
BEN NELSON, Nebraska
MARK PRYOR, Arkansas
JON TESTER, Montana
ARLEN SPECTER, Pennsylvania

                    Charles J. Houy, Staff Director
                  Bruce Evans, Minority Staff Director
                                 ------                                

 Subcommittee on Transportation and Housing and Urban Development, and 
                            Related Agencies

                   PATTY MURRAY, Washington, Chairman
ROBERT C. BYRD, West Virginia        CHRISTOPHER S. BOND, Missouri
BARBARA A. MIKULSKI, Maryland        RICHARD C. SHELBY, Alabama
HERB KOHL, Wisconsin                 ROBERT F. BENNETT, Utah
RICHARD J. DURBIN, Illinois          KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota        SAM BROWNBACK, Kansas
PATRICK J. LEAHY, Vermont            LAMAR ALEXANDER, Tennessee
TOM HARKIN, Iowa                     SUSAN COLLINS, Maine
DIANNE FEINSTEIN, California         GEORGE V. VOINOVICH, Ohio
TIM JOHNSON, South Dakota            THAD COCHRAN, Mississippi (ex 
FRANK R. LAUTENBERG, New Jersey          officio)
ARLEN SPECTER, Pennsylvania
DANIEL K. INOUYE, Hawaii, (ex 
    officio)

                           Professional Staff

                              Peter Rogoff
                          Meaghan L. McCarthy
                             Rachel Milberg
                            Jonathan Harwitz
                         Jon Kamarck (Minority)
                      Matthew McCardle (Minority)
                        Ellen Beares (Minority)

                         Administrative Support
                              Teri Curtin


                            C O N T E N T S

                              ----------                              
                                                                   Page

Opening Statement of Senator Patty Murray........................     1
Opening Statement of Senator Christopher S. Bond.................     4
Statement of Hon. Shaun Donovan, Secretary, Department of Housing 
  and Urban Development..........................................     6
    Prepared Statement...........................................     8
FHA Past and Present.............................................     8
FHA's Challenges.................................................     9
FHA Performance Today............................................     9
Enhancing FHA Operations.........................................    10
Priorities Going Forward.........................................    11
Troublesome Lenders..............................................    13
Early Payment Defaults...........................................    14
Loss Mitigation..................................................    15
Loss Mitigation Costs on FHA Fund................................    15
Mortgages Currently in Mitigation................................    16
Statement of Senator Frank R. Lautenberg.........................    16
    Prepared Statement...........................................    16
Low- and Moderate-Income Homeowners..............................    17
FHA Solvency.....................................................    18
Statement of Senator George V. Voinovich.........................    18
    Prepared Statement...........................................    18
Increase in FHA Lenders..........................................    19
Demolition of Properties.........................................    19
Neighborhood Stabilization Program (NSP).........................    21
HOPE for Homeowners Program......................................    21
HOPE for Homeowners..............................................    21
Demolition of Properties.........................................    21
Mortgage Scams...................................................    22
HECMS............................................................    23
Statement of Hon. Kenneth M. Donohue, Inspector General, 
  Department of Housing and Urban Development....................    24
    Prepared Statement...........................................    25
The Evolving Landscape...........................................    26
Departmental Issues..............................................    27
OIG Observations.................................................    27
Increased Risks to FHA...........................................    29
OIG Concerns Regarding Critical Front-End and Back-End Processes 
  (Improving the Quality of FHA Originations and the Enforcement 
  of Bad Actors).................................................    32
OIG Challenges...................................................    35
Statement of J. Lennox Scott, Chief Executive Officer, John L. 
  Scott Real Estate, on Behalf of the National Association of 
  REALTORS......................................................    36
    Prepared Statement...........................................    37
Need for Increased Capacity......................................    38
Increased Oversight/Risk Management..............................    38
Technical Corrections to FHA Programs............................    39
FHA and Use of the Homebuyer Tax Credit..........................    40
Statement of Mia Vermillion, Senior Loan Consultant, Guild 
  Mortgage, Lakewood, Washington.................................    40
    Prepared Statement...........................................    41
Mortgage Fraud Activity..........................................    43
Maximum Loan Limit...............................................    44
Mortgage Rescue Scams............................................    44
Default/Bailout..................................................    45
FHA Appraisal Process............................................    46
Pierce County....................................................    46
HECMS............................................................    47
FHA Improvements.................................................    48
Additional Committee Questions...................................    48
Questions Submitted to Hon. Shaun Donovan........................    48
Questions Submitted by Senator Patrick J. Leahy..................    48
The New Issue Bond Program (NIBP)................................    50
The Temporary Credit and Liquidity Program (TCLP)................    50
Question Submitted by Senator Frank R. Lautenberg................    51
Question Submitted by Senator Sam Brownback......................    51
Questions Submitted by Senator George V. Voinovich...............    51


  ROLE OF THE FEDERAL HOUSING ADMINISTRATION (FHA) IN ADDRESSING THE 
                             HOUSING CRISIS

                              ----------                              


                        THURSDAY, APRIL 2, 2009

                           U.S. Senate,    
 Subcommittee on Transportation and Housing
       and Urban Development, and Related Agencies,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:01 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Patty Murray (chairman) presiding.
    Present: Senators Murray, Lautenberg, Bond, and Voinovich.


               OPENING STATEMENT OF SENATOR PATTY MURRAY


    Senator Murray. This subcommittee will come to order. This 
morning the subcommittee will hold its first hearing in the 
111th Congress, and I can't think of a more timely subject for 
us to examine than the current economic crisis and its impact 
on homeowners across the country. There is no question that a 
perfect storm of Wall Street greed, irresponsible mortgage 
lending, and uninformed decisions by borrowers are at the heart 
of our economic crisis. What this subcommittee will explore 
today is what role the Federal Government and, more 
specifically, the Federal Housing Administration will play in 
the stemming of the housing crisis and assisting in our 
Nation's long-term recovery.
    First of all, I'd like to extend a very warm welcome to our 
newly confirmed HUD Secretary, Shaun Donovan. Welcome. Good to 
have you here today. This is Secretary Donovan's first 
appearance before the subcommittee, but he and I have had many 
conversations about the challenges that HUD is facing on a wide 
variety of issues from homeless veterans to housing counseling 
to the foreclosure crisis.
    We look forward to hearing from you today and to working 
with you to get the agency and the Nation headed down a 
sustainable path when it comes to housing.
    I also look forward to hearing from our second panel of 
witnesses, including HUD Inspector General Ken Donohue, and 
from our two housing experts from my home State of Washington, 
Mr. Jay Lennox Scott, who's the Chairman and CEO of John L. 
Scott Real Estate, a family-run business for three generations, 
and Ms. Mia Vermillion, who is the Senior Mortgage Consultant 
with Guild Mortgage in Lakewood, Washington.
    Now, I travel home every weekend and hear from my home 
State families about the challenges that they face, and I think 
it's important that Congress get on-the-ground perspective from 
experts in our communities who know what works and, 
alternatively, where there is room for improvement.
    Our Nation is facing the worst economic crisis in 
generations. Since December 2007 we lost 4.4 million jobs, 
including 2.6 million in just the past 4 months. At the root of 
this crisis is years of reckless, unregulated, and 
irresponsible mortgage lending. Many of the mortgages that were 
initiated and then repackaged and sold during this period now 
have a new name: toxic assets. They are a significant portion 
of the assets that are poisoning the balance sheets of some of 
the largest financial institutions in the world, bringing 
uncertainty to the entire international banking system.
    This impact has been felt in every sector of the American 
economy, stifling credit from car and student loans to the 
credit extended to help small businesses meet their payroll. 
It's important to note that the housing crisis is not just some 
abstract phenomenon impacting giant financial institutions. 
There are currently over 290,000 American homes in foreclosure, 
including 3,021 in my home State of Washington.
    The housing crisis has swept across our communities and 
some are now calling on the Federal Housing Administration to 
be the savior of the market. The Federal Housing Administration 
was established in 1934 when the Great Depression ground the 
mortgage lending market to a standstill. The lending industry 
would only extend very short-term loans to high income 
households that could afford a very high down payment. Low- and 
moderate-income families had no hope of participating. So the 
FHA created a mechanism for working families to achieve the 
dream of home ownership. It also lowered the risk to lending 
institutions by putting the full faith and credit of the 
Government behind new affordable mortgages.
    The FHA was an overwhelming success. FHA was there in good 
times and in bad, especially during recessions and periods of 
declining home values, as happened in the 1980s. Today, 75 
years after its founding to help American families purchase a 
home, the FHA is now being called upon to keep millions of 
families in their homes. In 2007, when Commissioner Montgomery 
testified before us, it was to talk about the fact that the FHA 
was almost irrelevant to the housing market. At the time, the 
FHA's presence in the market had dropped to only 3 percent 
because so many lenders had taken advantage of the housing boom 
and instead offered exotic mortgages that families couldn't 
afford. The FHA's modest loan limits kept it out of many 
markets, including Seattle, King County the most populous 
county in Washington State.
    Working with my colleagues, I was able to increase the FHA 
loan limits to make it relevant in these markets. But a lot of 
other things have changed with the FHA in a very short period 
of time that are threatening the integrity of the program and 
the taxpayers that stand behind it. The subprime market has now 
evaporated, and even the most creditworthy borrowers are having 
a hard time getting a mortgage.
    I want to read to you a part of a letter from a constituent 
of mine in Kirkland, Washington, who, like a lot of Americans, 
has scrimped and saved and has good credit and yet still can't 
purchase a home of their own. They wrote to me and they said:

    ``In spite of my 18 years teaching public school in the 
Puget Sound region, my husband and I have been unable to 
purchase our own home. My husband was laid off from his job in 
1998, returned to school to improve his employability, but 
couldn't for some time find more than part-time work.
    ``Now that we are finally in a more comfortable earnings 
bracket, we put every spare dollar into saving for a down 
payment and paying off the debt that we incurred during those 
darker days. Certainly there are many like us, unable to gather 
the money necessary to take the first steps to home ownership, 
but stably employed and with good credit, ready to make our own 
small contribution to the economy by taking on the 
responsibilities of home ownership.''

    That's not an unusual story and it's one of the many 
reasons that the solvency of the FHA is critical. The mission 
of the agency is to take care of creditworthy borrowers. 
Compared to the 3 percent market share FHA just had 2 years 
ago, today they guarantee over 25 percent of the total mortgage 
volume in the United States and the number of lenders with whom 
it does business has grown by more than 500 percent since 
fiscal year 2006. In Washington State, the number of FHA loans 
increased from just fewer than 9,000 in 2007 to over 30,000 in 
2008.
    We all want to lend a helping hand to the struggling 
families who need it, but we need to focus on exactly who the 
FHA can help through updated laws and revised policies. We 
don't want to invite a trend in which the worst mortgages are 
moved off the bankers' books and onto the Federal Government's.
    My constituents have been clear that they don't want to 
wake up to learn that Congress has taken steps that leave the 
taxpayer holding the bag, and that's exactly what could happen 
if the FHA is pushed to buy loans that could go bad soon or 
down the line. We have to ensure that FHA has the tools and 
flexibility to charge enough in fees to cover its costs, 
because if the FHA can't pay its debts it will be up to this 
subcommittee to appropriate the funds to cover that shortfall 
and we do not have the dollars to do that.
    We are in tough budget times. Every dollar we spend to 
cover defaults at the FHA is one less dollar going to public 
housing, homelessness prevention, or housing counseling to keep 
families in their homes.
    This subcommittee has previously examined longstanding 
challenges at the FHA, like outdated technology, personnel 
shortages, and inadequate underwriting. Just because FHA has 
become a major player in saving the housing market doesn't mean 
those challenges have disappeared. As we talk about FHA's 
expanded role, we have to also discuss more rigorous 
underwriting and oversight.
    I've convened this hearing with Senator Bond and I want to 
thank him for working with me on this because we want the FHA 
to be in a position to protect America's families and keep them 
in their homes, and to do that we have to ensure that the FHA 
isn't spread thin and it has the tools and resources needed to 
adequately staff, underwrite, and monitor its skyrocketing loan 
volume.
    Both American homeowners and the American taxpayers deserve 
to know the Federal Government is acting responsibly and 
swiftly to help families in financial distress and to jump-
start the ailing real estate market.
    So I look forward to the testimony and responses of all of 
our witnesses today, and with that I want to turn it over to my 
colleague, the subcommittee's ranking member, Senator Bond, who 
has been very critical in helping us to put this together 
today. So thank you very much, Senator.


            OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND


    Senator Bond. Thank you very much, Madam Chair. I hope I've 
been critical in helping and not in criticizing.
    Senator Murray. No, critical in helping, definitely.
    Senator Bond. I begin by endorsing your warning that this 
subcommittee and our ability to provide the many needs in 
housing is threatened by a potential major drain on our 
resources we can't stand. I appreciate your calling this 
hearing, as I certainly asked you to do. I think it's time that 
we laid out where we stand.
    I welcome our witnesses today. I congratulate the Secretary 
of HUD, Shaun Donovan, on his appointment and his willingness 
to take on a very challenging job during a very challenging 
time. I asked him repeatedly if he was willing to do it and he 
indicated that he was willing to take the chance. I know 
Secretary Donovan from his previous work. I've had good 
conversations with him. I am impressed with his knowledge, 
understanding, and his past forward.
    I also recognize Mr. Ken Donohue, the HUD IG. Ken has done 
a great job of providing the Department and the Congress with 
independent and objective analysis and oversight of HUD's 
responsibilities.
    Make no mistake, the health and solvency of FHA is at high 
risk. There are very troubling signs. FHA defaults are at their 
highest rates in several years. FHA's economic value had fallen 
by almost 40 percent over the past year. FHA-approved new 
lenders have increased by 525 percent over the past 2 years, 
and there are troubling signs that former subprime lenders and 
brokers have been approved to conduct FHA business. Fraudulent 
activity in the mortgage industry is on the rise, exposing FHA 
to more risk.
    I've just been advised by the U.S. Attorney for the Eastern 
District of Missouri that she and her office have filed 58 
individual and business criminal indictments, from large 
communities like St. Louis to small communities like Sykeston, 
and they have over 100 cases currently in review. That means 
the system is at risk.
    FHA has a significant increase in foreclosures, which 
endanger the stability of communities and neighboring homes. 
The rise in FHA defaults and foreclosures, especially in areas 
already victimized by subprime lending, threaten to make a bad 
problem worse. It is clear that the families who suffer 
foreclosure go through a financial crisis. They go through a 
tremendous personal upheaval, losing their homes. But 
communities are suffering when the foreclosure rates become 
high. I've heard community leaders as well as housing advocates 
outline what happens to a community with foreclosures. Even on 
a broader basis, the geniuses on Wall Street who took these 
mortgages, securitized them, sliced them, diced them, and sent 
them out to poison not only our financial system, but the 
world's financial system, are really a very significant part of 
the worldwide economic crisis that we face right now.
    Mr. Secretary, you inherited an agency that has 
longstanding challenges. I'm confident that you're up to the 
task of turning the agency around. I appreciate your 
recognition and willingness to tackle FHA's management and 
operational problems. But despite your skills and leadership, 
the Congress and the administration must not make your job 
harder by placing more risk on FHA until the problems are 
fixed, until the agency can handle it, or the agency will 
crash.
    I believe I'm hearing from Americans there's a message for 
Congress and the administration: The taxpayer credit card is 
maxed out, the alarm has sounded. If Congress and the 
administration place more risk on FHA before the problems are 
solved, this powder keg will explode and taxpayers will be on 
the hook.
    Now, we know that FHA has suffered from longstanding 
management and oversight problems, and in addition past 
administrations and Congress have contributed to FHA's woes by 
making changes to FHA so that it could refinance existing 
subprime mortgages. For example, the Bush administration 
created a new program called FHA Secure to allow the agency to 
refinance subprime borrowers who are late on a few payments. 
While the program served a fraction of troubled subprime 
borrowers and it was good, it did provide some assistance, the 
FHA terminated the program because of the negative financial 
impact on its insurance fund.
    In addition, Congress created the FHA Home for Homeowners 
Program as part of last summer's Housing and Economic Recovery 
Act of 2008. Out of concern about the increased risk, the FHA 
spoke against and voted against the bill. While this $300 
billion program has not served as many borrowers as 
anticipated, the Obama administration and some in Congress are 
advocating changes that would relax the standards of the 
program to increase participation.
    In addition, there are efforts in the House to reestablish 
no down payment programs that significantly contributed to 
FHA's troubles. The seller no down payment program defaulted at 
an unacceptable rate, higher than subprime loans. As a result, 
I strongly oppose those efforts.
    I look forward to working with the Secretary to ensure that 
you, Mr. Secretary, have the needed resources to carry out 
FHA's mission. It's vitally important that the FHA hire the 
necessary staff, provide consistent and comprehensive training, 
ensure that you install necessary safeguards to minimize fraud 
and abuse, and get your IT systems up to the modern day 
capabilities and the needs of the agency.
    FHA has a very important role to provide home buyers with 
clear and comprehensive requirements, to help ensure the 
success of their home ownership. If the homeowners don't 
succeed, they lose, the communities lose, and we all lose.
    Thank you, Mr. Secretary, for taking on this major task.
    Senator Murray. Thank you, Senator Bond.
    Mr. Secretary, we will now turn to you for your testimony. 
We do have your written testimony and we would ask you to 
summarize in about 5 minutes for the subcommittee.

STATEMENT OF HON. SHAUN DONOVAN, SECRETARY, DEPARTMENT 
            OF HOUSING AND URBAN DEVELOPMENT
    Secretary Donovan. Thank you very much. Chairwoman Murray, 
Ranking Member Bond, and members of the subcommittee. Thank you 
for the opportunity to speak with you today about the state of 
the Federal Housing Administration. I come before you in a 
historically unique moment. Our economy has deep challenges, 
unemployment is high, incomes are falling, and home 
foreclosures are greater than at any time since the Great 
Depression.
    The Obama administration has responded with a comprehensive 
program to stimulate our economy and revive our housing 
markets. Last week President Obama announced his intention to 
nominate David Stevens to be the Assistant Secretary for 
Housing, and the Federal Housing Commissioner. I believe that 
Mr. Stevens is one of the best and brightest in the mortgage 
business, with a deep range of experience, and will be a steady 
hand in helping to manage through these challenging times.
    Current market conditions highlight the critical role of 
the Federal Government in keeping mortgage credit flowing. In 
particular, FHA's role has grown substantially, from 3 percent 
of lending activity by dollar volume in 2006 to over 20 percent 
of all mortgages originated today.
    Like other market players, FHA is experiencing elevated 
defaults and foreclosures, and with it losses that exceed prior 
estimates. In contrast to the subprime sector, where unsafe 
loan features and poor underwriting made those mortgages risky 
from the start, for FHA the primary reason for defaults and 
foreclosures continues to be economic factors, especially loss 
of income. FHA, however, is unlikely to face the catastrophic 
losses born in the subprime sector.
    Moreover, much of our recent loss activities have been 
attributable to the growth in seller-funded down payment 
assistance, which accounted for a large and growing share of 
FHA losses and which Congress terminated last year. I thank you 
for your leadership on this issue and this should help to 
substantially reduce future losses in FHA's new business.
    Several other factors should mitigate the damage in the 
current recession--that the current recession wreaks on FHA's 
portfolio. First, credit scores of FHA borrowers have risen 
markedly as tighter underwriting standards in the private 
market have driven better borrowers to FHA. Second, before mid-
2008 FHA's loan limits reduced its market share and exposure in 
some of the Nation's highest cost housing markets, particularly 
in California.
    My overall goal then is to continue efforts to identify 
both the existing strengths and to honestly look at the 
weaknesses of FHA, to work with Congress to make sure that FHA 
has the right program mix and pricing structure, is actuarially 
sound, and has the organizational infrastructure to continue to 
expand home ownership opportunities to those families 
traditionally not well served by the private marketplace.
    Let me talk for a minute about the investments in both 
technology and human resources we need to make to build a sound 
infrastructure. FHA relies too heavily today on manual 
processes and needs to adopt more automated processes for 
underwriting and risk management. FHA staff spends too much 
time manually performing risk management duties, monitoring 
lenders and appraisers, and reviewing the underwriting of 
individual loan files. We must accelerate our adoption of 
market standard technologies for both of these areas.
    Specifically, technology can also enhance FHA's fraud 
detection by borrowers, lenders and appraisers. We have already 
secured the use of anti-fraud technology for our Hope for 
Homeowners Program and are now looking to expand the use of 
that tool to all of FHA's single family business, beginning 
with a pilot application in fiscal year 2009.
    These efforts tie in directly to the Obama administration's 
multi-agency combating mortgage fraud initiative. Under this 
initiative HUD and FHA will be playing a central role by 
investing in bringing anti-fraud systems on line. This 
initiative will also include additional resources from the FBI 
and the Justice Department to investigate and prosecute 
mortgage fraud.
    I also want to say a special mention to the early 
cooperation and collaboration I have had with HUD's Inspector 
General, Ken Donohue.
    Finally, as you well know, FHA's basic program data and 
technology systems are old and woefully inadequate. We will be 
requesting funding in our 2010 budget for IT investments and to 
prioritize the modernization of FHA IT systems, to upgrade our 
technology and core systems.
    Automated tools to assist in risk management will be a good 
addition, but FHA also needs more staff and staff with a 
different skills mix than our current work force. I want to 
thank you, Chairwoman Murray, and members of the entire 
subcommittee for providing additional funding specifically for 
the Office of Housing to hire approximately 200 additional 
personnel in the fiscal year 2009 budget. The agency has 
already developed a staffing plan and job announcements are 
under way.
    So my first priority is shoring up the basic infrastructure 
of the program. In addition, two other priorities are at the 
top of my list: helping homeowners avoid foreclosure and 
rethinking FHA's role in the new mortgage market. Last month, 
President Obama announced a bold plan to help borrowers avoid 
foreclosure. In addition to the making home affordable 
components, the President has called on Congress to enact 
carefully crafted bankruptcy reform along with important 
reforms to enable FHA to play a larger role in the overall 
effort to stabilize our Nation's housing market.
    As you know, housing legislation, H.R. 1106, has passed the 
House and is now before the Senate. We hope it gets enacted 
quickly so that more borrowers can avoid foreclosures. There 
are two specific provisions that we'd like to see enacted: 
changes to Hope for Homeowners as a viable prevention, 
foreclosure prevention tool; and reform of FHA's loan 
modification process to allow FHA to enhance its use of partial 
claims authority, to align our loan modification activities 
with making homes affordable.
    Finally, the recent mortgage market meltdown has provided 
ample evidence that we must work to rethink each and every 
aspect of the Nation's housing finance system. Building on its 
historic mission, I am committed to ensuring that FHA continues 
to provide liquidity and stability to the mortgage market, 
while at the same time developing the new products and programs 
that continue to expand access to home ownership to lower 
income and lower wealth households not well served by the 
private market.


                           PREPARED STATEMENT


    In summary, I want to assure the subcommittee that, while 
significant challenges exist, the FHA is preparing to meet 
these challenges head on. I'm looking forward to having Dave 
Stevens confirmed and take the reins at FHA and look forward to 
answering your questions. Thank you.
    [The statement follows:]

                Prepared Statement of Hon. Shaun Donovan

    Chairwoman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for the opportunity to speak with you today 
about the state of the Federal Housing Administration (FHA).
    I come before you in a historically unique moment. Our economy has 
deep challenges: unemployment is high, incomes are falling, and home 
foreclosures are greater than at any time since the Great Depression. 
The Obama administration has responded with a comprehensive and 
multifaceted program to stimulate our economy and revive our housing 
markets: a recovery package to create or preserve 3-4 million jobs, a 
comprehensive program to stabilize financial markets, lower mortgage 
interest rates and unfreeze credit markets; and new efforts to help 
homeowners refinance their mortgages, avert foreclosures, stabilize 
hard hit neighborhoods and end the downward pressure on housing prices.
    HUD has a critical role to play in each of these areas. I am deeply 
appreciative of your subcommittee for providing HUD with $13 billion in 
recovery funds, including a new infusion of funding for the 
Neighborhood Stabilization Program to help communities prevent blight 
and make foreclosed homes community assets rather than liabilities. HUD 
has been deeply involved in the development of the Obama 
administration's Homeowner Affordability and Stability Plan (HASP), 
including the Making Home Affordable initiative that will allow 4 to 5 
million homeowners now locked out of GSE refinance options to take 
advantage of today's lower rates, and help 3 to 4 million additional 
borrowers receive affordable, sustainable loan modifications and avert 
more costly foreclosures.
    But no part of HUD is more central and important to our national 
effort to promote affordable homeownership than the Federal Housing 
Administration, and I am committed to making FHA as responsive to 
market demands as it was when it was founded.

                          FHA PAST AND PRESENT

    As you all well know, the FHA was created in 1934 to address a set 
of economic conditions that were unquestionably of greater scale, but 
clearly of similar character to what we are facing today. Property 
values were declining. Unemployment was rising and incomes were 
dropping. Families could not pay their bills. It is no surprise that 
many homeowners could not meet their mortgage obligations. The overall 
contraction in the credit markets meant that borrowers had no place to 
turn to refinance out of their mortgages, which, at that point in 
history, were most often structured with 5-year terms and ``balloon'' 
repayment schedules.
    FHA was set up as a Government mortgage insurance company to 
protect financial institutions from risk of loss and, in so doing, to 
encourage lenders to make longer-term, fixed rate home loans. The goal 
was to create liquidity and stability for the mortgage and real estate 
markets--to provide families access to credit, to keep them in their 
homes, and to offer homebuyers a new way to buy homes, by offering 
longer-term affordable financing.
    The agency's mission has not changed since that time. As part of 
this mission, FHA continues to play a countercyclical role--serving as 
a backstop to the private mortgage market. FHA stays active in volatile 
and declining markets, continuing to make mortgage credit available to 
borrowers, even when private mortgage providers are withdrawing from 
the market. During difficult times, it is critically important to have 
an entity like FHA play this role--offering families access to near-
prime rate financing. FHA picked up private market slack in Texas, 
Oklahoma and Louisiana during the Oil Patch bust in the late 1980s and 
in Southern California during the early 1990s, and it is playing this 
role again today.
    Current market conditions highlight the critical role of the 
Federal Government in keeping mortgage credit flowing. With the 
collapse of global credit markets, FHA, Fannie Mae and Freddie Mac must 
continue to work with strong and well managed private sector entities 
to expand access to mortgage credit in the market. In particular, FHA's 
role has grown substantially from 3 percent of lending activity by 
dollar volume in 2006 to approximately 30 percent of all mortgages 
originated today.

                            FHA'S CHALLENGES

    FHA is now playing a critical role in addressing the current 
mortgage crisis, but FHA also faces many challenges today. Like many 
Federal domestic agencies, FHA has suffered under the penny-wise and 
pound foolish priorities of the previous administration. FHA was 
stagnant, limiting its ability to maintain adequate staffing levels and 
invest in state-of-the art technology. Repeated budget stalemates and 
resulting uncertainty of future funding levels undermined the ability 
to implement long-term organizational improvements.
    While FHA's volume of business has increased dramatically in the 
last 2 years and increased administrative appropriations will help 
ensure FHA properly oversees this workload. We certainly are 
appreciative of the additional funding and management flexibility we 
received in the fiscal year 2009 appropriations process and plan to 
bolster our staffing quickly. Outdated information technology (IT) 
systems, systems that were built to handle simpler and smaller mortgage 
programs, continue to serve as the primary vehicles for collecting, 
tracking, and validating program data and performance.
    At the same time, I know that you Senator Murray and the rest of 
the members of this subcommittee share my concerns of the importance of 
helping FHA continue to operate safely and soundly in the current 
environment. Your actions in the fiscal year 2009 budget to allow FHA 
to have greater staffing and flexibility across the departments of the 
agency was a critical first step in helping to build a stronger and 
more market savvy FHA. But it was just a first step. For FHA to realize 
its full potential to respond to the current mortgage crisis it will 
require additional resources and development of new and innovative 
reform initiatives.
    That is why I was so pleased last week when President Obama 
announced his intention to nominate David Stevens to be the Assistant 
Secretary for Housing/Federal Housing Commissioner. I believe that Mr. 
Stevens is one of the best and brightest in the mortgage business with 
experience ranging from mortgage originations, to secondary markets, to 
managing a national real estate firm. Should he be confirmed by this 
body, Mr. Stevens and I will work closely together to diagnose and 
address the challenges now facing FHA. Mr. Stevens brings a hands-on 
systems approach to mortgage origination, and is anxious to see 
firsthand the status of FHA's systems and programs and to quickly put 
in place process and technology improvements in all facets of FHA's 
operations

                         FHA PERFORMANCE TODAY

    Prior to a fuller review, it is already clear to me that the agency 
has done good work in meeting the growing needs of the industry and the 
public. With resources constrained, the leadership and career staff at 
FHA have worked hard to process rapidly growing levels of new business, 
upgrade business processes and bring new FHA products--like FHA Secure 
and Hope for Homeowners--to market in record time.
    But we all know that the FHA team cannot sustain their efforts and 
protect the programs over the long-term without an infusion of 
resources: for new staffing with new skills, investments in new state-
of-the-art technologies, and new efforts to reach out to enforcement 
agencies at all levels of Government to better monitor FHA partners. In 
addition, the organization must continually rethink how to best reshape 
its product mix and pricing, particularly in light of today's dramatic 
market changes. The organization needs all of us to commit to providing 
the support needed to implement strategic improvements in its business 
operations and program designs.
    As is the case with other mortgage market participants, currently 
FHA is experiencing elevated defaults and foreclosures and with it, 
losses that exceed prior estimates. In contrast to the subprime sector, 
where unsafe loan features and poor underwriting made those mortgages 
risky from the start, for FHA, the primary reason for defaults and 
foreclosures continues to be loss of income combined with low or 
negative home equity, and economic factors present in today's 
environment. Although this is a challenging time for all entities in 
the mortgage market, FHA is unlikely to face the catastrophic losses 
borne in the subprime sector. FHA loans continue to substantially 
outperform subprime loans: only 7 percent of FHA loans are seriously 
delinquent (greater than 90 days delinquent or in foreclosure) compared 
to more than 23 percent of subprime loans.
    Moreover, much of our recent loss activities have been attributable 
to the growth in seller-funded down payment assistance. These loans 
grew from under 2 percent of all FHA home purchase originations in 
fiscal year 2000 to greater than one-third of purchase originations in 
fiscal year 2007 and 2008. The seller-funded down payment originations 
result in completed foreclosure at three times the rate of loans where 
borrowers provided their own downpayments and while they only 
represented 12 percent of the FHA portfolio at the start of 2008, 
accounted for 30 percent of all foreclosure completions that year. The 
termination of this program should substantially reduce FHA loses on 
new originations in the years ahead.
    Several factors should mitigate the damage that the current deep 
recession wreaks on FHA's portfolio. First, before mid-2008, FHA's 
constrained loan limits reduced its market share and hence its exposure 
in some of the Nation's highest-cost housing markets, including 
California, where price declines and related foreclosure activity have 
been particularly intense.
    Second, FHA has been attracting better quality borrowers in the 
last year. With much tighter underwriting standards in the private 
market, more higher quality borrowers can't qualify for conventional 
financing and end up with FHA-insured loans. Credit scores for new 
borrowers grew sharply in 2008, averaging over 680 at the end of 2008, 
compared to prior year averages of around 640. This is a positive 
development although, given the dynamic housing market, it is difficult 
to say how long this trend will continue in the future.
    FHA is now playing its traditional role in today's turbulent 
market. But it's important to understand the positive trends as well. 
My goal is to continue my efforts to identify both the existing 
strengths and weakness of FHA, to work with Congress and the rest of 
the administration to make sure that FHA has the right healthy program 
mix and pricing structure, is actuarially sound, and the organizational 
capacity to continue to expand homeownership opportunities to those 
families traditionally not well served by the private market place.

                        ENHANCING FHA OPERATIONS

    Since FHA insurance is backed by the full faith and credit of the 
United States Government, I want to assure the market participants that 
FHA insurance is as reliable as ever and there is no possibility of FHA 
``running out of money.'' Under authority provided to all Federal loan 
programs, FHA has indefinite resources to honor its outstanding 
commitments. At the same time, I want to reiterate my concern that FHA 
does need to make significant business process improvements to cope 
with growing demand and secure state-of-the-art fraud detection and 
risk management systems.

Expanding Use of Automated Risk Management Tools
    It appears to me that FHA relies too heavily on manual processes 
and needs to adopt more automated processes for underwriting and risk 
management. Today, approximately 90 percent of FHA's 850 Office of 
Single Family staff and 100 percent of its contract dollars are devoted 
to risk management practices. They perform three types of risk 
management duties: assessing and monitoring business participants in 
FHA business, including lenders and appraisers; evaluating individual 
loan files to ensure compliance with FHA underwriting standards; and 
monitoring the entire insurance portfolio, by analyzing performance 
trends. The concentration of so many resources on quality control means 
that simply freeing up staff from other functions to provide additional 
support is not an option; there are very few staff who do anything but 
quality control.
    Underwriting.--Working in partnership with the GSEs, FHA developed 
and utilizes an automated underwriting engine, but has not been able to 
keep it updated for analytic, market and technological changes. This is 
an area I'll look to improve. Greater reliance and application of 
automated underwriting systems would also enhance uniformity in the 
application of policy changes, which are now subject to interpretation 
by four FHA Homeownership Centers (HOCs). Getting organizational 
standards aligned with centralized oversight is critical, as is the 
need to continuously enhance the training of existing staff in FHA's 
own rules and procedures.
    Fraud Detection.--Technology can also enhance FHA's fraud detection 
by borrowers. Automated risk management tools are being used industry-
wide with great success, offering an efficient and effective means to 
access a large amount of critical information that can be used to 
detect the most common types of mortgage fraud--falsification of 
borrower identity, income, and employment and misrepresentation of 
property value.
    Better automated tools will expand FHA's ability to closely monitor 
past and present practices of FHA-approved lenders and appraisers. 
Specifically, the best industry tools tap into public data sources that 
provide FHA with information that is not readily apparent in individual 
loan files or in the FHA-specific activities of lenders and appraisers. 
Access to this broader mortgage-related data set will help FHA uncover 
problematic practices before FHA insures loans or grants approval to 
lenders and appraisers to participate in FHA programs.
    To that end, we have already secured the use of anti-fraud 
technology for our HOPE for Homeowners program and are now looking to 
expand the use of that tool to all of FHA's single family business. 
Unfortunately, by statute, the HOPE for Homeowners funding cannot be 
used to support the core FHA refinance and purchase programs. Thanks to 
our fiscal year 2009 appropriation, we now have funding and an existing 
contract to begin testing the use of the fraud detection tool on the 
entire FHA single family portfolio. The pilot will serve as the basis 
of the framework for full implementation of the tool in fiscal year 
2010.
    These efforts tie in directly to the Obama administration's multi-
agency ``Combating Mortgage Fraud Initiative.'' Under this initiative, 
HUD and FHA will be playing a central role, and the Department has 
requested additional 2010 resources specifically for investing in 
additional systems to enhance fraud detection and monitor lender 
originations. This initiative will also include additional resources 
for the FBI and the Justice Department to investigate and prosecute 
mortgage fraud.
    Finally, as you well know, FHA's basic program data and technology 
systems are old and woefully inadequate. The basic IT infrastructure--
both hardware and software--is outdated and inflexible. The various 
data systems are not well-integrated, so time is wasted reconciling 
data across systems that all collect the same information individually. 
Finally, and of greatest concern, the systems were written to support 
business procedures that have changed substantially and the tools 
themselves force FHA to maintain some practices that no longer make 
sense. To that end, we will be requesting funding in our fiscal year 
2010 budget for IT investments and prioritize the modernization of FHA 
IT systems to upgrade our technology, to replace obsolete systems, and 
to invest in infrastructure that can support our core systems into the 
future.

Investing in Human Resources
    Automated tools to assist in risk management will be a good 
addition, but FHA also needs more staff and staff with a different 
skills mix than our current workforce. We need to bolster specific 
expertise and skill sets: housing finance, including underwriting and 
appraisals; quality control and risk management; and policy analysis 
and communications. Recent hirings have brought some new skills, but 
with one of the oldest workforces of all Federal agencies, retirements 
continue to take their toll.
    Therefore, I want to thank you, Chairwoman Murray and members of 
the subcommittee for providing an additional $12.7 million in funding 
specifically for the Office of Housing to hire approximately 200 
additional personnel. The agency has already developed a staffing plan 
and job announcements are underway.

                        PRIORITIES GOING FORWARD

    As noted earlier, my top priority for FHA is shoring up the basic 
infrastructure of the program to ensure that it continues to meet the 
needs of underserved borrowers through this current mortgage crisis.
    Helping Borrowers Avoid Foreclosure.--Last month, President Obama 
announced a bold plan to help borrowers avoid foreclosure. In addition 
to the Making Home Affordable components that I mentioned earlier, the 
President has called on Congress to enact carefully crafted bankruptcy 
reform, along with important reforms to enable FHA to play a larger 
role in the overall effort to stabilize our Nation's housing market. As 
you know, housing legislation (H.R. 1106) has passed the House and is 
now before the Senate. We hope it gets enacted quickly, so that more 
borrowers can avert foreclosures
    I would like to direct your attention to two critical elements of 
that package: proposed changes to Hope for Homeowners and reform of 
FHA's loan modification tools.
    While Congress and the administration had high hopes for the Hope 
for Homeowners program when originally enacted last year, it has 
refinanced very few borrowers. I still believe in the original premise 
of Hope for Homeowners: that many investors would be willing to accept 
a refinance for less than the full amount of their loan to avoid the 
uncertain possibility of future defaults. It could fill an existing 
program void to refinance underwater borrowers who do not qualify for 
either the Making Home Affordable refinance or loan modification 
programs is a necessary addition to a comprehensive array of 
foreclosure prevention tools.
    We look forward to working with you and other leaders in the Senate 
and House to develop a set of Hope for Homeowners programmatic reforms 
that will provide HUD greater flexibility to better meet this critical 
need in the marketplace.
    In addition, I urge the Senate to enact pending provisions to 
enhance FHA's loss mitigation program. Specifically, we are anxious to 
incorporate new legislative authorities to enhance FHA's use of partial 
claims to help facilitate more aggressive and timelier modifications in 
FHA insured loans that are in imminent danger of default. These changes 
will more closely align the FHA loan modification program with the 
Making Home Affordable modification program in the conventional market. 
More importantly, these reforms hold the promise of reducing losses to 
the FHA fund by intervening at the earliest sign of mortgage payment 
difficulties
    Creating New and Innovative Products.--FHA can also be a market 
leader in developing and introducing new mortgage products to make it 
easier and less expensive for homebuyers to finance energy 
improvements. Energy improvements reduce long-term costs to 
homeownership in the form of lower utility bills. In addition to making 
Energy Efficient Mortgages (EEMs) easier to obtain for homebuyers, we 
can work with Fannie Mae and Freddie Mac to coordinate product designs 
so that they are easily understandable and accessible to lenders and 
borrowers.
    Getting to scale in energy efficient mortgage development will 
require the creation, testing and potential adoption of a range of 
approaches. The objectives for these programs include creating the 
proper incentives for energy-efficiency, being ``user-friendly'' to 
both borrowers and lenders, and exhibiting a sound cost and risk 
profile compared to other energy investments. Those approaches include 
streamlining HUD's existing, but under-utilized energy efficient 
mortgage program, and allowing greater flexibility in use of the EEM. 
The program would extend the benefits of the existing FHA Energy 
Efficient Mortgage (EEM) program to more homeowners through a 
coordinated approach that addresses supply-side, demand-side, and 
financing issues, while providing a mechanism for evaluating strengths 
and weaknesses of the initiative.
    Rethinking FHA's Role in the 21st Century Mortgage Market.--The 
recent mortgage market meltdown has provided ample evidence that we 
must work to rethink each and every aspect of the Nation's housing 
finance system. Building on its historic mission, I am committed to 
insuring that FHA continues to provide liquidity and stability to the 
mortgage market, while at the same time developing the new products and 
programs that continue to expand access to homeownership to lower-
income and lower-wealth households not well served by the private 
market. This is not to say that all households should become 
homeowners--we still need to provide decent and affordable rental 
housing to those who by choice or necessity remain as renters. But FHA 
has led the market in the past, and I am committed to making FHA once 
again a market leader.

                               CONCLUSION

    In summary, I want to assure the subcommittee that while 
significant challenges exist, the FHA is prepared to meet these 
challenges head on. I'm looking forward to having David Stevens 
confirmed and take the reins at FHA.
    Together we are committed to an ambitious reform agenda:
  --Modernizing FHA's core technology systems;
  --Enhancing our business practices;
  --Ferreting out fraud among borrowers and lenders;
  --Fixing and scaling up the Hope for Homeowners refinance program for 
        ``underwater'' borrowers;
  --Revamping FHA loan modification efforts to reduce foreclosures;
  --Stimulating new energy efficiency mortgage products into the 
        market; and
  --Restoring FHA to a respected position of leadership in the 
        marketplace.
    I want to thank you for having me here and I'd be happy to answer 
any questions.

    Senator Murray. Thank you very much, Mr. Secretary.
    We are now going to a round of questions by subcommittee 
members. We will limit them to 5 minutes because we do have 
votes starting at 11:30 and we have a second panel. We want to 
make sure we have enough time to get to a second round for the 
Secretary as well as do that.
    Let me begin, Mr. Secretary. Back in November right before 
the election, Business Week magazine published a cover story 
that was entitled ``FHA-Backed Loans: The New Subprime.'' It 
pointed out instances where subprime lenders that had been 
disciplined in several States were being allowed into the FHA 
guarantee program. It pointed out times where companies that 
had officially filed for bankruptcy were still allowed to write 
mortgages with an FHA guarantee. It even pointed out companies 
that never verified incomes when they made subprime mortgages, 
but now have been allowed to reorganize themselves into 
companies that are participating with the FHA.
    The number of brokers and lenders doing business now with 
the FHA has gone through the roof. As of the end of 2008, FHA 
had over 3,300 approved lenders. That is a 525 percent increase 
compared to 2006. When you add the number of brokers now doing 
business with the FHA, the numbers have skyrocketed from 16,000 
in mid-2007 to 36,000 today.
    I wanted to ask you if you believe the FHA has adequate 
procedures in place to screen out lenders and brokers that 
caused this housing crisis. And how do you do that when the 
number of lenders has increased by more than 500 percent in 
just the last 2 years?
    Secretary Donovan. Chairwoman, a very, very important 
question. Let me start first by making a distinction that I 
think is critically important. I am absolutely concerned and 
very focused on the issue of ensuring that troublesome lenders 
don't migrate to the FHA programs. But I also want to be clear 
that FHA's products are not subprime products. We have never 
and we will never allow products that have exploding or hidden 
fees that are short-term with large adjustments in interest 
rates.
    If you look at the default rates today and compare FHA's 
roughly 7 percent default rate to the roughly 23 percent 
default rate in the subprime market, I think it's clear that on 
a product basis FHA is not subprime and will never be subprime. 
That certainly will not happen under my watch.

                          TROUBLESOME LENDERS

    But to get more directly to your question, there is 
absolutely more that we must do and that we are doing to ensure 
that we do everything we can to stop the migration of 
troublesome lenders into the FHA products. We've already taken 
significant action under my watch to begin to do that. In fact, 
today we are issuing a mortgagee letter to remind lenders of 
the procedures and processes that they must put in place.
    A couple weeks ago we activated SWAT teams to look at and 
make visits unannounced to ten of the most troublesome lenders, 
and those teams will continue to focus on areas where we have 
troublesome data from those. There are a range of other things 
that I talked about in my testimony that we must do: improve 
our systems, improve our training and technology.
    In addition to that, I would highlight that we have worked 
closely with you and the subcommittee and currently there are 
in the H.R. 1106 legislation that is before the Senate at this 
point increased authority that would allow us to screen out 
lenders where they have been suspended or debarred from other 
programs and to give us other additional authorities to stop 
the migration of lenders.
    So while we are acting quickly to try and limit that, and 
I'm certainly concerned about it, I think there is also more 
that we can do on a legislative basis to try to make sure we do 
that.
    Senator Murray. As an appropriation subcommittee, our 
interest is knowing, do you have the resources to adequately 
screen all of those people at this time?
    Secretary Donovan. What I would say is that the additional 
resources that we were provided in the 2009 bill by you are 
very helpful, but I think we need to go further in addition, 
particularly on the systems front, and I look forward to 
working with you as part of the 2010 process, as well as report 
back to you on what we're doing with the investments in 2009.
    Senator Murray. Okay and we will be asking those questions 
as we move forward.
    Recently the FHA has experienced a spike in early payment 
defaults, defaults when the borrower has made no payment or 
very few payments before the FHA had to make good on its 
guarantee. In your view is this just a sign of a worsening 
economy or do you believe the FHA is now covering loans that 
should never have been made in the first place?

                         EARLY PAYMENT DEFAULTS

    Secretary Donovan. We've looked carefully at this data and 
what we've seen is that early payment defaults have increased 
substantially, but they've actually increased slightly slower 
than the overall growth in the volume in the FHA program. So in 
other words, they've gone from about .8 percent to roughly .6 
percent of all of the originations. So yes, there has been a 
significant increase. What we've also found is that the large 
majority of those early payment defaults result from job loss 
and other issues that are directly tied to the economy.
    So, having said that, though, I do think there are--and 
I've talked with Ken Donohue very recently about this--there 
are ways that we can begin to ensure--and this was part of the 
mortgagee letter that we released today--to ensure that we are 
getting all of the detailed information we need on those early 
payment defaults, to look at them more closely and ensure that 
fraud is not happening even in a small percentage of those.
    Senator Murray. Thank you very much.
    Senator Bond.
    Senator Bond. Thank you, Madam Chair.
    I believe most people know my view on the no down payment 
mortgage issue, but for the record, with the movement starting 
on the other side for reinstating that, what's your view on no 
down payment mortgages?
    Secretary Donovan. Let me start by saying thank you, 
Senator Bond, and to the chairwoman, for your leadership, and 
the entire subcommittee, on this issue. When you look at the 
facts, what we have seen is a dramatic increase in defaults 
from these seller-funded down payment programs. They have 
accounted for roughly a third of all the claims in recent 
months at FHA, and I think it's been a critically important 
change to make sure that we don't allow those types of programs 
to continue to hurt the future of FHA. So I want to thank you 
for your leadership on that.
    Senator Bond. Thank you for your clear statement.
    Mr. Secretary, on the question of defaults and 
foreclosures, how does FHA define a default and when does it 
move to foreclosure? We have, you said, 7 percent essentially 
in default. What--where do you decide when to go for mitigation 
into declaring a default or foreclosure? How does that process 
work?

                            LOSS MITIGATION

    Secretary Donovan. Yes. I do want to say that there have 
been significant efforts at FHA around loss mitigation. I think 
we've seen through the efforts more broadly that we've made 
through the Making Home Affordable Plan that there is an 
opportunity to avoid the major costs that foreclosures have 
both on families and communities.
    But as you rightly point out, there are situations where 
you can't go far enough to save that home and that foreclosure 
is the only option. What we've seen over recent months is that 
in roughly two-thirds of the cases where we have a default we 
are able to figure out some loss mitigation that will allow 
that person to stay in their home and to avoid foreclosure, 
whereas about one-third of the cases that we look at where 
they're seriously delinquent end up in foreclosure immediately.
    What we've also seen--and you've been very clear that this 
is an important thing to look at; you're absolutely right--
making sure that that loss mitigation that we're doing is 
successful in the long term. Our recent data indicates that 2 
years after loss mitigation more than 90 percent of the 
modifications and adjustments that we're making continue to be 
successful. So we do feel like our loss mitigation efforts have 
generally been successful. We continue to look closely at the 
fact of whether there are other things we can do. We're making 
some modifications along the lines of the Making Home 
Affordable Plan. There are some changes in H.R. 1106 that we do 
think are helpful for partial payments of claim in certain 
situations that we don't currently have authority on. But 
that's an explanation of the way our programs are working.
    Senator Bond. What is the cost on the two-thirds that you 
have been able to go into loss mitigation? Is there a portion 
of that loss assumed by the FHA? What are the costs of those 
mitigations to the FHA fund?

                   LOSS MITIGATION COSTS ON FHA FUND

    Secretary Donovan. I actually have a precise number on 
that. This year there were about 48,000 loss mitigation cases 
and the cost of those mitigation efforts was about $107 
million. If we had had a loss on all of those 48,000, the value 
of those mortgages was about $2.5 billion. I'm not saying we 
would have taken the full loss on that, but you can see that 
should they be successful, those loss mitigation efforts, that 
$107 million cost far outweighs the losses we would have had.
    Senator Bond. Yes. We're all about keeping people in homes 
that they can afford and making reasonable adjustments. I'd 
like to see the originators sharing more of that cost and not 
just the taxpayers, because there ought to be some burden on 
the people who write the mortgages that aren't working. In the 
private sector, I know there is a loss. But certainly 
mitigation of $107 million compared to what the burdens would 
have been makes some sense.
    Do you know how many mortgages currently are in mitigation 
and do they differ from State to State?

                   MORTGAGES CURRENTLY IN MITIGATION

    Secretary Donovan. We do see significant differences State 
to State. I gave you the figure, the 48,000 that we've done 
over the past year. I don't have an exact number here. I'd be 
happy to provide you more information of the details of what's 
in mitigation.
    What I would say is that, unlike the broader mortgage 
market, where our delinquencies in the rest of the market have 
been heavily concentrated in States like California, Florida, 
Nevada, about 50 percent of all foreclosures in the country are 
in California and Florida, we're seeing FHA's portfolio is, 
because of the loan limits, very differently spread 
geographically.
    So Midwest is where we have a lot of our loss mitigation 
efforts and we have seen a higher level of foreclosures in 
those areas, Detroit in particular, Ohio. Senator Voinovich is 
here. We've had discussions about Cleveland and other efforts 
there where we can try to minimize the effect of those 
foreclosures in those communities.
    Senator Bond. Thank you, Madam Chairwoman.
    Senator Murray. Senator Lautenberg.

                STATEMENT OF SENATOR FRANK R. LAUTENBERG

    Senator Lautenberg. Thank you, Madam Secretary. I ask 
consent that my statement be included in the record.
    Senator Murray. Without objection.
    [The statement follows:]

           Prepared Statement of Senator Frank R. Lautenberg

    Madam Chairman, a home is more than just a building. It is a place 
of safety from the elements. It is a place for families to spend time 
together and for children to do their homework. And it is a source of 
financial security that families use to build their future.
    That's the reason this housing crisis weighs so heavily on our 
Nation: it not only puts our economy at risk--it puts families at risk, 
too. Millions of families have already lost their homes because they 
were sold risky sub-prime mortgages--and millions more are at risk from 
job losses and other unexpected expenses. Instead of realizing the 
American Dream, 60,000 households in New Jersey may have their home 
taken away this year.
    People are working harder than ever before--and still losing their 
homes. Congress and the administration must continue to take steps to 
stop the foreclosure crisis. The Federal Housing Administration will 
play a big role in our efforts. During the housing boom, homebuyers--
even those who qualified for FHA-backed loans--turned to the private 
sector for their loans. But now that the housing bubble has burst, 
borrowers are turning back to the FHA again. The agency has become a 
life raft in a sea of debt for current homeowners looking to refinance 
into a fixed-rate mortgage. And it is a source of hope for first-time 
homebuyers.
    I am pleased that the Economic Recovery law included a temporary 
increase of the FHA's maximum loan limit for high-cost metropolitan 
areas to help homeowners and homebuyers more easily get FHA loans. 
There are 12 counties in New Jersey that will benefit from this change 
and I encourage our residents to take advantage of these resources.
    But with its new responsibilities and its new customers, FHA may 
not be able to keep up with consumer demands. When FHA lost business 
during the housing boom, it also lost staff and attention from the last 
administration.
    The average computer system at HUD is about 18 years old. I came to 
the Senate from a company that depended on computers and technology. 
And I know you cannot manage billions of dollars worth of business with 
too few staff or technology that is outdated.
    In these tough times, we need to make sure FHA has the funding and 
staff to do its job.
    Americans are relying on FHA to provide mortgages, investigate 
fraud, and help revive the housing market. That is no small task. I 
look forward to working with this subcommittee to accomplish these 
important goals.

    Senator Lautenberg. Mr. Secretary, when I see you here and 
look at your history of service to Washington and to a previous 
administration, you look so young. The job must be easy.
    Right now New Jersey, for instance, currently has a surplus 
of vacant affordable housing because prospective home buyers 
can't find an agency to insure their loan. Now, will FHA 
consider changing its policy so it can start insuring loans on 
properties that are restricted for low- and moderate-income 
homeowners?
    Secretary Donovan. Two things I would say about that, 
Senator. And I appreciate your comments about my appearance of 
youth despite the difficult circumstances that we're facing in 
the housing market and the country today.

                  LOW- AND MODERATE-INCOME HOMEOWNERS

    What I would say is, first of all, that in many ways this 
is the time that FHA needs to be ensuring that there's adequate 
credit available to low- and moderate-income homeowners. We 
continue to be a source for people traditionally left out of 
the market, particularly low- and moderate-income buyers, to be 
able to become homeowners.
    Further than that, as you point out, there are vacant homes 
around the country and it's been very important through our own 
foreclosures, as well as through partnership with funding that 
Congress has appropriated and we're very appreciative of 
through the recovery bill under the Neighborhood Stabilization 
Program, to begin to try to buy up and insure that foreclosed 
homes get rehabilitated and get sold again as quickly as 
possible, oftentimes to low- and moderate-income borrowers.
    So we are working carefully, closely with our own portfolio 
of REO homes with Neighborhood Stabilization funding to make 
sure that we limit the period of time and the impact that those 
vacant homes have on communities, particularly low- and 
moderate-income communities.
    Senator Lautenberg. So FHA essentially writes off the loss 
from what may have been a subprime loan, and that's FHA's 
responsibility, is it not? I mean, the failures are FHA's, fall 
into FHA's lap.
    Secretary Donovan. We do not take losses on any subprime 
products. The subprime products have not been part of FHA's 
programs. We do have losses on traditional FHA products.
    Senator Lautenberg. The regulations were there to prevent 
that from happening before the crisis began developing?
    Secretary Donovan. That's right. But what we will do 
through the funding in the Neighborhood Stabilization Program, 
which runs actually through our Community Development Block 
Grant rather than FHA--that's where we have funding 
appropriated by Congress to work with local areas to acquire 
those homes that may have had subprime mortgages on them.
    There also is the Making Home Affordable Plan, which is 
modifying loans to affordable interest rates that might have 
been subprime to begin with.
    Senator Lautenberg. Because it's a sad situation to see 
people who need housing and empty houses and not to be able to 
at least get them out of the weather and keep them whole for a 
while.
    Secretary Donovan. That's absolutely right. In fact, when 
the President put forward the Making Home Affordable Plan we 
did extensive research and believe that by stopping those 
foreclosures and avoiding the vacancies of those homes, the 
blight that they can introduce into a community, we can save 
all American homeowners, not just the foreclosed homes but all 
American homeowners, roughly $6,000 on average in the values of 
their homes. So that goes exactly to your point.
    Senator Lautenberg. The FHA currently funds its own 
operations through homeowner fees. With the increase in demand 
for FHA-backed mortgages, can FHA adequately continue to help 
home buyers, homeowners, and still remain self-funded?

                              FHA SOLVENCY

    Secretary Donovan. Let me say, Senator, we are looking very 
closely at that issue, at the premiums that we charge, at the 
losses that we have. At the time that we provide details of the 
President's 2010 budget, we will have detailed information in 
there about whether we believe the current insurance premiums 
fully cover the losses in the programs.
    We have had to take over the last few years' additional 
losses against the claims and the foreclosures, but we are 
looking very carefully and we should within a few weeks be able 
to present to you our estimates of whether it will be self-
financing in the current programs.
    Senator Lautenberg. Thank you.
    Thanks, Madam Chairman.
    Senator Murray. Senator Voinovich.

                STATEMENT OF SENATOR GEORGE V. VOINOVICH

    Senator Voinovich. Thank you. I would like to ask that my 
written statement be made part of the record.
    [The statement follows:]

           Prepared Statement of Senator George V. Voinovich

    Thank you Senators Murray and Bond for holding this hearing on 
FHA's role in the current housing crisis. As many of you may know, Ohio 
has been hit very hard by the housing crisis, and I have long been 
concerned about the foreclosure tornado ripping through our cities and 
neighborhoods. According to the Mortgage Bankers Association's most 
recent report, Ohio is among the top 10 States in the Nation in 
foreclosures, 4.09 percent of mortgages are in foreclosure in Ohio and 
another 9.49 percent are past due. Unlike other States in the Nation, 
Ohio's housing crisis has not stemmed from speculation or the bursting 
of a housing bubble. The Foreclosure crisis in Ohio has been the result 
of the economic downturn and irresponsible lending practices.
    Over the past few years, I have worked to stop the rise of 
foreclosures in my home State. I introduced the first piece of 
legislation enacted to address the foreclosure crisis, The Mortgage 
Debt Relief Act, which was signed into law December 2007. In addition, 
I have worked relentlessly for FHA reform. Last Congress, I introduced 
the Expanding American Homeownership Act to allow homeowners facing 
foreclosure or resetting interest rates to refinance without the usual 
burdens associated with a FHA loan by increasing and simplifying FHA's 
loan limits and loan terms. I was pleased when similar FHA 
modernization legislation was enacted in the Housing and Economic 
Recovery Act last summer. But I am also concerned about the recent 
trend of increased defaults of FHA loans and what this means for the 
solvency of the FHA. FHA must balance the responsibility to provide an 
adequate resource for refinancing with the responsibility to make sound 
loans. I look forward to hearing from our witnesses about additional 
ways we can increase FHA's fiscal soundness and effectiveness.
    One of the primary missions of the FHA is to reach borrowers who 
are underserved, or not served, by the existing conventional mortgage 
marketplace. It is important that during this time of economic 
difficulty, FHA continue to serve this critical role in the housing 
market. During past recessions, including the downturns of the early 
1980s, FHA remained a viable credit enhancer and was therefore 
instrumental in preventing a more catastrophic collapse in housing 
markets and a greater loss of homeowner equity. As housing prices fall 
and credit remains difficult to obtain, many homeowners and prospective 
homebuyers will need the less-expensive, safer financing alternative 
that FHA mortgage insurance provides. With the FHA's share of the 
mortgage market up from 2 percent 3 years ago to nearly one-third of 
mortgages today, there is no doubt that consumers are flocking to FHA 
loans.
    As we continue to work together to restore the housing market and 
FHA's fiscal soundness, I hope the FHA can establish itself as a 
resource to the many families who are searching for a way to refinance 
in order to stay in their homes, or who are looking to make a first 
time home purchase, while maintaining their lending standards.

    Senator Voinovich. The chairman has talked about the fact 
that you've had a 500 percent increase in lenders, and what I'd 
like to know is--you don't have to give it to me now because 
you probably haven't got the numbers--but how many people do 
you have working in that area right now, and with the 
additional work that you have are you going to be able to 
handle that work with the current folks that you've got, and 
how many more do you think would be needed to do the job the 
way it's supposed to be done?

                        INCREASE IN FHA LENDERS

    Secretary Donovan. That's a very important question. First 
of all, let me just say, while we do have a large number of new 
applicants for FHA business--you've got the numbers right, over 
a fivefold increase in the last few years--our volume has gone 
up not quite that much, but close to that, and our largest 10 
lenders continue to be roughly 90 percent of all loans 
originated. So while we do have lots of new lenders, they tend 
to be much smaller lenders and not in aggregate to originate 
that much of the business.
    What I would say is we have begun hiring a significant 
number. I'd be happy to provide you detailed information about 
exactly how many of those folks are doing lender approvals and 
lender monitoring. But we have begun to increase that, and I 
think in the 2010 budget you'll see our proposal for the 
additional staff that we would need to be able to do that. I'd 
be happy to provide more details to you.

                        DEMOLITION OF PROPERTIES

    Senator Voinovich. The other thing that we did when I 
talked to you in your office was the fact that in my city we 
have, the city of Cleveland, a provision that says that when 
you sell a property you're supposed to notify the person that 
it's on the demolition list. I'm pleased that you have changed 
that policy and you're going to abide by that ordinance, and 
I'm sure there are ordinances all over the United States like 
it.
    The thing that's troublesome to me is that in so many of 
your properties they get on the demolition list, and when they 
do it appears that--for example, you're selling properties to 
the city of Cleveland right now that are in pretty bad shape. 
But you're expecting the city to pay for the demolition of 
those properties with the NSP funds or some other funds.
    I just wonder why doesn't HUD, when they have properties 
that have so deteriorated that they have been condemned not pay 
for the demolition of those properties. I know you hire people 
to go out and they're supposed to maintain them, but from my 
experience they go out, they allegedly maintain them, and 
before you know it they're in a position where they're on the 
demolition list.
    I just wonder if somebody ought to look at maybe the people 
that you're hiring to try and either get them to do a better 
job or look at it from the point of view that they're your 
properties, they've gotten in bad shape, and an ordinary person 
owning them would have to pay for demolition. Why doesn't HUD 
pay for the demolition?
    Secretary Donovan. First of all let me say, the leadership 
and the approach that I want to bring to HUD is not to be 
defensive. You brought us an issue about the way we were 
coordinating or not coordinating with local areas on this issue 
of demolition and where homes have been condemned. You were 
absolutely right. We made a change to our policy that's now 
nationwide. So I want to thank you publicly for bringing that 
to our attention and working with us on that. That's the kind 
of approach I'll try to bring to any issue where we work 
together.
    I think it is a fair point that we ought to be looking more 
broadly at our policies around our foreclosed homes and to be 
working more closely with cities across the country, and I 
think that is an issue worth looking at and evaluating whether 
we ought to be involved in the cost of the demolitions of those 
homes.
    Senator Voinovich. I'd like you to look at it and the 
reason why you're not--from a public policy, it seems to me you 
should take care of them if you let them get in bad shape. But 
there's a reason why you don't have it in your budget to get 
the job done.
    I've got three other questions real quick. One of them is, 
you've received recommendations for a change in regulations for 
the NSP program and I'd like to know the status of those 
recommendations, because they come from some very responsible 
organizations.
    The other thing is, you've got the Home for Homeowners 
Program and then the President's Making Home Affordable and I'd 
like to have some written explanation as to what's the 
difference between the one program and the other program.
    Last but not least, on the Homes for Homeowners or Hope for 
Homeowners, whatever they call it, that very few loans have 
been made under that program and I'd like to know why and what 
are you doing to remedy it so that more people will be able to 
take advantage of the program?
    Secretary Donovan. Do you want me to answer now?
    Senator Voinovich. No, I just pose those. I'd like to have 
those, the answers to that, in writing if I could.
    Secretary Donovan. Absolutely, I'd be happy to do that.
    Senator Murray. If you could provide those in writing, the 
subcommittee would appreciate it, knowing that as well. So 
thank you.
    [The information follows:]

                NEIGHBORHOOD STABILIZATION PROGRAM (NSP)

    HUD has developed a document responding to several NSP issues: 
errors and omissions in the October 6, 2008 NSP notice as published in 
the Federal Register; policy changes recommended by grantees and 
interest groups; and statutory changes made by the American Recovery 
and Reinvestment Act (Recovery Act) to the NSP authorizing language in 
the Housing and Economic Recovery Act of 2008 (HERA). HUD will be 
proposing changes to several policy areas that have been of concern to 
grantees and interests groups, specifically the discount provisions and 
the need for full appraisals for de minimus value properties. The 
notice will also establish rules for treatment of program income 
generated from the use of NSP in light of the Recovery Act's repeal of 
the HERA revenue provisions and implement other changes mandated by the 
Recovery Act. HUD expects to issue this document in May.

                      HOPE FOR HOMEOWNERS PROGRAM

    HOPE for Homeowners is not a different program but an integral part 
of the comprehensive approach embodied by the administration's plan, 
Making Home Affordable program, which is intended to bring stability to 
the housing market and help American families reduce their monthly 
mortgage payments to more affordable levels, or assist homeowners with 
loans owned or guaranteed by Fannie Mae or Freddie Mac an opportunity 
to refinance into more affordable monthly payments.
    As an integral part of the Making Home Affordable program, a 
revised HOPE for Homeowners program would help reduce defaults and 
foreclosures. It would assist financially struggling homeowners by 
providing relief to them, stabilizing home values, and allowing lenders 
to liquidate toxic assets into new and performing assets. It is 
intended to help homeowners whose loans are not owned or securitized by 
Fannie Mae or Freddie Mac, who are behind on their payments, who owe 
far more than they are worth, and who may find that modifying the terms 
of their loans is not a workable solution. The program would assist 
homeowners by taking into consideration their ability to pay and making 
their mortgage sustainable over the long haul.

                          HOPE FOR HOMEOWNERS

    There are significant barriers to participation created by the 
legislative language as evidenced by its restrictive eligibility 
requirements, its high costs to the consumer, and the departure from 
standard FHA business rules. Lenders have stated that they are 
reluctant to commit the resources to such a complex and costly program, 
and that it is more cost effective for them to focus their efforts on 
other available loss mitigation strategies to assist homeowners.
    Consequently, the administration is seeking legislative amendments 
to the HOPE for Homeowners program as outlined in H.R. 1106, which 
would specifically lower costs to the consumer, ease the restrictive 
eligibility criteria, and make the program easier for lenders to offer. 
If the eligibility criteria are amended to allow more homeowners into 
the program, the premiums are reduced, and the program looks and feels 
more like a standard FHA program, HOPE for Homeowners would not only be 
a viable program, but would also be an attractive solution to the 
obstacles faced by both the consumers and lenders.

                        DEMOLITION OF PROPERTIES

    On average, the Department annually acquires approximately 50,000 
single family properties from HUD-approved lenders. To ensure that such 
properties are properly secured, maintained, and marketed for sale, HUD 
uses Management and Marketing (M&M) Contractors. These contractors are 
required to appraise HUD-owned properties using FHA Roster Appraisers, 
establish the list price for such properties, and market and sell 
properties for the maximum price the market will bear. The Department 
uses this disposition strategy as it is necessary to replenish the 
Mutual Mortgage Insurance Fund and is the most effective way for FHA to 
generate proceeds to provide homebuyers an affordable loan financing 
alternative to conventional and subprime loans.
    Thus, HUD does not require its contractors to simply demolish its 
properties based on their appraised value. Instead, the conditions of 
the real estate markets are also factored in the contractors' 
determination of the ultimate disposition or sale of a property. In 
markets such as Cleveland, for example, ``hard to sell'' properties are 
offered to local governments at deep discounts to further the 
Department's affordable housing and neighborhood stabilization 
objectives. In addition, to the extent that the Department is aware of 
a HUD-owned property being condemned or due to receive a Notice of 
Condemnation, HUD's contractors have been directed to disclose this 
information to all potential purchasers of HUD homes.
    Lastly, the Department, via its Neighborhood Stabilization Program 
(NSP), has awarded the city of Cleveland more than $16 million to 
address its high rate of foreclosed, abandoned properties, which 
contribute to blight within many of Cleveland's neighborhoods. Under 
the NSP program, local governments may acquire, demolish and rebuild, 
or rehabilitate foreclosed properties using NSP Federal grant funds. 
Additionally, to assist local governments in combating blight and in 
maximizing their use of the NSP grant funds, the Department is offering 
HUD-owned foreclosed properties valued at $20,000 or less (i.e., those 
considered to be ``demolition properties'') for $100. Specifically, 211 
HUD-owned properties have been held off the market by the Department, 
pending a direct sale to the city of Cleveland. Many of these 211 homes 
are valued at $20,000 or less, with a collective value of $2,105,200.

    Senator Murray. Again, we have votes in about 40 minutes. 
So I just have a couple of really quick questions and if 
anybody else has any quick ones. We want to get to the second 
panel.
    The first one was about mortgage scams. We're seeing these 
signs in communities: Call 1-800. People are being ripped off. 
We put $2 million into the Appropriations Committee last year 
to deal with that and $6 million to the Neighborhood 
Reinvestment Corporation. Can you just share with the 
subcommittee really quickly what you are doing in terms of 
dealing with that?

                             MORTGAGE SCAMS

    Secretary Donovan. Yes. This is a serious issue. I've seen 
it from my own experience as a local housing official, as well 
as the concerns that you're raising at the national level. Two 
things that we're doing: One is we're moving very quickly, and 
I've already sat down and met with Attorney General Holder 
about this issue, and we are beginning to work together with 
them, along with the FBI and our own IG, to try to target these 
rescue scams in a range of areas, as well as bringing in State 
attorney generals from around the country, who oftentimes are 
on the front lines of this issue.
    I think you'll also see as we get into the details of our 
budget proposals that this is an area where we think not only 
through FHA, but also through our fair lending area, because 
often these scams tend to target minority communities more 
heavily than they do other communities, that we will have an 
increased focus both in funding and programs on this issue.
    Senator Murray. We're going to continue to follow that as 
well.
    I would like for you to provide in writing--we are 
guaranteeing loans now that are as large as $730,000. I 
supported that. I thought it was the right move. But I would 
like you to share with the subcommittee the default and 
delinquency experience of the borrowers with those higher loans 
as we look to what our next policy is going to be.
    Secretary Donovan. Absolutely.
    Senator Bond. Madam Chair, I'm going to keep this very 
short because I want to--we have to move on and we need to hear 
the IG. I would just note that last year, at the recommendation 
of the Treasury, I introduced the origination commission 
proposal to regulate the clicks. We regulate the bricks with 
the savings and loans and the banks, but nobody is regulating 
the people who don't originate loans, and that is one reason 
why I think there are 58 criminal indictments just in the 
Eastern District of Missouri alone and more than 100 under 
investigation.
    I would like any thought that the Secretary has on whether 
that is the right way to go and any suggestions you have on the 
legislation.
    I do want to ask one last question on the HECMs. How many 
have been originated and how many defaulted? Are there any 
specific problems with the implementation of the program and 
the financial risk to the United States?

                                 HECMS

    Secretary Donovan. I'd be happy to have a further 
discussion and provide you more detailed information on the 
HECMs. What I can tell you because of the nature of the program 
it doesn't have a default issue per se in the same way. But 
what we've seen is in the entire history of the program under 
10,000, about 9,300 HECM loans have been assigned to HUD out of 
a total of 391,000 loans. So it's a very small percentage.
    We do see some increase, given the economic climate 
recently, in HECM borrowers who are unable to pay their taxes 
and insurance, and we are looking very carefully at that issue 
to make sure that our HECM lenders are responding 
appropriately. I think that's an area where we have to make 
sure that we don't end up, because of the nature of the HECM 
program, with a problem down the line. So that's an area where 
we need to have some increased focus.
    Senator Bond. I should have phrased the question 
differently. But if people start living a whole lot longer, as 
all of us senior citizens hope we will, there is a potential 
downstream risk, and I don't know whether you've looked at it. 
We'll be happy to discuss that with you.
    Thank you, Madam Chair. Thank you very much, Mr. Secretary.
    Secretary Donovan. Thank you, Senator.
    Senator Murray. Mr. Secretary, thank you very much for your 
testimony today. We will have a number of questions in writing 
that we'll submit to you and hope we can get a prompt response. 
But thank you very much.
    Secretary Donovan. I appreciate your interest in this issue 
and all of the collaboration we've had thus far. Thank you.
    Senator Murray. We will now turn to our second panel and if 
those witnesses would please come forward. We're going to be 
hearing from our Inspector General, the Honorable Kenneth 
Donohue, who will begin his testimony as soon as he is at the 
table here. We also will be hearing from Mr. Lennox Scott, who 
is the Chief Executive Officer of John L. Scott Real Estate in 
Bellevue, Washington, and Ms. Mia Vermillion, who is a Senior 
Loan Consultant with Guild Mortgage in Lakewood, Washington.
    So once our witnesses are in front of us we will begin 
their testimony. I want all of you to know we do have your 
testimony in writing. It will be part of the record and we 
would ask each of you to limit your verbal testimony to 5 
minutes.
    Mr. Donohue, we'll begin with you.

STATEMENT OF HON. KENNETH M. DONOHUE, INSPECTOR 
            GENERAL, DEPARTMENT OF HOUSING AND URBAN 
            DEVELOPMENT
    Mr. Donohue. Chairman Murray, Ranking Member Bond, members 
of the subcommittee, thank you for inviting me here today. I 
appreciate the opportunity to testify on the role of FHA in 
addressing the housing crisis.
    Through our work in auditing and investigating many facets 
of FHA programs over the course of many years, we have had 
concerns regarding the FHA systems and infrastructure to 
adequately perform its current requirements. This was expressed 
by the OIG to the FHA prior to the current influx of loans and 
numerous proposals that expanded its reach. We remain keenly 
interested in FHA's ability and capacity to oversee newly 
generated businesses.
    The volume of single family loans has increased by tripling 
from $59 billion in 2007 to over $180 billion in 2008. FHA's 
share of insured endorsements has increased from 21 percent to 
70 percent, which includes home sales and refinancing.
    We believe there's a critical need for more resources for 
FHA: (1) to enhance its IT systems; (2) to increase personnel 
to deal with escalation in processing requirements; (3) to 
increase its training of personnel to maintain a workforce with 
the necessary skills; (4) to oversee the numerous contractors 
it maintains; and (5) to increase its oversight in all critical 
front end issues, including areas such as appraisal, lender 
approval, and underwriting process.
    We are gratified the new penalty provision we helped craft 
was inserted into the HERA bill. That statute now creates a 
penalty for committing fraud against FHA programs and will be a 
useful tool for prosecutors and the law enforcement community 
to employ.
    The results of the latest actuarial studies show that HUD 
has sustained significant losses in its single family programs, 
making a robust program reserve smaller. As of September 30, 
the fund's economic value was an estimated $12.9 billion, an 
almost 40 percent drop from over $21 billion a year ago. The 
current value represents 3 percent of the mortgages insured by 
FHA. Although above the 2 percent ratio required by law, it is 
below the 6.4 percent ratio for the same time last year.
    If more pessimistic assumptions are factored in, the ratio 
could dip below 2 percent in succeeding years, requiring an 
increase in premiums or Congressional appropriation 
intervention to make up the shortfall.
    The tightening credit market has increased FHA's position 
as a loan insurer and with that is coming an increase in 
lenders and brokers seeking to do business with the Federal 
programs and a concern regarding some of these loan 
originators. For example, we currently have under investigation 
several FHA lenders who are also lenders in the subprime 
market. The movement towards HUD is already under way, as 
reflected in the recent statistics. FHA lender approvals 
increased 525 percent in a 2-year period. We note that FHA and 
GNMA's lenders and issuers' approval processes are largely 
manual. Both groups will be challenged within current 
constraints to keep up with the increased volume. Given the 
recent aggressive history of the industry that is now seeking 
to do business with the FHA, we think it may be prudent to 
review standards for participation.
    As you can see from my exhibit, the current application 
contains a certification for those seeking to do business with 
GNMA that if they knowingly make a false statement they could 
be subject to criminal penalties, such as 18 U.S.C. 1001. There 
are no such attestation requirements for lender applicants with 
the FHA.
    Moreover, we have recently initiated inspection of the 
mortgage review board enforcement actions and its effectiveness 
in resolving cases of serious noncompliance with FHA 
regulations, particularly during the period of significant 
changes in the housing market.
    Another area of concern is the growing home equity 
conversion mortgage program. We are aware that the larger loan 
limits can be attractive to exploiters of the elderly whether 
it is by third party or even family members who seek to strip 
equity from seniors. Due to the vulnerability of the population 
this program serves, we are also concerned about the evasions 
of statutory counseling requirements.

                           PREPARED STATEMENT

    Finally, the HUD IG has initiated a broad range of 
strategies to leverage limited resources. As you can see from 
the other exhibit, we are key partners in a variety of Federal 
and State task forces, such as the Department of Justice 
National Mortgage Fraud Teams and in many key jurisdictions 
across the country.
    Thank you, madam.
    [The statement follows:]

             Prepared Statement of Hon. Kenneth M. Donohue

    Chairwoman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for inviting me to testify today. I very much 
appreciate the opportunity to speak on the important issue of the role 
of the Federal Housing Administration (FHA) in addressing the housing 
crisis currently confronting our Nation.

                               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 OIG strives to 
make a difference in HUD's performance and accountability. The 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, the OIG operates independently with separate budget 
authority. This independence allows for clear and objective reporting 
to the Secretary and to 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 $45+ billion annual budget 
and, in the case of FHA, through mortgage insurance premiums.
    The last 2 years have seen enormous and damaging developments in 
the mortgage market: the dissolution of the subprime and Alt-A loan 
markets; dramatic drops in housing prices in most areas of the country; 
a concomitant rise in default and foreclosures; financial insecurity in 
the mortgage-backed securities markets represented by the Government 
takeover of Fannie Mae and Freddie Mac; the collapse of credit markets; 
and, as a primary vehicle to address these issues, an urgent reliance 
on the FHA to bolster the mortgage market. As the Mortgage Asset 
Research Institute has stated, the unprecedented onslaught of financial 
losses, reputational damages, and rehabilitative public policies will 
forever reshape the mortgage industry.
    While there are other programs at HUD that are being utilized in a 
significant way to help stimulate the economy (i.e., billions of 
dollars in new funding to Community Development Block Grants, to 
increased Public Housing assistance, etc.), which are also vulnerable 
to fraudulent and abusive activities, the focus of this testimony is on 
the salient issues facing the FHA program due to the mortgage crisis 
and to an increased reliance on our Department to resolve foreclosure 
matters at this critical juncture. The current degree of FHA 
predominance in the market is unparalleled.
    First off, to put the FHA issues into perspective, we have recently 
stated in testimony to the Congress that, through the multitude of our 
work in auditing and investigating many facets of the FHA programs over 
the course of many years, we have had, and continue to have, concerns 
regarding FHA's systems and infrastructure to adequately perform its 
current requirements and services. This was expressed by the OIG to the 
FHA through audits and reports regarding a wide spectrum of areas prior 
to the current influx of loans coming into the program and prior to the 
consideration of the numerous proposals that expanded its reach. We 
continue to remain concerned regarding FHA's ability and capacity to 
oversee the newly generated business.
    Some of these are long-standing concerns that go back to unresolved 
issues highlighted in our work products from as far back as the early 
to mid-1990s. In my discussions with the Secretary, it is clear he is 
committed to positioning the Department as rapidly as he can to try to 
deal with the changing dynamics. As the President recently stated, 
however, the Government is an ocean liner, and not a speed boat, when 
it comes to moving it in a new direction. The same can be said for some 
of our departmental programs.

                         THE EVOLVING LANDSCAPE

    The past year and a half have certainly produced a lot of changes 
and initiatives. In response to increasing delinquencies and 
foreclosures brought about by the collapsing subprime mortgage market, 
in September 2007, HUD acted administratively to provide mortgage 
assistance through the FHA Secure program to refinance existing 
subprime mortgages. The program was expanded in May 2008 to provide 
lenders the added flexibility to refinance and insure more mortgages, 
including those for borrowers who were late on a few payments and/or 
received a voluntary mortgage principal write-down from their lenders. 
This program served a fraction of its anticipated scope. The FHA 
recently issued a formal letter terminating the program stating that 
``maintaining the program past the original termination date would have 
a negative financial impact on the MMI Fund.''
    The Housing and Economic Recovery Act (HERA) passed last summer, 
created a new Hope for Homeowners program to enable FHA to refinance 
the mortgages of at-risk borrowers. While activity to date has been 
limited, the FHA was authorized to guarantee $300 billion in new loans 
to help prevent an estimated 400,000 homeowners from foreclosure. The 
Congress is working on legislation to revise this program so as to 
increase participation. These proposals, and others, to remedy a 
dysfunctional mortgage market are likely to increase the challenges to 
the OIG. While the goal to help homeowners in distress is important, a 
redraft to relax qualification requirements for borrowers and lenders 
may create a situation that could be exploited by fraud perpetrators to 
take advantage of desperate homeowners, at risk-lenders, and the FHA 
insurance fund. The HERA legislation also authorized changes to the 
FHA's Home Equity Conversion Mortgage (HECM) program that will enable 
more seniors to tap into their home's equity and obtain higher payouts 
which raises new oversight concerns for this agency.
    As we turn to today's environment, the volume of Single-Family FHA-
insured loans has enlarged in fiscal year 2008 by tripling from $59 
billion in fiscal year 2007 to over $180 billion in fiscal year 2008. 
The latest figures from Single-Family market comparisons from the first 
quarter of fiscal year 2009 show that FHA's total endorsements have 
increased from 21 percent of the market the year before to 70 percent 
of the market which includes both home sales and refinances. FHA's home 
sales' market share (excluding refinances) has increased from 
approximately 6 percent to close to 20 percent during this time period. 
Many potential homeowner loans may not have come to the agency yet as 
some of the new initiatives are still taking hold and the industry is 
flushing out its options and possibly posturing for more favorable 
terms.
    FHA will be challenged to handle its expanded workload or new 
programs that require the agency to take on riskier loans then it 
historically has had in its portfolio. This surge in FHA loans is 
likely to overtax the oversight resources of the FHA, making careful 
and comprehensive lender oversight difficult. In addition, our 
experience in prior high FHA volume periods (such as from 1997-2001) 
shows that the program was vulnerable to exploitation by fraud schemes, 
most notoriously flipping activities, that undercut the integrity of 
the program.

                          DEPARTMENTAL ISSUES

    It is our understanding from the Department that, even with the 
projected increase in FHA business, they are planning for only 40 more 
staff positions starting in fiscal year 2009. It remains very tight 
particularly as it relates to departmental oversight. For example, the 
mortgage licensing provisions contained in the new legislation set 
minimum standards for nationwide licensing and a registration system 
for mortgage broker and loan officers. When we last testified earlier 
in the year, we had been told that there was one FHA person in the 
RESPA (Real Estate Settlements Procedure Act) unit who was assigned to 
work with the States in complying with this new regulatory requirement.
    Though the recently-passed Omnibus Appropriations bill containing 
fiscal year 2009 funding will help to alleviate some of its funding 
constraints, we believe there is a critical need for more resources for 
FHA: (1) to enhance its IT systems; (2) to increase its personnel to 
meet the escalation in processing requirements; (3) to increase its 
training of personnel to maintain a workforce with the necessary skills 
to deal with the responsibility of this new portfolio; (4) to oversee 
the numerous contractors it maintains; and (5) to increase its 
oversight of all critical front-end issues including such important 
areas as the appraisal, lender approval and underwriting processes.
    We are also concerned that increases in demand to the FHA program 
are having collateral implications for the integrity of the Government 
National Mortgage Association (Ginnie Mae) mortgage-backed securities 
(MBS) program including the potential for increases in fraud in that 
program. HUD too needs to consider the downstream risks to investors 
and financial institutions of Ginnie Mae's eventual securitization of a 
large proportion of the Hope for Homeowners and Home Equity Conversion 
Mortgage (HECM) Single-Family loans. Ginnie Mae securities are the only 
MBS to carry the full faith and credit guaranty of the United States. 
If an issuer fails to make the required pass-through payment of 
principal and interest to MBS investors, Ginnie Mae is required to 
assume responsibility for it. Typically, Ginnie Mae defaults the 
issuers and assumes control of the issuer's MBS pools. Like FHA, Ginnie 
Mae has seen an augmentation in its market share (it has even in some 
recent months surpassed both Fannie Mae and Freddie Mac) and increased 
$150 billion in outstanding mortgage-backed securities and commitments 
during a 1 year period from fiscal year 2007 to fiscal year 2008. It 
too has stretched and limited resources to adequately address this 
increase. From a different vantage point, the industry has noted that 
Ginnie's struggle to keep pace with FHA could also reduce liquidity at 
a critical moment in the housing market.
    The OIG has initiated investigations of Ginnie Mae MBS fraud. In 
one recent case, the two former corporate officers of a Michigan 
financial company were convicted of defrauding Ginnie Mae by retaining 
the funds obtained from terminated and/or paid off loans. The 
defendants failed to disclose to Ginnie Mae that the loans were 
terminated, while one of the defendants utilized the funds from the 
paid-off loans to invest in the stock market and to make fraudulent 
monthly payments to Ginnie Mae on the loans that were previously paid-
off in order to conceal the fraud. The fraud began during July 1998 and 
continued until October 2007, resulting in a loss of approximately 
$20,000,000.
    Despite all these enumerated issues, we are gratified that a new 
penalty provision was inserted into the Housing and Economic Recovery 
Act (now 18 U.S.C. section 1014). When we corresponded during 
consideration of that legislation, we stated our belief that a new 
penalty enunciated specifically for the FHA program would be beneficial 
from an oversight and enforcement perspective. We assisted in its 
development and were very pleased that it was included in the final 
passage. The statute now creates a penalty of up to $1 million and 30 
years in prison for committing fraud against FHA programs, similar to 
the predicates established in the Financial Institutions Reform, 
Recovery and Enforcement Act, and will be a useful tool for prosecutors 
and the law enforcement community to employ in order to address those 
who would seek to defraud the program.

                            OIG OBSERVATIONS

    The results of the latest actuarial study show that HUD has 
sustained significant losses in its Single-Family program making a once 
fairly robust program's reserves smaller. The study shows that FHA's 
fund to cover losses on the mortgages it insures are contracting. As of 
September 30, the fund's economic value was an estimated $12.9 billion, 
an almost 40 percent drop from over $21 billion a year ago. The $12.9 
billion economic value represents 3 percent of the mortgages insured by 
the FHA. Although above the 2 percent ratio required by law, it is well 
below the 6.4 percent ratio from the same time last year. Moreover, 
these latest projections used macroeconomic forecast data as of June 
2008 and are profoundly sensitive to the accuracy of those forecasts. 
If more pessimistic assumptions are factored in, the ratio could dip 
below 2 percent in succeeding years requiring an increase in premiums 
or Congressional appropriation intervention to make up the shortfall. 
We think it might be useful for the Department to conduct interim 
assessments of the viability of the fund. Further, the new Office of 
Management and Budget (OMB) Director is quoted in a March 18, 2009 
online OMB blog as saying that the Congressional Budget Office recently 
estimated FHA loans of the last few years as accruing $15 billion in 
losses, and that OMB needed to move the true costs of this program to 
the budget's discretionary ledger. Since its inception in 1934, FHA has 
been self-sustaining and premiums paid to the fund have covered the 
losses due to fluctuating defaults and foreclosures.
    A significant problem facing FHA, and the lenders it works with, is 
the fallout from decreasing home values. This increases the risk of 
default, abandonment and foreclosure, and makes it correspondingly 
difficult for FHA to resell the properties. About 7.3 percent of FHA 
loans are currently in default (i.e., more than 90 days non-payment 
status, foreclosure or bankruptcy). The Mortgage Bankers Association 
reports a 30-day + delinquency rate for FHA loans of about 13 percent. 
A major cause for concern is that even as FHA endorsement levels meet 
or exceed previous peaks in its program history, FHA defaults have 
already exceeded previous years. Default levels on FHA loans are above 
those for prime conventional loans as evidenced below:




    This reinforces the importance for FHA approved lenders to maintain 
solid underwriting standards and quality control processes in order to 
withstand severe adverse economic conditions. Another extensive problem 
confronting FHA has been its inability to upgrade and replace legacy 
(developed in the 1970s and 1980s) application systems that had been 
previously scheduled to be integrated. The FHA systems environment 
remains at risk and must evolve to keep up with its new demands. Add to 
that an escalation in the properties owned and managed by FHA and the 
overall picture becomes more complicated. The chart below is an OIG 
analysis of some areas of the Nation and of the projected potential 
impact of subprime loans refinanced to FHA.



                         INCREASED RISKS TO FHA

    Until recently, FHA's market share remained quite low as 
conventional subprime loans were heavily marketed by lenders. The 
tightening credit market has increased FHA's position as a loan insurer 
and, with that, is coming an increase in lender/brokers seeking to do 
business with the Federal program and an overall concern regarding some 
of these loan originators. For example, we currently have under 
investigation for alleged inappropriate activities several FHA lenders 
who were also lenders in the subprime market. The movement toward HUD 
is already underway as reflected in recent statistics. FHA approval of 
new lenders increased 525 percent in a 2 year period. For example, as 
of the end of fiscal year 2008, FHA had over 3,300 approved lenders as 
compared to 997 at the end of fiscal year 2007 for an increase of 330 
percent. If you compare the fiscal year 2008 totals (over 3,300) to the 
fiscal year 2006 totals (692) it is a 525 percent increase. Lender 
approvals for fiscal year 2009 currently total over 1,600.
    The integrity and reliability of this crop of program loan 
originators is, in our view, unproven and, in light of the aggressive 
recent history of this industry, may pose a risk to the program. The 
Mortgage Bankers Association (MBA) in recent testimony stated the ``MBA 
is concerned that since the once lucrative subprime market has 
evaporated, some of the less scrupulous lenders who specialized in that 
business are now turning their attention to FHA lending.''
    In addition, we have seen lenders reacquiring FHA approval despite 
past abuses. A previous investigation on an FHA lender in New York led 
to the debarment of its owner for a period of 5 years from originating 
FHA insured loans. After the debarment was served, the lender, under 
the same owner, resumed operations using the same fraudulent practices. 
We again reviewed some of the loans and determined that the 
originations were fraudulent similar to the loans investigated in the 
first case. The OIG, in conjunction with the U.S. Attorney's Office and 
departmental officials, sought and received an injunction against them 
in order to stop the business from operating. Following the injunction, 
FHA withdrew their lender approval.
    Our audit work also highlights how problem lenders may regain 
admission into the FHA program even when previous transgressions were 
apparent. For example, we reviewed an Arizona corporation that was 
approved as an FHA mortgage lender by HUD in 1996. This particular 
lender had 13 active branch offices and sponsored close to 2,000 FHA-
approved loan correspondents nationwide. As highlighted in our audit, 
this lender had a number of serious issues related to RESPA violations 
such as paying marketing fees, non-competition fees and quality 
incentives to real estate companies in exchange for more than $57 
million in FHA mortgage business. The corporation's license was 
suspended by the State and it filed for bankruptcy. One of the 
principal owners and principal managers reconstituted under a different 
name but operates from the same location. In 2008, HUD approved the new 
entity to originate and process FHA loans despite its principals' prior 
citations for RESPA violations.
    Adding to the risk, FHA is now, due to loan limit increases, 
serving new metropolitan areas with which it previously has had little 
interaction. Recent legislation increased maximum FHA loan limits to 
$729,750. With such entry, come new players and unknown hazards. The 
effects of this significantly increased loan limit are potentially much 
greater losses sustained by FHA on defaulted loans and that the loans 
may be much more attractive to perpetrators of fraud who will be able 
to extract greater payouts in fraudulent loans schemes.
    Simultaneous to this confluence of events, is an increase in the 
reported incidents of mortgage fraud. As the Federal Bureau of 
Investigation (FBI) points out, a significant portion of the mortgage 
industry is void of any mandatory fraud reporting and presently there 
is no central repository to collect all mortgage fraud complaints. 
Mortgage fraud incidents reports, as compiled, however, by the Mortgage 
Asset Research Institute in the overall marketplace, have increased by 
45 percent in the second quarter compared to a year-ago period. It's 
most recent third quarter assessment states that fraud incidence is at 
an ``all-time high'' and that ``reported mortgage fraud is more 
prevalent now than in the heyday of the origination boom.''
    Our long-term investigative exposure in the area of mortgage fraud 
schemes impacting both FHA and conventional loans (since most fraud 
schemes cross loan programs) has given us vast experience and extensive 
knowledge. Many ``traditional'' fraud schemes continue to affect FHA 
and are described below:
  --Appraisal Fraud.--Typically central to every loan origination fraud 
        and includes deliberately fraudulent appraisals (substantially 
        misrepresented properties, fictitious properties, bogus 
        comparables) and/or inflated appraisals (designed to ``hit the 
        numbers''); appraiser kickbacks; and appraiser coercion.
  --Identity Theft.--Often includes use of bogus, invalid or misused 
        Social Security numbers and may include involvement of illegal 
        aliens, false ownership documents or certifications.
  --Loan Origination Fraud.--Including false, fraudulent and 
        substantially inaccurate income, assets and employment 
        information; false loan applications, false credit letters and 
        reports; false gift letters; seller-funded down payments; 
        concealed cash transactions; straw buyers; flipping; kickbacks; 
        cash-out schemes; fraud rings; and inadequate or fraudulent 
        underwriting activities.
    While these types of mortgage fraud schemes continue to operate, 
changing market conditions have generated new, or variant, schemes:
  --Rescue or Foreclosure Fraud.--Recent trends show that certain 
        individuals in the industry are preying on desperate and 
        vulnerable homeowners who are facing foreclosure. Some improper 
        activities include equity skimming (whereby the homeowner is 
        approached and offered an opportunity to get out of financial 
        trouble by the promise to pay off the mortgage or to receive a 
        sum of money when the property is sold--the property is then 
        deeded to the unscrupulous individual who may charge the 
        homeowner rent and then fails to make the mortgage payment 
        thereby causing the property to go into foreclosure) and lease/
        buy-back plans (wherein the homeowner is deceived into signing 
        over title with the belief that they can remain in the house as 
        a renter and eventually buy back--the terms are so unrealistic 
        that buy-back is impossible and the homeowner loses possession 
        with the new title holder walking away with most or all of the 
        equity).
  --Bankruptcy Fraud.--Typically chapter 7 bankruptcy petitions are 
        filed in lieu of chapter 13 petitions on behalf of debtors; 
        however, property sales information is fraudulently withheld 
        from the bankruptcy court and the properties are leased back to 
        the debtors at inflated rents. The debtors' property ownership 
        and equity are stripped from them.
  --Home Equity Conversion Mortgage (Reverse Mortgage) Fraud.--FHA 
        reverse mortgages are a new and potentially vulnerable area for 
        fraud perpetrators. We are aware that the larger loan limits 
        can be attractive to exploiters of the elderly, whether it is 
        by third parties or by family members, who seek to strip equity 
        from senior homeowners. Due to the vulnerability of the 
        population this program serves, we are also concerned about 
        evasions of statutory counseling requirements or of fraud by 
        counseling entities. We are working with the chairman and 
        members (Senator McCaskill, in particular) of the Senate 
        Committee on Aging and the chairman of the House Committee on 
        Financial Services to address some of their concerns regarding 
        these issues. We have also been partnering with the AARP and 
        other groups to foster consumer protection education awareness. 
        The following represent some of the types of schemes that we 
        are encountering:
    --Flipping.--The perpetrator creates a fake mortgage company and 
            ``lends'' funds to the borrower (no money changes hands, no 
            loan is given, but a mortgage is filed). The subject 
            refinances the borrower into a HECM. At closing the title 
            company pays all outstanding debt including the fraud 
            perpetrators' fake mortgage and the perpetrator walks away 
            with the payoff.
    --Recruitment.--Some HECM-related fraud activities involve an 
            investor who sells the property to an elderly straw buyer 
            and enters into a quit claim deed with the straw buyer. The 
            buyer applies for the HECM loan within a short timeframe 
            and the appraisal used to originate the HECM loan is then 
            fraudulently inflated. This allows the investor to 
            illegally divert the proceeds of the loan. Straw buyers are 
            ``recruited'' in residential areas with a high rate of 
            renters. The buyers are often unaware that they must pay 
            property taxes and some are unaware that the cash due to 
            them at closing has been diverted. A current investigation 
            involves recruiting elderly homeless to live in properties 
            victimizing these seniors who often have desperate needs.
    --Annuity.--Another activity that we currently have under 
            investigation involves financial professionals fraudulently 
            convincing HECM borrowers to invest HECM proceeds in a 
            financial product, such as an annuity, in an improper way. 
            The financial professionals receive increased fees and, in 
            the case of annuities, the victims are unable to get access 
            to their savings for many years or even past their 
            projected life expectancy.
    --Unauthorized Recipient.--Individual, often family members, may 
            keep HECM payments after the authorized recipient dies or 
            permanently leaves the residence.
    HECM loans represent a significant investment by FHA, with 
considerable recent increases. The chart below shows a 253 percent 
increase in the dollar amount of HECM loans from 2004 through 2008.




    In addition to the schemes described previously, the following case 
histories also illustrate some of the types of prevalent mortgage fraud 
that the OIG typically encounters:
  --In January 2009, in Philadelphia, Pennsylvania, an appraiser and 
        two settlement agents, were collectively sentenced to 45 months 
        incarceration and 9 years probation and ordered to pay HUD 
        $235,802 in restitution for their earlier guilty pleas to 
        making false statements to HUD and committing a conspiracy and 
        wire and identity fraud. The defendants and others provided 
        fraudulent appraisals and other documents used by unqualified 
        borrowers to obtain FHA-insured mortgages. HUD realized losses 
        of $4,460,588 after 183 mortgages defaulted.
  --In September 2008, two defendants in South Florida were charged in 
        a 21 count indictment for their participation in a mortgage 
        fraud scheme that resulted in the approval and disbursement of 
        six mortgage loans totaling $980,000. According to the 
        indictment, one of the defendants, through his company, sold 
        six properties in Miami-Dade County to unqualified buyers using 
        FHA loans. In all six sales, the same defendant, through straw 
        donors, fraudulently financed the down payments and closing 
        costs of the buyers. The second defendant, one of the false 
        donors, was also a silent investor in the scheme. Both 
        defendants allegedly received sizable payments once the 
        properties were sold. When the loans were closed, four of the 
        six properties went into foreclosure.
  --An investigation was initiated against a southwest mortgage 
        company. The investigation revealed that the defendant, a real 
        estate broker and owner of an investment company, fraudulently 
        sold 17 properties to undocumented aliens in the Fort Worth, 
        Texas area. The fraudulent FHA loans totaled $1,060,600. The 
        defendant placed false Social Security numbers on the loan 
        applications, inflated loan application figures, made side 
        payment agreements with the borrowers for down payments that, 
        in some cases, were never made and conducted other fraudulent 
        activities. Subsequently, 12 of the 17 loans defaulted and HUD 
        sustained a loss of $445,862. On December 31, 2008, the 
        defendant was sentenced to 37 months in prison, 36 months 
        probation and ordered to pay restitution of $445,862.
  --In Rockford, Illinois, a loan officer, realtor, loan processor, and 
        company employers were charged with conspiracy, making false 
        statements to HUD, and mail fraud, in a 35 count indictment. 
        Specifically, the defendants were alleged to have engaged in a 
        complex scheme to defraud HUD through a litany of false and 
        fraudulent statements on FHA loan applications. These included, 
        but were not limited to, the following: verifications of 
        employment, pay stubs, W-2's, credit letters, cashier's checks, 
        Social Security numbers, Social Security cards, and letters 
        containing Social Security Administration letterhead. Overall, 
        50 FHA loans were in question, with losses totaling in excess 
        of $2 million.
    To meet the current crisis, the HUD OIG has initiated a broad range 
of strategies to leverage available resources including participation 
in Task Forces [See exhibit]. We are a key partner in the FBI National 
Mortgage Fraud team and have provided a full-time supervisory special 
agent to the FBI to coordinate our joint activities. We also sponsor 
training sessions for the FBI on FHA fraud and participate in special 
joint operations such as ``Operation Malicious Mortgage.''

   OIG CONCERNS REGARDING CRITICAL FRONT-END AND BACK-END PROCESSES 
 (IMPROVING THE QUALITY OF FHA ORIGINATIONS AND THE ENFORCEMENT OF BAD 
                                ACTORS)

    To some extent, the FHA has had to work with the hand it was dealt 
in terms of funding and of industry-led initiatives to diminish its 
authority. As others have noted, the FHA cannot keep pace with an 
industry that is increasingly technology driven, and it cannot use its 
revenues to invest in any new technology. Many of its deficiencies 
could be mitigated with additional resources dedicated to systems and 
staffing enhancement. Our audit and investigative work point to 
critical front-end and back-end process issues that, if strengthened, 
could enable the FHA to overcome some of its present vulnerabilities.
    Appraiser Oversight.--Our work of the FHA appraiser roster 
identified more critical front-end weaknesses as evidenced in the 
quality control review and monitoring of the roster. The roster 
contained unreliable data including the listing of 3,480 appraisers 
with expired licenses and 199 appraisers that had been State 
sanctioned. In a further review, we found that HUD's appraiser review 
process was not adequate to reliably and consistently identify and 
remedy deficiencies associated with appraisers.
    The FHA's current Single-Family insured exposure totals over $560 
billion representing 4.8 million FHA-insured mortgages. Inflated 
appraisals cause higher loan amounts. If the properties foreclose, the 
loss to the insurance fund is greater. With significant increases in 
volume and new responsibilities in the mortgage marketplace, we do 
believe it may be time for the Department to return to an FHA Appraiser 
Fee Panel similar to the one dismantled by statute in 1994. It is 
essential if the mortgage industry wants to overcome perceptions 
regarding its integrity and its role in the current economic crisis 
that it ensures true market values are correctly estimated. Such a move 
would relieve pressures on appraisers to return predetermined values 
and would change a system based on misplaced incentives. A recent study 
indicated that 90 percent of appraisers felt pressure ``to hit the 
number'' provided (i.e., on the sales contract). The old FHA fee panel 
was rotational and guaranteed work as long as the appraiser met certain 
HUD requirements.
    Our concern that appraisers tied to lenders may impact the quality 
of the FHA appraisal was also a matter of interest elsewhere as 
evidenced in last year's settlement involving Fannie Mae and Freddie 
Mac and the New York Attorney General whereby lenders selling loans to 
those entities were required to follow stricter guidelines to ensure 
that people involved in the processing of loans did not also choose the 
appraiser. While the FHA fee panel was disbanded a number of years ago, 
the Department of Veterans Affairs has not abandoned this concept and 
we believe that this Department might want to follow suit thus 
eliminating the relationship between the loan officers, real estate 
agents and appraisers. We should remain cognizant that the downstream 
negative effect of overinflated appraisals is long-term and can be 
fundamentally corrosive to the housing market and to even, as we know 
today, the world economy.
    Late Payment Endorsement Requirements Changed.--Results from a 
number of other key audits have noted significant lender underwriting 
deficiencies, inadequate quality controls, and other operational 
irregularities. In another important front-end audit, we analyzed the 
impact of FHA late endorsement policy changes affecting FHA insured 
loans. On May 17, 2005, the Federal Housing Commissioner issued 
Mortgagee Letter 2005-23, which significantly changed the requirements 
for late endorsements for Single-Family insurance. A request for 
endorsement is considered late whenever the loan binder is received by 
the FHA more than 60 days after mortgage loan settlement or funds 
disbursement, whichever is later. The Mortgagee Letter removed the 
prior 6-month good payment history requirement for these loans and 
provided an additional 15 days grace period before the current month's 
payment was considered late.
    We conducted a review of this rule change and found that, although 
FHA asserted the change did not materially increase the insurance risk, 
FHA did not perform a risk analysis to support this determination. Our 
review of the performance of loans from seven prior OIG late 
endorsement audits (i.e., Wells Fargo, National City Mortgage, Cendant, 
etc.) found a 3\1/2\ times higher risk of claims when loans had 
unacceptable payment histories within the prior 6 months. Since the 
issuance of the Mortgagee Letter, the default rate for loans submitted 
late has increased and is significantly higher than the default rate 
for loans submitted in a timely manner. The HUD Handbook itself 
acknowledged the risk of unacceptable payment histories by stating that 
``Past credit performance serves as the most useful guide in 
determining a borrower's attitude toward credit obligations and 
predicting a borrower's future actions.''
    We issued an audit report in 2006 and recommended that HUD rescind 
the Mortgagee Letter until appropriate rule changes could be designed 
that were supported by an adequate risk assessment. The FHA disagreed 
with our audit report and declined to implement the audit 
recommendations. We referred this matter to HUD's Deputy Secretary who 
concurred with our recommendations on February 27, 2007 and ordered the 
FHA to immediately rescind the Mortgagee Letter.
    Initially, the FHA agreed to implement the Deputy Secretary's 
directive but failed to take action, instead taking efforts to dispute 
our audit results. This continued until April 2008, when the Deputy 
Secretary's office again intervened, at our request, and instructed the 
FHA to publish the proposed rule change in the Federal Register 
reinstating the 6 month payment history requirement for late 
endorsements. In June 2008, the proposed rule change was published in 
the Federal Register for comment.
    Although the final rule rescinding the Mortgagee Letter was never 
published, we were notified by the Audit Resolution and Corrective 
Action Tracking System that the audit recommendation had been closed at 
the request of the FHA. Indeed it was not implemented, therefore, in a 
Memorandum dated March 18, 2009, we informed the FHA that, given the 
amount of time that had lapsed and the absence of a corrective action, 
the OIG would report this in our next Semi-Annual Report to Congress. 
Given the current mortgage crisis, concerns over losses to the 
insurance fund, and requirements for transparency, we believe that this 
is an important recommendation that should not be dismissed.
    Capturing Key Information in, and Upgrading, Data Systems.--Another 
major input process, touched on earlier in the testimony, is the 
integration and upgrading of FHA legacy systems. While there has been 
much discussion on an overall plan, and what particular types of 
systems are needed to go forward, we think it would be useful at this 
juncture to reposition the discussion to ascertain which data should 
actually be collected, and maintained, in the system in order to 
control the new demands placed on the program. Our audit work and our 
investigative ``Systemic Implication Reports'' transmitted to the 
Department over the years, makes it clear that, at a minimum, we need 
the system to track identifying information on key individuals involved 
in the transaction such as the originating loan officer.
    This person, for example, is central to the initiation part of the 
loan process where due diligence should hypothetically be done on the 
application material (i.e., credit scores, appraisal information, 
etc.). We would like to see that that person's name and corresponding 
identifying information (i.e., license, etc.) are put in FHA's data 
fields. This will allow the FHA and OIG to key in on a vital part of 
the loan process in which fraud typically can occur. If the system 
could also capture information on other loan participants such as the 
real estate agent for the seller and buyer, and other parties to the 
transaction, that too would be helpful for purposes of increasing 
integrity in the processes in our investigative and audit functions.
    Further, we think it could be beneficial for the FHA to come 
together more significantly in a unified lender oversight consortium 
with Fannie Mae, Freddie Mac, the Federal Deposit Insurance 
Corporation, and Ginnie Mae in order to, among other things, create 
standardized forms that could produce common machine readable data 
fields with consistent information as well as to leverage existing data 
systems.
    Additionally, FHA will be challenged within current resource 
constraints to keep up with the increasing volume of entities doing 
business. FHA controls currently rely upon random, manual processes by 
contractors to select for review approximately 2 percent of lender 
endorsements, a decrease from 5 percent due, in part, to an increase in 
volume and to funding limitations. FHA then relies upon post-
endorsement automated lender or service performance information, such 
as high delinquency or early default rates, to target these entities 
for examining a limited number of loans for quality assurance reviews. 
We believe FHA needs the resources to take advantage of commercial off-
the-shelf pre-screening loan software or to require at least the larger 
lenders use such tools as part of their underwriting process.
    Lender Approval Process.--Earlier in this testimony we discussed 
the increasing number of applicants coming into FHA for lender approval 
and the abuses that could result. It should be noted that FHA's lender 
approval process, like the review of loan processes described in the 
preceding paragraph, is largely manual. The FHA lender approval 
procedure has different requirements dependent on the type of lender 
making the application. The general process appears to try to strike a 
balance between not overburdening the applicant with extraneous 
requirements with a need for important oversight information. In light 
of the recent aggressive history of the industry that is now seeking to 
do business with this Department, we think it may be prudent to review 
the standards and qualifications for participation. While we are 
currently auditing this process and will make recommendations when the 
work is completed, due to the urgent nature of the current 
circumstances confronting the Nation and this Department from the 
fallout of the mortgage crisis, we believe some interim steps might 
need to be assessed.
    For example, while the current application contains a certification 
for those seeking to do business with the Ginnie Mae program that if 
they knowingly make a false statement in the application, then they may 
be subject to civil and criminal penalties (18 U.S.C. sections 1001, 
etc.), there is no such attestation requirement on the application for 
those seeking to do business with FHA program (See exhibit of 
Application for Approval to be FHA Lender and accompanying 
certification statements). Along those lines, we also believe that the 
FHA should have a criminal background check done on each applicant by 
seeking to access data systems that contain such information.
    Mortgagee Review Board.--As we move to a discussion of essential 
back-end processes, we note that we have recently initiated a review, 
at the request of Senator Grassley, of the Mortgagee Review Board (MRB) 
enforcement actions and its efficiency, effectiveness and impact in 
resolving cases of serious non-compliance with FHA regulations 
particularly during this period of significant changes in the housing 
market. FHA Single-Family endorsements total $71.7 billion in the first 
quarter of 2009, up 245 percent from the same period a year earlier, 
emphasizing the need for a strong deterrence to irregular mortgage 
lending practices. The MRB is a statutorily created board within the 
Department that has responsibility to sanction FHA-approved lending 
institutions that violate applicable housing laws and HUD regulations 
and policies. Established in 1989, it is the sole authorized 
enforcement body at HUD to remove noncompliant FHA lenders.
    Since FHA lending authority is held by more than 12,000 mortgagees 
and loan correspondents, FHA relies on risk management tools other than 
the MRB to protect its portfolio and the insurance fund including 
computerized monitoring of loan default and claim rates, post-
endorsement underwriting and appraisal reviews, and on-site lender 
monitoring. Nevertheless, we believe that a strong deterrence to 
abusive practices is an effective Board that reaches in a significant 
way to problematic lenders by, for example, imposing penalties viewed 
as of real financial consequence to the violating lender, by hearing 
cases against larger numbers of violators, and by better exposing 
decisions, in an effort to increase transparency, on more publicly 
visible sites such as the Department's Web site. Similarly, the 
Mortgage Bankers Association, in recent testimony, stated that the 
``FHA should have more aggressive, streamlined and timely processes to 
expel ``bad actors.''
    Specifically, our review of the MRB will determine the timeliness 
of decisions; evaluate controls over the mortgagee referral and 
enforcement processes; summarize data gathered on settlement agreements 
and collections; and provide an objective basis to comment on the 
effectiveness of the MRB as a regulatory body. We are looking into 
issues such as the types of penalties assessed; whether the penalties 
were mitigated to administrative payments; the sizes of the mortgagees 
brought before the board; the elapsed time from referral to board 
action; whether indemnification was required; and whether the 
mortgagees were repeat offenders or their principals were under limited 
denial of participations or debarred. We anticipate completion of this 
review shortly.

                             OIG CHALLENGES

    The task before the HUD OIG is a daunting one: addressing the 
elements of fraud that were involved in the collapse of the mortgage 
market; monitoring the roll-out of new FHA loan products in order to 
reduce exploitation of program vulnerabilities; and, combating 
perpetrators of fraud, including those who have migrated from the 
subprime markets, who would exploit FHA loan programs. The consequences 
of the current mortgage crisis, its worldwide economic implications, 
and the subsequent pressures placed on the Department and OIG could not 
have come at a more inopportune time. The Department, as a whole, has 
had significant new leadership responsibilities over the last 7 years 
in rebuilding communities devastated by disasters (i.e., lower 
Manhattan post-September 11th; the gulf coast region after hurricanes 
Katrina, Rita and Wilma; the Galveston area after recent hurricanes; 
California fires; and Midwest flooding) that have added tens of 
billions of dollars in new program funds that require quick 
distribution and keen oversight. In addition, HUD received over $13.6 
billion in the American Recovery and Reinvestment Act that again 
requires rapid dissemination to an even more widespread area.
    While there have been some monies appropriated for salaries and 
expenses needed for administering all these new programs and the recent 
passage of the fiscal year 2009 Omnibus Appropriation bill will help, 
the Department has historically not received analogous increases needed 
to deal with this new influx of requirements. They, and we, are quite 
stretched in our combined ability to keep up with the pace of new, 
critical needs and the changing dynamics of fundamental demands placed 
on the Department.
    Lastly, we would like to note, and emphasize, that we are pleased 
to be partnering with the FHA in a marketing endeavor to increase the 
general public's awareness of departmental anti-fraud activities and 
enhance education through better outreach activities, and to heighten 
efforts aimed at fraud prevention and at fraud reporting. The HUD OIG 
is launching a new Web site, www.mortgagefraud.gov, and with the FHA 
will be using this, as well as other avenues, to better publicize our 
hotline and activities. Below is the new HUD OIG brand insignia that 
will accompany our marketing effort to reach the public.




                               CONCLUSION

    As can be deduced from reading through the totality of issues 
raised in this testimony, a number of cross-cutting concerns transverse 
many of the highlighted FHA processes. These include: (A) inadequate 
quality controls; (B) reliance on manual processes; (C) over dependence 
on the honesty of program participant(s) to provide accurate and 
truthful information; (D) tendency to focus on entities rather than 
individuals; and (E) the need to work more with the mortgage industry 
to better capture data on individuals involved in the process. Further, 
although not within the control of the FHA, the fact that our 
nationwide mortgage lending system is fragmented with separate players 
embracing differing requirements creates opportunities for waste, fraud 
and abuse that a more unified approach could potentially ameliorate.
    In conclusion, though the challenges and tribulations are 
increasing, the Office of the Inspector General stands ready to assist 
in whatever way is deemed necessary and will be vigilant in its efforts 
to protect the funds of the American taxpayer. We thank you for the 
opportunity to relay our thoughts on these important issues based on 
the body of our work and of our experience, and greatly appreciate the 
activities of the Congress to protect the Department's funds from 
predatory and improper practices and to ensure an effective response on 
oversight at this critical time.

    Senator Murray. Thank you.
    Mr. Scott.

STATEMENT OF J. LENNOX SCOTT, CHIEF EXECUTIVE OFFICER, 
            JOHN L. SCOTT REAL ESTATE, ON BEHALF OF THE 
            NATIONAL ASSOCIATION OF REALTORS
    Mr. Scott. Thank you, Chairwoman Murray and Ranking Member 
Bond.
    I would like to talk a little bit about what's going on in 
the housing market. I'm going to refer to my chart quickly 
about how the housing market is working and the importance of 
FHA in today's solving the housing crisis. Today I represent 
the 1.2 million members of the National Association of 
REALTORS, myself and my company.
    In looking at the chart, the basis, the foundation of the 
residential housing market is in first-time home buyers coming 
into the marketplace. Some of them buy new construction, but 
the majority buys resale homes. So when you bring in first-time 
home buyers, it causes a chain reaction of sales up the price 
points.
    We break the market into four categories: the first-time 
home buyer category, the more affordable, the above the 
midpoint, and the high end. The inventories are always lower in 
the first-time home buyer category, and they increase as you go 
up the price points for that.
    We have seen an increase in sales activity in first-time 
home buyer category because of four reasons: the first one 
being the FHA loans with the flexible credit score. It is 
allowing more families to come into homeownership, and these 
are families, individuals or families, who have good credit, 
that can make the payment.
    The next item would be the mortgage interest rates have 
come down 1 percentage point since last October. This is due 
mainly in part to the Treasury stepping in to buy mortgage-
backed securities. That 1 percent lower on interest rates has 
created a 12 percent increase in purchasing power.
    The other two items that we have that are in fact helping 
the marketplace are that prices have just been lowered. This 
past 5 months starting in October, we saw inventory levels 
raised since October and prices adjusted lower. Even in the 
first-time home buyer price range, they adjusted the prices 5 
percent lower.
    Then the last item that we have is that Congress approved 
and President Obama signed a stimulus package on February 17 
that had the $8,000 first-time home buyer tax credit, and 
buyers were waiting for that tax credit. It came about and they 
are entering the marketplace.
    I'll give you an example of months supply real quick. In 
Tacoma, Pierce County area, the months supply for existing 
homes in the first-time buyer category is 4.6 months, around 
the midpoint is 8 months, above the midpoint is 13.8 months 
supply, and in the upper end it's 20 months supply. So that 
just gives you an idea of where the months of inventory is and 
pricing dictates off the monthly inventory levels.
    So we have a low inventory level in the more affordable, in 
the first-time buyer price range.
    Overall, the months supply is 7.2 months supply in Pierce 
County, Tacoma. Healthy is thought to be in the 5 to 6 months 
supply range. King County, for example, where Washington is--I 
mean, where Seattle is, is at an 8.3 months supply.
    So we believe FHA is playing a very important role and they 
can play even a greater role in the recovery of this housing 
crisis that is taking place. First--there's four points. First, 
we ask that FHA receive the funding necessary to increase the 
staff and improve technology. This just expedites the programs 
and the efficiency and the security of them.
    Second, we would like to see the $8,000 first-time buyer 
tax credit monetized, which means that it's available at the 
closing table, so that buyers can use that $8,000 for a down 
payment. I was talking with NAR chief economist Lawrence Hyun 
yesterday and we are projecting that would bring in an 
additional 500,000 first-time home buyers into the marketplace. 
They have good credit. They have the capability to make the 
payment. It's just that they do not have enough money for the 
down payment.
    That would stimulate the first-time buyer category and 
cause that chain reaction of sales up the price points. Already 
we're seeing in many areas of the Nation prices stabilizing in 
the first-time home buyer category, and this would then 
stabilize home prices in the more affordable and work its way 
upward.
    They would then pay this $8,000 back from the first-time 
buyer tax credit, which has already been approved by Congress 
and signed by the President. This would release pent-up demand.
    Also, we'd like to see the higher loan limits made 
permanent. They are making a difference, especially for move-up 
buyers, that they could then receive the lower interest rate. 
Their equities have gone down in this market correction. They 
need the FHA loans for credit. They have the capability. 
They're both buying and selling in the same market timing. It's 
okay to buy and sell at the same market timing in the upper 
price ranges. They just need the lower interest rates and the 
credit available to them.
    Lastly, ease the financing for condominiums. Right now 
there is a requirement for an environmental review on a Federal 
level. We would like to see that the environmental reviews at 
the State and local level be accepted. This would expedite the 
process for condominium projects to be able to move forward.
    Also we'd like to see that the 51 percent occupancy ratio 
be lowered to a number below 50 percent for that.

                           PREPARED STATEMENT

    We have submitted our written statement and we'd like to 
thank you for your support of the Federal housing program. 
Senator Murray, I'd like to thank you in particular for raising 
the temporary loan limits up to help us move this market 
forward during this housing crisis.
    [The statement follows:]

                 Prepared Statement of J. Lennox Scott

    Chairwoman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for inviting me to testify today on the role of 
the Federal Housing Administration in addressing the housing crisis.
    My name is Lennox Scott, and I am the chief executive officer of 
John L. Scott Real Estate in Bellevue, Washington. I am here today to 
represent the views of the nearly 1.2 million members of the National 
Association of REALTORS, who are involved in every aspect of the real 
estate business.
    The members of the National Association of REALTORS have had 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. With the collapse of the private 
mortgage market, the importance of the Federal Housing Administration 
has never been more apparent. As liquidity has dried up and 
underwriting standards have been squeezed tight, the FHA is one of the 
primary sources of mortgage financing available to families today. 
Without FHA financing, families would be unable to purchase homes and 
communities would suffer from continued foreclosure and blight.
    In 1934 the Federal Housing Administration was established to 
provide consumers an alternative during a lending crisis similar to 
what we face today. At that time, short-term, interest-only and balloon 
loans were prevalent. FHA was an innovator with the 30-year fixed rate 
mortgage. Once again, FHA is now the leader in providing safe, 
affordable financing. 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 downturn.
    FHA's market share has grown from less than 3 percent to more than 
30 percent in a very short time. While this change was necessary to 
provide a functioning mortgage market, it also provides concern for the 
safety and soundness of FHA. With such dramatic growth comes increased 
responsibility, and the need for increased infrastructure and staff.
    We believe FHA is doing its best to step up to the challenge. Over 
the last 18 months, FHA has demonstrated it can handle volume increases 
at four times 2007 levels while its market share increased to over 30 
percent. Despite receiving minimal additional resources, there are two 
reasons why FHA has been capable of handling the volume. First, once 
lenders have been approved by FHA, they perform all of the loan 
processing, underwriting, closing and insuring functions without HUD 
review. This takes the burden off FHA, although additional oversight in 
approval may be needed. Second, FHA's technology, despite being 25 
years old, remains resilient and fundamentally sound. That said, there 
are a number of changes that should be implemented to ensure that FHA's 
Mutual Mortgage Insurance Fund (MMIF) remains strong and healthy.

                      NEED FOR INCREASED CAPACITY

    For years FHA has been hampered by a lack of investment in staff 
and information technology. The Single Family FHA program currently 
operates with a nation-wide staff of about 900, which is approximately 
160 positions less than needed. In addition, FHA operates with 
technology that is an average of 18 years old. FHA Commissioner Brian 
Montgomery had said the software programs FHA uses are, in many cases, 
older than the staff maintaining it. Quickly upgrading the dozens of 
incompatible systems, such as the 30 year old COBOL system, to web 
based customer centric applications is necessary for the agency's 
continued existence and future success.
    Our membership believes that FHA cannot continue to serve its 
constituency without rapidly implementing a quality and systems 
initiative. Other financial institutions more adequately staffed and 
with more advanced technology have already gone out of business. It has 
been estimated that $65 million is required to upgrade the FHA systems 
and add the appropriate number of staff. These expenditures could save 
the taxpayer tens of millions of dollars per year and result in a more 
efficient Government mortgage insurance program.

                  INCREASED OVERSIGHT/RISK MANAGEMENT

    Recent articles have expressed concern about FHA's oversight of 
loan originators. In order for a lender to be a direct endorser for FHA 
(and not require HUD approval on every loan), they must submit an 
application to HUD. The number of applications has skyrocketed in 
recent months, and we agree with the concerns expressed about both time 
to process applications and provide the necessary oversight of lenders.
    Despite media concern that FHA has become a ``dumping ground'' for 
subprime loans and high-risk borrowers, the fiscal year 2008 
independent Actuarial Review demonstrates that the FHA Mutual Mortgage 
Insurance Fund (MMIF) is fiscally sound, and projected to remain so 
over the next 7 years. While the MMIF has experienced a decline in 
value, it remains above the congressionally mandated 2 percent 
capitalization ratio. A high percentage of the decline was the result 
of falling house prices--something everyone has been facing. In 
addition, the quality of borrowers utilizing FHA has improved. 
Borrowers now have higher credit scores and lower loan-to-value ratios; 
these changes are expected to further improve the financial status of 
the FHA MMIF.
    The Actuarial Review suggests that if current conditions continue, 
FHA will be able to handle the increased claim activity and decreased 
valuation of the housing market while meeting its current capital 
reserve requirements. However, it is important to note that the 
Actuarial Review is based on July 2008 data, and may not take into 
account the full impact of actual home value declines since then. The 
review also does not take into account the latest estimates of 
anticipated employment decline, which could impact borrower incomes and 
ability to pay. These factors--higher than expected home price declines 
and higher than expected unemployment--could present a troubling 
macroeconomic picture for FHA going forward. While current borrowers' 
higher credit quality provides some protection from these trends, it 
cannot eliminate all risks. The most recent data shows that FHA'a 
delinquency rate is climbing at a troubling rate.
    Additional personnel are needed to assure that FHA does not fall 
victim to fraud or abuse. Recent reports indicate an increase in early 
payment defaults, i.e those loans that are delinquent with just their 
first or second payment. Currently monitoring of these loans is limited 
due to staffing constraints. Increasing lender oversight and staff to 
monitor fraud and abuse will help keep FHA fiscally strong, and will 
protect the taxpayers' interest.

                 TECHNICAL CORRECTIONS TO FHA PROGRAMS

    The Housing and Economic Recovery Act (HERA) of 2008, signed into 
law in July 2008, provided a number of valuable reforms to FHA. 
However, not all of them have been able to be implemented due to 
confusion over implementation or interpretation of the law.
    HERA included provisions intended to ease financing of condominiums 
for FHA. However, HUD's attorneys have stated that the legislation does 
not specifically remove the requirement for an environmental review of 
the property for a condominium loan to be processed. This review is 
very time consuming and complicates the home purchase process. Since 
Congressional intent was to ease financing for condominiums, this 
matter should be clarified in the law so HUD may implement the new HERA 
provisions.
    Condominiums remain one of the more affordable housing options for 
American families. NAR further recommends that the FHA reduce the 51 
percent occupancy ratio to a number below 50 percent for all 
condominium developments. Amending the owner-occupancy rules for 
condominium developments for buyers with FHA mortgages will benefit all 
parties in the real estate transaction. Individuals and families 
purchasing condominiums will have access to more flexible and 
affordable financing opportunities. Potential buyers with FHA mortgages 
will have a wider choice of condominium developments. Finally, existing 
owners in these developments benefit as vacant units are purchased and 
occupied and the owner-occupied ratio increases.
    HERA also promoted the use of FHA's energy efficient mortgage (EEM) 
product. Currently an EEM may include up to $8,000 of energy efficient 
improvements to a home. However, HERA increased that amount up to 20 
percent of the value of the home. FHA has been unable to implement this 
provision due to a technical flaw in the statute. Given the 
administrations support of energy efficiency, we urge this technical 
correction be made to allow borrowers purchasing homes to use FHA to 
get the full benefit.
    Chairman Murray and the subcommittee members have been strong 
supporters of increasing the FHA loan limits, which was done in both 
the HERA legislation and in the American Recovery and Reinvestment Act 
(ARRA) passed earlier this year. ARRA reinstated the 2008 loan limit 
levels, at 125 percent of local area median home price, capped at 
$729,750. ARRA also provided the HUD Secretary with discretion to 
increase the limits in ``sub-areas,'' where home prices may far exceed 
the county average. However, HUD has chosen not to exercise this 
authority. We believe the loan limits need to be made permanent at the 
current levels, as to provide some stability to the market. We also 
believe that FHA should be encouraged to use their authority to 
increase the limits in communities that simply have prices higher than 
their surrounding counties.

                FHA AND USE OF THE HOMEBUYER TAX CREDIT

    The Housing and Economic Recovery Act of 2008 also includes a 
first-time homebuyer refundable tax credit up to $7,500 to first-time 
home buyers for the purchase of a principal residence on or after April 
9, 2008 and before July 1, 2009. This was followed by the American 
Recovery and Reinvestment Act, which offers a tax credit of up to 
$8,000 for first-time homebuyers who purchase on or after January 1, 
2009 and before December 1, 2009.
    Enabling homebuyers to have access to their tax credit funds at the 
time of closing, through a collateralized loan against the tax credit, 
would allow the home buyer to use the credit toward a down payment. The 
repayment of the funds borrowed against the credit would be obtained 
through use of the tax refund. During his confirmation hearings, HUD 
Secretary Shaun Donovan stated that FHA has the discretion to permit 
this type of financing mechanism. FHA regulations permit a borrower to 
use loan proceeds for a home purchase as long as the loan is ``secured 
by property or collateral owned by the borrower independently of the 
mortgaged property,'' Loans may be used for a down payment, and secured 
by the mortgaged property, in certain circumstances and assuming the 
loan is not provided by a party having a direct or indirect interest in 
the real estate transaction. This use of the tax credit benefits 
potential first-time homebuyers with little down payment available for 
purchase.
    Monetizing the tax credit through a loan combined with FHA's low 
3.5 percent down payment requirement would offer a strong incentive to 
buyers who would otherwise not purchase a home this year. NAR estimates 
that hundreds of thousands of buyers will take advantage of the tax 
credit. However, proactive use of the tax credit will release even more 
pent up demand in real estate markets across the country. Granting 
borrowers access to their tax credit through collateralized loans will 
further ensure FHA products are the mortgage products of choice for 
homebuyers.

                               CONCLUSION

    Today's FHA is not your father's FHA. Congress and HUD have made a 
number of important and valuable changes to FHA over the last several 
years that have enabled it to stand up to the challenges of today's 
mortgage market. FHA is now the principal source of financing for 
millions of American families. Without FHA our economic crisis would be 
significantly prolonged.
    There are a number of reforms that can be made to FHA to ensure its 
continued success and its availability to hardworking families. We urge 
the subcommittee to review our proposals and consider using these 
suggestions to strengthen FHA. We thank you for your continued support 
of Federal housing programs, and stand ready to work with you to keep 
these programs viable.

    Senator Murray. Thank you very much for your excellent 
testimony.
    Ms. Vermillion, we'll go with you.

STATEMENT OF MIA VERMILLION, SENIOR LOAN CONSULTANT, 
            GUILD MORTGAGE, LAKEWOOD, WASHINGTON
    Ms. Vermillion. Madam Chair, distinguished members of the 
subcommittee----
    Senator Murray. You want to turn on your mike in front of 
you.
    Ms. Vermillion. Madam Chair, distinguished members of the 
subcommittee: I am honored to be here today. I'm glad to assist 
this subcommittee in any way possible. Please note I am here as 
a lender, with over 25 years experience, and not a 
representative of my current employer.
    I started originating home loans in Texas and have been in 
the great State of Washington for the last 9 years. My 
experience includes a number of HUD products, such as the 
Tribal 184, but for today we're discussing only the basic FHA 
fixed rate loan.
    As you have pointed out, in Washington State FHA loans went 
out of favor and have now come back. Many loan originators 
during 2004 and 2007 had no knowledge of FHA. They'd never done 
anything that required asset and income verification, so if you 
didn't have to ask anybody for information it was very simple 
to close loans. In retrospect, the lower volumes in these 
bubble years actually benefited the FHA insurance fund by 
avoiding the losses associated with the revaluation of those 
assets.
    Currently we have a great climate for FHA loans and they 
are playing a critical role in reviving this real estate 
market. Thanks in great part to Senator Murray, the increased 
loan limits have allowed buyers of more expensive homes to 
benefit from FHA financing. First-time home buyers are out in 
droves. I usually teach three to four home buyer classes each 
month following the 5 hour format of the Washington State 
Housing Finance Commission and our class attendance is sharply 
up--a good indicator that buyers want to be better informed 
before committing to a mortgage loan.
    Our trade organization I'm sure has let you know that the 
biggest challenge for FHA lenders relates to warehouse 
capacity. We have a huge demand for funds and many lenders are 
struggling to accommodate the volume.
    The FHA loan program is a cornerstone of our prudent 
lending as we move forward. One of my personal concerns is the 
attempted revival of the seller-funded down payment assistance 
program. The current down payment for FHA is only 3.5 percent. 
There are a number of sound down payment assistance programs 
such as the Washington State Housing Finance Commission offers. 
The down payment can come from relatives, 401k, or buyers' own 
funds.
    When a seller funnels a down payment to a borrower, we're 
not only actually doing a zero down loan; in most cases that 
borrower is paying more as a higher price for that home than 
they otherwise would.

                           PREPARED STATEMENT

    In conclusion, I hope we all learn from this current 
housing crisis and do not repeat some of the practices that 
have led us here. Thank you for your time and attention.
    [The statement follows:]

                  Prepared Statement of Mia Vermillion

    I am honored to be here today and glad to assist this subcommittee 
in any way possible. Please note that I am here as a lender with over 
25 years of experience and not as a representative of my current 
employer. I started originating home loans in Texas and have been in 
Washington State for the last 9 years. My experience includes a number 
of HUD products, such as the Tribal 184 loans. For today, I am 
discussing the basic FHA 30 year fixed rate loan, known as a 203B.
    In Texas we experienced a very challenging real estate market in 
the early 1980s. Fixed interest rates went from 11.5 percent to 18 
percent. The market responded with financial innovation and produced 
many adjustable rate products for conventional loans. Compared to these 
products, FHA loans often took longer to close and thus fell out of 
favor in the market. When the overheated real estate market cooled off 
these conventional loans became very difficult to obtain. At that time, 
FHA then became the only loan option for buyers who were not VA 
eligible and did not have the 10-20 percent down payment required for 
conventional loans.
    Moving forward to Washington State, FHA loan endorsements for the 
most common loan type--the 203B--grew from 15,372 loans in 2000, to 
30,766 loans in 2003. After that the number of FHA closed loans dropped 
to 15,556 in 2004, 8,290 in 2005, 7,707 in 2006 and 8,704 in 2007. 
Please refer to the attached chart from the HUD site.

   WASHINGTON STATE FHA 203B CLOSED LOANS 1990 THRU FEBRUARY 28, 2009
------------------------------------------------------------------------
                          Year                                 Loans
------------------------------------------------------------------------
2009....................................................       \1\ 6,307
2008....................................................          30,500
2007....................................................           8,704
2006....................................................           7,707
2005....................................................           8,290
2004....................................................          15,556
2003....................................................          30,755
2002....................................................          24,162
2001....................................................          22,958
2000....................................................          15,372
1999....................................................          18,657
1998....................................................          17,698
1997....................................................          14,169
1996....................................................          13,175
1995....................................................           9,150
1994....................................................          22,791
1993....................................................          20,704
1992....................................................          13,908
1991....................................................          16,411
1990....................................................          21,183
                                                         ---------------
      Total.............................................        338,157
------------------------------------------------------------------------
\1\ Two Months Activity.

Source: HUD.


    Many loan originators during 2004-2007 had no knowledge of 
FHA and had never done anything besides a conventional loan. 
The market provided varieties of zero down loans, and loans 
with no proof of income or assets required. These loans not 
only made it easy for borrowers to qualify, but made it easy 
for the loan originators. There was just not much work involved 
when documentation was not necessary. So FHA, requirements for 
strict borrower income documentation, asset verifications 
combined with Realtor perceptions that the FHA product was 
unwieldy, resulted in lower volumes. In retrospect the lower 
volumes in the ``bubble years'' has actually benefited the FHA 
insurance fund by avoiding the losses resulting from the re-
valuation of real estate.
    And now we have come full cycle again. In 2008 Washington 
State had 30,500 FHA loans closed. FHA loans are again the best 
product for both buyers and people trying to refinance--as long 
as they still have some equity. Conventional loans have 
additional fees, and mortgage insurance companies are 
experiencing heavy losses and tightening their guidelines. Loan 
officers who have never before collected W2s, bank statements, 
and paystubs are learning we are ``back to the basics'' in 
mortgage lending. FHA loans are playing a critical role in 
reviving this real estate market. In this environment of 
uncertainty, FHA provides a stable source of liquidity. Thanks 
in great part to Senator Murray, we now have increased loan 
limits so buyers of more expensive homes can also benefit from 
FHA financing.
    This is especially true for the first time homebuyers who 
are benefiting from a combination of lower prices, great 
interest rates, and the $8,000 tax credit. I usually teach 
three to four home buyer classes each month, following the 5 
hour format of the Washington State Housing Finance Commission. 
Our class attendance is sharply up, a good indicator that 
buyers want to be better informed before committing to a 
mortgage loan.
    Mindful of loan quality, most lenders have now implemented 
minimum FICO scores for their FHA product. These actions will 
benefit the insurance fund going forward.
    As you have heard from our trade organization, the Mortgage 
Bankers Association, the largest challenge for FHA lenders 
relates to warehouse capacity. With rates nearing record 
levels, there is a huge demand for funds. The credit crisis has 
removed much of the warehouse capacity from the industry and 
many lenders are struggling to accommodate the volume. This 
will have a negative effect on consumers as it impacts our 
ability to continue to make good loans to qualified borrowers, 
a key element to revive our housing industry.
    The FHA loan program is a cornerstone of our prudent 
lending as we move forward. One of my personal concerns is the 
attempted revival of the ``seller funded down payment.'' The 
current down payment for FHA is only 3.5 percent, and there are 
a number of sound down payment assistance programs such as the 
Washington State Housing Finance Commission offers. The down 
payment can also come from relatives, 401k accounts, or a 
buyer's own funds. When a seller funnels the down payment to a 
borrower, we are actually not only doing a zero down loan, but 
in most cases the buyer is paying a higher price for that home 
than they otherwise could.
    In conclusion, I hope we all learn from this current 
housing crisis and do not repeat some of the practices that 
have led us here.
    Thank you for your time and attention.

    Senator Murray. Thank you very much.
    I appreciate both of you traveling all the way out here 
from Washington State to lend us your advice and counsel as we 
move forward to deal with this very important issue. So thank 
you for being here.
    Mr. Donohue, I do want to start with you on questioning. 
None of us want to see the FHA's portfolio infected with the 
kind of bad loans that caused the current economic crisis that 
we're in. Historically, FHA's strong underwriting and 
programming compliance process has prevented that from 
happening.
    Your testimony and your written testimony explained in 
great detail the different forms of fraud that can enter into 
the FHA loan guarantee process. Have your audits shown that 
there is a significant increase in any of these forms of fraud 
since the FHA's role started to expand in this current credit 
crisis?

                        MORTGAGE FRAUD ACTIVITY

    Mr. Donohue. Senator, first of all let me thank you and 
Senator Bond for the support you've given me over the past 
several years as the IG. I do want to say too that my friend 
Secretary Donovan--we met regularly and discussed these very 
issues in a very practical way.
    I think the best way to answer this question is that with 
the increased volume of FHA activity going back on we're seeing 
an increase in regard to fraud activity. It stands to reason 
and certainly the FBI and ourselves, have both commented that 
as the time goes on with the more activity--the way I look at 
it is to instill as much prevention as you possibly can to 
ensure that you're doing what you can to prevent that.
    I made reference to my easel over here that I think, 
stating to the effect that when applicants come back into our 
business at FHA they need to know that if they lie, if they 
provide false information that they're going to be held 
accountable to a particular criminal statute.
    I think FHA--and I was pleased by the comments of the 
Secretary as far as being very proactive as far as ensuring the 
policing of lenders and brokers. I have a host of ideas I've 
spoken to the Secretary about, and I think my comments 
mentioned that, such as--my best example of this, Senator, was 
a matter that came up in your very State, in Seattle, 
Washington. I couldn't help but notice about a month ago there 
was an article in the paper about a scam that went on with 
regard to activity. It mentioned convicts, including 
embezzlers, robbers, rapists, being involved in mortgage fraud 
activity.
    It was the leadership of the Senate and I believe the State 
as well to try and police that and make sure it doesn't happen 
again. So I think we're trying to, working close with the State 
and the Federal authorities and DOJ, to make sure we police 
these activities when we hear about it, and we get information 
from the Department. They refer cases to us on a regular basis.
    Senator Murray. Thank you very much.

                           MAXIMUM LOAN LIMIT

    Mr. Scott, in your testimony you talked about the raised 
loan limits and our support of that. As the law is currently 
written today, the maximum loan limit is supposed to be 
adjusted downward by over 100,000 on January 1, 2010. Maybe you 
and Ms. Vermillion both could comment on what you believe would 
happen to the market if those higher loan limits are allowed to 
adjust downward as is currently called for.
    Mr. Scott. Well, the higher loan limits provide a lower 
interest rate for borrowers in those price ranges. That 
increases the purchasing power. It allows them to move forward 
in their purchases. Especially in the condition where the 
months supply is so high, it helps get the markets moving in 
that price category.
    Otherwise they're jumping maybe from a conforming loan up 
to a jumbo loan. The jumbo loan interest rates are higher than 
the Government-backed loans of FHA. So it is extremely 
important in the marketplace.
    Also, I talked about first-time buyers up 500,000 
additional if we can get the money at the closing table. That 
would equate into a million sales overall because of the chain 
reaction effect of monetizing the $8,000 first-time home buyer 
tax credit at the closing table, and that combined--the higher 
loan limits are a piece of that chain reaction of sales.
    Senator Murray. Ms. Vermillion, can you comment on that?
    Ms. Vermillion. I agree with that, and I think it's really 
critical. We have the first-time home buyers out right now 
because of the combination of low interest rates, lower home 
prices, and the $8,000 tax credit. So as Mr. Scott has pointed 
out, that is the very first chain on our chain reaction, and I 
think the higher limits for FHA are critical to ensure good 
loans for upper income borrowers.
    Senator Murray. I expect that you don't expect the current 
economic crisis to be gone by 2010. That would say we're past 
this and we need to move on? Do you see that extending out into 
next year?
    Mr. Scott. Well, the economics will come forward as they 
may. But also, the higher loan limits create fairness across 
the Nation to have access for families to have affordable 
priced loans. So this--on both coasts and in several areas 
throughout the Nation, there are higher cost areas, and just 
making loans accessible.

                         MORTGAGE RESCUE SCAMS

    Senator Murray. Are either one of you concerned about an 
influx of shady lenders and brokers into the FHA program now 
that the subprime market has disappeared?
    Ms. Vermillion. I am very concerned about that. We're 
seeing a lot of ``mortgage rescue'' scams. We're seeing a lot 
of ``loss mitigation'' scams. And we are seeing increased fraud 
in the FHA arena, since that's the primary lending mechanism 
now. We saw that in Texas back in the 1980s and we're seeing it 
again.
    Senator Murray. Okay, thank you very much.
    Senator Bond. Thank you, Madam Chair.
    A special thanks to our private sector witnesses from 
Washington traveling here. It really helps to hear your views 
of the challenges on the ground and providing adequate 
financing for homeowners. Ms. Vermillion, I appreciate your 
recognition of the point that I made with Secretary Donovan and 
he so strongly endorsed, that we don't need any mechanisms that 
encourage foreclosure. It may not be fraudulent, but they are 
just in a position to be foreclosed if they don't have enough 
money to put down a down payment.

                            DEFAULT/BAILOUT

    I turn to our good friend the Inspector General, Mr. 
Donohue. With this tremendous fivefold increase in business of 
the FHA, what's your honest assessment that the explosion of 
FHA authorities and responsibilities might lead to a default or 
the requirement for a significant bailout from taxpayers, 
either through what I consider to be a back door way of marking 
it down as directed spending, taking it out of the budget, 
appropriating it, or having to recognize it elsewhere on the 
budget?
    What are the risks to taxpayers?
    Mr. Donohue. Well, Senator, based on my testimony you could 
see the impact it's had on the FHA MMI fund. It's going the 
wrong direction. I will state again, as I know you've been an 
avid supporter of the elimination of selling down. You know how 
strongly I felt about that.
    Senator Bond. We were together on that one.
    Mr. Donohue. And I'm so pleased to see that end, and so on. 
But I do think, as it goes--I think the FHA is trying to make 
some corrective actions. They're working with us. Obviously, if 
in fact it goes down to the 2 percent margin, then of course 
they're faced with the very thing that has been raised today, 
and that's the fact of appropriated funds or an increase in 
premium. I think that's the only two alternatives that would be 
placed to ensure the fact that the FHA stays solvent.
    Senator Bond. What do you think is the real--are we looking 
at the potential of a significant taxpayer bailout, given where 
we are now? Can you assess that?
    Mr. Donohue. Well, it's hard to say, sir. I think that, 
based on the numbers we're seeing, I think that it's going to 
wrong direction by the sheer volume. I think it's something I'd 
have to take a look at in more detail to comment to you about 
as far as to the volume. I think with the increased volume 
certainly is increased premiums. There are actuarial studies 
that would indicate that it has impacted on this past year.
    I see my job, sir, as to try and do everything I possibly 
can to work with FHA to insure in a proactive way that we 
prevent any bad activity from coming further into this program 
as a result of it. But as far as specifics, it's just the 
pattern we're seeing and the direction its going is not going 
in the direction which I would like to see and as you would not 
like to see.
    Senator Bond. I would be interested in any further thoughts 
that you have on needs for FHA staffing. We will be seeing that 
in the budget, and the IT system.

                         FHA APPRAISAL PROCESS

    But there's a particular area where I think we've seen some 
really questionable activities. That is in the appraisal 
process. A good appraisal is essential to make sure that we are 
not insuring something that isn't worth it. The value of the 
property has to be accurate. There is always a risk of conflict 
of interest. I live in a small town. The appraisers are good 
friends with everybody else.
    There is also a danger that appraisers--and I believe that 
some of the 58 actions that have been brought by the U.S. 
Attorney for the Eastern District put appraisers in with the 
mortgage originators.
    What kind of steps, what additional steps, should FHA take 
to make sure that they are getting--that the appraisals are 
being made by competent people without conflict and on a 
professional, realistic evaluation of the property?
    Mr. Donohue. Senator, I think this is a concern that we've 
shared for some time. The large amount of increase in appraisal 
activity has drawn the application process. We have seen in our 
cases and across the country licenses expired. We have seen the 
absence of good review. As you all know, dating back to 1994 
FHA had an appraisal fee panel that used to actually go back 
and approve FHA appraisals specifically and monitor that 
number.
    I talk to the appraisers as well and of course their 
challenge is that they're asked to hit the mark, whether it's 
going down or going up. I think that's of great concern. I 
couldn't help but notice that the New York Attorney General 
with FNMA had gone back and expressed a third party resolution 
to have some uninterested person hire the appraiser involved, 
and I think it's an interesting notion.
    The former general counsel at HUD and I have spoken and he 
came out of the Mortgage Bankers Association. He expressed to 
me directly concerns in the ongoing process that appraisals are 
the thing that we have to look at so very, very carefully.
    Finally, sir, the VA itself, which doesn't deal with the 
volume we deal with, has an appraisal fee program that's still 
in place and they approve their appraisers on a regular basis.
    Senator Bond. Is that something that the FHA should 
consider?
    Mr. Donohue. I think they'd have to look at that, sir. They 
don't certainly do the volume that FHA has done, but I 
certainly think it's worth taking a look at.
    Senator Bond. Thank you very much for your suggestions.
    Thank you, Madam Chair.
    Senator Murray. Thank you.
    Mr. Scott and Ms. Vermillion--Ms. Vermillion, you live and 
work in Pierce County, that's one of the hardest hit areas in 
our State. Mr. Scott, I know you're familiar with that area as 
well. I wanted to ask you if there's something particularly 
there that we should be focused on doing here at the Federal 
level to help that county.

                             PIERCE COUNTY

    Ms. Vermillion. Pierce County has been the hardest hit 
compared to many places in Washington. I believe a great deal 
of that is due to the economic numbers.
    The other thing I would like to see--and I don't know if 
HUD has the ability to do this; I am assuming they do--is the 
tracking of foreclosures based on originators or based on 
sellers. I know we have the notice of deferment--I'm sorry. We 
debar people if they've been involved. But it was my experience 
previously that typically if someone is involved in fraud that 
they don't typically complete one transaction; they typically 
do multiple transactions.
    The other thing that's happened in Pierce County is partly 
just the economy. We did an FHA loan for a real estate agent, 
very successful, obviously a full documentation loan, tax 
returns, et cetera. That person's income has sharply gone down, 
to the point where she is currently working additional part-
time jobs. But she is at risk of losing her home. And that is 
not something that anybody could have anticipated in 
retrospect.
    Senator Murray. Mr. Scott, any comments on that?
    Mr. Scott. Yes. The Pierce County market changed the year 
before the Seattle market did, and so the cumulative effects of 
the years of the economic situation. But as I've pointed out 
earlier, the months supply in the first-time buyer category has 
already stabilized and we're seeing renewed activity that will 
move up the price points.
    If we can monetize the $8,000 for an FHA loan at the 
closing table, that would make a huge impact. If FHA and the 
IRS could get together and figure that out, that would be just 
incredible for our Nation to move these programs forward.
    We are very excited about having David Stevens as nominee 
for the head of FHA. The National Realtor Association is very 
excited about that.
    Senator Murray. Okay, that's good to know. Thank you very 
much for that.

                                 HECMS

    Mr. Donohue, I wanted to ask you about HECMs. Senator Bond 
referred to them earlier. They're relatively new, but it is a 
pretty rapidly growing business for FHA. Those reverse mortgage 
programs are obviously mostly senior citizens. Can you talk a 
little bit about any special concerns you might have about 
HECMs and their potential impact on solvency?
    Mr. Donohue. I certainly can, Senator. I'm sure you agree 
this is a very vulnerable population of people with regard to 
HECMs, from everything from the third party to family 
participation. We're seeing--we have cases throughout the 
country that deal with some of these as well. The larger loan 
limits are certainly going to have a concern with regard to it 
as to making it attractive to go and pursue these matters.
    The other thing we're interested about is the statutory 
counseling, to make sure they are going back and sitting down 
with these people and addressing these matters as a primary 
concern.
    We have said--I have met with Senator McCaskill and the 
Senate Committee on Aging. We have met with the AARP, the 
Mortgage Bankers Association. They're all concerned about the 
effect of this program. I think we'd like to see as they go 
through the process, be it the counselor or the closing agent, 
to make sure when they see something that's not right to refer 
those matters to us and address those things rather quickly.
    It's a consumer issue that I think, as I said, AARP and 
they are very much involved with. We're trying to do as much 
outreach, too, also in letting the communities know how to be 
on guard with regard to the possibility of this activity.
    Senator Murray. Thank you.

                            FHA IMPROVEMENTS

    Senator Bond, thank you. I just have one final question to 
Mr. Scott and Ms. Vermillion. FHA's not been known as the 
easiest bureaucracy to deal with. You're on the ground out 
there. Can you tell me your experience? Is it improving, not 
improving? Does it need improvement? What are you seeing?
    Ms. Vermillion. I'm an FHA fan. I've been working with them 
for a long time. So when you say it's a bureaucracy, in our 
level we're originating the loans, we're funding the loans, 
we're fine.
    In terms of going back to the appraisal issue, that has 
become a concern for a number of appraisers. VA has us use a 
panel. FHA used to do that and it became so unwieldy it was a 
problem. I think again if we can address that with monitoring 
quality that we will be there. But I'm a big fan of FHA loans. 
I would appreciate them having the additional technology and 
staff to do what they need to do to keep us going.
    Mr. Scott. We appreciate the FHA loans. It's making a 
difference in the marketplace. Of course, the technology 
enhancements always make a difference.
    Senator Murray. You both talked about increased staffing, 
particularly because of the high use right now, too. So I 
appreciate that.
    Mr. Scott. Well, it's not only on newly originated 
transactions, but it would also be refinance activity coming 
through on top of that, and they will need the staffing.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Murray. Okay. At this time I will ask the 
subcommittee members to submit for the record, any additional 
questions they have for the witnesses.
    [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. Shaun Donovan
            Questions Submitted by Senator Patrick J. Leahy

    Question. Secretary Donovan, I would like to explore how ongoing 
issues surrounding HUD and the housing markets are impacting rural 
areas.
    I understand that the Department is working with the Department of 
Energy on a memorandum of understanding regarding the utilization of 
weatherization funding from the stimulus. Additionally I understand 
that it is your intention to make assisted housing automatically 
eligible for weatherization funds. I believe that this type of 
coordination is important to ensure that stimulus funds are well 
utilized, but would like you to clarify what projects will be eligible 
to receive funding.
    As part of this MOU will all types of assisted housing such as 
section 8, those that have received funds through the HOME, CDBG, and 
Low Income Housing Tax Credit Programs be automatically eligible for 
weatherization funds?
    Answer. HUD and DOE signed a Memorandum of Understanding on May 6, 
2009 aimed at streamlining the use of DOE weatherization funds in HUD-
assisted, public housing, and Low Income Housing Tax Credit (LIHTC) 
multifamily properties. The MOU was aimed primarily at eliminating 
duplicative income verification requirements which have proved to be a 
barrier to the use of these funds in these properties in the past. DOE 
published a Proposed Rule implementing the terms of the MOU in June 
2009, solicited public comments, and published a Final Rule on January 
25, 2010.
    The following projects are generally covered by the new regulation: 
(1) Public housing; (2) Project-based section 8 assisted housing, 
section 202 Supportive Housing for the Elderly, section 811 Supportive 
Housing for Persons with Disabilities; (3) Certain Low Income Housing 
Tax Credit (LIHTC) properties. Under the terms of the MOU and the DOE 
rule, HUD will provide DOE with a list of properties in these 
categories where at least two-thirds of their residents meet the DOE 
income requirement (200 percent below poverty) for weatherization 
assistance. Properties identified by HUD that appear on this list will 
not be required to provide independent income verification, but will 
automatically meet the DOE income eligibility requirements.
    Due to lack of available data, several programs are not 
specifically covered by the rule: section 221(d)3 and d(5), and section 
236 Below Market Interest Rate properties, as well as Indian housing, 
unless they fall into one of the three categories noted above. Section 
8 tenant-based rental vouchers are also not addressed. However, any of 
these programs will continue to be eligible for weatherization 
assistance through normal DOE procedures.
    Please note that it is not entirely accurate to say that the MOU 
and subsequent DOE Rule would make assisted housing ``automatically 
eligible for weatherization funds''--it is still up to individual 
States and local weatherization providers to allocate these funds to 
individual properties, according to local preferences and priorities 
and as outlined in each State's weatherization plan. Nothing in the 
Final Rule overrides these State prerogatives. Most States have focused 
their resources on single-family housing; the DOE regulation will 
streamline procedures for verifying rental incomes in those States and/
or for those local weatherization providers who wish to allocate funds 
for multifamily weatherization assistance.
    Question. The Neighborhood Stabilization Program has helped many 
communities around the country address their redevelopment needs. 
However for many rural States, conditions other than foreclosures have 
led to distressed housing markets. I believe that this program should 
be more flexible in order to support addressing the diverse issues 
facing in our housing markets.
    Would the Department be open to modifying or waiving the 
established targeting areas for States receiving the minimum allocation 
under this program? Further, would the Department support counting the 
redevelopment of demolished, vacant or blighted properties toward the 
requirement that 25 percent of the NSP units serve very low income 
families? And, for State's like Vermont that have not received adequate 
counseling assistance due to relatively low foreclosure rates, but 
still facing the skyrocketing foreclosure crisis, will the Department 
allow at least 10 percent of a State's allocation of NSP funds to be 
used for foreclosure counseling and prevention activities?
    Answer. With regard to expanding target areas for States with 
minimum Neighborhood Stabilization Program (NSP) allocations, a 
provision in Public Law 111-22 authorized HUD to permit qualifying 
States to expand their target areas and is in the process of issuing 
guidance to implement this provision. With regard to properties 
eligible to meet the requirement that 25 percent of NSP funds be 
expended to provide housing to households at or below 50 percent of 
area median income, HUD is constrained by the NSP authorizing language 
in the Housing and Economic Recovery Act of 2008 (HERA) which 
specifically states that only abandoned or foreclosed properties can 
qualify as meeting this low income benefit requirement. Finally, HERA 
defines the eligible uses of NSP funds and foreclosure counseling is 
included as not an eligible use. HUD has, however, permitted the use of 
NSP funds to pay for housing counseling when it is associated with the 
purchase of a property assisted with NSP funds.
    Question. Due to the frozen credit markets, Housing Finance 
Agencies (HFAs) cannot find investors for their mortgage revenue bonds 
or liquidity providers to back their bonds. As a result, more than 30 
housing finance agencies across the country are being forced to suspend 
or limit their mortgage lending programs. Among the housing recovery 
plans announced by the administration at the beginning of March, 
support for HFAs was among these plans.
    What specific steps are the Department and administration going to 
take to improve liquidity for State HFAs and when will this action be 
taken?
    Answer. On October 19, the administration announced a new 
initiative to provide critically needed assistance to State and local 
HFAs to help support low mortgage rates and expand resources for low 
and middle income borrowers to purchase or rent homes that are 
affordable over the long term. Following up on the intent to support 
HFAs first outlined in February under the Homeowner Affordability and 
Stability Plan, the administration's initiative has two parts: a New 
Issue Bond Program (NIBP) to support new lending by HFAs and a 
Temporary Credit and Liquidity Program (TCLP) to improve the access of 
HFAs to liquidity for outstanding HFA bonds.

                   THE NEW ISSUE BOND PROGRAM (NIBP)

    The New Issue Bond Program (NIBP) provided temporary financing for 
HFAs to issue new housing bonds. Treasury purchased securities of 
Fannie Mae and Freddie Mac backed by these new housing bonds. With 
these investments, the HFAs have issued an amount of new housing bonds 
equal to what they are authorized to issue with the allocations 
provided them by Congress but have been unable to issue given the 
current challenges in housing and related markets. The program may 
support up to several hundred thousand new mortgages to first time home 
buyers this coming year, as well as refinancing opportunities to put 
at-risk, but responsible and performing, borrowers into more 
sustainable mortgages. The NIBP will also support development of tens 
of thousands of new rental housing units for working families.

           THE TEMPORARY CREDIT AND LIQUIDITY PROGRAM (TCLP)

    Fannie Mae and Freddie Mac are administering a Temporary Credit and 
Liquidity Program (TCLP) for HFAs to help relieve current financial 
strains and enable them to continue to serve their important role in 
providing housing resources to working families. Treasury has agreed to 
purchase a participation interest in the Temporary Credit and Liquidity 
Facilities (TCLFs) provided to HFAs under the program, providing a 
credit and liquidity backstop. The TCLP provides HFAs with temporary 
credit and liquidity facilities to help the HFAs maintain their 
financial health and preserve the viability of the HFA infrastructure 
so that HFAs can continue their Congressionally supported role in 
helping provide affordable mortgage credit to low and moderate income 
Americans, as well as continue their other important activities in 
communities.
    On January 13, the administration announced the completion of all 
transactions under the State and local Housing Finance Agency (HFA) 
Initiative, With these transactions, the Obama administration helps 
support low mortgage rates and expands resources for low and middle 
income borrowers to purchase or rent homes that are affordable over the 
long term.
    Over 90 State and local HFAs representing 49 States participated in 
the NIBP for an aggregate total new issuance of $15.3 billion. Twelve 
HFAs participated in the TCLP for an aggregate total usage of $8.2 
billion. The Initiative is expected to come at no cost to the taxpayers 
and to the Government Sponsored Enterprises.
    Question. With more and more Americans facing eviction and the 
threat of homelessness, the already-long waiting lists for section 8 
vouchers continues to swell. In Vermont, the Vermont State Housing 
Authority has intermittently had to close the wait list and it has been 
thousands of people long at different times--a wait of several years 
for assistance finding a safe and affordable place to live.
    What does the Department plan to do about the increasing demand for 
rental assistance? Will you support the creation of additional 
vouchers?
    Answer. The housing choice voucher program is HUD's largest 
affordable housing program, which currently assists over 2 million 
families. Under the fiscal year 2010 Appropriations Act, HUD received 
$75 million in new vouchers for the Veterans Affairs Supportive Housing 
(VASH) program, which targets voucher rental assistance and supportive 
services to homeless veterans. HUD also received $15 million in new 
vouchers for the Family Unification Program (FUP), which provides 
rental assistance to families for whom the lack of adequate housing is 
a primary factor in the separation of a child from their family. In 
addition, HUD received $150 million in new voucher assistance for 
tenant protection activities such as public housing demolition and 
disposition.
    HUD recognizes that long waiting lists are common in many areas of 
the country. While vouchers are a vital component in addressing that 
need, additional funding requests cannot adversely impact funding needs 
for other critical HUD programs and initiatives. HUD is seeking to 
expand affordable housing opportunities for families not only through 
the use of tenant-based rental assistance but also by increasing 
affordable housing production and preserving existing housing stock.
                                 ______
                                 
           Question Submitted by Senator Frank R. Lautenberg

    Question. In the wake of the credit crisis, the New Jersey Housing 
and Mortgage Finance Agency--along with housing and finance agencies 
around the country--is having trouble finding agencies that will insure 
loans for homes designated for low-income homeowners. I understand 
that, under current policy, the Federal Housing Administration (FHA) 
does not insure mortgage loans made to purchasers of income-restricted 
housing. New Jersey currently has a surplus of vacant affordable 
housing because prospective home buyers cannot find an agency to insure 
their loan.
    Will the FHA consider changing its policy so it can start insuring 
loans on properties that are restricted for low- and moderate-income 
homeowners?
    Answer. FHA does not permit any form of ``resale'' restriction as a 
general practice, any type of requirement that would prevent a home 
from being sold on the open market to any buyer. However, when resale 
restrictions are established as part of a specialized affordable 
homeownership program, the FHA does have regulatory authority to permit 
these types of arrangements. We would be happy to work with the New 
Jersey Housing and Mortgage Finance Agency to ensure that FHA financing 
is available to home buyers purchasing homes that are part of the 
agency's program.
                                 ______
                                 
              Question Submitted by Senator Sam Brownback

    Question. Secretary Donovan, most economists agree that the housing 
market continues to be the primary concern for the economy. Part of 
solving that is decreasing the amount of housing stock available. To 
assist in that, Congress included a first-time home buyer tax credit in 
legislation last year and then increased and extended the tax credit in 
this year's stimulus legislation. Unfortunately, the tax credit can 
only be effective in helping individuals get into homes if it can be 
utilized up-front. I understand there is confusion in the marketplace 
as to whether that tax credit can be monetized and used at closing for 
downpayment and closing costs. In a response to a question from my 
colleague, Senator Corker, I'm told that you stated that the Federal 
Housing Administration (FHA) has the ``discretion'' to allow for the 
tax credit to be monetized (under certain specific provisions of FHA's 
underwriting guidelines). However, I also understand that some lenders 
are having trouble receiving clear guidance from HUD as to whether the 
tax credit can be used as collateral to obtain a loan for down payment 
and closing costs at closing.
    Can you provide clarity and certainty as to whether this can be 
allowed?
    Answer. FHA will not permit the home buyer tax credit to be 
monetized and used to meet the borrower's downpayment, which is also 
referred to as FHA's statutory 3.5 percent minimum cash investment 
requirement. However, an advance on the credit (or monetization) may be 
used to help cover the borrower's closing costs.
                                 ______
                                 
           Questions Submitted by Senator George V. Voinovich

    Question. At HUD and the FHA, do you have the human capital needed 
to responsibly approve new lenders doing business with the FHA?
    Answer. Yes. FHA's monthly average number of entities requesting 
approval as an FHA lender has decreased from 396 in fiscal year 2008, 
to 215 in fiscal year 2009, to 154 for fiscal year 2010 to date. In 
addition, turnaround time for applications that meet all of FHA 
requirements during the first review is within the 30-day standard set 
by FHA's Lender Approval Division. FHA is working to obtain the 
necessary system and contracting dollars needed to comply with the 
additional eligibility standards for approval as an FHA lender in the 
``Helping Families Save Their Homes Act of 2009'' (Public Law 111-22).
    Question. Do you have the human capital to investigate the 
potential abuse by lenders misleading homeowners?
    Answer. This question is very general and thus it is difficult to 
provide a comprehensive response. FHA and HUD have a myriad of 
responsibilities and consumer protections built into its various 
programs. For instance, Housing's Office of Regulatory Affairs and 
Manufactured Housing is equipped to enforce violations under the Real 
Estate Settlement Procedures Act (RESPA). HUD's Office of Fair Housing 
and Equal Opportunity (FHEO) is equipped to investigate violations of 
Fair Housing laws. Within FHA, approved lenders serve as the financial 
intermediary between FHA and the homeowner. Consequently, FHA does not 
receive a great deal of direct consumer complaints regarding potential 
abuses by lenders. Nonetheless, FHA does pay particular attention to 
any complaint regarding abuses within its loan programs. FHA uses a 
rigorous nationwide Quality Assurance program to monitor lender 
performance and compliance with its program rules and regulations. As 
an element of its risk-based lender targeting, FHA incorporates 
complaints received on abusive or misleading lending practices. Any 
instances of consumer abuse discovered during FHA lender reviews are 
addressed via administrative action through FHA's Mortgagee Review 
Board. All instances of potential fraud and/or criminal activity are 
referred to HUD's Office of Inspector General for investigation.
    Question. What training is provided for new FHA lenders regarding 
FHA loan guidelines? Who ensures that FHA loan guidelines are being 
carried out, such as agency rules requiring borrowers to document their 
income, down payment requirement, and a time commitment to living in 
the home?
    Answer. FHA is constantly monitoring lender performance and loan 
level compliance from the moment a lender is approved to originate and/
or service FHA loans, and from the instant a loan is originated. Lender 
applications for FHA approval undergo an evaluation of: (1) the 
company's financial capacity/resources; (2) its possession of 
appropriate State licensing; (3) the eligibility of the company and its 
principals, owners and officers to participate in Government programs; 
and (4) the company's quality control and compliance plans and 
procedures. Once approved, lenders recertify annually to ensure 
continued adherence to FHA requirements. Moreover, if a lender wishes 
to gain Direct Endorsement approval, it must undergo a ``Test Case'' 
evaluation, which helps FHA assess the lender's knowledge of and 
adherence to FHA underwriting guidelines.
    After ensuring that a lender meets all approval requirements, FHA 
switches the focus of its monitoring activities to the loans 
underwritten by a lender. All loans are required to pass certain checks 
prior to insurance endorsement, including but not limited to, 
verifications of borrower identity, confirmation that borrowers do not 
possess outstanding obligations to the Government, and certification 
that borrowers have not participated in property flipping activities. 
Following endorsement of a loan, FHA staff conducts Post Endorsement 
Technical Reviews (PETRs), emphasizing compliance with FHA requirements 
to ensure that loans do not pose a risk to the FHA insurance fund.
    FHA's Quality Assurance Division (QAD) also administers the Credit 
Watch Termination Initiative, which identifies underwriting lenders and 
originators whose default and claim rates are deemed excessive relative 
to other lenders in the same HUD Field Office Jurisdiction. 
Additionally, Headquarters QAD is responsible for the Neighborhood 
Watch Early Warning System, which is used to monitor lender and 
servicer performance by FHA staff, lenders, and other stakeholders. 
Utilizing Neighborhood Watch to assess risk indicators and default 
rates, FHA staff target lenders for on-site review by QAD Divisions 
that are based in field offices throughout the country.
    QAD offices located in the field conduct HUD Lender Monitoring 
Reviews that include on-site loan level review of lender files, and a 
review of lenders' compliance with FHA program requirements. FHA's 
review of loans continues throughout the life of the loan.
    FHA's National Servicing Center conducts an analysis of lenders' 
participation in loss mitigation, which identifies those lenders in 
need of additional training from the NSC, as well as those that should 
be considered for a lender monitoring review or possible investigation.
    During the course of quality assurance reviews, HUD staff identify 
potential evidence of fraud and refer those findings to the HUD OIG. 
Additionally, evidence of program violations is referred to the 
Enforcement Center and/or the Mortgagee Review Board for possible 
administrative action.
    The Mortgagee Review Board may take the following administrative 
actions against mortgagees and lenders: withdrawal, suspension, 
probation, letter of reprimand, and cease and desist. The Board also 
has the power to impose civil money penalties as well as enter into 
settlement agreements. It is only by settlement agreement that the 
Board can obtain an indemnification agreement. The Board does not have 
statutory authority to require indemnification.
    As stated above, the Board can penalize FHA lenders and mortgagees 
for material violations of HUD requirements and may also enter into 
settlement agreements.
    Question. Why is the participation rate for the Home for Homeowners 
program so low when foreclosure rates continue to increase? What can be 
done to improve the Hope for Homeowners program to increase 
participation?
    Answer. HOPE for Homeowners (H4H) was initially authorized under 
the Housing and Economic Recovery Act of 2008 to provide a mechanism to 
help distressed homeowners refinance into FHA insured loans. 
Unfortunately, due to several obstacles to participation, including 
steep borrower fees and costs, complex program requirements, and lack 
of operational flexibility in program design, the original program only 
assisted a small number of homeowners.
    The administration has taken a number of steps to improve the 
uptake for the program. On April 28, 2009, the administration announced 
steps to incorporate H4H into the Making Home Affordable program. In 
addition, on May 20, 2009, the President signed the ``Helping Families 
Save Their Homes Act of 2009'' which provided improved program 
features. The legislation eases eligibility requirements and 
streamlined the application process for the HOPE for Homeowners 
program.
    Guidance for the improved H4H program was issued in October and 
went into effect on January 1. However, there are some continuing 
challenges to maximizing program uptake. Because of legislative 
language mandating certain underwriting features for the program, 
servicers must modify their underwriting systems. In addition, the 
underwriting features also raise questions about the pricing of H4H MBS 
in market place. The administration is pursuing regulatory and 
legislative changes to increase the number of at-risk borrowers who can 
benefit from the program.
    Question. How does the Obama administration's foreclosure plan--
``Making Home Affordable'' coordinate with Home for Homeowners to help 
families refinance into more affordable loans?
    Answer. As mentioned above, the H4H program has been integrated 
into the administration's comprehensive approach to stabilizing the 
housing markets--the Making Home Affordable program. When a borrower 
approaches a participating MHA servicers for assistance, the servicer 
is required to offer the option for a H4H refinancing in tandem with 
the MHA trial modification option. To ensure proper alignment of 
incentives, servicers and lenders will receive pay-for-success payments 
for H4H refinancing similar to those offered for Home Affordable 
Modifications. The Home Affordable Modification program is intended to 
bring stability to the housing market and help American families reduce 
their monthly mortgage payments. The revised H4H program is intended to 
help homeowners whose loans are not owned or securitized by Fannie Mae 
or Freddie Mac, who are behind on their payments, who owe far more than 
they are worth, and who may find that modifying the terms of their 
loans is not a workable solution. The program would assist homeowners 
by taking into consideration their ability to pay and making their 
mortgage sustainable over the long haul.
    Question. In my hometown of Cleveland, the foreclosure crisis has 
ripped through like a tornado. I have supported the Neighborhood 
Stabilization Program (NSP) created last summer to provide local 
communities resources to address vacant, abandoned, and foreclosed 
properties. Recently, it has been brought to my attention that HUD is 
selling condemned HUD-owned properties to the city of Cleveland for the 
city to use its limited NSP resources to demolish the home. Can you 
please explain to me why HUD cannot use its own resources to demolish 
the homes they should have taken care of in the first place?
    Answer. On average, the Department annually acquires approximately 
50,000 single family properties from HUD-approved lenders. To ensure 
that such properties are properly secured, maintained, and marketed for 
sale, HUD uses Management and Marketing (M&M) Contractors. These 
contractors are required to appraise HUD-owned properties using FHA 
Roster Appraisers, establish the list price for such properties, and 
market and sell properties for the maximum price the market will bear. 
The Department uses this disposition strategy as it is necessary to 
replenish the Mutual Mortgage Insurance Fund and is the most effective 
way for FHA to generate proceeds to provide home buyers an affordable 
loan financing alternative to conventional and subprime loans.
    Thus, HUD does not require its contractors to simply demolish its 
properties based on their appraised value. Instead, the conditions of 
the real estate markets are also factored in the contractors' 
determination of the ultimate disposition or sale of a property. In 
markets such as Cleveland, for example, ``hard to sell'' properties are 
offered to local governments at deep discounts to further the 
Department's affordable housing and neighborhood stabilization 
objectives. In addition, to the extent that the Department is aware of 
a HUD-owned property being condemned or due to receive a Notice of 
Condemnation, HUD's contractors have been directed to disclose this 
information to all potential purchasers of HUD homes.
    Lastly, the Department, via its Neighborhood Stabilization Program 
(NSP), has awarded the city of Cleveland more than $16 million to 
address its high rate of foreclosed, abandoned properties, which 
contribute to blight within many of Cleveland's neighborhoods. Under 
the NSP program, local governments may acquire, demolish and rebuild, 
or rehabilitate foreclosed properties using NSP Federal grant funds. 
Additionally, to assist local governments in combating blight and in 
maximizing their use of the NSP grant funds, the Department is offering 
HUD-owned foreclosed properties valued at $20,000 or less (i.e., those 
considered to be ``demolition properties'') for $100. Specifically, 211 
HUD-owned properties have been held off the market by the Department, 
pending a direct sale to the city of Cleveland. Many of these 211 homes 
are valued at $20,000 or less, with a collective value of $2,105,200.
    Question. Secretary Donovan, in a previous meeting I gave you a 
list of recommended modifications to the Neighborhood Stabilization 
Program supported by the ``National Foreclosure Prevention and 
Neighborhood Stabilization Task Force.'' What is the status of the 
proposed regulatory modifications for NSP?
    Answer. The Department implemented several regulatory changes for 
NSP in a notice issue in June 2009. These changes reduced the required 
purchase discount for NSP properties to 1 percent and eliminated the 
overall portfolio discount requirement. HUD also reduced appraisal 
requirements associated with properties having value below $25,000. The 
notice also implemented several statutory amendments made to NSP by the 
American Recovery and Reinvestment Act of 2009, most notably the repeal 
of NSP revenue provision. This enabled HUD to implement program income 
provisions for NSP that parallel the program income requirements of the 
Community Development Block Grant program. The Department is committed 
to working closely with its NSP grantees to address and resolve 
programmatic issues that arise in the implementation of the program.

    Senator Murray. Well, I'd like to thank all of our 
witnesses today, especially for keeping your testimony tight, 
as we are in budget mode here and have a number of amendments 
that we'll start voting on shortly. But thank you again to both 
of our Washington State folks for coming out here. To all the 
FHA and to Mr. Donohue, we appreciate your testimony.

                         CONCLUSION OF HEARING

    At this time the subcommittee will be recessed subject to 
the call of the Chair.
    [Whereupon, at 11:25 a.m., Thursday, April 2, the hearing 
was concluded, and the subcommittee was recessed, to reconvene 
subject to the call of the Chair.]

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