[Senate Hearing 111-373]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-373

  CURRENT TRENDS IN FORECLOSURES AND WHAT MORE CAN BE DONE TO PREVENT 
                                  THEM

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 28, 2009

                               __________

          Printed for the use of the Joint Economic Committee





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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

HOUSE OF REPRESENTATIVES             SENATE
Carolyn B. Maloney, New York, Chair  Charles E. Schumer, New York, Vice 
Maurice D. Hinchey, New York             Chairman
Baron P. Hill, Indiana               Edward M. Kennedy, Massachusetts
Loretta Sanchez, California          Jeff Bingaman, New Mexico
Elijah E. Cummings, Maryland         Amy Klobuchar, Minnesota
Vic Snyder, Arkansas                 Robert P. Casey, Jr., Pennsylvania
Kevin Brady, Texas                   Jim Webb, Virginia
Ron Paul, Texas                      Sam Brownback, Kansas, Ranking 
Michael C. Burgess, M.D., Texas          Minority
John Campbell, California            Jim DeMint, South Carolina
                                     James E. Risch, Idaho
                                     Robert F. Bennett, Utah

                     Nan Gibson, Executive Director
               Jeff Schlagenhauf, Minority Staff Director
          Christopher Frenze, House Republican Staff Director















                            C O N T E N T S

                              ----------                              

                                Members

Hon. Carolyn B. Maloney, Chair, a U.S. Representative from New 
  York...........................................................     1
Hon. Sam Brownback, Ranking Minority Member, a U.S. Senator from 
  Kansas.........................................................     3
Hon. Elijah E. Cummings, a U.S. Representative from Maryland.....     4
Hon. Kevin Brady, a U.S. Representative from Texas...............     5

                               Witnesses

William Shear, Director, Financial Markets and Community 
  Investment, Government Accountability Office...................     7
Susan Wachter, Professor, Finance and Real Estate, The Wharton 
  School, University of Pennsylvania.............................     8
Keith Ernst, Director of Research, Center for Responsible Lending    10
Joseph Mason, Professor of Finance, Louisiana State University...    12

                       Submissions for the Record

Prepared statement of Representative Carolyn B. Maloney, Chair...    32
    Government Accountability study titled ``Characteristics and 
      Performance of Nonprime Mortgages''........................    33
    Chart titled ``Estimated Percentage of Seriously Delinquent 
      Nonprime Loans by Congressional District''.................    90
Prepared statement of Senator Sam Brownback, Ranking Minority 
  Member.........................................................    91
Prepared statement of Representative Kevin Brady.................    92
Prepared statement of William Shear..............................    93
Prepared statement of Susan Wachter..............................   103
    Article titled ``Systemic Risk and Market Institutions''.....   105
Prepared statement of Keith Ernst................................   120
Prepared statement of Joseph Mason...............................   126
Prepared statement of Representative Michael C. Burgess, M.D.....   127
    Article titled ``Housing Push for Hispanics Spawns Wave of 
      Foreclosures''.............................................   128

 
                     CURRENT TRENDS IN FORECLOSURES
                       AND WHAT MORE CAN BE DONE
                            TO PREVENT THEM

                              ----------                              


                         TUESDAY, JULY 28, 2009

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m., in Room 
210, Cannon House Office Building, The Honorable Carolyn B. 
Maloney (Chair) presiding.
    Representatives present: Maloney, Hinchey, Cummings, 
Snyder, Brady, and Burgess.
    Senators present: Brownback.
    Staff present: Gail Cohen, Nan Gibson, Colleen Healy, 
Justin Ungson, Andrew Wilson, Jeff Schlagenhauf, Jeff Wrase, 
Chris Frenze, and Robert O'Quinn.

OPENING STATEMENT OF THE HONORABLE CAROLYN B. MALONEY, CHAIR, A 
               U.S. REPRESENTATIVE FROM NEW YORK

    Chair Maloney. The committee will come to order.
    Good morning. I want to welcome our distinguished panel of 
witnesses, and thank you all for your hard work and your 
testimony today.
    Today, the Government Accountability Office released a 
study which I requested that looks at the performance of 
nonprime loans in every congressional district in the United 
States. This is a valuable report because it captures the 
national trends and also gives us data so basic we can see the 
effects on our constituents.
    The default and foreclosure rates for these mortgages in my 
New York district are relatively low compared to the rest of 
the country, but rising foreclosures continue to inflict pain 
in communities across the nation.
    Borrowers, lenders, governments and neighbors all pay the 
price for vacant houses that attract vandalism and increase 
crime, that destroy communities and burden local governments.
    The map behind me gives us a snapshot of the mortgage 
crisis inherited by the Obama administration. The map 
highlights an important point: the pain of foreclosures is not 
being felt evenly across the United States. What we see are 
pockets of pain, more heavily concentrated in certain areas of 
the country, and the red or the darker color highlights where 
the foreclosures are, and they are primarily in the States of 
California, Florida, Illinois, Massachusetts, Nevada, and New 
Jersey.
    Congress and the administration have undertaken numerous 
efforts to stem the tide of foreclosures. Key measures include 
incentives to servicers to modify loans in the administration's 
Home Affordable Modification Program and an expansion of 
eligibility to receive a low-cost FHA loan in Hope for 
Homeowners.
    Additionally, Congress has allocated money to counselors to 
help homeowners get the information they need to be able to 
modify their loans. Today, Treasury and HUD are meeting with 
mortgage servicers in an effort to speed the pace of 
modifications which are not happening quickly enough.
    Servicers may be swamped, but families are literally 
drowning.
    I look forward to our witnesses' insights into how the 
current policies are working and any proposed changes that will 
help us keep families in their homes. The pockets of pain may 
be due at least in part to differences in house price 
appreciation or the local economy, but the problems may also 
stem from different lending practices throughout the country.
    Earlier this month, the Joint Economic Committee held a 
hearing on predatory lending and the targeting of minorities 
for high cost loans. In that hearing, we heard testimony that 
States have had difficulty enforcing anti-predatory lending 
laws because of Federal preemption of those laws for nationally 
chartered banks. Fortunately, some state attorneys general, 
including my home state of New York, took an active role in 
pursuing abuses at nationally chartered banks. While our 
immediate efforts are aimed at turning back the current tide of 
foreclosures, it is just as important for us to realize how we 
got into this predicament and how we can prevent it from 
happening in the future.
    Last week, the Federal Reserve Board of Governors proposed 
significant changes to regulation Z of the Truth in Lending Act 
ratcheting up disclosure requirements and altering compensation 
to brokers, ending any incentive to direct borrowers into more 
expensive products. The improved amendments to disclosure 
information for consumers will help consumers gauge the true 
cost of mortgages and compare different products.
    Additionally, the Fed recognized if brokers have a 
financial incentive to steer borrowers into more expensive 
products, that improved disclosure may be ineffective. I am 
hopeful that these proposed changes will change the flawed 
misalignment of incentives between borrowers and brokers.
    We must do all we can to keep families in their homes. I 
look forward to the testimony today from our witnesses. Thank 
you for being here.
    [The prepared statement of Representative Maloney appears 
in the Submissions for the Record on page 32.]
    [The Government Accountability study titled 
``Characteristics and Performance of Nonprime Mortgages'' 
appears in the Submissions for the Record on page 33.]
    [The chart titled ``Estimated Percentage of Seriously 
Delinquent Nonprime Loans by Congressional District'' appears 
in the Submissions for the Record on page 90.]
    I now recognize Senator Brownback for up to 5 minutes.

   OPENING STATEMENT OF THE HONORABLE SAM BROWNBACK, RANKING 
          MINORITY MEMBER, A U.S. SENATOR FROM KANSAS

    Senator Brownback. Thank you very much, Chairwoman. I 
appreciate the hearing, and I appreciate the panelists being 
here. I ask that my full statement be included in the record. I 
am just going to summarize briefly.
    We have got a deep recession going on, no question about 
that. We are now seeing unemployment rates continue to inch up. 
We are seeing a lot of people not being able to service the 
mortgages that they got. It is a very difficult situation.
    I think the key thing we need to focus on is getting 
unemployment rates down. That is the item that we need to do. I 
grow concerned that we may look at doing things that can be 
harmful in the longer term, such as modification in bankruptcy 
and cram down provisions and things like that that will 
actually end up driving interest rates up on individuals 
seeking to get a mortgage or to get a loan.
    I am also concerned that some of these rewritings of 
mortgages, they are not moving very fast. We should note that, 
according to a June report of this year by the Congressional 
Budget Office, while $50 billion of TARP funds have been 
committed to the Administration's foreclosure mitigation plan, 
the Treasury has not yet disbursed any of the funds allocated 
as of June 17, 2009, for foreclosure mitigation. None of them.
    I think if we are going to have an impact here, these funds 
need to be used and put forward. I have noted that a number of 
mortgages that were modified in the first two quarters, close 
to 50 percent of the loans modified in the first two quarters 
of 2008 were in default again 9 months after the modification. 
Now, you can look at that and say 50 percent of them made it, 
and that is a good thing, at least through that 9 months. My 
guess is that the group that didn't make it, there was also 
something that happened in the employment market to one or 
another of the occupants, if it is a married spousal situation, 
that was there.
    My point in saying these things is I think we need to keep 
our eye on the ball here. And the key piece of this being we 
have got a mortgage mitigation program that is out there. Let's 
get that going. Let's work aggressively on getting unemployment 
rates down by getting the economy going again.
    I thought some of the provisions that were done that would 
stimulate the economy are ones that could help us get these 
unemployment rates down. What I am hearing from a number of my 
institutions back home, I met with some credit unions about 2 
weeks ago, they were saying that people are turning their car 
keys over to them even while they are still paying for the car 
while they are current in their car payments because somebody 
in the family has lost their job. They are looking at the 
income stream, and they are saying I know I am current on this 
car payment, but I can see what is coming down the road and I 
want to give you the car back now. I know I am going to have to 
pay the difference, but maybe you can get it sold quicker, and 
my situation is deteriorating. I just think we have to keep a 
manic focus on these unemployment rates because that is the key 
in this whole picture here, particularly on mortgages and 
mortgage foreclosures. Because if people don't have the income 
stream, they are not going to be able to afford what they have 
committed that income stream to. I hope we can focus on what we 
need to do to get that unemployment rate down.
    Thank you for holding the hearing.
    [The prepared statement of Senator Brownback appears in the 
Submissions for the Record on page 91.]
    Chair Maloney. Mr. Cummings.

 OPENING STATEMENT OF THE HONORABLE ELIJAH E. CUMMINGS, A U.S. 
                  REPRESENTATIVE FROM MARYLAND

    Representative Cummings. Thank you, Madam Chairman. I want 
to thank you for calling this hearing and thank our witnesses 
for being here.
    As I listened to Senator Brownback, I could not help but 
think about an event that we held in my district about a month 
and a half ago where we had a thousand people show up, all of 
whom were losing their homes. We were able to help at least 4- 
or 500 of them, if not more, because we were able to put the 
borrower together with the lender and they were able to sit 
down and work out things.
    The fact is that, you know, I too believe that we need to 
address this unemployment problem. But as I told my 
constituents, one out of every 10 who was losing their house, 
by the way, the question is what will happen. And I told them 
we will get through this downturn, but the question is who will 
be living in their house after it is over. Who will have their 
job. Will their company even exist.
    I think that we have to get through this storm. So the fact 
is that we have got to, I think going back to what Senator 
Brownback said, one of the things that we have got to do is we 
have got to do what the President's people are doing today, and 
that is get to these lenders and say, number one, you have got 
to hire the personnel that you need because what we found, one 
of the biggest problems is that when people call, they can't 
get anybody on the phone. While we have been bailing out the 
banks big time, they ought to be able to find somebody to 
answer the phone.
    Two, we have discovered that a lot of times when folks try 
to get these modifications, that they just could not--they were 
basically put on a stall plan. In other words, they were told 
you don't have to make any payments right now, we will try to 
work it out for you. While they are waiting to get it worked 
out, they are falling more and more in debt. And the next thing 
you know, by the time the lender comes back and says we are not 
going to modify, then they are really in bad trouble.
    I think we have to have some practical solutions to this. 
The research has shown that borrowers can be separated into 
three categories, and this is according to The Post this 
morning. It says those delinquent borrowers who will self-cure 
or catch up on their loans, even without a modification, those 
borrowers, that despite a mortgage modification, will end up in 
foreclosure anyway, and those borrowers who cannot make their 
current payments but can keep up with a lower modified payment.
    It seems as if the lenders, and understandably, according 
to The Post this morning, are more concerned, only concerned 
about those folks who with a modification can work it out. What 
I proposed in legislation is a bill which would give short-term 
loans to folks over an 18-month period. Hopefully, they will be 
able to find a job and do what Senator Brownback just talked 
about, that is, get this economy back going, but it seems to me 
if you have a bucket of people who are going into foreclosure 
every day, and you have got empty houses, you have got folks, 
vultures coming along and picking up those houses for cheap 
prices. In my neighborhood, there is one house that is going 
for one-sixth of what the other houses are valued at.
    Everybody's property values are going down. It seems to me 
we need to do something to stop that hemorrhaging. It is one 
thing to do something for Wall Street, but it is another thing 
to do something for the very people who have supplied the very 
money that we have used to bail out Wall Street. My 
constituents are saying, ``You are using my tax dollars to bail 
out Wall Street, what about me? What about me?''
    And they are saying that if the TARP funds have been paid 
back and the banks claim to be well, and they have paid back 
some $68 billion, why not help some folks who are under stress. 
I am interested to hear your solutions to this problem.
    The last thing I think we can do is turn our heads to our 
constituents, and the chairman pointed out this map because for 
every one of these people, they don't want to hear wait, wait, 
wait because they won't have a house. They won't have anywhere 
to live. It is not just about them, it is bigger than them. It 
is about their children and it is about transferring wealth and 
it is about generations yet unborn.
    Thank you, Madam Chair. I yield back.
    Chair Maloney. Thank you.
    Mr. Brady.

    OPENING STATEMENT OF THE HONORABLE KEVIN BRADY, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Representative Brady. Thank you, Madam Chairwoman. I am 
pleased to join you in welcoming the witnesses testifying 
today.
    There have been a number of policy blunders during the last 
20 years that have inflated an unsustainable housing bubble.
    On a macro level, the Federal Reserve pursued an overly 
accommodative monetary policy for far too long after the 2001 
recession. This policy, along with huge capital inflows rising 
from international imbalances, kept long-term U.S. interest 
rates far too low during much of this decade.
    On a micro level, both the Clinton administration and Bush 
administration pursued a broadly supported national home 
ownership strategy, and increased the home ownership rates 
among historically disadvantaged groups.
    After 1992, Federal officials pressed commercial banks, 
thrifts and mortgage banks to weakened loan underwriting 
standards, to reduce downpayments, develop exotic loan products 
such as interest only and negatively amortizing loans to help 
low income families qualify for mortgage loans to buy homes.
    After 2000, Fannie Mae and Freddie Mac spurred the 
explosive growth in subprime mortgage lending by purchasing 
millions and millions of dollars of privately issued subprime 
mortgage backed securities. As in previous bubbles, 
unfortunately, swindlers took advantage of the unwary as the 
housing bubble neared its zenith. On the one hand, some home 
buyers misled lenders about their income and net worth to 
secure mortgage credit to speculate in housing.
    On the other hand, some builders and lenders deceived home 
buyers about the obligations they were assuming. The housing 
bubble burst in July 2006. House prices have subsequently 
fallen by 32 percent, according to the S&P price index. Fallen 
housing prices create uncertainty about the value of mortgage 
backed securities that triggered a global financial crisis and 
the subsequent recession.
    As history proves time and time again, good intentions do 
not necessarily produce good results. Today many Americans, 
especially historically disadvantaged families that Federal 
officials intended to help, are suffering. Interest resets on 
adjustable rate mortgage loans, falling housing prices that 
make refinancing difficult or impossible, and a rapidly 
escalating unemployment rate caused many families to fall 
behind on their mortgage payments, to default, and face a 
possibility of foreclosure.
    Consequently, home mortgage loan delinquency and 
foreclosure rates are ballooning, a cascade of foreclosures may 
have serious negative externalities, dumping millions of 
foreclosed homes on the market may keep housing prices 
depressed for years, reducing household wealth, upending the 
budget of localities that depend on property taxes, and muting 
any economic recovery.
    On February 18 of this year, President Obama announced the 
making home affordable initiative to refinance or modify 
existing mortgage loans to prevent unnecessary foreclosures. So 
far, neither this initiative nor earlier programs under 
President Bush have produced significant results. For example, 
the Hope for Homeownership Program enacted in 2008 helped only 
25 homeowners through February of this year. About 4,000 loans 
were refinanced through the FHA secure program that expired 
late last year, and only 13,000 loans were modified under the 
FDIC's conservatorship of IndyMac.
    Given the enormity of the home foreclosure problem, I look 
forward to hearing from our witnesses today about what can be 
done effectively to ameliorate it.
    I yield back.
    [The prepared statement of Representative Brady appears in 
the Submissions for the Record on page 92.]
    Chair Maloney. Mr. Hinchey.
    Representative Hinchey. Thank you, Madam Chair. I am very 
anxious to hear what our friends are going to say.
    Mr. Cummings made the points I would make, and I very much 
appreciate him for doing it and the way he did it, so I am just 
going to pass on and hope we can get into the hearing.
    Chair Maloney. Now I would like to introduce our panel of 
witnesses.
    Dr. William Shear is director of financial markets and 
community investment Government Accountability Office. He has 
directed substantial bodies of work addressing the Small 
Business Administration, the Federal Housing Administration, 
regulation of the housing GSCs, the rural housing service and 
community and economic development programs. Dr. Shear received 
his PhD in economics from the University of Chicago.
    Dr. Susan M. Wachter is the Richard B. Worley professor of 
financial management and professor of real estate and finance 
at the Wharton School at the University of Pennsylvania. Dr. 
Wachter served as assistant secretary for policy development 
and research at HUD under President Clinton. She served as 
president of the American Real Estate and Urban Economic 
Association, and was co-editor of Real Estate Economics. She is 
codirector of the Penn Institute for Urban Research and 
director of the Wharton Geospatial Initiative.
    Dr. Keith Ernst is director of research at the Center For 
Responsible Lending. He has published research predicting the 
subprime foreclosure crisis in 2006, examining the relative 
cost of mortgage lending by delivery channel and on evaluating 
the effectiveness of State regulations in the subprime mortgage 
market. He holds both a law degree and a graduate degree in 
public policy studies from Duke University.
    Dr. Joseph Mason is the Herman Moyse Jr. Louisiana Bankers 
Association endowed professor at the Louisiana State University 
and senior fellow at the Wharton School, and a financial 
industry and monetary policy consultant. He also formerly 
taught at Georgetown University and Drexel University, and 
before that was a financial economist at the Office of the 
Controller of the Currency in Washington, DC.
    Chair Maloney. Welcome to all of our panelists. Would you 
begin Dr. Shear for 5 minutes.

  STATEMENT OF WILLIAM SHEAR, DIRECTOR, FINANCIAL MARKETS AND 
     COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE

    Dr. Shear. Chairman Maloney and members of the committee, 
it is a pleasure to be here today to discuss our work on the 
state of the nonprime mortgage market. My statement today is 
based on a report being released at this hearing. As we all 
know too well, non-prime loans accounted for an increasing 
share of the overall mortgage market from 2000 through 2006. 
Throughout this period, an increasing proportion of subprime 
and Alt-A mortgages had loan and borrower characteristics that 
have been associated with a higher likelihood of default and 
foreclosure.
    After the surge in volume, in the summer of 2007, the 
subprime and Alt-A market segments contracted sharply, partly 
in response to a dramatic increase in default and foreclosure 
rates for these mortgages.
    With respect to loan performance, serious delinquency rates 
were highest for subprime loans and certain adjustable rate 
mortgages. In addition, these rates varied by State as shown on 
the displayed map. Approximately 1.6 million of the 14.4 
million nonprime loans originated from 2000 through 2007 had 
completed the foreclosure process as of the end of this March.
    Of the 5.2 million loans that were still active at the end 
of March, that is, that had not been prepaid or completed the 
foreclosure process, almost one quarter were seriously 
delinquent, meaning that they were either 90 or more days 
behind in payments or already in the foreclosure process.
    Serious delinquency rates were especially high for certain 
adjustable rate mortgages. For example, in the subprime market, 
the serious delinquency rates for short term hybrid ARMs, which 
feature a fixed interest rate for two or three years and an 
adjustable rate thereafter, was 38 percent as of the end of 
March.
    In the Alt-A market, the serious delinquency rate for 
payment option ARMs, which allow borrowers to make payments 
lower than needed to cover accrued interest, was approximately 
30 percent. At the state level, California, Florida, Illinois, 
Massachusetts, Nevada, and New Jersey had the highest rates. 
Each state had serious delinquency rates above 25 percent, and 
Florida's rate of 38 percent was the highest in the country. In 
contrast, 12 States had serious delinquency rates of less than 
15 percent, including Wyoming's rate of 9 percent, which was 
the lowest in the country.
    We also looked at loans originated from 2004 through 2007, 
so a segment of this entire period we looked at. These loans 
from these more recent years--what we call cohort years--
accounted for the majority of troubled loans. This trend is 
partly attributable to a stagnation or decline in home prices 
in much of the country beginning in 2005, and worsening in 
subsequent years. Of the active subprime loans originated from 
2000 through 2007, 92 percent of those that were seriously 
delinquent as of the end of March were originated during this 
shorter period between 2004 and 2007.
    Furthermore, these loans made up 71 percent of the subprime 
mortgages that have already completed the foreclosure process. 
Our full report provides additional information on the 
performance of nonprime loans. In two subsequent reports at the 
request of this committee, we will provide additional 
information on the condition of the nonprime mortgage market. 
These reports will include examinations of the extent of 
negative home equity among nonprime borrowers and the influence 
of different loan, borrower and economic variables on the 
likelihood of default.
    It is a privilege to appear before this committee. I would 
be glad to answer any questions.
    [The prepared statement of William Shear appears in the 
Submissions for the Record on page 93.]
    Chair Maloney. Thank you very much.
    Dr. Wachter.

STATEMENT OF SUSAN WACHTER, PROFESSOR, FINANCE AND REAL ESTATE, 
         THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA

    Dr. Wachter. Chairman Maloney and members of the committee, 
thank you for the invitation to testify at today's hearing.
    Today, according to the MBA, the foreclosure rate is 4 
percent, four times the historical average and the highest it 
has ever been since the Great Depression. It is fair to say, 
despite considerable efforts to date, the Federal Government 
has failed to stem the foreclosure crisis. While much has been 
done and more can be done, there is a fundamental problem that 
is difficult to address with policy initiatives. The problem of 
foreclosed homes and mortgages in default started in a wave of 
foreclosures of subprime loans. In the coming years, there will 
be another wave of foreclosures, in part due to the recasting 
of payment option mortgages. These, and other complex, 
nontraditional mortgages, were a very small part of the market 
until they grew at an alarming rate starting in 2003. By 2006, 
they were almost half the total volume of mortgage 
originations.
    As these untested, seemingly affordable but unsustainable 
mortgages were originated, they fueled an artificial house 
price boom which inevitably collapsed.
    While the initial source of the problem was recklessly 
underwritten nontraditional mortgages, the asset bubble this 
created, the artificially and unsustainably inflated house 
prices, has been and is now a problem for many who borrowed for 
homes in the years 2004 and later. Homeowners who borrowed 
conservatively, putting 20 percent down and using tried and 
tested mortgages with steady mortgage payments, are in trouble. 
If they must sell due to job loss, for example, many of these 
owners who purchased at inflated prices will be forced into 
foreclosure.
    Americans are now increasingly threatened with loss of 
their homes and their jobs, and the problem will get worse 
before it gets better.
    The chart that is before you shows the growth in 
foreclosures and the decline in house prices, demonstrating the 
role of plummeting house prices in the worsening foreclosure 
problem. The current rate of 4 percent is expected to get 
worse, with an additional million homes in foreclosure by the 
end of year.
    As average home prices fall for more and more households, 
and with the increase in the supply of foreclosed homes on the 
market, the amount for which they could sell their homes will 
increasingly be less than what they owe on their mortgages. A 
loss of a job, illness, or a sudden increase in required 
mortgage payments will force owners to sell and will force 
foreclosure.
    Today, the threat of a job loss is worsening and there may 
well be an increase in mortgage payments due for option ARMs in 
the coming years.
    Are there additional steps we can take to mitigate the 
crisis? The crisis will abate when home prices stop falling. 
But, in fact, home prices are still falling although the rate 
of decline is decelerating. They will continue to fall until 
fundamentals turn around. The key fundamental factor is 
unemployment, thus the importance of fiscal stimulus. It is 
also critical that mortgage rates remain affordable, thus the 
importance of continuing Federal support for the FHA and the 
GSEs, and the maintaining of historically low mortgage rates.
    In addition, it is important to stem excess foreclosures 
which are adding to the forces driving home prices down in an 
adverse feedback loop.
    Losses upon foreclosures are extreme. However, if mortgage 
amounts due exceed home values, loan modifications based on 
lowering or postponing interest rate payments alone may not be 
able to stem the growing foreclosure problem.
    The administration's HAMP plan is attempting to address the 
lack of incentives and capacity of mortgage servicers to 
respond to the foreclosure problem. A recently issued GAO 
report has suggestions. And, in fact, the administration is 
convening a meeting today to encourage further efforts.
    In addition, it would be useful to implement, as suggested 
in the University of Pennsylvania IUR Task Force Retooling HUD 
report, and for which I believe there is legislation, 
monitoring of the progress of the HAMP program, especially 
spatially since there is, as the map GAO put in front on you, 
an important spatial component to the problem.
    Further loan modifications through principal write downs 
may be necessary. This involves marking mortgages, especially 
second mortgages, to market.
    The financial system that triggered the crisis encouraged 
the production and securitization of uneconomic loans which 
eventually brought the system down. As I have written 
elsewhere, private label securitization failed, as did the 
markets, basically because securitization was not subject to 
market discipline.
    Is a less pro-cyclical financial system an achievable goal? 
I have written with co-authors and wish to enter in the record 
an article which addresses the underlying failure of the 
regulatory market structure. There we address the incentives to 
dismantle lending standards and the artificial housing boom 
which made it seem that loans being made were safe when they 
were lethal.
    Going forward, regulatory supervision needs to be put into 
place to prevent this.
    Thank you.
    [The prepared statement of Susan Wachter appears in the 
Submissions for the Record on page 103.]
    [The article titled ``Systemic Risk and Market 
Institutions'' appears in the Submissions for the Record on 
page 105.]
    Chair Maloney. Thank you very much.
    Mr. Ernst.

  STATEMENT OF KEITH ERNST, DIRECTOR OF RESEARCH, CENTER FOR 
                      RESPONSIBLE LENDING

    Mr. Ernst. Good morning, Chairwoman Maloney and Ranking 
Members Brownback and Brady and members of the committee.
    Thank you for your continued efforts to address the 
foreclosure crisis, and for the invitation to participate 
today.
    I serve as director of research for the Center For 
Responsible Lending, a nonprofit, nonpartisan research and 
policy organization dedicated to protecting homeownership and 
family wealth by working to eliminate abusive financial 
practices. CRL is an affiliate of Self-Help, a nonprofit, 
community development financial institution that has provided 
over $5.6 billion of financing to 62,000 low wealth families, 
small businesses, and nonprofit organizations in North Carolina 
and across America.
    Before summarizing our research, it is worth a moment to 
reflect on the devastating consequences of the foreclosure 
crisis. An estimated 13 million mortgages will have been 
foreclosed by 2014. One out of ten mortgagors is currently 
delinquent. Tens of millions of homes near foreclosed 
properties have suffered a decrease in value resulting in 
hundreds of billions of dollars of lost wealth.
    Although many factors are important in today's crisis, 
risky subprime loans have been a central concern. Empirical 
research shows that these loans carried an inherit and 
excessive risk. This risk was driven both by the terms of the 
loans and by the conditions under which they were made. In 
other words, substantial risk was part and parcel of the 
subprime market irrespective of borrower qualifications. In 
2006, the Center published a projection that one in five 
weakened subprime loans would end in foreclosure, a projection 
that was derided at the time as pessimistic but actually has 
turned out to be an underestimate.
    A complementary 2008 study that we undertook with 
researchers from the University of North Carolina also found 
that subprime loans were risky products. This report showed 
that subprime loans were three times more likely to fail than 
lower cost, primarily fixed rate mortgages made to comparable 
borrowers. The study also found that subprime loans with 
adjustable interest rates, prepayment penalties, and those made 
through a broker were riskier. In fact, when these factors were 
layered into the same loan, the risk of default was four to 
five times higher on subprime mortgages.
    Finally, CLR published research demonstrating that lower 
credit score borrowers who obtained their loan through a 
mortgage broker paid significantly more than their counterparts 
who dealt correctly with lenders. In a related development last 
week, we were pleased to see the Federal Reserve announce a 
proposal to eliminate the yield spread premiums that we believe 
were at the heart of these disparities. Notwithstanding this 
development, and in light of our research, Congress should take 
additional steps to prevent reckless lending that could once 
again fundamentally disrupt our economy.
    Most importantly, we urge you to support the consumer 
financial protection agency embodied in H.R. 3126. The measure 
would consolidate the consumer protection that is already 
currently scattered across different agencies and create a 
single agency with the sole mission of protecting families and, 
by extension, our economy. The agencies currently charged with 
this mission were warned early and repeatedly about the dangers 
of subprime mortgages, yet, not only did they fail to act to 
protect consumers, but in many instances they frustrated State 
consumer protection efforts as well.
    It is also imperative to pass legislation that would 
require sensible and sound underwriting and prevent abusive 
loan practices that contributed to reckless and unaffordable 
home mortgages. H.R. 1728 represents a good start to this end.
    Finally, we urge Members to take further action to help 
save the homes of the millions of families facing impending 
foreclosure. As part of this effort, we must closely monitor 
and evaluate opportunities to improve the Administration's home 
affordable program. At the same time, we strongly believe that 
no voluntary program will be effective until there is a 
backstop available to homeowners. For that reason, we are 
pleased to see that Congress is beginning to revisit the need 
to permit judges to modify mortgages in bankruptcy court as a 
last resort.
    Thank you again for your invitation to appear today. I look 
forward to your questions.
    [The prepared statement of Keith Ernst appears in the 
Submissions for the Record on page 120.]
    Chair Maloney. Thank you.
    Dr. Mason.

  STATEMENT OF JOSEPH MASON, PROFESSOR OF FINANCE, LOUISIANA 
                        STATE UNIVERSITY

    Dr. Mason. Thank you, Madam Chair and committee members, 
for inviting me to testify today. I have submitted a more 
detailed paper I would like to ask to be included as part of 
the record. What follows is a summary of that work.
    Recent history of servicing is rife with examples of 
subprime servicer problems and failures resplendent with detail 
on best and worst practices. The industry has been through 
profitable highs and predatory lows, over time reacting to 
increased competition with greater efficiency.
    But intensively customer service-based enterprises, such as 
servicing, are hard to evaluate quantitatively so that proving 
a servicer's value is difficult even in the best business 
environment. Unfortunately, today's is not the best business 
environment. So proving servicer value has now become crucial 
to not only servicers' survival, but the survival of the market 
as a whole.
    There are seven key reasons why servicers are facing 
difficulty with today's borrowers. First, modification is 
expensive.
    Second, the arrearages that servicers have to pay to 
investors are a drag on profits.
    Third, modifications and defaults mean that mortgage 
servicing rights values decline for servicers.
    Fourth, increased fees are only a partial fix.
    I wrote about these in the fall of 2007. Many have been 
addressed in recent administration proposals. But, as 
congressman Cummings mentioned, when servicers have their 
business threatened, employees and the expertise they bring 
flee. Reduced servicing staff, particularly with respect to the 
most talented employees that have other options, will have a 
demonstrably adverse effect on servicing quality. And, indeed, 
has had that effect.
    So most importantly, what we need to pay attention to now 
is that servicer bankruptcy creates very perverse dynamics. 
While most securitization documents stipulate a transfer of 
servicing if the pool performance has deteriorated, or if the 
servicer has violated certain covenants which are expected to 
generally precede bankruptcy, the paucity of performance data 
makes it difficult for the trustee or the investors to detect 
servicer difficulty prior to bankruptcy, to make the change, 
and get servicing to someone who can carry it out effectively 
and efficiently, and modify loans effectively and efficiently.
    Default management is much more art than science. While 
modifications can be a useful loss mitigation technique when 
appropriate policies and procedures are in place, servicers 
that are unwilling or unable to report the volume, type and 
terms of modifications--and there have been many--to 
securitized investors or regulators may be poorly placed to 
offer meaningful modifications.
    The main drawback, therefore, with current policy is the 
industry can use modification to game the system and investors 
are wary of that. Some servicers are taking advantage of both 
borrowers and securitized investors, and I think it makes sense 
to incentivize the securitized investors to help promote more 
modifications where economically meaningful.
    There are four major reasons for investor concern. First of 
all, and this has been well known since the late 1990s, 
aggressive re- aging makes delinquencies look better than they 
really are. Re-aging is the process by which you declare a loan 
to be current once again after it has been in default. 
Investors know that redefault rates on modified loans are high, 
approaching 80 percent, so calling the modified loan current 
again immediately is disingenuous at best.
    Second, aggressive representations and warranties also skew 
reported performance. At their best, representations and 
warranties help stabilize pool performance. At their worst, 
representations and warranties inappropriately subsidize the 
securitization. In practice, it is difficult to decompose the 
difference between stabilization and subsidization, and we need 
to pay attention to that.
    Third, re-aging and representations and warranties are used 
to keep deals off their trigger points that would lock 
servicers out of the value of the subordinate pieces of the 
securitization they hold. Residual holders, nee servicers, 
continue to push for lowering delinquency levels no matter how 
artificially in order to maintain positive residual and 
interest only strip valuations that keep the servicer out of 
insolvency. Triple A class investors are, therefore, at the 
mercy of servicers who are withholding information on 
fundamental credit performance through modification.
    Fourth, current private sector industry reporting doesn't 
capture even these most basic manipulations. Servicers that 
utilize unlimited modifications or modifications without 
appropriate controls can end up necessitating greater credit 
enhancements in securitizations to maintain credit ratings, 
whether because of servicer capabilities or the possibility for 
maintaining this residual value by delaying step down in the 
securitization by skewing delinquencies.
    These problems are all well known. The State foreclosure 
prevention working group's first report in February 2008 
acknowledged that senior bond holders fear that some servicers, 
primarily those affiliated with the seller, may have incentives 
to implement unsustainable repayment plans to depress or defer 
recognition of losses in the loan pool in order to allow the 
release of over-collateralization and, therefore, value to the 
servicer themselves. This is a clear conflict of interest that 
I think can be rectified in the next iteration of policy-making 
in this regard.
    Regulators can, therefore, do a great service to both 
industry and borrowers in today's financial climate by 
insisting that servicers report adequate information to access 
not only the success of major modification initiatives, but 
also performance overall. The increased investor dependence on 
third-party servicing that has accompanied securitization 
necessitates substantial improvements to investor reporting in 
order to support appropriate administration and, where helpful, 
modification of consumer loans in both the private and the 
public interest. Without information, though, even the most 
highly subsidized modification policies are bound to fail. 
Thank you.
    [The prepared statement of Joseph Mason appears in the 
Submissions for the Record on page 126.]
    Chair Maloney. Thank you very much for your testimony.
    Chair Maloney. First, I would like to ask all of the 
panelists to respond to the article that was on the front page 
of The Washington Post today on foreclosures saying they are 
often in the lenders best interests. It says in many cases, 
there is a financial incentive to let borrowers lose their 
homes rather than work out a settlement that some economists 
are putting forward.
    Dr. Shear, would you like to respond? And Dr. Wachter, you 
referenced it in your statement earlier. Dr. Mason, how it 
impacts securitization, your point of changing the law is a 
relevant one.
    Dr. Shear.
    Dr. Shear. I would like to comment on it, not directly, but 
I want to make reference to, as many of you know, we issue 
reports on the TARP program every 2 months. The last one was 
issued last week.
    When I read this article, I see it through the lens of our 
last TARP report which dealt with the HAMP program.
    We realize the enormity, as Treasury does, and the 
challenges of running this program, and we have made a number 
of recommendations. The HAMP program has a lot of incentive 
payments to try to get servicers, borrowers, and investors to 
come together to resolve, to modify certain mortgages. And so I 
see it through our lens as an audit agency that we think that 
Treasury really has to develop a strong system of internal 
controls to ensure that the different parties are taking the 
actions that the incentives are supposed to provide to them.
    Chair Maloney. Thank you.
    Dr. Wachter.
    Dr. Wachter. I haven't read the article, but I have heard 
it references a Boston study. All economics studies rely on 
assumptions, as this one does, so they must be tested for the 
validity of their conclusions.
    Nonetheless, it is absolutely true that lenders 
individually often do have the incentive to foreclose. It is 
often the economic solution for lenders individually, when it 
is not for lenders in the aggregate. If lenders foreclose, 
adding foreclosure supply, this further drives down prices, 
leading to further foreclosures. This is why it is a collective 
problem and why we need to address it from a policy 
perspective.
    I agree with the comments of my colleagues on the panel 
regarding the need for reporting and monitoring.
    Chair Maloney. Mr. Ernst.
    Mr. Ernst. Building off that answer, it is true that 
foreclosure starts continue to outpace modifications. In a 
sense we are falling behind with each passing month. The 
modifications that have been done in the recent past have not 
always been as helpful as they could have been. I think some of 
the data that went into that article reflected modifications 
before the Administration's program went into effect, for 
example, and there are reasons to believe there are more 
opportunities than that article suggests.
    To the extent that article is raising the concern that not 
every borrower can be helped, certainly that will be true. But 
I think what that article also stands for is that much more can 
be done to help borrowers avert needless foreclosure, to 
relieve the pressure on declining housing prices and to help 
turn communities around that currently are being devastated by 
the foreclosure process.
    Dr. Mason. Thank you for the question. It is an important 
one. It is an issue that I originally brought up in my October 
2007 paper that not everyone is suited for a modification. A 
borrower has to want a modification and be able to afford a 
modification. I was led to this conclusion by working with 
members of NACA in Boston who had a very successful community-
based modification effort.
    I think that the figures that you are seeing in that 
article are suggesting that, because of the substantial number 
of redefaults, you can most likely expect to go through the 
foreclosure process anyway. So now you add to the cost of the 
modification to the cost of the foreclosure that you do anyway; 
and of course, the total cost of the two becomes greater than 
the cost of just foreclosing in the first place.
    So I think we are overextending modification perhaps, 
expecting too much out of modification programs.
    Can it help? Certainly.
    Is it the entire solution? No.
    As Dr. Wachter mentioned, we do have a collective problem 
that comes down to the inventory of real estate on the market 
right now that is suppressing home prices. When we have 
builders publicly announcing that they are going to continue to 
build now new smaller homes that compete directly with the 
price of foreclosed homes on the market, we have an even worse 
inventory problem and can expect more down the road.
    This introduces what some other members have talked about 
today, an interplay between employment and housing. If you are 
looking to keep up construction to maintain employment--by 
building more houses, that adds to the inventory that 
suppresses housing values. I think you are going in a circle 
and you need to stop that exercise at some point.
    Chair Maloney. Thank you.
    Senator Brownback.
    Senator Brownback. Thank you.
    Dr. Wachter, you were noting in here we have four times the 
historical average of foreclosures taking place, which is a 
horrific level, and I think everybody is pointing out the 
problems that led to it. I really do believe from this point on 
forward we need to make sure money is available to buy houses, 
maybe we incentivize the repurchasing of houses would be a good 
thing as well because you try to get people into the 
marketplace to get some of the depressed housing prices off, 
but that unemployment is going to be the key figure for us to 
be watching from this point on forward. I may be off on that, 
but I would like to know if you, or maybe Dr. Shear knows this, 
is there a correlation that we have seen historically between 
unemployment rates over a period of time and foreclosure rates, 
that we could have some predictability or thought as to where 
these foreclosure rates go if we get to a 10 percent 
unemployment rate into next year, as some are predicting?
    Dr. Wachter. Yes, Senator, there is literature that links 
unemployment to foreclosure. Indeed, it suggests as 
unemployment worsens, foreclosures will increase. I would be 
pleased to provide some of the formulas that specifically link 
unemployment and foreclosures.
    Senator Brownback. Is there a rule of thumb? Do we have any 
sort of rule of thumb on unemployment rates over time and 
foreclosure?
    Dr. Wachter. The reason there is not a rule of thumb is 
because there is an interactive variable which is home price 
declines. It is the combination of home price declines and 
unemployment, so it is not simply linearly related to 
unemployment.
    Senator Brownback. So as your price declines continue, and 
unemployment rates go up, the number of foreclosures go up by 
some factor?
    Dr. Wachter. That is correct.
    Senator Brownback. So we could expect this four times 
historical average to go up as unemployment goes up, but as the 
housing market flattens, you were noting that the housing 
market flattens.
    Dr. Wachter. Before the flattening, we still have home 
prices declining. We do expect that 4 percent rate to increase.
    Senator Brownback. To what?
    Dr. Wachter. This is unknowable, since we don't know how 
much prices will fall and we don't know how much unemployment 
will increase. But nonetheless, estimates out there are that 
the foreclosure rate could go as high as 5 or 6 percent. Others 
on this panel probably have other estimates.
    Senator Brownback. Let me continue that line of 
questioning. We are going into next year with a higher 
unemployment rate next year as unemployment trails economic 
recovery. So does that rate continue to go up through next 
year?
    Dr. Wachter. Yes, I believe so.
    Senator Brownback. Have you seen any estimates on that?
    Dr. Wachter. Again, the estimates vary. The consensus 
estimate is north of 5 percent.
    Senator Brownback. Dr. Shear, do you have a comment or 
thought on this?
    Dr. Shear. For the most part, I will defer to Dr. Wachter 
and the other panelists. I will just point out in the report 
that we issued last week, there were some statistics provided 
on changes in unemployment rates in different States in the 
country and impacts on housing. So there are some simple 
statistics in that report that might be useful.
    Senator Brownback. So those are higher in the States where 
you have high unemployment rates, and higher or more of a 
decline in housing prices, correct?
    Dr. Shear. Yes. There is a higher level of serious 
delinquencies and foreclosures in States with declining home 
prices and with--we did it based on increases in unemployment 
rates in those States. So we have some statistics that provide 
a map with that kind of information.
    Senator Brownback. So what are we looking at the highest 
foreclosure rates projections into next year in the worse 
situations in the country?
    Dr. Shear. We haven't projected, so I can't really address 
that.
    Mr. Ernst. If I might, unemployment is certainly a critical 
element of this foreclosure crisis that we are in. But I think 
we shouldn't lose sight of what makes this foreclosure 
different. In the boom years of subprime lending in 2005 and 
2006, subprime loans accounted for one in every five mortgages 
being originated. In many, many instances these mortgages were 
made without due regard of the ability of the borrowers to 
repay. So this crisis, unlike the crises that have developed 
some of these formulas that help us understand the important 
relationship between unemployment and housing prices, has this 
added layer of inherent risk in the outstanding loan pool. I 
think that is an important additional dimension.
    That is why it is critical that modification efforts be 
pursued to their ultimate because these borrowers are not 
governed just by the natural laws or the economic laws that 
have been driving research to date, but have this added layer 
of risk that they are challenged by.
    Senator Brownback. It seems like that was the dynamite cap, 
a big one, and it has exploded the rest of it.
    I would appreciate, Dr. Wachter, the formula, if you could, 
if you can get that in to us. Thank you.
    Chair Maloney. Thank you.
    Mr. Cummings.
    Representative Cummings. Following up what you just said, 
we are finding now that a lot of prime, and I think you may 
have said it, prime borrowers are being foreclosed upon?
    Mr. Ernst. Certainly foreclosure and delinquency rates are 
up across the board. I think it is a little difficult in some 
of the prime data to tease out which are the contributions from 
prime mortgages and which are the contributions from Alt-A 
mortgages, a segment that is also detailed in the GAO report 
that we are getting to see today. But certainly it is true, it 
is undeniable that rates are up in every mortgage segment. That 
is true.
    Representative Cummings. When we look at this map, Dr. 
Wachter, it is interesting when you look at this map, when you 
look at the middle of the country, they have the lowest 
foreclosure rates, and then you look at these other States, 
Florida and California and so on with the highest, so is it 
safe to say, and I remember many months ago now when Bernanke 
came before us, this committee, and they talked about, we were 
talking about this whole idea of foreclosure and he and others 
kept saying, Well, it is spotty. You have some foreclosures in 
some States but you don't have them in others and it is going 
to work out, basically. This was awhile back now.
    I am wondering, does this mean likely in these States, 
following up on what Senator Brownback was talking about, does 
this mean that these are likely high unemployment States and 
rapid decline in value of property States? Do you follow me?
    Dr. Wachter. Yes, that is exactly right. They are both.
    Representative Cummings. So how do we get here though? 
That's what I am trying to figure out. This is a lot of yellow, 
yellow being the least, the States that are better off. And so 
they were doing something different.
    Dr. Wachter. Yes, that is correct.
    Representative Cummings. What were they doing?
    Dr. Wachter. This is a continuation of Mr. Ernst's point. 
The mortgages that were originated in states shown in the 
deeper colors like red were these nontraditional mortgages. So 
they had a larger share of the market, therefore causing 
artificially high housing prices at which homeowners today can 
no longer sell. That problem is pervasive in these States with 
high foreclosure problems. These are where the nontraditional 
mortgages were disproportionately originated. By the way, 
unemployment rates are also higher in these areas, in part 
because of the extremity of the housing crisis.
    Representative Cummings. So the Obama administration has 
put out I will call it a tool kit to try to deal with 
foreclosure. As I said a little earlier, in my district when we 
were able to put the borrower together with the person, with 
the lender, we were able to get some results. The question 
becomes is there something, other tools that need to be in this 
kit? And what would they be because right now people are 
drowning in foreclosure. Listening to the statistics you all 
just announced, it looks like we are heading toward a worsening 
condition come next year, if not before. So what are the tools 
that you would put in that tool kit, if any? Dr. Wachter, and 
then I will get to you, Dr. Mason, if I have time.
    Dr. Wachter. Counseling is critical. The GAO report 
suggests that HUD should monitor that the counseling is 
occurring.
    Secondly, it is extremely important to monitor the progress 
and to look servicer-by-servicer at that progress.
    Third, we must look at second liens. Second liens are 
indeed a problem, and having the cooperation of the owners of 
the second mortgages is key to finding a solution to this 
problem.
    Representative Cummings. Dr. Mason.
    Dr. Mason. You have to keep in mind in some of those 
regions that you have a heavy reliance on pay option arm loans 
with unnaturally low payments. Those loans help payment 
affordability, not price affordability.
    In those regions as well, you have a lot of investor 
properties. In reviewing the operations of several large 
mortgage origination firms, myself and other experts have 
established that the labels ``prime'' and ``Alt-A'' assigned by 
the originator, mean nothing. The originator has a separate 
internally classified area that is called ``stealth prime'' or 
``shadow prime'' or ``stealth Alt-A'' which really weren't Alt-
A or prime, but could look like Alt-A or prime loans from the 
outside if the lower monthly payments offset the borrowers' 
lies about their income.
    Part of the reason originators did that was because the 
borrower would have four, five, six, I have seen 25 investor 
properties. Such an owner has no interest in residing in the 
house. They were hoping to ride the bubble; 24 of those homes 
are going to be into foreclosure, there is nothing you can do 
about that.
    But in these regions in particular in red, what you saw was 
aggressive expansion to the frontier of the urban area. In many 
of these places you have developments literally in the middle 
of nowhere, 2\1/2\ hours outside the city center with no easy 
access to roads or transport to integrate them in the rest of 
the urban area. The idea was to build on spec. Build it and 
they will come. There is nothing there now. There is farmland 
around it, and no reason to be there. Other spec building was 
done in the inner city converting neighborhoods that were 
formerly disadvantaged into viable housing. So the same effect 
is happening. Again, there is no desire to live there once the 
house goes into foreclosure.
    I think part of the way out here is the fundamental aspects 
of the Community Reinvestment Act that we talked about years 
ago of rebuilding communities, not just focusing on the 
individual home, but giving a person a reason to live there, in 
fact giving a group of people a reason to live there, which 
builds community and builds value to the home.
    Representative Cummings. Thank you very much.
    Chair Maloney. Mr. Brady.
    Representative Brady. Thank you, Madam Chairwoman. When you 
look at this map, clearly there are areas in the Northeast and 
others that are economically distressed. But you also see, 
especially California, Florida and Nevada, the result of 
speculation. I have an acquaintance who, sadly, told me he has 
got a retired mom in Nevada who took out--invested in three 
homes, took out zero down payment loans, hoping to make money 
for retirement.
    We are probably not going to be able to help people like 
that. I think it is sort of naive to say that every borrower 
can be helped. I want to focus on those who took out loans in 
good faith, had a job, have run into a tough situation, need 
help; if we can sort of provide that cushion in time, then be 
able to work out that distress. We have got a home that has got 
a higher value, the family stays in. That ought to be our 
focus.
    I sometimes wonder if lenders have the specific knowledge 
that would allow them to identify those borrowers and really 
focus on them.
    A couple of points I wanted to follow up on. I have a 
frustration that the same bank regulators who provide the 
guidance to effectively lower standards and create exotic loans 
to help people get in the homes, without recognizing their 
inability to repay--and then we are blissfully ignorant of the 
impact of all that across our economy--are today in the same 
banks, with the same regulators who have declared every 
commercial loan to be a problem loan, and blissfully ignorant 
of what impact it will have on a spiral down on the commercial 
foreclosures that the Chairwoman held a hearing on most 
recently.
    My point there is, regulators don't always get it right. In 
fact, they can exacerbate a problem going both directions. And 
it has been hard for Congress to really get a handle on that.
    I want to follow up on what Dr. Wachter said earlier. My 
question is sort of basic. How long can we expect foreclosures 
to rise? When do you think they will level off and hopefully, 
at some point, decline? Knowing there are a lot of factors, Dr. 
Wachter basically said through the end of 2010 we expect 
foreclosures to rise. Is that your general sense? Is that the 
general sense of the panel as well?
    Yes, Dr. Mason. Mr. Ernst.
    Mr. Ernst. Yes, I would agree with that.
    Representative Brady. Given a lot of circumstances, do you 
expect them to level off in 2011 and start to decline, or are 
we waiting to see at that point how the economy does and other 
factors?
    Dr. Shear. I will start with a partial answer, because we 
haven't tried to forecast what will happen to foreclosures 
going forward. But what I will say based on what we have done, 
there are certainly hundreds of thousands of people who are in 
danger of losing their homes with the serious default rates we 
see in many parts of the country.
    In particular, what I would point to is that now, with the 
payment option ARMs, many of them were originated in the years 
2004, 2005, 2006, and those are mortgages that had what we call 
negative amortization, but after 5 years they get recast. So 
many of them are being recast now. You already see a serious 
delinquency rate of about 30 percent on those mortgages. And 
that is a place where we expect it to get worse.
    Representative Brady. Do you expect the foreclosures, as 
they rise in 2010, will they level off at a high rate in 2011?
    Dr. Shear. We are not forecasting, but I am just pointing 
out that there are a number of people that are in trouble. We 
don't know--we haven't forecast house prices, but we are 
particularly concerned about payment option ARMs because so 
many of them are going to be recasting now and will become less 
affordable to those homeowners.
    Representative Brady. Yes. Other panelists.
    Mr. Ernst. Just to come back around to my initial answer. 
To put some numbers to it, we have almost 6 million mortgages 
in this country right now that are delinquent or in some stage 
of the foreclosure crisis. Last quarter, 700,000 homes entered 
foreclosure for the first time.
    So why are these numbers continually building and going in 
the direction they are? One answer is, every effort at 
modifying mortgages to date has been predicated on the 
voluntary participation of servicers and their willingness and 
ability to build up the capacity and the wherewithal to be able 
to execute those modification plans.
    So I think one of the things that Congress is starting to 
revisit is the question of whether there needs to be a fallback 
position to help borrowers when the systems designed to 
encourage voluntary modification fall short.
    Dr. Wachter suggested the principal modifications may be 
something that need to be investigated and encouraged. And one 
way to think about doing that is through permitting bankruptcy 
judges, as a last resort, to play a role.
    Representative Brady. I was wondering, trying to get a 
handle of the problem going forward, Dr. Wachter, Dr. Mason, do 
you want to talk about what 2011 would hold for us? A leveling 
off of the high rate of foreclosure, or do we start to see a 
decline?
    Dr. Mason. A leveling off in 2011. There is some 
uncertainty how far you are going into 2011 because of the pay 
option ARM problem. The original resets that were in the 
contract would have been 2010, 2011, but those resets are also 
tied to when the homeowner maxes out the loan-to-value ratio 
based upon negative amortization and reassessment at either 115 
or up to 125 LTV. So that is bringing those reset dates even 
closer in.
    All that negative amortization and reassessment does is 
increase the peak that we hit in 2010 versus a shallower 
reduction into 2011. We are not sure which is going to occur 
there. We are sure that the effects are going to easily drag 
into 2011, 2012, and beyond. And that is why I am particularly 
maddened by this continued building on adding inventory to 
homes.
    Chair Maloney. Thank you very much.
    Mr. Hinchey.
    Representative Hinchey. Thank you, Madam Chairman. This is 
a very interesting hearing. I thank you for everything you have 
said and the responses to the questions.
    We are dealing with one of the most difficult set of 
circumstances economically that this country has ever faced. 
The worst since the 1930s. We are doing some things about it, 
but we are not doing nearly enough.
    This subprime mortgage crisis is a major part of it, which 
has not been addressed adequately. It is a problem that, as we 
have discussed here, has been going on for now more than 5 
years, maybe as much as 6 years. In the initial years, it was 
completely ignored and intentionally ignored by the regulators 
who were supposed to deal with this. And the situation came 
about as a result of not just some accident, but some 
manipulation of the oversight and regulatory operations that 
are necessary to prevent these kinds of things from happening.
    We saw what happened back in the 1930s. Situations like 
this were addressed. They were addressed adequately. And they 
stopped. They stopped not just then, but for 50 years. Now we 
are dealing with a situation that has not been addressed 
adequately.
    The last Secretary of the Treasury, Secretary Paulson, even 
though he wanted to ignore the economic problems for a long 
time, he focused our attention on the banks. Seven hundred 
billion dollars. A lot of us voted against that because we knew 
that that wasn't dealing with all of the aspects of this 
problem in a very constructive way.
    So the subprime mortgage crisis is a major part of the 
issue that we are dealing with. And it is going to continue to 
be part of the problem. It may have peaked but, nevertheless, 
it is going to continue for some time to be a major part of the 
problem.
    So I wonder if you could tell us what, in your opinion, are 
the major regulatory manipulations and shortcomings that led to 
this problem that we are facing and what we should be doing--
what this Congress and what this administration should be doing 
to stop it and to deal with it more effectively.
    Dr. Shear. Okay if I start?
    Representative Hinchey. Please, Mr. Shear.
    Dr. Shear. You raise a very important question, because 
sometimes memories are short and people say, ``Well, once we 
get out of this crisis, it won't happen again.'' And there has 
been attention placed on how to try to ensure that things like 
this don't happen again.
    Chairman Maloney referred to changes in regs Z in the Truth 
in Lending Act. I will mention that there has been legislation 
that has been introduced in both the 110th and the 111th 
Congress in House Financial Services that proposed statutory 
expansions in the Truth in Lending laws. And I will mention 
that we have a report we are issuing Friday, done for that 
committee, that looks at the potential impacts of certain 
provisions that could protect borrowers.
    We have also done work on the regulatory structure 
involving the financial services industry. We have a regulatory 
structure that doesn't meet the needs of our modern financial 
markets; namely, you had a lot of subprime lenders and Alt-A 
lenders that are either independent or nonbank subsidiaries 
that haven't been subject to sufficient oversight. And we have 
addressed those issues.
    So I think it is very important to keep our eye on what 
changes should occur in the regulatory structure, what changes 
should be made to make sure that mortgage lenders that are 
outside of banks, how they are regulated, and how Truth in 
Lending provisions can protect consumers.
    Representative Hinchey. Dr. Wachter, you said specifically 
that there was a failure of regulatory market structures. Maybe 
you could amplify that.
    Dr. Wachter. Yes, there was. In work with colleagues 
Patricia McCoy and Andrey Pavlov in an article written in the 
Connecticut Law Review, we talk about regulatory arbitrage and 
the race to the bottom. In other work with Anthony Pennington-
Cross, we talk about State regulation and preemption, the move, 
again, to the regulator with least regulation.
    At the same time, there was an expansion of private label 
securitization, which in fact incentivized the provision of 
mortgages that did not reflect the risk.
    Again, in work with colleagues, we showed that, amazingly, 
the price of this risk, the cost of this risk to borrowers, was 
decreasing over time as securitizers attempted to place more of 
these mortgages in the market.
    Now the critical piece there is that these securitizations 
were not, in fact, marked to market. There was not only 
regulatory failure; there was also market failure. These 
securities did not face the discipline of the market. They were 
heterogeneous and were therefore impossible to trade.
    As a finance professor, I believe that markets do indeed 
move towards equilibrium, but only if markets are allowed to be 
in play. In this case, these securities did not trade. They 
were marked to model. Those models were, in part, put together 
by the rating agencies, which also failed.
    Representative Hinchey. Mr. Ernst.
    Mr. Ernst. I agree with that. Certainly, we have issued a 
report detailing the failures of specific regulatory agencies, 
but I think it is also important to see that there was a 
systemic built-in defect in the regulatory system.
    We had multiple agencies in charge of consumer protection 
and, as a result, we largely had no agency accountable for 
consumer protection.
    We had interagency guidance, for example, in subprime 
lending. But, it came too late and was too weak to prevent the 
crisis from unfolding. I think that is why, going forward, we 
favor consolidating consumer protection in one agency that can 
move forward with that mission and produce timely regulations 
that will help prevent the next crisis from happening. There 
are specific agencies and these specific problems, but there is 
also a systemic dimension to this crisis as well.
    Dr. Mason. If I could, I would also like to agree that the 
dispersion of responsibility for consumer protection regulation 
is a problem. And that can be solved fairly easily. But the way 
I look at this, this is a classic--what we call asymmetric 
information--crisis. There is risk in the system. There always 
is. People took risks, but we get a shock to asset values. 
Investors don't know who is exposed to the shock, so they pull 
back from the system as a whole until they can get better 
information.
    But this information shortcoming is not an efficient 
markets problem. All the information is used. The problem is 
there is not enough information.
    Now, anytime you have financial innovation, there is always 
a point at which you don't have information. That is part of 
financial innovation. That is not a problem unless you get too 
much reliance upon the new innovative products. That is what we 
had here.
    Bank regulators allowed huge reliance upon securitization 
and illiquid markets for funding what we typically take to be 
the foundation of our financial system, that is, commercial 
banks where depositors keep their money. These are institutions 
that we have typically kept very conservative and prohibited 
from getting too risky. Instead, banks were allowed to go 
funding themselves with the newest most innovative financial 
instruments in untested markets.
    So information is crucial, but information is costly so you 
never have enough information. Hence, the trick to allowing 
innovation to proceed is balancing the amount of information 
that is not out there with other existing risk exposures. This 
is a crucial point because the question then comes down to: If 
you had a systemic risk regulator, who would listen to it? 
Because the systemic risk regulator would not get information 
from anywhere to back their argument that a substantial risk 
exists because the information doesn't exist.
    So part of the job of managing risk and information is to 
look for the dog that didn't bark. There wasn't data on these 
markets. We didn't know where real estate values were going. We 
didn't know what asset-backed securities were worth.
    In fact, one key element that triggered the crisis was the 
development of what we now know as the ABX that is publicized 
by the Markit group which told us an index of the prices on 
major residential mortgage-backed securities. In fact, when 
investors saw that home values were falling, they started 
shorting the market rationally because the information told 
them where the market was going. And that is what caused the 
crisis.
    So we had too much product sold on the basis of this 
noninformation and we experienced a shock when information 
entered the market.
    Dr. Wachter. If I may add to that, the ABX indicator did 
not cause the market to fall. In fact, it was a lagging 
indicator. I am not as pessimistic as Dr. Mason. I do believe 
the information is, and was, out there. I believe it can be 
monitored and should be monitored.
    Chair Maloney. Thank you very much. That was very 
informative.
    Congressman Burgess.
    Representative Burgess. Thank you. This is indeed a 
fascinating discussion this morning.
    Dr. Mason, let me just ask you one quick question on 
follow-up to something you said. If I understood you correctly, 
you said that there is a problem now that builders are 
continuing to build, although they are building a different 
product, but that different product is now competing with the 
existing housing stock which has yet to be absorbed from the 
foreclosure bubble; is that correct?
    Dr. Mason. That is correct. I look at it as an an inventory 
problem. If we add to the inventory, we have more of an 
inventory problem.
    Representative Burgess. Well, are the builders who are 
building these new products able to get the interim financing 
to build these new products?
    Dr. Mason. You've got me on that one. I would like to know 
that myself.
    Representative Burgess. Well, Madam Chairwoman, perhaps we 
could explore that further, because that would seem to be a 
fundamental issue that needs to be addressed.
    I want to just talk a little bit about this chart. It is 
the first time I have seen it. It is a fascinating chart--and 
not because Texas looks so good, but it does. And I will tell 
you the reason it does is because we went through a frightening 
real estate contraction in the late 1980s with the implosion of 
the savings and loans.
    I don't think the enthusiasm for pricing real estate really 
caught on in Texas because of having so recently been burned in 
that last real estate bubble in the 1980s. I can't claim that 
it was necessarily Kevin's and my leadership that made Texas a 
safe place to be, but we are all grateful that Texas looks as 
good as it does.
    But it does bring up the point that there are many 
congressional districts where things look rather startling. And 
it does seem to be something that does follow congressional 
district lines.
    I am struck by the fact that Michigan, which has been in 
crisis for some time as far as its employment figures, actually 
doesn't look too bad on the foreclosure side. Perhaps because 
all of those foreclosures happened much earlier in this 
sequence, and we are just looking now at the aftermath of what 
has been a tough and lingering recession in that area.
    And, Dr. Shear, I would like for you to comment on this, 
since you are the representative from the Government 
Accountability Office. In January of this year, the Wall Street 
Journal published an article on January 5 dealing with some of 
the problems that were brought to the subprime loan industry by 
Members of Congress who were encouraging the letting of these 
subprime, no-document, ninja loans to people in their 
congressional districts to bolster homeownership, to improve 
the economy. I don't know why, but this was a rather intense 
article. It was a long article.
    Dr. Shear, the point that was made over and over again, 
that it was also tied to political contributions as well. This 
homeowners' group, HOGAR, that was set up to foster home 
ownership, if there were contributions through this agency, 
people could place fellows that were actually lobbyists within 
the organization or they get favorable press releases from a 
real estate organization.
    Did you encounter any of this in the course of your 
investigation? Did you look into this at all?
    Dr. Shear. That is something that we haven't looked into.
    With respect to your observation about Michigan, let me 
make one comment. One of the things that we tend to observe 
when we look where this problem is the most pronounced is in 
places where you had housing price bubbles that were occurring. 
Housing prices were high to begin with, and they were rising. 
You had certain bubbles going on and you had kind of intense 
marketing of certain products.
    Now the bubble has broken in those places. Michigan never 
was one that was having the uptick in prices, such as in 
California and in some parts in the Northeast.
    Representative Burgess. But, again, coming back to the 
article last January, the reason that those markets in southern 
California and Florida were perhaps having some of the problems 
was that it was being generated by, actually, Members of 
Congress.
    We are talking about new regulations and the Congress is 
going to be the one to stop reckless behavior, but it looks 
like Congress might have been one of the proximate causes in 
driving the reckless behavior.
    Dr. Shear. I really don't have any basis to really react to 
that.
    Representative Burgess. I am going to try to help you get 
some basis. Let me put these thoughts down on paper and, Madam 
Chairman, I am going to make a request to the Government 
Accountability Office that they look into this, because we have 
a crisis right now in confidence. No one believes Congress. Our 
approval ratings are abysmally low, and no one believes we can 
fix the things that we keep telling the American people we are 
going to fix. And if we never come back and address the fact 
that we may have been a part of the cause of this--we may not 
have caused all of it, but we certainly may have lit the fuse 
that caused the implosion of the bubble.
    I think it is incumbent upon us to deal with that before we 
go forward with an entirely new regulatory scheme that--who is 
going to believe we can set one up when we couldn't even police 
ourselves in 2004 and 2005?
    Dr. Shear. And what I say, and it is really a general 
statement for the committee and both sides of the aisle, is 
that we are always happy to meet with your staffs and to 
discuss what issues you think we should be looking at, just as 
we have for the committee in looking at this crisis.
    Representative Burgess. Well, Madam Chairman, I will make a 
copy of the Wall Street Journal from January 5 and I would like 
to enter a copy of this into our record today.
    [The prepared statement of Representative Burgess appears 
in the Submissions for the Record on page 127.]
    [The article titled ``Housing Push for Hispanics Spawns 
Wave of Foreclosures'' appears in the Submissions for the 
Record on page 128.]
    Chair Maloney. Thank you very much. I would like to go back 
to the loan modification programs by Treasury that everyone is 
mentioning. I would like a clarification, Dr. Shear. The loan 
modification programs by Treasury are limited to owner-occupied 
housing; isn't that correct?
    Dr. Shear. Yes, that is my understanding.
    Chair Maloney. So, in other words, we are not trying to 
bail out speculators, similar to what some of my colleagues 
have been talking about, but only those owner-occupied housing?
    Dr. Shear. Yes. I think it is focused especially on those 
that have high debt-to-income ratios and that are in danger of 
losing their homes.
    Chair Maloney. We have also heard about high re-default 
rates for modified loans. But the FHFA's report shows that loan 
modifications in 2008 tended to increase, not decrease 
payments. Only recently have modifications led to lower 
payments. Do you think this may be part of the problem?
    Dr. Shear. We are certainly aware of certain studies done--
what FHFA has observed, what the Office of the Comptroller of 
the Currency and others have looked at--that if you are going 
to have a chance for modifications to lead to a better outcome, 
that you are going to have to reduce the monthly payments that 
the borrowers are making.
    Chair Maloney. When we talk about the servicers, the same 
parties who originated these bad loans are now in the business 
of modifying them. Why do you think they will do a better job 
this time?
    Anyone?
    They created these bad loans. Now they are modifying them. 
Why are they going to do a better job?
    Dr. Mason. That is the point of what I wrote. I see no 
reason to keep doing the same thing and expect a different 
outcome.
    Chair Maloney. There seems to be a problem with 
understaffing--which some of you talked about--with the 
servicers, which is contributing to the delays. But also it has 
been reported that servicers do not have the right incentives 
to modify these loans.
    That was part of your testimony, Dr. Mason. Your paper on 
the disparities in servicer quality seemed to indicate that 
mortgage backed securities and collateralized debt that vary by 
servicer make it even more difficult for investors to judge the 
value of the asset--and, back to one of your points, that not 
really knowing the extent of the problem and the value in the 
problem.
    Why do you think that we have not been using up the $50 
billion in TARP funds? Could you share your thoughts, Dr. 
Shear, of the efforts of Treasury and loan modification? I 
believe you testified that they have not even started to use 
this $50 billion.
    Dr. Shear. Well, in our report, what we point out is that 
there was a certain period of time where there were--I think 
they call them trial periods. I think it was actually this 
week, which was the first week that those would come. So there 
are some numbers included on the highlights page of our report 
that reports how many letters went out, how many applications 
came in, how many are involved in this trial period. So it is a 
matter that I think it is the way the HAMP program was set up 
and now we will start to see----
    Chair Maloney. So it hasn't really been in the process of 
kicking in until now.
    Dr. Shear [continuing]. It hasn't kicked in. That is a very 
good way of putting it.
    Chair Maloney. I have no further questions.
    Mr. Burgess, do you have further questions?
    Representative Burgess. Yes. Thank you, Madam Chairwoman.
    First off, on just the foreclosure rate--and several of you 
gave your opinions as far as projections--are we likely to see 
a secondary reduction or a secondary increase in foreclosures 
because of the joblessness that is now accompanying the 
lengthening recession? The initial wave of foreclosures was a 
lending practice problem. Some of that is still going on.
    I think Newsweek said today the recession was over. But are 
we going to see another dip in foreclosures or another increase 
in foreclosures because of the job situation? I will take 
anyone's answer on that.
    I will ask Dr. Mason to comment.
    Dr. Mason. We are expecting a feedback loop through to 
extend the crisis. I have done some work to parameterize that 
feedback loop. It is very rough work but, in general, yes, we 
expect the unemployment situation to continue the foreclosure 
crisis.
    Representative Burgess. I don't have a dollar figure--that 
is what I was just looking for--to see if I could tell you how 
many billions of dollars Congress has committed to helping 
people with the foreclosure crisis. It is a lot. We did 
something with Fannie and Freddie last July, we did some more 
in September, we did TARP in September and October. We did a 
stimulus package and we have done HOPE for Homeowners. How big 
a help have those programs been?
    Dr. Mason. I want to make the point that there is a 
disconnect between the unemployment and the foreclosure 
problem. Most people who will be hit by job losses, by and 
large, aren't in homes that they are trying to buy. They are 
renters. And so that is why the correlation in the foreclosure 
effect is less than one, and it is significantly less than one.
    So I think if you are thinking about fiscal policy 
alternatives, it may make sense to expand unemployment 
benefits. That would, of course, help someone in their home 
continue to afford the home, perhaps on a modified loan basis, 
but also would more broadly help those who haven't had a chance 
to enter home ownership and, of course, maybe give them a 
chance to do so later on.
    Dr. Wachter. I would say that the Federal efforts to date 
have been critical in bringing us back from the precipice. We 
were at a precipice. We were facing the collapse of the 
financial system and the global economy. And we are no longer 
at that precipice. This is due to the Federal intervention.
    Representative Burgess. Which Federal intervention?
    Dr. Wachter. It was actually a series of interventions and 
the combination of these interventions that brought us back 
from the precipice. But the stimulus was critically important.
    Representative Burgess. We haven't spent the stimulus yet. 
We are going to spend it right before Election Day, I think.
    Dr. Wachter. My understanding is some of it has been spent. 
But even the expectation that it will be spent matters. 
Secondly, and very importantly, the Fannie and Freddie support, 
which kept mortgages at historically low rates of 5 percent, 
has been absolutely critical to containing the crisis.
    Representative Burgess. Dr. Wachter, in your statement, 
when you were talking about marking mortgages to market, you 
have this sentence--and I don't want to take it out of context. 
It says: There's an uncomfortably high probability that the 
Obama modifications will not succeed in quelling the 
foreclosure crisis due to the impact of so many underwater 
homeowners being so deeply under water.
    Could you expound on that statement?
    Dr. Wachter. It is absolutely the case. We are seeing an 
increase in foreclosures. And it is a concern. We have been 
through a great recession and we were facing the potential 
collapse of the economy. So we have had significant positive 
impacts of a series of programs.
    That is not to say that the foreclosure problem has been 
completely stemmed. This is an ongoing problem. It continues to 
pull down the economy and it needs to be further addressed.
    Representative Burgess. Well, I think Chairwoman Maloney 
referenced the fact that $50 billion that was available under 
TARP has yet to be dispersed for Help for Homeowners. Did I 
understand that exchange correctly? Dr. Shear.
    Dr. Shear. The Hope for Homeowners program--again, we 
looked at HAMP. It still hasn't played out yet--because of when 
the program basically started--in terms of those who completed 
the trial period and are really heading into loan 
modifications. I think this is the first week. With the 
meetings going on and outlined----
    Representative Burgess. Did you say this is the first week?
    Dr. Shear [continuing]. It is the first week where 
modifications would occur. There was a certain 3-month period 
that was worked into it. Again, I could pull out some 
information and provide it to the committee from our report as 
far as the timelines involved in the program.
    Representative Burgess. The timeline would be extremely 
helpful because people are going to say you passed TARP in 
September, October; now we are seeing help this week on the 
homeowner front. That is a significant lag between action and 
reaction.
    Dr. Shear. And we can certainly make that material--it is 
in our report from last week--but if the committee wants it, we 
could put it into the record for this hearing.
    [The report entitled, ``Troubled Asset Relief Program: 
Treasury Actions Needed to Make the Home Affordable 
Modification Program More Transparent and Accountable,'' was 
released by the Government Accountability Office on July 23, 
2009, and can be found on the GAO website at http://
www.gao.gov.]
    Representative Burgess. Dr. Wachter, so I understood.
    Your comments from earlier, the bailout bill--we weren't 
supposed to call it that--the financial rescue package that was 
enacted by Congress in October you feel was one of the things 
that was important in preventing the crisis, the foreclosure 
crisis from being worse?
    Dr. Wachter. I do think we would have had significantly 
more job losses without the stimulus.
    Representative Burgess. I was referring to the financial 
rescue package that most of us call the bailout, for 
convenience, that passed the 1st of last October.
    Dr. Wachter. Yes, absolutely. I do think the bank rescue 
has been very significant in bringing civility back to markets.
    Representative Burgess. So this has been a bipartisan 
rescue of both the Bush and Obama administrations that 
prevented the abyss from being deeper?
    Dr. Wachter. I do believe some efforts that were begun even 
prior to Obama's Presidency contributed to the move back from 
the precipice.
    Representative Burgess. Thank you, Madam Chairwoman. I will 
yield back the balance of my time.
    Chair Maloney. Thank you very much.
    I would like to thank all of our witnesses for being here 
today to talk about the trend in nonprime foreclosures and what 
can be done to prevent it in the future. We must do everything 
we possibly can to keep American families in their homes, to 
stabilize our housing prices, stabilize our economy.
    I thank all of you for your research, your time here today, 
and your commitment to helping our country solve these really 
critical challenges.
    Thank you very much for being here. I appreciate it. 
Meeting adjourned.
    [Whereupon, at 11:36 a.m., the committee was adjourned.]

                       SUBMISSIONS FOR THE RECORD

    Prepared Statement of Carolyn B. Maloney, Chair, Joint Economic 
                               Committee
    Good morning. I want to welcome our distinguished panel of 
witnesses and thank you all for your testimony today.
    Today, the Government Accountability Office released a study which 
I requested that looks at the performance of non-prime loans in every 
Congressional district in the United States. This is a valuable report, 
because it captures the national trends and also gives us data so 
granular that we can see the effects on our constituents.
    The default and foreclosure rates for these mortgages in my New 
York district are relatively low compared to the rest of the country, 
but rising foreclosures continue to inflict pain in communities 
throughout the nation.
    Borrowers, lenders, governments, and neighbors all pay the price 
for vacant houses that attract vandalism and increase crime, which 
destroy communities and burden local governments.
    The map behind me is a snapshot of the mortgage crisis inherited by 
the Obama Administration.
    The map highlights an important point--the pain of foreclosure is 
not being felt evenly across the United States. What we see are pockets 
of pain more heavily concentrated in certain areas of the country--most 
notably California, Florida, Illinois, Massachusetts, Nevada, and New 
Jersey.
    Congress and the administration have undertaken numerous efforts to 
stem the tide of foreclosures.
    Key measures include incentives to servicers to modify loans in the 
Administration's Home Affordable Modification Program and an expansion 
of eligibility to receive a low cost FHA loan in Hope for Homeowners.
    Additionally, Congress has allocated money to counselors to help 
homeowners get the information they need to be able to modify their 
loans.
    Today, Treasury and HUD officials are meeting with mortgage 
servicers in an effort to speed the pace of modifications, which are 
not happening quickly enough.
    Servicers may be swamped, but families are drowning.
    I look forward to our witnesses' insights into how the current 
policies are working and any proposed changes that will help us keep 
families in their homes.
    The pockets of pain may be due at least in part to differences in 
house price appreciation or the local economy. But the problems may 
also stem from different lending practices throughout the country.
    Earlier this month, the Joint Economic Committee held a hearing on 
predatory lending and the targeting of minorities for higher cost 
loans. In that hearing, we heard testimony that states have had 
difficulty enforcing anti-predatory lending laws because of federal 
pre-emption of those laws for nationally chartered banks.
    Fortunately, some state attorneys general, including in my home 
state of New York, took an active role in pursuing abuses at nationally 
chartered banks.
    While our immediate efforts are aimed at turning back the current 
tide of foreclosures, it is just as important for us to realize how we 
got in this predicament and prevent it from happening again.
    Last week, the Federal Reserve Board of Governors proposed 
significant changes to Regulation Z of the Truth in Lending Act 
ratcheting up disclosure requirements and altering compensation to 
brokers. The improved amendments to disclosure information for 
consumers will help consumers gauge the true cost of mortgages and 
compare different products.
    Additionally, the Fed recognized that, if brokers have a financial 
incentive to steer borrowers into more expensive products, then 
improved disclosure may be ineffective. I am hopeful that these 
proposed changes will change the flawed misalignment of incentives 
between borrowers and brokers.
    We must do all we can to keep families in their homes. I look 
forward to the testimony of our witnesses to help us do just that.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    Prepared Statement of Senator Sam Brownback, Ranking Republican
    I wish to thank Chair Maloney for arranging today's hearing and to 
thank today's expert panel on home foreclosures and foreclosure 
mitigation.
    American households are suffering in the current deep recession: 
many have experienced large losses in their retirement and housing 
wealth; millions of workers have lost their jobs and unemployment is 
expected to continue to rise; and a large and growing number of 
families have faced foreclosures on their homes. We are observing the 
painful effects of the collapse of the housing bubble.
    As is well known, home foreclosures are not only devastating for an 
individual homeowner, but also for neighborhoods and communities. 
Unfortunately, given the depth of our current post-bubble recession, 
foreclosures continue to grow at a rapid pace and at a faster pace than 
home retention and loan modification efforts. We hear reports that the 
capacities of loan servicers to modify mortgage loans are strained; 
that struggling homeowners find it difficult to negotiate the maze of 
steps necessary to execute a mortgage modification; that loan servicers 
fear possible legal repercussions from modifying a mortgage when a 
borrower has more than one mortgage; and that some unscrupulous 
borrowers and lenders may be trying to game the loan modification 
initiatives. I look forward to hearing from our panel today about 
impediments to stepping up the pace of mortgage loan modification 
efforts for struggling American families.
    There are numerous private and government-sponsored initiatives 
aimed at increasing the pace of loan modifications and keeping 
creditworthy borrowers in their homes. However, it does not appear that 
the government-sponsored initiatives have had much of an impact on the 
large and growing number of home foreclosures. And in too many 
instances, even when a mortgage has been modified, re-default rates are 
high--close to 50% of loans modified in the first two quarters of 2008 
were in default again nine months after the modifications. Some of the 
re-defaults likely arise because of the depth of the recession, which 
has pushed a large number of American workers into unemployment, making 
it difficult or impossible for them to keep up on even a modified 
mortgage. Re-defaults also arise because of continued declines in home 
prices, which push borrowers further underwater, even under modified 
loan terms.
    We are in a difficult economic situation in which continuing 
declines in home prices are pushing more borrowers underwater on their 
mortgages and in which growing unemployment prevents an increasing 
number of homeowners from keeping current on their mortgages. There 
have been some signs of late that the housing market may be bottoming 
out. If so, an arrest of the plunge in home prices may help reduce the 
growth in foreclosures. At the same time, most forecasts are for 
continued increases in the unemployment rate for some time to come, 
which will contribute to more foreclosure activity ahead.
    Some argue that the lackluster performance of loan modification 
efforts to date calls for a sledgehammer approach of modifying the 
bankruptcy code to allow judges to ``cram down'' modifications of 
loans. This would be the wrong answer. Given that mortgage loan 
servicers are struggling to handle the large volumes of modifications 
they are facing, it is difficult to imagine that bankruptcy judges 
would have an easier time. More importantly, allowing for cram down, 
even if sold as a temporary solution only for loans made over the past 
few years, would lead to higher interest rates on future mortgages and 
fewer mortgage loans. Lenders, quite simply and rationally, would have 
to build into the rates they charge an expectation of a possible future 
mortgage modification in a bankruptcy proceeding. Cram down would lead 
to higher interest rates on mortgages and effectively would penalize 
the vast majority of Americans who did not overextend themselves or 
speculate during the bubble but, rather, lived within their means.
    Loan modification efforts to stem the tide of foreclosures have 
been progressing at an increasing pace. Yet that pace is not keeping up 
with the rate of growth of new foreclosures and loan defaults and re-
defaults. Unfortunately, the Administration's latest effort to provide 
mortgage relief, called the ``Making Home Affordable'' program that was 
launched on February 18 of this year, has yet to show any significant 
results. I wish to note that, according to a June 2009 report by the 
Congressional Budget Office, while $50 billion of TARP funds have been 
committed to the Administration's foreclosure mitigation plan, the 
Treasury has not yet disbursed any of the funds allocated, as of June 
17, 2009, for foreclosure mitigation. Given the gravity of the 
foreclosure problem, this delay is unacceptably long. If this is an 
example of the efficiency of a government that is supposed to be able 
to operate a ``competitive'' health care plan to keep private health 
care providers efficient, I am highly skeptical.
    While our focus today will be on residential foreclosures and 
mortgage modifications, we need also to keep in mind the deteriorating 
market for commercial real estate, a topic that we considered in an 
earlier Joint Economic Committee hearing. Given recent warnings by 
Federal Reserve Chairman Bernanke of possible future need for Federal 
action to help stem a growing tide of commercial foreclosures, it would 
be helpful for the Fed, Treasury, and the Administration to provide a 
contingency plan and to provide information about whether TARP funds 
might be used and under what conditions. Looking forward and planning 
would be a welcome change from a recent atmosphere of hurried reaction.
    I look forward to the testimony of today's expert panelists.
                               __________
       Prepared Statement of Kevin Brady, Senior House Republican
    I am pleased to join in welcoming the witnesses testifying before 
us today on the rapidly escalating number of home foreclosures.
    A number of policy blunders during the last twenty years inflated 
an unsustainable housing bubble. On a macro level, the Federal Reserve 
pursued an overly accommodative monetary policy for far too long after 
the 2001 recession. This policy along with huge capital inflows arising 
from international imbalances kept long-term U.S. interest rates far 
too low during much of this decade.
    On a micro level, both the Clinton and Bush administrations pursued 
a National Home Ownership Strategy to increase the home ownership rate 
among historically disadvantaged groups. After 1992, federal officials 
pressed commercial banks, thrifts, and mortgage banks to weaken loan 
underwriting standards, reduce down-payments, and develop exotic loan 
products such as interest only and negatively amortizing loans to help 
low income families qualify for mortgage loans to buy homes. After 
2000, Fannie Mae and Freddie Mac spurred the explosive growth in 
subprime mortgage lending by purchasing millions and millions of 
dollars of privately issued subprime mortgage-backed securities.
    As in previous bubbles, swindlers took advantage of the unwary as 
the housing bubble neared its zenith. On the one hand, some home buyers 
misled lenders about their income and net worth to secure mortgage 
credit to speculate in housing. On the other, some builders, realtors, 
and lenders deceived home buyers about the obligations that they were 
assuming.
    The housing bubble burst in July 2006. House prices have 
subsequently fallen by 32 percent according to the S&P/Case-Shiller 
Home Price Index. Falling housing prices created uncertainty about the 
value of mortgage-backed securities that triggered a global financial 
crisis and the subsequent recession.
    As history proves again and again, good intentions do not 
necessarily produce good results. Today, many Americans, especially 
historically disadvantaged families that federal officials intended to 
help, are suffering. Interest resets on adjustable rate mortgage loans, 
falling housing prices that make refinancing difficult or impossible, 
and a rapidly escalating unemployment rate caused many families to fall 
behind on their mortgage payments, default, and face the possibility of 
foreclosure.
    Consequently, home mortgage loan delinquency and foreclosure rates 
are ballooning. A cascade of foreclosures may have serious negative 
externalities. Dumping millions of foreclosed homes on the market may 
keep housing prices depressed for years, reducing household wealth, 
upending the budgets of localities that depend on property taxes, and 
muting any economic recovery.
    On February 18, 2009, President Obama announced the Making Home 
Affordable initiative to refinance or modify existing mortgage loans to 
prevent unnecessary foreclosures. So far, neither this initiative nor 
earlier programs under President Bush have produced significant 
results. For example, the Hope for Homeowners program, enacted in 2008, 
helped only 25 homeowners through February 3, 2009. About 4,000 loans 
were refinanced through the FHA-Secure program that expired on December 
31, 2008. Only 13,000 loans were modified under the FDIC's 
conservatorship of IndyMac.
    Given the enormity of the home foreclosure problem, I look forward 
to hearing from today's witnesses about what can be done to ameliorate 
it.

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                 Prepared Statement of Susan M. Wachter
    Chairwoman Maloney, Vice Chairman Schumer, and other distinguished 
members of the Committee:
    Thank you for the invitation to testify at today's hearing on 
``Current Trends in Foreclosure and What More Can Be Done to Prevent 
Them.'' It is my honor to be here today to discuss the continuing wave 
of foreclosures for nonprime borrowers in the residential housing 
market and current policy options to reduce foreclosure rates and 
modify mortgages.
    Today according to the MBA, the foreclosure rate is 4.00%, four 
times the historical average and the highest it has ever been since the 
Great Depression.
    It is fair to say that the considerable response to date by the 
federal government has not yet worked to stem this crisis. Why is this? 
While much has been done and more can be done, there is a fundamental 
problem that is difficult to address through policy initiatives. In my 
comments today, I will discuss this, the causes behind the difficult 
situation we are in today, and what might be done going forward.
    The problem of foreclosed homes and mortgages in default started in 
a wave of foreclosures of subprime loans; in the coming years there 
will be another wave of foreclosures, in part, due to the so-called 
recasting of payment option mortgages. These and other complex 
nontraditional mortgages were a very small part of the mortgage market 
until they grew at an alarming rate starting in 2003; by 2006, they 
were almost half of the total volume of mortgage originations. As these 
untested, seemingly affordable, but unsustainable mortgages were 
originated, they fueled an artificial house price boom which inevitably 
collapsed. While the initial source of the problem was recklessly 
underwritten nontraditional mortgages, the asset bubble this created, 
the artificially and unsustainably inflated house prices, has been and 
is now a problem for many who borrowed for homes in the years 2004 and 
beyond. Homeowners who borrowed conservatively, putting 20% down using 
tried and tested mortgages with steady mortgage payments are in 
trouble; if they must sell due to job loss, for example, these owners 
who purchased at inflated prices will be forced into foreclosure.
    Americans are now increasingly threatened with loss of their homes 
and their jobs and the problem will get worse before it gets better.
    The chart that is attached, showing the growth in foreclosures and 
the decline in house prices, demonstrates the role of plummeting house 
prices in the worsening foreclosure problem. As average home prices 
fall, for more and more households, the amount for which they could 
sell their homes is less than what they owe on their mortgages. A loss 
of a job, illness, or increases in required mortgage payments will 
force owners to sell and will force foreclosure, since homes cannot be 
sold for the amount of the mortgage due. Today the threat of job loss 
is worsening as unemployment grows, and there will be a new wave of 
rises in mortgage payments required for option ARMs in the coming 
years.
    Are there additional steps we can take now to mitigate the crisis? 
The crisis will abate when home prices stop falling. A key fundamental 
factor is growing unemployment, thus the importance of fiscal stimulus 
that is currently in place. It is also critical that mortgage rates 
remain affordable, thus the importance of continuing federal support 
for FHA and the GSEs and the maintenance of today's historically low 
mortgage rates. In addition, it is important to stem excess 
foreclosures which are adding to the forces driving home prices down. 
In an adverse feedback loop, more homes on the market pull down prices, 
which results in even more homes that cannot sell for the mortgage 
amount. This feeds an expectation that prices will fall more, further 
foreclosures, and a downward spiral.
    Losses upon foreclosure are extreme. However, if mortgage amounts 
due exceed home values, loan modifications based on lowering or 
postponing interest rate payments alone may not be able to stem the 
growing problem. The Administration's Home Affordable Modification Plan 
(HAMP) is attempting to address the lack of incentives and capacity of 
mortgage servicers to respond to the foreclosure problem. The recently 
issued GAO report has a number of suggestions and in fact the 
administration is convening a meeting today to encourage further 
efforts. In addition, it would be useful, as suggested in the Penn IUR 
Task Force Report to HUD, to monitor the progress of the HAMP program 
spatially, since as documented by research (see Wachter 2009 and 
Wachter, forthcoming, and Bernstein et al.) there is an important 
spatial component to the problem. Further loan modifications with 
principal write-downs may also be necessary. This involves marking 
mortgages, especially second mortgages held by banks, to market.
    The financial system that triggered the crisis encouraged the 
production and securitization of uneconomic loans which eventually 
brought the system down. As I have written elsewhere, private-label 
securitization itself failed, since these securities were not in fact 
subject to market discipline. Is a less pro-cyclical financial system 
an achievable goal? I have written with co-authors and wish to enter 
into the record an article to appear in the Yale Journal on Regulation 
which addresses the underlying failure of the regulatory and market 
structure. There we address the incentives to dismantle lending 
standards and the artificial housing boom which made it seem that the 
loans being made were indeed safe when they were lethal. Going forward 
regulatory supervision needs to be put into place to prevent this.
                              bibliography
    Scott Bernstein, ``How Do We Know It's Affordable? Helping 
Households Succeed Financially by Counting Location Efficiency and 
Housing +Transportation Costs,'' Presentation Given to the Interagency 
Task Force on Redefining Affordability, held at U.S. Dept. of Housing 
and Urban Development (July 8, 2009).
    Bostic, Raphael, Souphala Chomsisengphet, Kathleen C. Engel, 
Patricia A. McCoy, Anthony Pennington-Cross, and Susan M. Wachter. 
``Mortgage Product Substitution and State Anti-Predatory Lending Laws: 
Better Loans and Better Borrowers?'' Working Paper (2008).
    Pavlov, Andrey D. & Susan M. Wachter. ``Systemic Risk and Market 
Institutions,'' Yale Journal on Regulation (forthcoming 2009).
    Penn Institute for Urban Research. ``Retooling HUB for a Catalytic 
Federal Government: A Report to Secretary Shaun Donovan,'' Penn MR Task 
Force Report to HUD Secretary Shaun Donovan (2009).
    Wachter, Susan M. ``Bad and Good Securitization,'' Wharton Real 
Estate Review (forthcoming).
    Wachter, Susan M. ``Understanding the Sources and Way Out of the 
Ongoing Financial Upheaval,'' International Real Estate Review (2009).
    Zandi, Mark M. ``Obama's Housing Policy,'' Moody's Economy.com 
(March 9, 2009).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


  Prepared Statement of Keith S. Ernst, Center for Responsible Lending
    Good morning Chairwoman Maloney, Vice Chair Schumer, ranking 
members Brady and Brownback, and members of the committee. Thank you 
for your continued efforts to address the foreclosure crisis and for 
the invitation to participate today.
    I serve as Director of Research for the Center for Responsible 
Lending (CRL), a nonprofit, non-partisan research and policy 
organization dedicated to protecting homeownership and family wealth by 
working to eliminate abusive financial practices. CRL is an affiliate 
of Self-Help, a nonprofit community development financial institution 
that consists of a credit union and a non-profit loan fund. For close 
to thirty years, Self-Help has focused on creating ownership 
opportunities for low-wealth families, primarily through financing home 
loans to low-income and minority families who otherwise might not have 
been able to get affordable home loans. Self-Help's lending record 
includes a secondary market program that encourages other lenders to 
make sustainable loans to borrowers with weak credit. In total, Self-
Help has provided over $5.6 billion of financing to 62,000 low-wealth 
families, small businesses and nonprofit organizations in North 
Carolina and across America.
    In September 2007, our CEO Martin Eakes testified before this 
committee about the wave of coming subprime foreclosures and about some 
ways to prevent the crisis from escalating. As it turned out, our 
predictions--dismissed by some as pessimistic--actually underestimated 
the dimensions of the crisis. In light of what has happened, it is more 
essential than ever that Congress take immediate, strong steps to 
prevent foreclosures and bar the return of abusive, unsustainable 
lending that otherwise might once again fundamentally disrupt our 
economy.
    We recommend several key actions to mitigate the continued flood of 
foreclosures and avert similar crises in the future:

        (1) Create a Consumer Financial Protection Agency as outlined 
        in H.R. 3126;
        (2) Pass legislation requiring mortgage originators to 
        determine a consumer's ability to repay the mortgage and 
        encourage the Federal Reserve Board to finalize its proposed 
        rules banning yield spread premiums;
        (3) Ensure that the Administration's current efforts to prevent 
        foreclosures--the Home Affordable Program and the Hope for 
        Homeowners Program--work as effectively as possible, including 
        ameliorating the tax consequences of loan modification and 
        principal reduction; and
        (4) Lift the ban on judicial loan modifications of mortgages on 
        principal residences.
 i. foreclosures continue to soar and the mortgage market continues to 
                                suffer.
    Our most recent report on subprime mortgages shows that over 1.5 
million homes have already been lost to foreclosure, and another two 
million families with subprime loans are currently delinquent and in 
danger of losing their homes in the near future.\1\ Projections of 
foreclosures on all types of mortgages during the next five years 
estimate 13 million defaults (over the time period 2008Q4 to 2014).\2\  
Right now, more than one in ten homeowners is facing mortgage 
trouble.\3\ Nearly one in five homes is underwater.\4\
---------------------------------------------------------------------------
    \1\ Center for Responsible Lending, Continued Decay and Shaky 
Repairs: The State of Subprime Loans Today, p.2 (Jan. 8, 2009) 
[hereinafter ``Continued Decay''], available at http://
www.responsiblelending.org/mortgage-lending/research-analysis/
continued-decay-and-shaky-repairs-the-state-of-subprime-loans-
today.html.
    \2\ Goldman Sachs Global ECS Research, Home Prices and Credit 
Losses: Projections and Policy Options (Jan. 13, 2009), p. 16; see also 
Credit Suisse Fixed Income Research, Foreclosure Update: Over 8 Million 
Foreclosures Expected, p.1 (Dec. 4, 2008).
    \3\ Mortgage Bankers Association National Delinquency Study (March 
5, 2009).
    \4\ First American Core Logic (March 4, 2009).
---------------------------------------------------------------------------
    The spillover costs of the foreclosure crisis are massive. Tens of 
millions of homes--households where, for the most part, the owners have 
paid their mortgages on time every month--are suffering a decrease in 
their property values that amounts to hundreds of billions of dollars 
in lost wealth.\5\ These losses, in turn, cost states and localities 
enormous sums of money in lost tax revenue and increased costs for 
fire, police, and other services. As property values decline further, 
the cycle of reduced demand and reduced mortgage origination continues 
to spiral downward.
---------------------------------------------------------------------------
    \5\ Continued Decay, p. 3.
---------------------------------------------------------------------------
    As a result of the foreclosure crisis, the mortgage market itself 
is in deep trouble. Overall mortgage activity has plummeted. For 2008, 
residential loan production cratered: $1.61 trillion compared to $2.65 
trillion in 2007.\6\ Originations of subprime and Alt-A, (nonprime) 
mortgages all but stopped in 2008. Only an estimated $64 billion in 
such mortgages was originated last year.\7\ At its high point in 2006, 
non-prime lending constituted a third (33.6%) of all mortgage 
production. By the fourth quarter of 2008, it had fallen to 2.8%.\8\ 
These loans are not being originated in large part due to the collapse 
of the secondary market for these mortgages, which was driving demand 
and facilitating production. So far, 2009 has seen no reversal of this 
investor retreat.
---------------------------------------------------------------------------
    \6\ National Mortgage News (March 9, 2009).
    \7\ Inside B&C Lending (February 27, 2009).
    \8\ Id.
---------------------------------------------------------------------------
    On the consumer demand side as well, every major indicator is down. 
Between 2006 and 2008, existing home sales dropped 24 percent,\9\ while 
new home sales and new construction starts plummeted by 54 and 58 
percent, respectively.\10\ In February, mortgage applications for the 
purchase of homes hit their lowest levels since April 1998.\11\
---------------------------------------------------------------------------
    \9\ National Association of Realtors, http://www.realtor.org/
research/research/ehsdata.
    \10\ US Census Bureau, http://www.census.gov/const/
quarterly_sales.pdf and http://www.census.gov/const/www/
quarterly_starts_completions.pdf.
    \11\ Based on the Mortgage Bankers Association's Weekly Mortgage 
Applications Survey for the week ending February 27, 2009. The four-
week moving average for the seasonally adjusted Purchase Index reached 
its lowest level since April 1998. See www.mortgagebankers.org/
NewsandMedia/PressCenter/67976.htm.
---------------------------------------------------------------------------
ii. risky loans, not risky borrowers, lie at the heart of the mortgage 
                               meltdown.
    In October of last year, CRL provided lengthy testimony to the 
Senate Banking Committee that describes the origins of this crisis in 
detail.\12\ In this testimony, we focus on the question of whether the 
core problem in the subprime market was risky borrowers or risky loans. 
Specifically, many in the mortgage industry blame the borrowers 
themselves, saying that lower-income borrowers were not ready for 
homeownership or not able to afford it.\13\ Yet our empirical research 
shows that the leading cause of the problem was the characteristics of 
the market and mortgage products sold, rather than the characteristics 
of the borrowers who received those products.
---------------------------------------------------------------------------
    \12\ Testimony of Eric Stein, Center for Responsible Lending, 
before the Senate Committee on Banking (Oct. 16, 2008) [hereinafter 
``Stein Testimony''], available at. http://www.responsiblelending.org/
mortgagelending/policy-legislation/congress/senate-testimony-10-16-08-
hearing-stein-final.pdf.
    \13\ Favorite industry targets to blame for the crisis are the 
Community Reinvestment Act (CRA) and Fannie Mae and Freddie Mac (the 
GSEs). For a complete discussion of why CRA and the GSEs did not cause 
the crisis, see Stein testimony, pp. 25-33.
---------------------------------------------------------------------------
    More specifically, research has shown that the risk of foreclosure 
was an inherent feature of the defective subprime loan products that 
produced this crisis. Loan originators--particularly mortgage brokers--
frequently specialized in steering customers to higher rate loans than 
those for which they qualified. They also aggressively sold loans with 
risky features and encouraged borrowers to take out so-called ``no 
doc'' loans even when those borrowers typically had easy access to 
their W-2 statements and offered them to the originators.\14\ Market 
participants readily admit that they were motivated by the increased 
fees offered by Wall Street in return for riskier loans. After filing 
for bankruptcy, the CEO of one mortgage lender explained the incentive 
structure to the New York Times: ``The market is paying me to do a no-
income-verification loan more than it is paying me to do the full 
documentation loans,'' he said. ``What would you do?'' \15\
---------------------------------------------------------------------------
    \14\ See, e.g., Glenn R. Simpson and James R. Hagerty, Countrywide 
Loss Focuses Attention on Underwriting, Wall Street Journal (Apr. 30, 
2008).
    \15\ Vikas Bajaj and Christine Haughney, Tremors at the Door: More 
People with Weak Credit Are Defaulting on Mortgages, New York Times 
(January 26, 2007).
---------------------------------------------------------------------------
    These risky, expensive loans were then aggressively marketed to 
homebuyers and refinance candidates, often irrespective of borrower 
qualifications. In fact, in late 2007, the Wall Street Journal reported 
on a study that found 61% of subprime loans originated in 2006 ``went 
to people with credit scores high enough to often qualify for 
conventional [i.e., prime] loans with far better terms.'' \16\ Even 
applicants who did not qualify for prime loans could have received 
sustainable, thirty-year, fixed-rate subprime loans for--at most--half 
to eight tenths of a percent above the initial rate on the risky ARM 
loans they were given.\17\ Perhaps even more troubling, originators 
particularly targeted minority communities for abusive and equity-
stripping subprime loans, according to complaints and affidavits from 
former loan officers alleging that this pattern was not random but was 
intentional and racially discriminatory. \18\
---------------------------------------------------------------------------
    \16\ Rick Brooks and Ruth Simon, Subprime Debacle Traps Even Very 
Credit-Worthy As Housing Boomed, Industry Pushed Loans To a Broader 
Market, Wall Street Journal at A1 (Dec. 3, 2007).
    \17\ Letter from Coalition for Fair & Affordable Lending to Ben S. 
Bernanke, Sheila C. Bair, John C. Dugan, John M. Reich, JoAnn Johnson, 
and Neil Milner (Jan. 25, 2007) at 3.
    \18\ Julie Bykowicz, ``City can proceed with Wells Fargo lawsuit'', 
Baltimore Sun (July 3, 2009) (available at http://www.baltimoresun.com/
news/maryland/baltimore-city/bal-
md.foreclosure03jul03,0,5953843.story).
---------------------------------------------------------------------------
    In 2006, the Center for Responsible Lending published, ``Losing 
Ground: Foreclosures in the Subprime Market and their Cost to 
Homeowners.'' \19\ In this report, we projected that 1 in 5 recent 
subprime loans would end in foreclosure--a projection that turns out to 
have actually underestimated the scope of the crisis, although it was 
derided at the time as pessimistic and overblown. Our research showed 
that common subprime loan terms such as adjustable rate mortgages with 
steep built-in payment increases and lengthy and expensive prepayment 
penalties presented an elevated risk of foreclosure even after 
accounting for differences in borrowers' credit scores. It also showed 
how the risk entailed in these loans had been obscured by rapid 
increases in home prices that had enabled many borrowers to refinance 
or sell as needed. The latent risk in subprime lending has been 
confirmed by other researchers from the public and private sectors.\20\
---------------------------------------------------------------------------
    \19\ Ellen Schloemer, Wei Li, Keith Ernst, and Kathleen Keest, 
``Losing Ground: Foreclosures in the Subprime Market and their Cost to 
Homeowners'' (Center for Responsible Lending, December 2006) available 
at http://www.responsiblelending.org/mortgage-lending/research-
analysis/foreclosure-paper-report-2-17.pdf.
    \20\ See e.g., Yuliya Demyanyk, ``Ten Myth About Subprime 
Mortgages'', Economic Commentary, Federal Reserve Bank of Cleveland 
(May 2009) (available at http://www.clevelandfed.org/research/
commentary/2009/0509.pdf); Karen Weaver, ``The Sub-Prime Mortgage 
Crisis: A Synopsis'' Deutsch Bank (2008) (available at http://
www.globalsecuritisation.com/08_GBP/
GBP_GSSF08_022_031_DB_US_SubPrm.pdf) (concluding that subprime 
mortgages ``could only perform in an environment of continued easy 
credit and rising home prices).
---------------------------------------------------------------------------
    A complementary 2008 study that we undertook with academic 
researchers from the University of North Carolina at Chapel Hill, 
``Risky Borrowers or Risky Mortgages: Disaggregating Effects Using 
Propensity Score Models,'' supports the conclusion that risk was 
inherent in the loans themselves.\21\ The study compared the 
performance of loans made through a loan program targeted to low- and 
moderate-income income families and comprised primarily of lower-cost 
30-year fixed-rate loans to the performance of subprime loans, most of 
which were broker-originated and had nontraditional terms, such as 
adjustable rates and prepayment penalties.
---------------------------------------------------------------------------
    \21\ Lei Ding, Roberto G. Quercia, Janneke Ratcliff, and Wei Li, 
``Risky Borrowers or Risky Mortgages: Disaggregating Effects Using 
Propensity Score Models'' Center for Community Capital, University of 
North Carolina at Chapel Hill (September 13, 2008) (available at http:/
/www.ccc.unc.edu/abstracts/091308_Risky.php).
---------------------------------------------------------------------------
    In this study, the authors found a cumulative default rate for 
recent borrowers with subprime loans to be more than three times that 
of comparable borrowers with lower-rate loans. Furthermore, the authors 
were able to identify the particular features of subprime loans that 
led to a greater default risk. Specifically, they found that adjustable 
interest rates, prepayment penalties, and broker originations were all 
associated with higher loan defaults. In fact, when risky features were 
layered into the same loan, the resulting risk of default for a 
subprime borrower was four to five times higher than for a comparable 
borrower with the lower-rate fixed-rate mortgage from a retail lender.
    CRL also conducted a more targeted study to focus on the cost 
differences between loans originated by independent mortgage brokers 
and those originated by retail lenders. In ``Steered Wrong: Brokers, 
Borrowers and Subprime Loans,'' CRL analyzed 1.7 million mortgages made 
between 2004 and 2006.\22\ After matching brokered to retail-originated 
loans along multiple dimensions, including borrower credit scores, 
product type, and levels of debt and income verification, we observed 
consistent and significant price disparities between loans obtained 
through a broker and those obtained directly from a lender.
---------------------------------------------------------------------------
    \22\ Center for Responsible Lending, Steered Wrong: Brokers, 
Borrowers and Subprime Loans (April 8, 2008), available at http://
www.responsiblelending.org/mortgage-lending/research-analysis/steered-
wrongbrokers-borrowers-and-subprime-loans.pdf.
---------------------------------------------------------------------------
    Specifically, for subprime borrowers, broker-originated loans were 
consistently far more expensive than retail-originated loans, with 
additional interest payments ranging from $17,000 to $43,000 per 
$100,000 borrowed over the scheduled life of the loan. Even in the 
first four years of a mortgage, a typical subprime borrower who has 
gone through a broker pays $5,222 more than a borrower with similar 
creditworthiness who received their loan directly from a lender.
    This finding was not surprising given what we know about broker 
compensation. Mortgage brokers typically receive two primary types of 
revenue: an origination fee and a yield spread premium (YSP). The 
origination fee is paid directly by the borrower and is generally 
calculated as a percentage of the loan amount. The YSP is an extra 
payment that brokers receive from lenders for delivering a mortgage 
with a higher interest rate than that for which the borrower qualifies. 
In the subprime market, lenders usually will pay the maximum YSP only 
if a loan contains a prepayment penalty. The penalty ensures that the 
lender will recoup their YSP payment either through excess interest 
collected over time or from the penalty fee, should a borrower 
refinance to avoid those interest costs. Ironically, while most 
subprime borrowers believed their mortgage broker was looking for the 
best-priced loan for them, the YSP serves as a powerful financial 
incentive for brokers to steer borrowers into unnecessarily expensive 
loans.
              iii. preventing risky lending in the future.
A. Create the Consumer Financial Protection Agency
    In light of our research, we believe there are important additional 
steps Congress should take to prevent reckless lending that could once 
again fundamentally disrupt our economy. Most importantly, we urge you 
to support H.R. 3126, which would establish the Consumer Financial 
Protection Agency.
    As demonstrated above, the subprime market itself delivered loans 
with significant inherent risks over and above borrowers' exogenous 
risk profiles through the very terms of the mortgages being offered. 
Although financial regulatory agencies were aware of this risk, 
regulatory action was discouraged by the concern that any regulatory 
agency taking action against these types of loans would place their 
regulated institutions at a competitive disadvantage. In addition, the 
ability of lenders to choose their regulator has resulted in a system 
where lenders may exert deep influence over their regulator's 
judgment.\23\
---------------------------------------------------------------------------
    \23\ See e.g., Silla Brush, ``Audit: OTS knew bank data was 
skewed'', The Hill (May 21, 2009) (available at http://thehill.com/
business--lobby/audit-ots-knew-bank-data-skewed-2009-05-21.html).
---------------------------------------------------------------------------
    The Consumer Financial Protection Act would gather in one place the 
consumer protection authorities currently scattered across several 
different agencies, and would create a federal agency whose single 
mission is to protect our families and our economy from consumer abuse. 
The Agency would restore meaningful consumer choice by averting the 
race to the bottom that has crowded better products out of the 
market.\24\
---------------------------------------------------------------------------
    \24\ See Center for Responsible Lending, Neglect and Inaction: An 
Analysis of Federal Banking Regulators' Failure to Enforce Consumer 
Protections (July 13, 2009) available at http://
www.responsiblelending.org/mortgage-lending/policy-legislation/
regulators/neglect-and-inaction-7-10-09-final.pdf.
---------------------------------------------------------------------------
    H.R. 3126 is appropriately balanced to enhance safety and soundness 
and allow appropriate freedom and flexibility for innovation. The bill 
also incorporates the elements that are essential to an effective 
consumer protection agency. These include the following:

      The bill provides the Agency with essential rule-making 
authority to prevent abusive, unfair, deceptive and harmful acts and 
practices and to ensure fair and equal access to products and services 
that promote financial stability and asset-building on a market-wide 
basis.
      The bill provides the Agency with strong enforcement 
tools, along with concurrent authority for the States to enforce the 
rules against violators in their jurisdictions. We urge that the bill 
also ensure that individuals harmed by violations of the Agency's rules 
have redress.
      The bill reforms the preemption of State laws to ensure 
that States are not hamstrung in their efforts to react to local 
conditions as they arise and preserves the ability of states to act to 
prevent future abuses.
      The bill gives the Consumer Financial Protection Agency 
supervisory authority to ensure that financial institutions comply with 
the rules it puts in place and to give the Agency access to the real-
world, real-time information that will best enable it to make evidence-
based decisions efficiently.

    In other areas of the economy, from automobiles and toys to food 
and pharmaceuticals, America's consumer markets have been distinguished 
by standards of fairness, safety and transparency. Financial products 
should not be the exception--particularly since we have demonstrated 
that it is the subprime mortgage products themselves that raised the 
risk of foreclosure. A strong, independent consumer protection agency 
will keep markets free of abusive financial products and conflicts of 
interest. Dedicating a single agency to this mission will restore 
consumer confidence, stabilize the markets and put us back on the road 
to economic growth.
B. Prohibit predatory lending, particularly unsustainable loans, yield 
        spread premiums and prepayment penalties.
    It is also imperative to pass legislation that would require 
sensible and sound underwriting practices and prevent abusive loan 
practices that contributed to reckless and unaffordable home mortgages. 
For this reason, we urge the passage of H.R. 1728. While there are some 
ways in which this bill should be strengthened, it represents a 
critical step forward in requiring mortgage originators to consider the 
consumer's ability to repay the loan and to refinance mortgages only 
when the homeowner receives a net tangible benefit from the 
transaction.
    Another crucial advantage of H.R. 1728 is its establishment of 
certain bright line standards that will result in safer loans and in 
more certainty for originators of those loans. The bill's safe harbor 
construct would grant preferred treatment to loans made without risky 
features such as prepayment penalties, excessive points and fees, 
inadequate underwriting, and negative amortization. It would also ban 
yield spread premiums--which, as we explained earlier, were key drivers 
of the crisis--and it would permit states to continue to set higher 
standards if necessary to protect their own residents.
    Similarly, we strongly support the Federal Reserve Board's recently 
released proposal to ban yield spread premiums for all loan 
originators. While the Board's rule is not yet written tightly enough, 
it represents an important step forward in the recognition that 
disclosure alone is not enough to protect consumers and that certain 
practices themselves give rise to unfairness and unnecessary risk.
    Many industry interests object to any rules governing lending, 
threatening that they won't make loans if the rules are too strong from 
their perspective. Yet it is the absence of substantive and effective 
regulation that has managed to lock down the flow of credit beyond 
anyone's wildest dreams. For years, mortgage bankers told Congress that 
their subprime and exotic mortgages were not dangerous and regulators 
not only turned a blind eye, but aggressively preempted state laws that 
sought to rein in some of the worst subprime lending.\25\ Then, after 
the mortgages started to go bad, lenders advised that the damage would 
be easily contained.\26\ As the global economy lies battered today with 
credit markets flagging, any new request to operate without basic rules 
of the road is more than indefensible; it's appalling.
---------------------------------------------------------------------------
    \25\ Id.
    \26\ For example, in September 2006, Robert Broeksmit of the 
Mortgage Bankers Association told Congress, ``Our simple message is 
that the mortgage market works and the data demonstrate that fact,'' 
and ``I strongly believe that the market's success in making these 
`nontraditional' products available is a positive development, not 
cause for alarm.'' Statement of Robert D. Broeksmit, CMB Chairman, 
Residential Board of Governors, Mortgage Bankers Association, Before a 
Joint Hearing of the Subcommittee on Housing and Transportation and the 
Subcommittee on Economic Policy, U.S. Senate Committee on Banking, 
Housing and Urban Affairs, Calculated Risk: Assessing Non-Traditional 
Mortgage Products, available at http://banking.senate.gov/public/
_files/broeksmit.pdf./. In May 2007, John Robbins of the Mortgage 
Bankers Association said, ``As we can clearly see, this is not a macro-
economic event. No seismic financial occurrence is about to overwhelm 
the U.S. economy. And we're not the only ones who think so.'' John M. 
Robbins, CMB, Chairman of the Mortgage Bankers Association at the 
National Press Club's Newsmakers Lunch--Washington, D.C., available at 
http://www.mortgagebankers.org/files/News/InternalResource/
54451_NewsRelease.doc.
---------------------------------------------------------------------------
  iv. avoiding additional unnecessary foreclosures stemming from the 
                            current crisis.
    Finally, we urge this Committee to take further action to help save 
the homes of the millions of families facing impending foreclosure.
A. Ensure that Current Anti-Foreclosure Efforts are as Strong as 
        Possible.
    It is very important for all of us to monitor and evaluate the 
Treasury's Home Affordable Modification Program (HAMP) and HUD's Hope 
for Homeowners (H4H) program.
    The HAMP program has the potential to modify millions of mortgages. 
However, it has gotten off to a slow start, hampered by a severe 
problem with servicer capacity, by a piece-by-piece rollout of 
complementary programs addressing second liens and short sales, and by 
lagging compliance and appeals procedures. Many servicers who are 
participating in this voluntary program are apparently not following 
all of the program's directives. Most importantly, experience shows 
that they are not consistently following the requirement that loans be 
evaluated for HAMP eligibility before foreclosure proceedings are 
commenced.
    To improve HAMP, servicers should be barred from proceeding with 
any portion of a foreclosure action prior to considering the consumer 
for a modification. In other words, they should not be permitted to 
institute an action, and if an action has already been instituted, they 
should not be permitted to move forward at all. Right now, reports 
indicate that many servicers are operating as if the only thing 
prohibited before consideration for a modification is the final 
foreclosure sale--and, even worse, many foreclosure sales are still 
going forward while the HAMP review is in process.
    In addition, the net present value model must be far more 
transparent to consumers, consumers who are turned down must be told 
the specific reason for their denial through a formal declination 
letter, and the program needs to roll out a clear process for appeal of 
a decision above and beyond the servicer's own internal procedures.
    One way to help with the various concerns just listed is to create 
a mediation program that would require servicers to sit down face-to-
face with borrowers to evaluate them for loan modification eligibility. 
Similar programs are at work in several jurisdictions across the 
country, and they can be very helpful to ensure that homeowners get a 
fair hearing and that all decisions are made in a fair and transparent 
way.\27\
---------------------------------------------------------------------------
    \27\ Andrew Jakabovics and Alon Cohen, ``It's Time we Talked: 
Mandatory Mediation in the Foreclosure Process,'' Center for American 
Progress (June 2009) (available at: http://www.americanprogress.org/
issues/2009/06/pdf/foreclosure_mediation.pdf ).
---------------------------------------------------------------------------
    It is also crucial that the loan-level data that will be available 
to the Treasury Department by early August be released to the public, 
both in report form and in the maximum possible raw disaggregated form 
so that independent researchers and other interested parties can 
analyze the data themselves. In addition, the Treasury Department 
should publish benchmarks against which program performance will be 
evaluated.
    Considering the difficulties that HAMP is encountering as it tries 
to scale up, it would be prudent to institute a deferment program along 
the lines of the Home Retention and Economic Stabilization Act 
introduced early this session by Representative Matsui and Senator 
Menendez (H.R. 527 and S. 241). This legislation permits homeowners 
making less than a certain income who are stuck in dangerous home 
loans, such as subprime or payment option ARM mortgages, to avoid 
foreclosure for up to nine months as long as they make a market-based 
mortgage payment and remain responsible during their deferment period. 
This deferment period would end if the homeowner was offered a HAMP or 
other sustainable modification.
    As for the H4H program, so far, that program has failed to even 
begin to fulfill its promise. We supported recent legislative changes 
that offer some possibility for improving this program in a way that 
would jump start its use; however, the continued resistance of 
servicers and lenders to principal reduction and the need to extinguish 
all junior liens will likely continue to hamper this program's 
potential going forward. We do not believe the potential of this 
program will be able to be realized until Congress also lifts the ban 
on judicial modifications of primary residence mortgages (see section 
IV(B) below). We also must fix the perverse tax consequences that could 
befall homeowners using either one of these programs.\28\
---------------------------------------------------------------------------
    \28\ For more information on tax consequences of principal 
reduction, see Stein Testimony, p. 10.
---------------------------------------------------------------------------
B. Lift the Ban on Judicial Modifications of Mortgages on Primary 
        Residences
    We strongly believe that no voluntary program will be effective 
until there is a mandatory backstop available to homeowners. For that 
reason, we are pleased to see that Congress is beginning to revisit the 
need to permit judges to modify mortgages on principal residences.
    This solution, which carries zero cost to the U.S. taxpayer, has 
been estimated to potentially help more than a million families stuck 
in bad loans to keep their homes.\29\ It would also help maintain 
property values for families who live near homes at risk of 
foreclosure. And it would complement the various programs that rely on 
voluntary loan modifications or servicer agreement to refinance for 
less than the full outstanding loan balance.
---------------------------------------------------------------------------
    \29\ Mark Zandi, ``Homeownership Vesting Plan'', Moody's 
Economy.com (December 2008) (available at http://www.dismal.com/mark-
zandi/documents/Homeownership_Vesting_Plan.pdf).
---------------------------------------------------------------------------
    Judicial modification of loans is available for owners of 
commercial real estate and yachts, as well as subprime lenders like New 
Century or investment banks like Lehman Bros., but is denied to 
families whose most important asset is the home they live in. In fact, 
current law makes a mortgage on a primary residence the only debt that 
bankruptcy courts are not permitted to modify in chapter 13 payment 
plans.
    Proposals to lift this ban have set strict limits on how it must be 
done. Such proposals would require that interest rates be set at 
commercially reasonable, market rates; that the loan term not exceed 40 
years; and that the principal balance not be reduced below the value of 
the property. And if the servicer agrees to a sustainable modification, 
the borrower will not qualify for bankruptcy relief because they will 
fail the eligibility means test. As Lewis Ranieri, founder of Hyperion 
Equity Funds and generally considered ``the father of the securitized 
mortgage market,'' \30\ has recently noted, such relief is the only way 
to break through the problem posed by second mortgages.\31\
---------------------------------------------------------------------------
    \30\ Lewis Ranieri to deliver Dunlop Lecture on Oct. 1, Harvard 
University Gazette, Sept. 25, 2008, available at http://
www.news.harvard.edu/gazette/2008/09.25/06-dunlop.html.
    \31\ Lewis S. Ranieri, ``Revolution in Mortgage Finance,'' the 9th 
annual John T. Dunlop Lecture at Harvard Graduate School of Design, 
Oct. 1, 2008, available at http://www.jchs.harvard.edu/events/
dunlop_lecture_ranieri_2008.mov (last visited Oct. 13, 2008). Ranieri 
is ``chairman, CEO, and president of Ranieri & Co. Inc. and chairman of 
American Financial Realty Trust, Capital Lease Funding Inc., Computer 
Associates International Inc., Franklin Bank Corp., and Root Markets 
Inc. He has served on the National Association of Home Builders 
Mortgage Roundtable since 1989. . . .'' Harvard University Gazette, 
Sept. 25, 2008.
---------------------------------------------------------------------------
                               conclusion
    As we survey the broken mortgage market, it is important to 
remember that the benefits of homeownership have not changed. Long-term 
homeownership remains one of the best and most reliable ways that 
families can build a better economic future, and all of us have a 
strong national interest in ensuring that the mortgage market works to 
build our economy, not tear it down. In an effective home lending 
market, lenders and borrowers will enter transactions with the same 
fundamental measure of success--that is, a commitment to a mortgage 
that represents a solid investment both short-term and long-term. We 
urge Congress to take the actions we have outlined to ensure that 
opportunities for sustainable homeownership remain open and meaningful.
                               __________
                 Prepared Statement of Joseph R. Mason
    Thank you Congresswoman Maloney, Senator Schumer, and Committee 
Members for inviting me to testify today.
    Recent history is rife with examples of subprime servicer problems 
and failures, resplendent with detail on best--and worst--practices. 
The industry has been through profitable highs and predatory lows, over 
time reacting to increased competition with greater efficiency and, 
where sensible, increased concentration reflective of scale economies 
in processing and knowledge.
    Servicing is nothing if not a service industry, motivating 
borrowers to pay the loans under the servicer's own management even 
when the borrower cannot afford to pay others.
    But intensively customer service-based enterprises such as 
servicing are hard to evaluate quantitatively, so that proving a 
servicer's value is difficult even in the best business environment. 
Unfortunately, today's is not the best business environment, so proving 
servicer value has now become crucial to not only servicer survival, 
but the survival of the market as a whole.
    There are seven key reasons why servicers are facing difficulties 
with today's borrowers:
    1. Modification is Expensive. Modified and defaulted loans can cost 
thousands of dollars per loan per year to service, compared to roughly 
fifty dollars for performing loans.
    2. Arrearages are a Drag on Profits. Servicers have to pay 
investors as if the loan was current until the servicer resolves the 
delinquency, whether through modification or foreclosure.
    3. Mortgage Servicing Rights Values Decline. When loans default, 
servicing fees end, so the values of the loan servicing contracts 
decline.
    4. Increased Fees are only a Partial Fix. It is difficult to 
convince investors to accept a doubling of servicing fees, and even 
that will not cover typical increased costs. Servicers are reluctant to 
impose fees directly on borrowers, however, as those fees have been 
viewed as per se predatory in the past.
    5. When Servicers are Threatened, Employees (and Expertise) Flee. 
Reduced servicing staff, particularly with respect to the most talented 
employees that have other options, will have a demonstrably adverse 
affect on servicing quality.
    6. Servicer Bankruptcy Creates Perverse Dynamics. While most 
securitization documents stipulate a transfer of servicing if pool 
performance has deteriorated or if the servicer has violated certain 
covenants, which are expected to generally precede bankruptcy, the 
problem is that the paucity of performance data makes it difficult for 
the trustee or the investors to detect servicer difficulties prior to 
bankruptcy to make the change.
    7. Default Management is More Art than Science. While modifications 
can be a useful loss mitigation technique when appropriate policies and 
procedures are in place, servicers that are unwilling or unable to 
report the volume, type, and terms of modifications to securitized 
investors or regulators may be poorly placed to offer meaningful 
modifications.
    The main drawback with current policy is therefore that the 
industry can use modification to game the system and investors are 
wary. There are four major reasons for investor concern.
    1. Aggressive Reaging makes Delinquencies Look Better than they 
Really Are. Investors know that redefault rates on modified loans are 
high, so calling the modified loan ``current'' again immediately is 
disingenuous at best.
    2. Aggressive Representations and Warranties also Skew Reported 
Performance. At their best, representations and warranties help 
stabilize pool performance. At their worst, representations and 
warranties inappropriately subsidize the deal. In practice, it is 
difficult to decompose the difference between stabilization and 
subsidization.
    3. Reaging and Representations and Warranties are used to Keep 
Deals off their Trigger Points. Residual holders, nay, servicers, 
however, continue to push for lowering delinquency levels, no matter 
how artificially, in order to maintain positive residual and interest-
only strip valuations that can keep them from insolvency. Aaa-class 
investors are therefore at the mercy of servicers who are withholding 
information on fundamental credit performance in lieu of modification.
    4. Current Industry Reporting does not Capture even the Most Basic 
Manipulations. Servicers that utilize unlimited modifications or 
modifications without appropriate controls could end up necessitating 
greater credit enhancement to maintain credit ratings, whether because 
of servicer capabilities or the possibility for delaying step-down by 
skewing delinquencies.
    The State Foreclosure Prevention Working Group's first Report in 
February 2008 acknowledged that senior bondholders fear that some 
servicers, primarily those affiliated with the seller, may have 
incentives to implement unsustainable repayment plans to depress or 
defer the recognition of losses in the loan pool in order to allow the 
release of overcollateralization to the servicer.
    Regulators can therefore do a great service to both the industry 
and borrowers in today's financial climate by insisting that servicers 
report adequate information to assess not only the success of major 
modification initiatives, but also performance overall. The increased 
investor dependence on third-party servicing that has accompanied 
securitization necessitates substantial improvements to investor 
reporting in order to support appropriate administration and, where 
helpful, modification of consumer loans in both the private and public 
interest. Without information, even the most highly subsidized 
modification policies are bound to fail.
                               __________
             Prepared Statement of Michael C. Burgess, M.D.
    Thank you Madam Chair, and I thank the witnesses for testifying 
here today.
    I am looking forward to hearing more about the current home 
foreclosure situation and the effectiveness of the government workout 
plans to date.
    Most people in my district share the opinion of CNBC's Rick 
Santelli in his epic rant on the floor of the Chicago Mercantile 
Exchange back in February. They don't want to support other adults who 
signed a contract to pay a mortgage that they ultimately could not 
afford and they don't want the government to help people who are 
delinquent on their mortgages. Yet, foreclosures raise interest rates 
for everyone and hurt home equity and appraisal values. What do we say 
to those people who are still paying their monthly mortgage but are now 
living in a home that has lost $50,000 or $100,000 in equity? These 
homeowners have very little incentive to continue to make that payment, 
especially if they experience a significant life event like the loss of 
a job or major medical situation.
    Home foreclosures seem to be rising despite the government's best 
efforts to reverse the trend through programs like ``Hope for 
Homeowners'' and changes to Federal Housing Administration loan 
provisions. Perhaps the continued foreclosure trend can be attributed 
to the fact that foreclosure is often the best method to work out or 
``cram down'' mortgages. As the front page of today's Washington Post 
put it, ``banks and other lenders in many cases have more financial 
incentive to let borrowers lose their homes than to work out 
settlements.'' According to the article, the Administration is seeking 
to influence lenders' calculus in part by offering them incentives to 
modify home loans.
    If banks need more financial incentives to help people in this 
economic environment, they are clearly not in a position to take on the 
risk of continuing to carry less than prime or high risk loans. The 
idea that we can pay off banks in order to save some delinquent 
homeowners is one that continues to anger not just Rick Santelli and 
the guys on the floor in Chicago, but people across this country who 
feel like they are the victims of their own responsible behaviors.
    Banks and lenders are being rewarded and given incentives despite 
the fact that they were engaged in risky lending behaviors in order to 
appease political activist groups who pushed them into tough lending 
situations. [WSJ Article, ``Housing Push for Hispanics Spawns Waves of 
Foreclosures''].
    With that, I yield back the balance of my time.
                               __________
         Housing Push for Hispanics Spawns Wave of Foreclosures

   (By Susan Schmidt and Maurice Tamman, the Wall Street Journal, 5 
                             January 2009)

            (Copyright (c) 2009, Dow Jones & Company, Inc.)

    California Rep. Joe Baca has long pushed legislation he said would 
``open the doors to the American Dream'' for first-time home buyers in 
his largely Hispanic district. For many of them, those doors have 
slammed shut, quickly and painfully.
    Mortgage lenders flooded Mr. Baca's San Bernardino, Calif., 
district with loans that often didn't require down payments, solid 
credit ratings or documentation of employment. Now, many of the 
Hispanics who became homeowners find themselves mired in the national 
housing mess. Nearly 9,200 families in his district have lost their 
homes to foreclosure.
    For years, immigrants to the U.S. have viewed buying a home as the 
ultimate benchmark of success. Between 2000 and 2007, as the Hispanic 
population increased, Hispanic homeownership grew even faster, 
increasing by 47%, to 6.1 million from 4.1 million, according to the 
U.S. Census Bureau. Over that same period, homeownership nationally 
grew by 8%. In 2005 alone, mortgages to Hispanics jumped by 29%, with 
expensive nonprime mortgages soaring 169%, according to the Federal 
Financial Institutions Examination Council.
    An examination of that borrowing spree by the Wall Street Journal 
reveals that it wasn't simply the mortgage market at work. It was 
fueled by a campaign by low-income housing groups, Hispanic lawmakers, 
a congressional Hispanic housing initiative, mortgage lenders and 
brokers, who all were pushing to increase homeownership among Latinos.
    The network included Mr. Baca, chairman of the Congressional 
Hispanic Caucus, whose district is 58% Hispanic and ranks No. 5 among 
all congressional districts in percentage of home loans not tailored 
for prime borrowers. The caucus launched a housing initiative called 
Hogar--Spanish for home--to work with industry and community groups to 
increase mortgage lending to Latinos. Mortgage companies provided 
funding to that group, and to the National Association of Hispanic Real 
Estate Professionals, which fielded an army to make the loans.
    In years past, minority borrowers seeking loans were often stopped 
cold by a practice called red-lining, in which lenders were reluctant 
to lend within particular geographical areas, often, it appeared, on 
the basis of race. But combined efforts to open the mortgage pipeline 
to Latinos proved successful.
    ``We saw what we refer to in the advocacy community as reverse red-
lining,'' says Aracely Panameno, director of Latino affairs for the 
Center for Responsible Lending, an advocacy group. ``Lenders were 
seeking out those borrowers and charging them through the roof,'' she 
says.
    Ms. Panameno says that during the height of the housing boom she 
sought to present the Hispanic Caucus with data showing how many 
Latinos were being steered into risky and expensive subprime loans. 
Hogar declined her requests, she says.
    When the national housing market began unraveling, so did the 
fortunes of many of the new homeowners. National foreclosure statistics 
don't break out data by ethnicity or race. But there is evidence that 
Hispanic borrowers have been hard hit. In part, that's because of large 
Hispanic populations in areas where the housing bubble was pronounced, 
such as Southern California, Nevada and Florida.
    In U.S. counties where Hispanics account for more than 25% of the 
population, banks have taken back 6.7 homes per 1,000 residents since 
Jan. 1, 2006, compared with 4.6 per 1,000 residents in all counties, 
according to a Journal analysis of U.S. Census and RealtyTrac data.
    Hispanic lawmakers and community groups have blamed subprime 
lenders, who specialize in making loans to customers with spotty credit 
histories. They complain that even solid borrowers were steered to 
those loans, which carry higher interest rates.
    In a written statement, Mr. Baca blamed the foreclosure crisis 
among Hispanics on borrowers' lack of ``financial literacy'' and on 
``lenders and brokers eager to make a bigger profit.'' He declined to 
be interviewed for this story.
    But a close look at the network of organizations pushing for 
increased mortgage lending reveals a more complicated picture. 
Subprime-industry executives were advisers to the Hogar housing 
initiative, and bankrolled more than $2 million of its research. 
Lawmakers and advocacy groups pushed hard for the easy credit that 
fueled the subprime phenomenon among Latinos. Members of the 
Congressional Hispanic Caucus, who received donations from the lending 
industry and saw their constituents moving into new homes, pushed for 
eased lending standards, which led to problems.
    Mortgage lenders appear to have regarded Latinos as a largely 
untapped demographic. Many were first or second-generation U.S. 
residents who didn't own homes. Many Hispanic families had multiple 
wage earners working multiple cash jobs, but had no savings or 
established credit history to allow them to qualify for traditional 
loans.
    The Congressional Hispanic Caucus created Hogar in 2003 to work 
with industry and community groups to increase mortgage lending to 
Latinos. At that time, the national Latino homeownership rate was 47%, 
compared with 68% for the overall population. Hogar called the figure 
``alarming,'' and said a concerted effort was required to ensure that 
``by the end of the decade Latinos will share equally in the American 
Dream of homeownership.''
    Hogar's backers included many companies that ran into trouble in 
mortgage markets: Fannie Mae and Freddie Mac, both now under federal 
control; Countrywide Financial Corp., sold last year to Bank of America 
Corp.; Washington Mutual Inc., taken over by the government and sold to 
J.P. Morgan Chase & Co.; and New Century Financial Corp. and Ameriquest 
Mortgage Corp., both now defunct.
    Hogar's ties to the subprime industry were substantial. A 
Washington Mutual vice president served as chairman of its advisory 
committee. Companies that donated $150,000 a year got the right to 
place a research fellow who would conduct Hogar's studies, which were 
used by industry lobbyists. For donations of $100,000 a year, Hogar 
offered to provide news releases from the Hispanic Caucus promoting a 
lender's commercial products for the Latino market, according to the 
group's literature.
    Hogar worked with Freddie Mac on a two-year examination of Latino 
homeownership in 63 congressional districts. The study found Hispanic 
ownership on the rise thanks to ``new flexible mortgage loan products'' 
that the industry was adopting. It recommended further easing of down-
payment and underwriting standards.
    Representatives for Hogar declined repeated requests for comment.
    The National Association of Hispanic Real Estate Professionals, one 
of Hogar's sponsors, advised the group, shared research data and built 
a large membership to market loans to Latinos. By 2005, its ranks had 
grown to 16,000 agents and mortgage brokers.
    The association, called Nahrep, received funding from some of the 
same players that funded Hogar. Some 22 corporate sponsors, including 
Countrywide and Washington Mutual, together paid the association $2 
million a year to attend conferences and forums where lenders could 
pitch their loan products to loan brokers.
    While home prices were rising, the lending risk seemed minimal, 
says Tim Sandos, Narhep's president. ``We would say, `Is he breathing? 
OK, we'll give him a mortgage,' '' he recalls.
    Nahrep's 2006 convention in Las Vegas was called ``Place Your Bets 
on Home Ownership.'' Countrywide Chairman Angelo Mozilo spoke, as did 
former Housing and Urban Development Secretary Henry Cisneros, a force 
in Latino housing developments in the West.
    Countrywide and other sponsors contracted with Nahrep to set up 
regional events where they could present loan products to loan brokers 
and their customers. Mr. Sandos says his organization doesn't get paid 
to promote particular lenders.
    At the height of the subprime lending boom, in 2005, banking and 
finance companies gave at least $2.3 million in campaign contributions 
to members of the Hispanic Caucus, according to data from the Center 
for Responsive Politics.
    In October 2008, a charitable foundation set up by Mr. Baca 
received $25,000 from AmeriDream Inc., a nonprofit housing company and 
Hogar sponsor. Mr. Baca has long backed AmeriDream's controversial 
seller-financed down-payment assistance program. AmeriDream provided 
down-payment money to buyers, a cost that was covered by home builders 
in the form of donations to the nonprofit.
    New housing legislation last fall outlawed the program. Mr. Baca is 
cosponsoring a bill that would allow AmeriDream and similar nonprofits 
to resume arranging seller-financed down-payment assistance to low-
income Federal Housing Administration borrowers.
    Such seller-financed loans comprise one-third of the loans backed 
by the FHA, and have defaulted at nearly triple the rate of other FHA-
insured loans, according to agency spokesman William Glavin.
    In a news release, AmeriDream said the donation to Mr. Baca's 
foundation was intended to fund the purchase of gear for firefighters 
in his district. Local news reports say the foundation gave away 
$36,000 in scholarships this year.
    Internal Revenue Service records indicate that Mr. Baca's son, Joe 
Baca Jr., has an annual salary of $51,800 as executive director of the 
Joe Baca Foundation, which is run out of the congressman's home. Joe 
Baca Jr. says he currently is taking only about half that listed 
salary.
    Mr. Baca's office declined to comment on the AmeriDream 
contribution.
    Mr. Baca remains opposed to strict lending rules. ``We need to keep 
credit easily accessible to our minority communities,'' he said in a 
statement released by his office.
    Mortgage lending to Hispanics took off between 2004 and 2007, 
powered by nonprime loans. The biggest jump occurred in 2005. The 169% 
increase in nonprime mortgages to Hispanics that year outpaced a 122% 
gain for blacks, and a 110% increase for whites, according to a Journal 
analysis of mortgage-industry and federal-housing data. Nonprime 
mortgages carry high interest rates and are tailored to borrowers with 
low credit scores or few assets.
    Between 2004 and 2007, black borrowers were offered nonprime loans 
at a slightly higher rate than Hispanics, but the overall number of 
Hispanic borrowers was much larger. From 2004 to 2005, total nonprime 
home loans to Hispanics more than tripled to $69 billion from $19 
billion, and peaked in 2006 at $73 billion.
    Mortgage brokers became a key portion of the lending pipeline. Phi 
Nguygn, a former broker, worked at two suburban Washington-area firms 
that employed hundreds of loan originators, most of them Latino. 
Countrywide and other subprime lenders sent account representatives to 
brokerage offices frequently, he says. Countrywide didn't respond to 
calls requesting comment.
    Representatives of subprime lenders passed on ``little tricks of 
the trade'' to get borrowers qualified, he says, such as adding a 
borrower's name to a relative's bank account, an illegal maneuver. Mr. 
Nguygn says he's now volunteering time to help borrowers facing 
foreclosure negotiate with banks.
    Many loans to Hispanic borrowers were based not on actual income 
histories but on a borrower's ``stated income.'' These so-called no-doc 
loans yielded higher commissions and involved less paperwork.
    Another problem was so-called NINA--no income, no assets--loans. 
They were originally intended for self-employed people of means. But 
Freddie Mac executives worried about abuse, according to documents 
obtained by Congress. The program ``appears to target borrowers who 
would have trouble qualifying for a mortgage if their financial 
position were adequately disclosed,'' said a staff memo to Freddie Mac 
Chairman Richard Syron. ``It appears they are disproportionately 
targeted toward Hispanics.''
    Freddie Mac says it tightened down-payment requirements in 2004 and 
stopped buying NINA loans altogether in 2007.
    ``It's very hard to get in front of a train loaded with highly 
profitable activities and stop it,'' says Ronald Rosenfeld, chairman of 
the Federal Housing Finance Board, a government agency that regulates 
home loan banks.
    Regions of the country where the housing bubble grew biggest, such 
as California, Nevada and Florida, are heavily populated by Latinos, 
many of whom worked in the construction industry during the housing 
boom. When these markets began to weaken, bad loans depressed the value 
of neighboring properties, creating a downward spiral. Neighborhoods 
are now dotted with vacant homes.
    By late 2008, one in every nine households in San Joaquin County, 
Calif., was in default or foreclosure--24,049 of them, according to 
Federal Reserve data. Banks have already taken back 55 of every 1,000 
homes. In Riverside, Calif., 66,838 houses are owned by banks or were 
headed in that direction as of October. In Prince William County, Va., 
a Washington suburb, 11,685 homes, or one in 11, was in default or 
foreclosure.
    Gerardo Cadima, a Bolivian immigrant who works as an electrician, 
bought a home in suburban Virginia for $330,000, with no money down. 
``I said this is too good to be true,'' he recalls. ``I'm 23 years old, 
with a family, buying my own house.''
    When work slowed last year, Mr. Cadima ran into trouble on his 
adjustable-rate mortgage. ``The payments were increasing, and the price 
of the house was starting to drop,'' he says. ``I started to think, is 
this really worth it?'' He stopped making payments and his home was 
sold at auction for $180,000.
    In the wake of the housing slump, some participants in the Hispanic 
lending network are expressing second thoughts about the push. Mr. 
Sandos, head of Nahrep, says that some of his group's past members, 
lured by big commissions, steered borrowers into expensive loans that 
they couldn't afford.
    Nahrep has filed complaints with state regulators against some of 
those brokers, he says. Their actions go against Nahrep's mission of 
building ``sustainable'' Latino home ownership.
    These days, James Scruggs of Northern Virginia Legal Services is 
swamped with Latino borrowers facing foreclosure. ``We see loan 
applications that are complete fabrications,'' he says. Typically, he 
says, everything was marketed to borrowers in Spanish, right up until 
the closing, which was conducted in English.
    ``We are not talking about people working for the World Bank or the 
IMF,'' he says. ``We are talking about day laborers, janitors, people 
who work in restaurants, people who do babysitting.''
    Two such borrowers work in Mr. Scrugg's office. Sandra Cardoza, a 
$28,000-a-year office manager, is now $30,000 in arrears on loans 
totaling $370,000. ``Her loan documents say she makes more than me,'' 
says Mr. Scruggs.
    Nahrep agents are networking on how to negotiate ``short sales'' to 
banks, where Hispanic homeowners sell their homes at a loss in order to 
escape onerous mortgages. The association has a new how-to guide: ``The 
American Nightmare: Strategies for Preventing, Surviving and Overcoming 
Foreclosure.''