[Senate Hearing 111-854]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-854

 
   THE FEDERAL HOUSING ADMINISTRATION--CURRENT CONDITION AND FUTURE 
                               CHALLENGES

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

                                HEARING

                               before the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                                   ON

 EXAMINING THE CURRENT CONDITION AND FUTURE CHALLENGES OF THE FEDERAL 
                         HOUSING ADMINISTRATION

                               __________

                           SEPTEMBER 23, 2010

                               __________

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


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia             JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                 Beth Cooper, Professional Staff Member

             Jonathan N. Miller, Professional Staff Member

                 William Fields, Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

                Andrew J. Olmem, Jr., Republican Counsel

            Chad Davis, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                     Levon Bagramian, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                      THURSDAY, SEPTEMBER 23, 2010

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3
    Senator Schumer..............................................    25
    Senator Johnson
        Prepared statement.......................................    28

                               WITNESSES

David H. Stevens, Federal Housing Authority Commissioner and 
  Assistant Secretary for Housing, Department of Housing and 
  Urban Development..............................................     4
    Prepared statement...........................................    28
    Responses to written questions of:
        Senator Dodd.............................................    49
        Senator Vitter...........................................    51
Mathew J. Scire, Director, Financial Markets and Community 
  Investment, Government Accountability Office...................     7
    Prepared statement...........................................    33
    Responses to written questions of:
        Senator Vitter...........................................    52

                                 (iii)


   THE FEDERAL HOUSING ADMINISTRATION--CURRENT CONDITION AND FUTURE 
                               CHALLENGES

                              ----------                              


                      THURSDAY, SEPTEMBER 23, 2010

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:23 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Christopher J. Dodd, Chairman of 
the Committee, presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. Again, we 
are a little late getting started here this morning, and I 
apologize to my colleagues. But we have two very good witnesses 
here this morning to talk about this very, very important 
program, and I am delighted they are here.
    I have a brief opening statement, and then I am going to 
turn to my colleague from Alabama, my friend Richard Shelby. 
And we have been joined by Senator Merkley, Senator Reed, and 
Senator Corker as well. There is a strong interest in this 
subject matter, and so we will try and move along here this 
morning, if we can.
    I want to welcome the Members of the Committee and our two 
witnesses to this hearing, ``The Federal Housing 
Administration--Current Condition and Future Challenges.'' The 
Federal Housing Administration, FHA, has played a very critical 
and dramatic role in maintaining access to mortgage credit for 
millions of our fellow citizens at a time when the private 
sector has effectively disappeared from the marketplace. I 
think we would all agree to that point.
    According to recently released Government data, FHA along 
with VA and rural housing programs accounted for half--54 
percent--of all home purchase mortgages in the year 2009 and 
about 30 percent of all mortgages, including refinances. 
Together, with Fannie Mae and Freddie Mac, the Federal 
Government now stands behind more than 90 percent of the entire 
market. In short, if it was not for FHA, the amount of mortgage 
credit that would be available for home purchases would be cut 
in half. This would result in sharply lower demand and drive 
home prices further down, further stripping American families 
of the hard-earned home equity they have acquired over the 
years. In other words, FHA is doing what it has done for 
decades. It is playing a stabilizing force in our housing and 
mortgage markets. It is because of the central role that FHA is 
playing now and will continue, in my view, to play in the 
future that we need to ensure that the Federal Housing 
Administration is on a solid financial footing.
    There are clearly legitimate reasons for concern which have 
been expressed by many on this Committee. In 1990, the Congress 
established a minimum capital ratio for FHA of 2 percent. That 
capital cushion was established to make sure that the program 
premiums would be there to pay for its losses, with some margin 
of error. Last year, the annual actuarial report noted that the 
capital cushion had declined to only 0.5 percent, a dangerously 
low figure. Moreover, serious delinquency rates reached all-
time highs at the end of 2009. I hasten to add, however, that 
even at their worst, FHA's delinquency rates were less than 
one-third of those for subprime mortgages. This is a tribute to 
the fact that FHA has insisted on real underwriting.
    Just to give you an idea, by the way, in the prime real 
estate market, the foreclosure rates--delinquency rates, excuse 
me, were 7 percent, the subprime were 30.6 percent, and FHA was 
9.4 percent. I think it is very important to cite those numbers 
because I think there is an impression that the FHA delinquency 
rates were hovering around the subprime rates, and they were 
much more closer to the prime rates--a little bit higher, by 
2.5 percent higher than prime rate delinquencies. Delinquencies 
at prime rate at 7 percent, FHA at 9.4 percent, and subprime at 
30.6 percent. So we are much closer to the prime, and I think 
those numbers are kind of important to keep in mind as we talk 
about what needs to be done.
    I for one do not find it surprising, obviously, that FHA 
has lost money or that it suffered higher delinquencies and 
foreclosures in the midst of the worst housing crisis that this 
Nation has experienced since the Great Depression. However, we 
do not want a program to continue operating with such a capital 
margin. That is unacceptable. So my point in making these 
statistics is not to minimize the importance of addressing the 
capital margins that have to be faced.
    So the purpose of this hearing is to examine what steps FHA 
is taking to restore its capital cushion consistent with its 
goals and mission to provide access to mortgage credit to 
traditionally underserved borrowers. I will say without 
preempting anyone's testimony, Commissioner Stevens, that you 
and Secretary Donovan, in my view, have been very active in 
addressing numerous operational and program weaknesses at FHA. 
As a result, the quality and performance of the portfolio has 
improved significantly, and the program seems to be on a far 
more solid footing.
    In addition, FHA has strengthened its oversight of lenders. 
It is demanding higher performance from originators, 
strengthened underwriting standards, and has increased 
enforcement which has forced the industry to sit up and take 
notice. I strongly commend you and Secretary Donovan for the 
steps that you have been taking.
    However, as the GAO points out, while applauding your 
progress, there is far more to be done. We all agree with that. 
I certainly do. So I look forward to hearing your testimony 
this morning and working with you in the remaining weeks of my 
tenure here, as I am sure the Members at this dais already who 
have a strong interest in this subject matter. And I see 
Michael Bennet of Colorado has joined us, and Tim Johnson is 
here as well. We will have a continuing interest in the subject 
matter when the new Congress convenes in January.
    With that, let me turn to my colleague from Alabama.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Thank you for 
putting this hearing together.
    Last August, Congress passed emergency legislation to 
provide the Federal Housing Administration additional 
flexibility in assessing annual premiums on the loans that it 
insures. The legislation also required that the FHA 
Commissioner come before this Committee ``to discuss the 
finances, including premiums,'' of the Federal Housing 
Administration. Congress provided the premium assessment 
flexibility at the request of FHA.
    Commissioner Stevens stated at the time, and I quote, 
``Without this authority, FHA will face increasing challenges 
in meeting multiple mandates to serve underserved borrowers, 
maintain the congressionally mandated capital reserve ratio, 
and provide liquidity to the market.''
    Today, I look forward to examining not only how the FHA 
fund reached the point where emergency action was required, but 
also those steps we should consider here to improve FHA's long-
term viability.
    In addition to fulfilling the statutory requirements for 
FHA to appear before this Committee, this hearing provides a 
valuable opportunity for us here to hear from the GAO, the 
Government Accountability Office. Earlier this year, Chairman 
Dodd and I asked the GAO to examine the FHA fund, and today we 
will hear the results of that examination.
    We know that the capital reserves of the fund have fallen 
to critical levels in recent years. We also know that many new 
loans have not matured enough for their impact on the fund to 
be fully known yet. But given the hundreds of billions of 
dollars in taxpayer-funded bailouts to the auto companies, to 
Fannie Mae, and to Freddie Mac, I believe we must do everything 
here in our power to prevent the American people from having to 
pay for yet another Government bailout. This will not be an 
easy undertaking, and certainly it will not be popular with 
many special interest groups. Nevertheless, I believe it must 
be done so that the most important special interest group--the 
American taxpayers--are protected.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Do any of my colleagues here want to make a quick opening 
comment? If not, I will introduce our witnesses. I thank my 
colleagues. Bob, the Corker rule prevails.
    [Laughter.]
    Chairman Dodd. The Corker rule lives.
    Let me first of all introduce David Stevens. I want to 
welcome him back. Commissioner David Stevens is the Assistant 
Secretary for Housing at the United States Department of 
Housing and Urban Development, as well as the Commissioner of 
the Federal Housing Administration. He has significant real 
estate experience based on many years of experience.
    In fact, I remember just going through your nomination 
process and how thrilled I am, and I think the Committee, that 
you stuck with it. We went through a couple of rough weeks 
there, but I cannot tell you how fortunate we are to have you 
and have someone with your practical experience in this field, 
something that is not prevalent throughout the Administration, 
I might point out, but to have people like you who actually 
know what it is every day to get out and deal with these issues 
is very, very valuable.
    Bob Corker knows about it. Obviously, he was involved in 
the business and knows practically what it is like, and to have 
someone in a policy position who knows what it is like has been 
tremendously helpful. So I am glad you are with us, and I am 
anxious to hear your thoughts this morning. You have direct 
responsibility for oversight and Administration of the FHA 
insurance portfolio, which includes single-family and 
multifamily housing, insured health care facilities, and other 
programs. Again, we are pleased to have you with us.
    Mathew Scire is a Director of GAO's Financial Markets and 
Community Investment team, with almost 30 years of audit 
experience, and currently is responsible for leading GAO's 
audit work involving housing programs. His team is focusing on 
a wide range of issues, including FHA's mortgage insurance 
program, Treasury's loan modification efforts, and the use of 
Recovery Act funds by public housing agencies and others. And, 
again, I always say that we are so fortunate to have GAO. It 
does actually just a fabulous job. You are highly regarded and 
thought of, and so we thank you for coming before us today as 
well.
    Mr. Stevens, we will start with you and then turn to Mr. 
Scire, and then we will open up the floor for some questions. 
Take about 5 minutes or so, if you would, 5 or 6 minutes. By 
the way, we will take any and all supporting data, evidence, 
testimony--not only from you but from my colleagues--and it 
will be included in the record.

   STATEMENT OF DAVID H. STEVENS, FEDERAL HOUSING AUTHORITY 
COMMISSIONER AND ASSISTANT SECRETARY FOR HOUSING, DEPARTMENT OF 
                 HOUSING AND URBAN DEVELOPMENT

    Mr. Stevens. Thank you, Senator. Chairman Dodd, Ranking 
Member Shelby, Members of the Committee, thank you for the 
opportunity to testify today on the financial condition of the 
Federal Housing Administration. I have submitted a longer 
document to the record.
    With Congress's help over the last year, FHA has made 
significant reforms that have put the agency on a stronger 
financial footing. I would like to discuss those reforms today 
and explain why our ability to protect the taxpayer for the 
future depends on Congress enacting the broader, more 
comprehensive set of reforms we have proposed.
    As you know, last year we informed Congress of the 
independent actuary's findings that the FHA's secondary 
reserves had fallen below 0.53 percent of the total insurance-
in-force, below the required 2-percent level. I told you then 
that Secretary Donovan and I would do everything in our power 
to ensure that the taxpayer was protected. And today, while we 
are by no means out of the woods, we have made significant 
headway toward stabilizing the portfolio.
    In fact, according to our third quarter report submitted to 
Congress, instead of losing $2.6 billion in funds, as the 
actuary predicted, FHA has generated an additional $1.3 billion 
in capital resources through the third fiscal quarter and 
continues to earn more funds for the taxpayer. Furthermore, 
actual foreclosures of FHA-insured homes have been 20 percent 
less than projected, which is why we have paid $3.7 billion 
less in claims than projected. This was only possible because 
the Administration had already begun implementing the most 
sweeping set of reforms to FHA's credit policy, risk 
management, lender enforcement, and consumer protections in the 
agency's history.
    Mr. Chairman, last year we said we would hire the first 
chief risk officer in the organization's history, and with 
congressional approval, we have formally established a 
permanent Risk Management Office within FHA, headed by a Deputy 
Assistant Secretary, allowing us to assess and analyze risk 
more accurately and more proactively. We also said we would 
strengthen our lender enforcement policies, and we have, 
eliminating FHA approval for loan correspondents and increasing 
minimum net worth requirements for lenders who participate in 
the program.
    We suspended some well-known FHA-approved lenders and 
withdrawn FHA approval for over 1,500 others, and I have 
imposed over $4.25 million in civil money penalties and 
administrative payments to noncompliant institutions.
    We are sending a very clear message. If you do not operate 
ethically and transparently, we will not do business with you.
    We said we would restructure our mortgage premiums, and we 
have. In April, we raised them from 175 basis points up front 
to 225 basis points across all FHA product types. In early 
October, thanks to legislation passed here, we will reduce the 
minimum premium up front to 100 basis points, offset by an 
increase in the annual premium to 85 or 90 basis points, 
depending on the loan-to-value ratio. On behalf of the 
Secretary and myself, I want to thank the House--the Senate, 
excuse me, and particularly you, Chairman Dodd, and Ranking 
Member Shelby, for your leadership in passing this important 
legislation.
    In addition, we said we would improve the quality of the 
loans we make, and we have. We have strengthened credit and 
risk controls. We have implemented a two-step FICO floor for 
FHA borrowers. Purchase borrowers with credit scores below 580 
are now required to have a minimum 10-percent down payment to 
get an FHA loan. And only those with stronger credit can 
continue to get the FHA program with that minimum 3.5-percent 
down payment.
    We also promised to reduce seller concessions which often 
create incentives to inflate appraised value and are 
significantly more likely to go into default. That is why we 
have proposed to reduce the maximum allowable seller concession 
from 6 percent to 3 percent.
    Last, we said we would modernize the technology within the 
FHA, and with your help, we have made great strides toward 
improving technical capacity to handle the increased volume, 
delivering our first comprehensive technology transformation 
plan to Congress, and modernizing FHA's technology 
infrastructure. We have also awarded three contracts to upgrade 
our risk and fraud tools and are building staff capacity 
through hiring and training. The early results of these efforts 
are encouraging. I mentioned that our capital reserves are 
growing faster than projected and that claims payments are less 
than forecasted.
    Loan quality is improving as well. Our third quarter report 
shows that loan performance, as measured by serious 
delinquencies and early period delinquencies, has improved 
significantly, with the first year-over-year decline in 90-day 
delinquencies in years. The average credit score in our current 
insurance endorsements has risen from 634 in 2007 to near 700 
today.
    Going forward, the President's budget projects that these 
actions will produce an additional $4.1 billion in FHA receipts 
in fiscal year 2011, funds that FHA earns for the taxpayer.
    Of course, despite the progress we have made, Mr. Chairman, 
the job is far from over. Secretary Donovan and I remain 
committed to comprehensive FHA reform legislation. In August, 
Senators Mark Begich and Sherrod Brown introduced Senate bill 
3704. This bill is similar to the House-passed H.R. 5072, which 
would give FHA the tools necessary to manage risk, protect the 
fund, and protect the taxpayer.
    In addition to strengthening FHA's lender enforcement 
ability, the bill will allow for third-party loan originators 
to close FHA-insured loans in their name and extend FHA's 
ability to hold all lenders to the same standard by permitting 
us to recoup losses through required indemnification for loans 
that were improperly originated or in which fraud and 
misrepresentation were involved.
    Building a strong foundation for the future requires us to 
pass this legislation, and I hope that you will pass it by the 
end of the year.
    Mr. Chairman, these reforms are important not only because 
we still have a long way to go, but because home prices may 
still decline further, and conditions may get worse before they 
get better. They are also important because we know the 
critical role FHA is playing in the housing market right now.
    Mr. Chairman, this makes it even more important that we 
continue to deliver on our commitments to strengthen the FHA 
and assist responsible home borrowers who need a helping hand 
while working to facilitate the return of private capital to 
the housing market. We look forward to working with Congress 
closely on all of these issues as we further reduce risks to 
the American taxpayer and ensure FHA can continue to provide 
stability to the housing market at a moment when it is most 
needed.
    Thank you for the opportunity to testify, and I look 
forward to answering any questions.
    Chairman Dodd. Thank you very much for that.
    Mr. Scire.

 STATEMENT OF MATHEW J. SCIRE, DIRECTOR, FINANCIAL MARKETS AND 
     COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Scire. Mr. Chairman, Ranking Member Shelby, Members of 
the Committee, thank you for the opportunity to be here today 
to discuss FHA's mortgage insurance program.
    Since 1934, FHA has been an important player in the 
mortgage market, especially for first-time home buyers. FHA 
insures these loans under its Mutual Mortgage Insurance Fund. 
Almost 1 year ago, HUD released the results of the latest 
independent actuarial review showing that the capital ratio 
used to measure the financial soundness of the fund had 
declined to 0.53 percent, well below the statutory minimum of 2 
percent.
    At the request of this Committee, we have been evaluating 
the program and issued our first report yesterday. Overall, our 
work pointed to further actions needed to better evaluate the 
fund's financial condition and guidance for rebuilding the 
capital ratio.
    Let me start by describing the reasons for the capital 
ratio's steep decline since its peak in 2006. Put simply, the 
capital ratio declined because its numerator--the economic 
value of the fund--declined sharply while its denominator--the 
insurance-in-force--grew rapidly.
    Let us take first the insurance-in-force. This measure of 
the amount of all loans FHA insures rose as the demand for 
mortgage insurance grew. By the end of 2009, FHA had 
outstanding insurance that was more than 6 times the level it 
had at the end of 2006. The decline in the fund's economic 
value is due to several factors, including more pessimistic 
forecasts for house prices, which would result in higher 
claims, and more pessimistic assumptions about losses. From a 
budgetary perspective, the worsening expectations for loan 
performance ultimately resulted in HUD recognizing a $10 
billion increase in the cost of the program in 2009 alone and a 
like reduction in the program's capital reserve account. If 
this account, which now stands at $3.5 billion, were to be 
depleted, FHA would require additional Federal funds to cover 
its cost on outstanding insurance.
    It is important to note that the economic value of the fund 
depends in large measure on cash-flows derived from estimates 
of loan performance over a 30-year period. FHA and its 
contractor have enhanced their methods for assessing the fund's 
financial condition, but there is more that FHA can do to 
improve the reliability of its estimates. In particular, past 
reviews have relied on single economic forecasts to determine 
compliance with the 2-percent requirement. However, this 
approach does not fully account for the variability in future 
house prices and interest rates and, therefore, may tend to 
overestimate the fund's value.
    We recommend that FHA use an alternate approach known as 
stochastic simulation to estimate the fund's capital ratio for 
purposes of assessing compliance. This approach uses hundreds 
of different economic paths and offers the prospect of more 
reliably estimating the fund's economic value.
    Beyond steps to improve how it measures the fund's health, 
FHA has also taken proposed steps for improving the fund's 
financial condition, and the Commissioner describe many of 
those. However, FHA has not specified when it expects to return 
the fund's capital ratio to its minimum 2 percent, nor what 
further steps it needs to take to do so. Likewise, the Congress 
in 1990 specified when it expected FHA to first reach a 2-
percent ratio. It did not specify what it expected of FHA 
should the ratio subsequently fall below 2 percent or specify a 
timeframe for returning the capital ratio to 2 percent.
    Finally, we report on changes in the performance and 
characteristics of FHA loans. The delinquency rate for FHA-
insured loans increased in recent years. However, in some 
respects, the characteristics of the most recent FHA loans are 
less risky than in past years. An increasing share of FHA-
insured loans went to borrowers with higher credit scores, for 
example. Also, loans with seller-funded down payment assistance 
are no longer permitted.
    On the other hand, FHA insured relatively more streamlined 
refinance loans in 2009. But probably most important to 
consider is the sheer size of recent loan cohorts. Because 
these loans now represent a substantial portion of FHA's 
portfolio, they will be important to the future of FHA and its 
efforts to rebuild the financial condition of the fund.
    Overall, the challenge FHA faces today is not dissimilar to 
that it faced nearly 20 years ago when it was first required to 
achieve a 2-percent capital ratio. It met that challenge in 5 
years. Then, as now, it may be necessary for the Congress to 
specify the time period it expects FHA to return the capital 
ratio to 2 percent, taking into account FHA's statutory 
operational goals and its role in supporting the mortgage 
market. Also, to provide the Congress with more reliable 
estimates of the fund's value, there is more that FHA can do to 
more fully recognize the impact that volatility in house prices 
and interest rates may have.
    We are committed to providing the Congress with effective 
oversight of the FHA program, including its efforts to rebuild 
the fund's capital ratio, while serving an important role in 
the mortgage market. We look forward to supporting the 
Committee's efforts.
    This concludes my opening remarks. Thank you again for the 
opportunity to speak today. I would be glad to take any 
questions that you may have.
    Chairman Dodd. Well, thank you again, Mr. Scire, and thank 
you and your staff as well for the work you have done.
    Let me jump right in, and I will ask the clerk to put 
around 6 minutes or so on here so we can give everybody a 
chance to get involved in this discussion.
    Let me ask you, Mr. Stevens, Commissioner Stevens, a 
contemporary question. We are going to be passing a continuing 
resolution, I think probably next week, that will carry us over 
I think until December at some point. But one of the items that 
I hope gets included in that CR is a 1-year extension of the 
expanded loan limits for FHA and the GSEs. Commissioner 
Stevens, can you speak to the issue and why it is important to 
do this prior to leaving for our election recess?
    Mr. Stevens. Thank you for the opportunity to answer that 
specific question. At this point, as you stated in your opening 
remarks, between Freddie Mac, Fannie Mae, FHA, and VA, we play 
a critical role in providing needed financing for every 
homeowner in America today. And there is still a significant 
gap in any available private capital to come into the market at 
virtually any price.
    The issue for FHA in particular in extending the limits is 
not about the maximum dollar amount. I think it is important 
for everybody to recognize that. Less than 3 percent of our 
portfolio is over $417,000. We are doing very few large loans.
    The real issue is the formula itself. FHA's floor today 
under HERA is $271,000, and it is based on a formula based on 
median sales price. If the limits were not extended for another 
year, we would, A, recalculate the median home values of every 
home in every county in America, which would be lower. In 
addition to that, the formula for FHA financing would drop from 
125 percent of median value to 115 percent, which would have a 
double impact on reducing available credit for the FHA program 
nationwide. And this is not about high-cost markets. This is 
about every county across the Nation that would suddenly have a 
reduced access to home ownership. We are not talking about 
wealthy millionaires. We are talking about the average American 
family's ability to access and finance a home in today's world 
given the complete absence of other capital.
    So it is for this reason that not only for FHA but for the 
GSEs as well, the absence of capital and the needed 
availability of liquidity that this Administration does support 
an extension for another year.
    Chairman Dodd. Well, isn't there the added problem as well 
that you actually then--you are driving home prices down, 
therefore reducing the amount of equity that people may have 
accumulated in their home, thus reducing the wealth creation. 
Isn't that also----
    Mr. Stevens. Absolutely. The secondary effect is absolutely 
as you say, Senator, that it will lower--lack of access means 
less available buyers, which means more inventory on the 
market, which will depress home values potentially even 
further. And it is for all those reasons that we recommend that 
we do an extension responsibly for another year, giving this 
market a chance to complete the healing process and begin to 
regain its necessary recovery.
    Chairman Dodd. I have not had a chance to talk to my friend 
and colleague Richard Shelby, but I would hope my colleagues 
would take a look at this in the next 2 weeks. Whether or not 
we can include something like this as part of the CR could be 
very important. And I would just ask them to pay attention to 
it and give me your advice and counsel on it as well.
    Mr. Scire raised the issue of having a legislatively 
mandated time line. We legislatively mandated the 2 percent. 
There is a certain attractiveness to that, but I think you may 
have--in fact, I identified one of the potential problems, 
which is the question I would like to raise with you, Mr. 
Scire, and that is the potentially countercyclical feature of 
having a legislatively imposed time line.
    Are you concerned that a time line might tie the 
Department's hands, undermine the FHA's ability to do its job 
at exactly the time when we may want them to be more aggressive 
in moving these areas? Clearly, the program seems to be 
restoring the program's capital without a time line. And do you 
believe that such a time line is needed? And let me ask you, 
Mr. Stevens, that as well.
    So give me the potential problem of the counter--the 
procyclical nature. Excuse me.
    Mr. Scire. Well, you saw that we were very careful in our 
recommendation----
    Chairman Dodd. I know.
    Mr. Scire. ----because FHA obviously has some competing 
goals. And what we think is that this is an excellent 
opportunity for the Congress to weigh in on and to give 
direction to FHA as to where that balance should be between 
financial soundness and its role in supporting the mortgage 
market. So I think that that is where we would leave that.
    Chairman Dodd. Well, is it overkill a little----
    Mr. Scire. There is another advantage to----
    Chairman Dodd. If you are moving in the right direction on 
these things and doing what needs to be done and the reforms 
that are necessary, does a legislatively imposed time line to 
achieve that--and it seems to sort of disregard other factors 
that may be occurring out there that could contribute to that 
kind of a decision and thus make it more procyclical. That is 
my point.
    Mr. Scire. Well, I do not disagree that a time line, a too 
advanced time line would be counterproductive given where we 
are in the market today. So that is why it is important to 
consider what role you expect of FHA in the next few years or 
whatever amount of time you think makes sense to get back to a 
2-percent ratio.
    What it does provide for you is a means for holding FHA 
accountable, and so, you know, one of the things that you might 
expect here is for FHA to lay out what it thinks might be a 
reasonable timeframe for achieving a 2-percent capital ratio 
while meeting its----
    Chairman Dodd. Well, let us ask the man right here, the man 
we have at the table. Mr. Stevens, how do you respond to that?
    Mr. Stevens. I respond in two ways. One, I believe a time 
line would be the wrong way of approaching the FHA reform, and 
just to be very clear, the National Housing Act does not say 
the Secretary can, if he wants to. It is ``the Secretary 
shall'' do everything in his authority to get the capital 
reserves back above 2 percent.
    As you can tell by the actions that I have reviewed today, 
we have done the most aggressive, sweeping set of reforms to 
get the FHA capital return to above 2 percent, and those steps 
are in process.
    I do agree with at least some of the tenor of the points 
that you have made, that if you put a time line in place, it 
could force actions that could have broader adverse impacts to 
the markets. And so it is those unintended impacts that could 
ultimately be of concern.
    The other variable which I think is important is any 
forecast against an actuarial reserve is highly dependent on 
home price expectations. The HPI is the single biggest 
determinant on how it is going to impact capital on a broad 
portfolio. Despite all the other credit characteristics, that 
and our ability to bring in premium are the two biggest drivers 
we have right now that will ultimately the capital reserve. And 
so based on last year's forecast, when we submitted and went 
through the minimum capital reserve results, the actuarial firm 
had laid out a prospective view on when the capital reserves 
might return above 2 percent. And at that time, it was between 
3 and 4 years. And, you know, at this point we remain committed 
to believing that that time line can be reached, and a lot of 
it has to do with our ability to implement the reforms that we 
have asked of Congress to get into the market so that they can 
take hold both in increasing premium and helping us hold 
lenders accountable for loans they should not have originated 
to indemnify the FHA. It is those kinds of actions that will 
help us get there. We do believe the time line is a challenge.
    Chairman Dodd. OK, and others may raise this. One last 
thing. I have gone over the time, but let me pose just one more 
because this is one that we debated extensively in the 
financial reform bill, and that is--and my good friend Bob 
Corker was, I think, the leading advocate of this, though 
others were as well. And there is a lot he says that I agree 
with, and that is, mandating minimum down payment requirements. 
I believe 5 percent is what we were debating at the time. And I 
pointed out earlier that the delinquency rates obviously in FHA 
were not substantially worse than the prime rate area. But, 
nonetheless, there is an argument for it, but there is also an 
indication if you have good underwriting standards, mandating a 
certain minimum down payment requirement may be--would you 
comment on that? What are your thoughts on that?
    Mr. Stevens. Thank you, Senator----
    Chairman Dodd. And I apologize to my colleagues. that is 
the last question I will have.
    Mr. Stevens. I do want to reflect that I bought my first 
home in Denver, Colorado, in 1970-something with a 3-percent 
down payment from the FHA with at the time my young bride, and 
had we not been able to get an FHA loan, we would not have 
bought a home; neither would thousands of other people in our 
community and, obviously, many more across the country.
    Down payment alone is not the single characteristic that 
results in default, and as we have all learned through this 
past period, it is the layering of risk that caused high 
default rates.
    The FHA portfolio is very different. It is all owner-
occupied. It is all primary residence. It is all--if you can 
believe it or not, we fully document every single loan. I know 
that is a shock to many in the industry. And so the only risk 
variable ultimately ends up being that 3.5-percent down payment 
for those borrowers that can qualify.
    Even the actuarial firm recognized that the changes that we 
had recommended to control that risk would eliminate the vast 
majority of the delinquency attributes that are associated with 
the portfolio.
    Let me give it another way. We show that loans with FICOs 
under 580 have a worse default rate at below 95 percent than 
our loans at maximum loan to value, just over 580 to 620. So 
you can get performance characteristics with a low down payment 
as long as you control the credit quality standards across the 
remainder of that spectrum. And so I think our core concern 
when we established our policies that we implemented was to 
balance the need to provide available liquidity for home 
ownership across America, particularly first-time homeowners in 
underserved markets, which has been core to our mission over 
time, without creating the unintended consequences of 
eliminating capital and slowing any recovery in the housing 
market. And it was those two balancing acts, while looking at 
the credit characteristics underlying them, that resulted in 
this two-step approach. Under 580, 10 percent down. Over 580, 
the performance is clearly different and can support the 
minimum down payment requirement.
    Chairman Dodd. Thank you very much.
    Senator Shelby, I apologize.
    Senator Shelby. Do you believe, though, that underwriting 
standards do play a role and should play a role on any loan?
    Mr. Stevens. Yes.
    Senator Shelby. Of course, I know why the minimum down 
payment. You said you paid 3 percent down. I am sure you didn't 
default, but I am sure you had good credit and you were going 
to pay that loan or die. You know, a lot of us would. But 
underwriting is the key to anything, whether it is bonds, 
diligence. You do diligence on this. Now, there are some people 
with bad credit and bad history that could pay 20 percent down 
on something and they think nothing--you know, if something 
happened, they would just walk off from the loan and so forth.
    But I do believe myself that underwriting is a key to a lot 
of this, a lot of this, period. And what we want, as I 
understand it, I certainly want a good housing program, but I 
don't want a welfare program. I mean, that doesn't help anybody 
in the long run. It makes you not viable down the road.
    And speaking of that, how are you going to grow to at least 
have that 2 percent and when is that? You don't want a 
statutory framework, but what do you want?
    Mr. Stevens. Senator, as I said earlier, and these are 
complex answers because there are obviously economic variables, 
I can take an existing economic scenario and say, if that 
scenario holds true, our capital would return to a level by X 
period.
    Senator Shelby. You are speaking of the economy as a whole?
    Mr. Stevens. I am talking specifically more about----
    Senator Shelby. And unemployment and all this, people 
having a few dollars?
    Mr. Stevens. Yes. The big drivers are going to be the home 
price index. It is going to be the discount rates in the market 
and it is going to be recovery rates or what we recover on 
defaulted loans. Those are going to be some of the major 
drivers that will ultimately allow us to run a formulaic 
process that allows us to determine precisely when the capital 
gets back. That was done in the last actuarial, and the one we 
will submit to you in November, again, we will have an 
expectation--the independent actuarial firm will have an 
expectation of when that capital should get above 2 percent.
    There is no doubt that the premium authority you just 
granted us will add at current run rates an additional $300 
million a month in premium, which will allow us to build faster 
had you not given us that authority. So it is those kinds of 
changes that will get us there and we will forecast that for 
you, again, in the upcoming actuarial review, which ends at the 
end of the fiscal year.
    Senator Shelby. What is it going to take financially for a 
lot of us not to be concerned about FHA, just as we go back 10 
years ago, close to it----
    Mr. Stevens. Yes.
    Senator Shelby. ----we were really concerned about Freddie 
Mac and Fannie Mae.
    Mr. Stevens. Senator----
    Senator Shelby. A lot of us are concerned about FHA, and 
you know why.
    Mr. Stevens. Yes.
    Senator Shelby. What is it going to take to allay these 
concerns?
    Mr. Stevens. Senator, I think we all should have a concern 
about FHA. I think it is the only responsible way----
    Senator Shelby. You are the Commissioner, so it is right in 
your lap.
    Mr. Stevens. ----and I am concerned about it, and as you 
may recall, when I testified in front of this Committee for my 
nomination hearing, I stated at the time that I believed FHA 
was being adversely selected in the markets, and we have the 
2006, 2007, and 2008 portfolios are terrible books that were 
allowed to be originated with relatively limited scrutiny by 
those involved, and we are going to be paying the price on 
those loans for many years to come. And if home prices flatten 
or recover, the strength of the fund will grow quicker. If home 
prices recede and worsen, depending on that pace, that will 
make the recovery much slower.
    But I will tell you, I remain extremely concerned about it. 
I have my Chief Risk Officer here with me today. It is what he 
spends the vast majority of his time focused on. And I think we 
will both feel comfortable probably around the same time. At 
this point, the aggressive actions we are taking and the 
results we are seeing, even in the third quarter report we just 
submitted to all of you, is clearly a reflection that what we 
are doing is having an impact.
    But we are absolutely not out of the woods and we retain 
the same level of concern, I believe, that it would only be 
responsible and that you would want us to have.
    Senator Shelby. Of the FHA portfolio, roughly what 
percentage are underwater right now? It has got to be growing, 
and high.
    Mr. Stevens. The general consensus of economists, the Mark 
Zandis of the world, et al., are that roughly 20 to 25 percent 
of all loans in America have negative equity. Now, they are 
concentrated----
    Senator Shelby. What about FHA, though?
    Mr. Stevens. It is going to be less dramatic simply because 
our concentration, we are not----
    Senator Shelby. What does less dramatic mean?
    Mr. Stevens. I don't have a precise number for you----
    Senator Shelby. It would be high, though, would it not?
    Mr. Stevens. It would definitely--it is high for all 
portfolios and would be high for the FHA.
    Senator Shelby. Is this the highest in the history of FHA?
    Mr. Stevens. We have not done the analysis, Senator, to 
see----
    Senator Shelby. Can you go back and do the analysis, say, 
for the last 20 years and furnish that to the Committee and see 
where FHA was in 1990----
    Mr. Stevens. Sure.
    Senator Shelby. ----2000, 2005, you know, all this----
    Mr. Stevens. Yes.
    Senator Shelby. ----because we would like to know.
    Mr. Stevens. Yes, and----
    Senator Shelby. We want you to survive.
    Mr. Stevens. And Senator----
    Senator Shelby. If we don't have the information, we don't 
want to be shocked like we have been before.
    Mr. Stevens. I completely agree, and the ability to be 
transparent----
    Senator Shelby. Are you going to furnish that information 
and get it to the Committee?
    Mr. Stevens. We will furnish you our best estimate of what 
that number is.
    Senator Shelby. Now, wait a minute. We don't want your 
judgment. We want statistics. You can go back and see. You have 
got to have data on the percentage of loans, say, in 2000, 2005 
out there, how many foreclosures, how many underwater, and all 
this. You keep up with that. You have to. If you don't keep up 
with it, you are in trouble.
    Mr. Stevens. We do benchmark appraised values across the 
country and we use a home price index----
    Senator Shelby. By ``benchmark,'' what does that mean to 
FHA?
    Mr. Stevens. You can't--it would be an extraordinary 
project to take six million loans in every community across the 
Nation and reappraise every one of them based on today's 
values.
    Senator Shelby. Well, I am not talking about that. I am 
saying, how many people are underwater today? How many pending 
possible foreclosures do you have? It has got to be high, and 
we need to know, because I think that goes to the bottom line 
of what GAO is talking about.
    Mr. Stevens. We will report to you our pending 
foreclosures. Underwater is based on negative equity. It 
requires an estimation of the existing value of the property, 
of which we have about six million loans across the country. We 
can do that by looking at market areas against local home price 
indexes that we use. We will go through that process.
    Senator Shelby. Would you call those hard numbers? Would 
they be hard numbers? We are looking at hard numbers.
    Mr. Stevens. They will be the best numbers that we can 
discern. I would encourage the GAO and others to take a look at 
them and come up with their best estimates, as well.
    Senator Shelby. In other words, if somebody was going to 
buy your portfolio, they would be looking at what was really in 
that portfolio----
    Mr. Stevens. They would use the----
    Senator Shelby. ----what was performing, what was not 
performing, what was----
    Mr. Stevens. Right.
    Senator Shelby. ----shaky, right?
    Mr. Stevens. And, Senator, they would use the same 
methodology that we will embark on.
    Senator Shelby. And you are going to furnish this 
information to the Committee?
    Mr. Stevens. We will furnish that to the Committee, yes, 
sir.
    Senator Shelby. Can you do this in the next month or so? 
You should be able to do that.
    Mr. Stevens. We will do our best.
    Senator Shelby. I have got to ask, Mr. Scire, are you 
skeptical, real skeptical, doubtful that FHA is going to get 
toward that 2 percent, just 2 percent, goal?
    Mr. Scire. I don't think we have any way of knowing when 
FHA will get to the 2 percent. FHA actually is in the best 
position to do that estimate, and so I would expect that it 
would be able to say, with the policy changes it has enacted, 
with the ones it is contemplating, using its modeling, and this 
does involve assumptions about future economic activity, but 
they should be able to tell us what their expectations are 
about getting to a 2-percent ratio.
    Senator Shelby. What is your judgment today on the 
financial condition of FHA? For the record here and before this 
Committee.
    Mr. Scire. Right.
    Senator Shelby. Honestly----
    Mr. Scire. Well, today, where the capital reserve account 
is down to a $3.5 billion level----
    Senator Shelby. Isn't that a dangerous level?
    Mr. Scire. Well, it doesn't leave much of a cushion.
    Senator Shelby. That is right.
    Mr. Scire. So what will be really interesting to see is 
over the next month or two, as the FHA receives the results of 
this year's independent actuarial review, whether or not the 
changes and expectations for future house prices or interest 
rates, how that affects what their estimate will be for the 
fund and how that might trickle down to or reflect in that 
capital reserve account come next year.
    So I am very curious to see the results of this year's 
actuarial review, and again, these estimates are based on 
expectations going out 30 years and are highly dependent on 
expectations for house prices and interest rates, so they can 
move around quite a bit.
    Senator Shelby. Thank you. Thanks, Mr. Chairman.
    Chairman Dodd. Thank you very, very much.
    Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, gentlemen, for your testimony today.
    Mr. Stevens, you noted that you made some significant and 
important changes, a risk officer, I understand the FICO scores 
for your applicants have gone up significantly, that you have 
got a much better book this year of loans than you had when you 
stepped into office, and that is positive.
    But one of the issues that is affecting all the questions 
we ask today is foreclosure rates. If they continue to 
accelerate, then the value of the portfolio goes down. Your 
ability to reach the 2 percent capital level is further put 
off. And there are some provisions that are involved with FHA 
mortgages that allow some mitigation tools, and let me ask you, 
are you taking specific steps to ensure that homeowners 
understand if they have FHA insurance that there is a full 
range of FHA loss mitigation tools and reducing these 
foreclosures?
    We are hearing that services, mortgage services or mortgage 
holders are not telling people potentially into default or on 
the edge that they have these mitigation techniques. What are 
you doing to make sure they know what their rights are?
    Mr. Stevens. I appreciate that question and it is clearly 
of critical concern to us. There are a couple of things in 
place. First of all, the Protecting Tenants from Foreclosure 
Act requires that the consumer be notified that it is an FHA 
loan. We require it of all servicers to notify their borrower 
if it is an FHA mortgage. There are a couple of additional 
steps that we mandate, which is required of every servicer in 
the FHA portfolio, is they must engage in the loss mitigation 
requirements of FHA in the early period of default for every 
consumer. I believe that in past periods, there was less 
monitoring of servicer compliance with that.
    We have instituted a very robust set of servicing 
reporting, which we review monthly, to look at exactly how they 
are engaging in loss mitigation on their portfolio and what 
percent of their portfolio they are in compliance on. There are 
outliers. There are outliers amongst some of the larger 
servicers and we are working very aggressively with them and we 
will take further actions to extend our ability punitively to 
make sure that they comply with that policy.
    But we completely share--I completely share the concern 
about making sure every homeowner is protected with every right 
available to them, particularly in the FHA portfolio.
    Senator Reed. One of the particular tools that you have 
available is the occupied conveyance, which essentially allows 
someone to stay in the property even though legally they have 
lost title to the property. Are you using this tool, and if you 
are, how aggressively effectively are you using it?
    Mr. Stevens. We use the occupied conveyance tool primarily 
for people who are in the property, and most often in times of 
illness or some severe situation where the Secretary deems that 
they should be protected and we provide for the occupied 
conveyancy. We do have a much broader set of loss mitigation 
tools, Senator, that can provide a number of solutions to keep 
people in their homes. Quite frankly, it is the broadest set of 
loss mitigation standards that I have ever seen in sort of an 
investor portfolio that is available to keep people in their 
homes.
    We have not broadened the occupied conveyance standard at 
this time. To do so could add some significant expense and 
could be extremely problematic. I would be glad to submit some 
further information to you if you want some further 
clarification of that.
    Senator Reed. Thank you. One issue here, just a general 
comment, perhaps, is that you are also attempting to 
marginalize the technology of FHA.
    Mr. Stevens. Yes.
    Senator Reed. We had these discussions with your 
predecessor, who--one of the reasons I think you couldn't 
accurately assess risk and control your risk was you had no 
idea what was going on because of technological gaps. How well 
are you doing in that regard?
    Mr. Stevens. So there are two sides to that question. The 
first is we do have a number of tools that have been available 
without technology, and I want to make clear that upon being 
sworn in, I established a very specific set of protocols 
including very deliberate monthly reporting in detail of 
performance of our total portfolio, and this set of robust 
reporting is now being managed by the Chief Risk Officer and it 
allows us to have much more data than perhaps previous 
Administrations took the opportunity to engage and look at. So 
I do think that there is a lot of data available.
    That being said, we do need enhancements. We have 
implemented and actually awarded the first three contracts 
which on our first focus area was risk and fraud, and we 
awarded our most recent, the third contract, just a few days 
ago to completely upgrade our ability to establish automated 
risk and fraud tools which will enable us to catch fraudulent 
transactions very early on in the process, something that FHA 
did not previously have the ability to do. The rest is--a lot 
of funding will come in the 2011 budget. In that, we will 
implement new capabilities as the funds come to us according to 
our plan that we submitted to Congress.
    Senator Reed. The current level of insurance, the maximum 
is $729,750. That will expire at the end of this year. What is 
your position with respect to extension?
    Mr. Stevens. As I said earlier, first of all, the 
Administration supports extending all the limits for another 
year. I do want to make clear, with FHA, we do very few loans 
at that limit, but it is more around--the formula would also 
expire and it would affect hundreds of counties across the 
Nation that would now have their loan limits reduced, even for 
lower sort of median-income homes if we were to not extend the 
formula.
    Senator Reed. Very good. And a quick question to Mr. Scire. 
In terms of your recommendations, the modeling of FHA, the 
fund, is being done now by contractors. You are recommending a 
slightly different approach that you feel would be more 
accurate in assessing capital levels, and again, one of the key 
questions around here is when do we get to 2 percent. You are 
suggesting perhaps if we measure it differently, we might be 
closer to it or further away. Can you just very briefly, 
because my time is expired, comment on what your advice would 
be?
    Mr. Scire. Our recommendation is that FHA move away from 
using a single economic scenario for estimating the value of 
the fund for the purposes of compliance with the 2 percent, and 
the reason we recommend that is that it would tend to overstate 
cash-flows. And so stochastic simulation is what we are 
recommending. It is a widely accepted practice. FHA itself 
recognizes the utility of it in terms of--or the usefulness of 
looking at many scenarios in terms of its stress scenarios that 
it does. But it is not used for purposes of compliance with the 
2 percent. So we think that that is a direction that it needs 
to take.
    Senator Reed. Your comments, quickly, Mr. Stevens.
    Mr. Stevens. So first of all, we agree with the GAO's 
recommendation. The new contract for our next actuarial review 
will include stochastic modeling. I do want to emphasize that 
we run multiple paths on a deterministic approach, which is how 
most of the analytics on our portfolio have been done by other 
agencies, as well, but we do believe the stochastic modeling is 
the right way to go.
    Senator Reed. Thank you gentlemen very much. Thank you, Mr. 
Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Corker.
    Senator Corker. Mr. Chairman, thank you, and I appreciate 
you having this hearing. I know that this will be the next 
topic, housing finance in general, that we all wrestle with, 
and certainly appreciate the witnesses ending this year with 
this kind of testimony.
    It seems to me, Mr. Stevens, at the FHA that what is 
happening right now is we have had a down market. You had a 
series of sort of bad vintage loans that you were dealing with 
when you came in, and that what you are in essence doing is not 
unlike what happens many times in the private sector when there 
is a downturn. You are sort of building through this and 
building volume and hoping that as things stabilize with this 
large volume of new loans, that you end up back at the capital 
requirements you need to have. Would that be a good summation 
of what you are doing?
    Mr. Stevens. I would say--if you don't mind, I would 
clarify that. We are not just hoping to get back there by 
building volume. We are raising premiums, and one of the most 
significant ways that we can address the existing bad books, 
outside of just building volume with better quality loans at 
higher premiums, is to have the ability to require 
indemnification from the lenders based on things beyond just 
fraud and misrepresentation. If they originated a loan outside 
of our policy guidelines and it wasn't fraud or 
misrepresentation, we have had limited capability to go after 
them and not pay their claim, and make them pay the claim.
    That is the way we could protect the balance sheet on even 
the past book years. That is actually in the FHA reform bill, 
and that is why we are very hopeful that Congress and the 
Senate particularly will not only introduce that, but get it 
passed so that we can hold the lenders accountable. That will 
actually strengthen the fund because we won't pay claims on 
some of the bad loans from the old books as we look at it.
    Senator Corker. In preparation for this next debate with 
GSEs and all of that, we spent a lot of time with the analysts 
over the last several weeks. Numbers of them are saying that 
with the volume that we have out there of unoccupied homes or 
homes for sale--I think there are about two million of them--
that it is likely that over the next 6 months, that housing 
prices will continue to decline before things start increasing. 
What kind of models are you all using internally?
    Mr. Stevens. We do look at the same relative forecasts that 
any economist that you and your staffs would be consulting 
with, as well, and we are seeing a series of forecast 
expectations that range from sort of a relatively flat 
environment to perhaps significant softness, particularly in 
some key market areas. And without question, the core point 
there is absolutely accurate, that the additional softening of 
any markets will clearly add incremental risk to portfolios and 
stress to the general housing recovery.
    The question is, if home values are going to drop, will it 
be broad-based nationally or will it be regionally or in select 
areas? What is the net impact to those particular areas that 
may be impacted? And then what kind of controls do you put in 
place? And more importantly, what kind of solutions do we think 
about to try to put in place to try to stabilize those markets?
    This is clearly the worst housing market any of us have 
ever lived through in our professional lives, and so attacking 
this in a very methodical but thoughtful way is extremely 
important at this time.
    Senator Corker. So the Chairman mentioned in his comments 
about extending the limit, the upper limit right now on FHA 
loans, and as a beginning point, that is something that is not 
particularly interesting to me. On the other hand, you did 
mention something about the formula and how the fact is that 
only 3 percent of your loans are above the normal limits, but 
the formula is the part that is important.
    So along the line of questioning that has gotten me in 
trouble multiple times in the past, is there a way to deal with 
the problem you have without actually raising that limit? In 
other words, I think most of us want to see--I think everybody 
actually wants to see the involvement that Government has in 
guaranteeing loans decrease. I think everybody here does. Is 
there a way to address the issue that you are talking about and 
still go ahead and drop down to the norm and somehow keep the 
formula in place, because you are only affecting, again, 3 
percent of the loans that you are actually originating today or 
insuring?
    Mr. Stevens. Senator, I think there would be a variety of 
ways to respond to the concern about FHA being able to provide 
ongoing financing for really the vast majority of the 
homeowners outside of the limit. Here would be my less than 
sophisticated response. We are under a very tight timeframe. 
Lenders already today are beginning to think about pricing for 
January loans and they are going to begin cutting back 
opportunity, home ownership opportunity, refinance opportunity, 
across the Nation here in just the next few short weeks.
    Considering the fact that the actual use of the higher loan 
limits is really not pervasive in the FHA portfolio, and quite 
frankly, the performance on them is very good, even though it 
is less than 3 percent of the portfolio, it is not a real 
impact driver, our recommendation is to simply extend the 
limits for another year.
    But I do share your concern, and I know we have spoken 
about it beyond this. The role of the U.S. Government in the 
housing finance system has got to pull back, particularly FHA, 
and there has to be a way for private capital to reengage. My 
discussions with private investors is they don't have an 
appetite for mortgages in this country to begin with, so even 
if we pulled back, there is no clear evidence there would be 
enough capital to support this housing system. So all those 
reasons combined that I just reviewed are why we recommend a 
simple extension for 1 more year rather than doing too much 
fine-tuning that could get lost in debate when it really is not 
particularly relevant to risk in the FHA portfolio.
    Senator Corker. Well, it just seems to me that it would be 
relatively simple for you all to--I mean, we are not going to 
do a lot of fine-tuning. We take recommendations from folks 
like you and look at them. It just seems to me there would be a 
way of accomplishing exactly what the Chairman laid out, and 
that is keeping the mortgage market operating, and if it is not 
really dealing with those larger loans, we could also as a 
Congress be taking a step back to the norm, which I think is 
also important. That is another important thing, I think, for 
the economy to sort of get back to the norm.
    I know my time is up, but it doesn't seem to me it is that 
difficult to do some of that fine-tuning you are talking about. 
All we would do is say yea or nay. We wouldn't be fine-tuning 
it ourselves, and I hope that--I know my time is up--that we 
could talk just a little bit more. It seems like there--or 
maybe is there a way to say that, look, you can't do more than 
3 percent?
    Mr. Stevens. We have had these discussions before about 
controlling the mix of FHA loans. I think that is a difficult 
approach to getting at it. I would be glad to follow up with 
you on that particular item. But again, our view at this time 
is that, over time, these temporary extensions need to ease 
back when there is private capital returning. At this time, 
given the limited impact of any loans in that area to begin 
with, the fact that it probably has some meaningful value in 
some of the real high-cost markets, even though it is not a 
meaningful value to the FHA portfolio broadly, and the very 
short timeframe that we have to respond right now and the 
increase in anxiety that is occurring across this broad housing 
finance market with all the participants, we continue to 
recommend that we do the extension for a year, but I would be 
glad to follow up and have a conversation with you about it.
    Senator Corker. Mr. Chairman, I thank you. I guess my only 
concern in closing is we end up with these things like SGR that 
never go away, AMT fixes that never go away. I think if there 
is a way you could help us, we understand the problem and I am 
very sensitive to the problem, but at the same time, I think we 
are getting into a territory which makes this a permanent 
extension forever and I hope you can help us think through 
another way. Thank you.
    Chairman Dodd. I appreciate Senator Corker's questioning, 
as well, and obviously, I think we are all trying to get the 
same result. I just would note before turning to my two 
colleagues, I believe, and this won't come as any great shock, 
obviously, but the realtors and others who are all coalescing 
around this idea of the extension as they see the problem, I 
think one of the major points you made is that there is so much 
in the housing market that is based on anticipation. No one 
knows this better than my colleague from Tennessee, having 
lived in this world, that that point you made about January, 
and while this is--I don't think most people recognize how much 
of that market depends upon that idea. And so that is the 
quandary, in a sense, we are in.
    So anyway, we will talk about it and I will talk to Senator 
Corker, as well, and hear any ideas on this as we go forward. I 
would like to be able to get a consensus, obviously. If we end 
up with a brouhaha on the floor of the Senate, that is not 
going to happen, so we need to figure out some way to get this, 
do this in a way that makes some sense.
    I was going to make the point--I am going to turn to 
Senator Merkley, but I wanted to make a point. When you 
mentioned Senator Brown and Senator Begich, the lead cosponsor 
on this FHA reform bill is Senator Bennet of Colorado, as well, 
and I wanted to make sure the record reflected that my 
colleague from Colorado is a lead advocate of that reform bill.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you all for your testimony.
    Commissioner, when you were talking about modeling risk, 
you mentioned, I believe, that home prices are the biggest 
driver. I assume that is because if home prices go down, more 
people walk away from their homes and also the recovery rate is 
lower, so it hits you on both ends. Is that kind of the 
correct----
    Mr. Stevens. That is correct.
    Senator Merkley. As you kind of test the boundaries of risk 
in that area, are there any scary numbers we should be aware 
of? For example, if home prices go down another 5 percent over 
the next 2 years, is the insurance fund bankrupt?
    Mr. Stevens. If it would be permissible, I would like to 
follow up with the Committee on two points. In the last 
actuarial review, we actually did testing on worsening home 
prices, and we will do it again when we submit the actuarial to 
you in November. It will show the prime path, but it will also 
show worst scenarios assuming deeper HPI recessions and it will 
show how that impacts the capital.
    So it is a concern and there are variances in those 
scenarios. But without giving an off-the-cuff response, if it 
would be permissible, I would like to give you more thoughtful 
feedback on how that----
    Senator Merkley. Absolutely. I would appreciate that. And I 
recognize that, essentially, these parameters are being applied 
to loans that were not originated, if you will, under your 
leadership, which brings me to the next topic, which is the 
subprime default rate under the FHA portfolio is really pretty 
shocking when we compare that to more conventional loans, and I 
am assuming that is a combination of factors, that a lot of 
these loans were liar loans, that a lot of these loans involved 
a 2-year teaser rate that popped up to a much higher level and 
people can't get out of them because of the prepayment 
penalties, and that a lot of people were steered into these 
loans when they actually qualified for a prime loan. I think 
the Wall Street Journal showed 60 percent of the subprime 
mortgage holders qualified for a prime loan.
    And so in 2010, there were still a lot of Alt-A loans that 
were scheduled to essentially hit the point at which families 
would be triggered from the lowest of the three payment options 
to the highest because they would max out their negative equity 
limits. Have we now worked our way through the vast bulk of 
triggers, if you will, that drive to higher payments and 
therefore trigger essentially default?
    Mr. Stevens. So there are a couple of variables that I 
think will be big trigger points that we are looking at. One of 
them, we have already passed through for the most part, and 
that was the 228 subprime spike, as it were, which caused an 
interest rate adjustment at the end of the second year, and 
that is why I think in the early phase of this default 
challenge we went through in this country, we saw the subprimes 
defaulting at a much higher rate in the early period. Now that 
seems to be moving to other potential product types and it 
began to evolve.
    One of the classic cases is this thing called the pay 
option ARM, which many of you are familiar with, that started 
with a very low initial teaser rate but then would escalate up 
over time. The challenge with those loans is they originated 
over multiple years and there are two triggers that will cause 
an adjustment. One is they either have a fifth or 10-year, some 
of them, a 10-year adjustment, that if a loan won't pay off 
over the remaining term, they do an automatic adjustment. We 
will see those come in in quantities over the next couple of 
years as we see this market move through, assuming no other 
recovery in sort of general home prices or perhaps on the 
employment side to help these borrowers stay in the home and 
pay them.
    I will add one other point, is these loans are held 
primarily on three large bank portfolios and the banks are also 
aggressively working with these loans and doing things outside 
of the contract itself to try to keep the people in the homes 
and offering them a variety of other options, whether it be the 
HAMP program that we provide or their own internal modification 
program. All that said, I think we still have a ways to go as 
we work through that portfolio and the markets in general.
    Senator Merkley. So you feel like your modeling has a 
pretty accurate reflection of the types of loans, the way in 
which they ripen, so that we have got our hands around the 
dimensions of the challenge?
    Mr. Stevens. Yes. That data clearly exists and it is being 
reviewed by members at Treasury, National Economic Council, and 
here at HUD, and we talk through those numbers, what the 
products underlying are. We talk to servicers about what they 
are doing to address them and what the experience is. We go to 
anybody, economists particularly, who can help us look at 
reasonable analytics on the portfolio. So all of that is being 
done.
    Senator Merkley. Well, this brings me to the next piece, 
which is specifically to ask about the yield-spread premium 
rules, or the steering payments, if you will. The Fed has put 
rules--well, they haven't put them in place yet, but April 2011 
they go into effect. The Dodd-Frank bill severely restricts the 
use of such steering payments. But does it make sense not to 
wait for those both to go into effect downstream and to apply 
kind of strict yield-spread premium rules now for loans being 
originated and being insured by FHA?
    Mr. Stevens. Senator, it is an important question and we 
are looking at that right now. We are looking at the 
implementation of the Dodd-Frank bill across a variety of 
parameters that exist in the FHA portfolio.
    It is interesting that the FHA loans are a little different 
in that it is sort of one product type. There is little 
opportunity to sort of game our system from that standpoint 
simply because every loan is a 30-year fixed-rate loan, fully 
documented, sort of vanilla, as it were, type of product. And 
so you don't have the optionality that loan originators can do 
with other programs that are less easily understood by 
consumers.
    That being said, we are looking at it and I will be glad to 
report back to you in terms of our timing and what we can do 
and implement in the early phase here.
    Senator Merkley. Yes. So essentially, you are no longer 
insuring subprimes and therefore there aren't really bonuses 
connected to steering people into subprimes?
    Mr. Stevens. Right.
    Senator Merkley. OK.
    Mr. Stevens. Well, and add to that, Senator, FHA never did 
subprime. FHA was always doing 30-year fixed rate mortgages and 
there were no 228s or that kind of product. We did have much 
lower credit quality in those past book years, some of which 
people compared to the same sort of credit scores as subprime 
borrowers, but the product itself was a 30-year fully 
amortizing fixed rate during that period.
    Senator Merkley. So when I see this analysis of the FHA 
portfolio and I am seeing default rates of 30-plus percent on 
the subprime component of the FHA inventory, those aren't 
actually subprimes?
    Mr. Stevens. That is actually a comparison of our portfolio 
against how a subprime portfolio performs.
    Chairman Dodd. Delinquencies in the FHA were 9.4 percent.
    Mr. Stevens. Right.
    Chairman Dodd. Prime rate was about 7 percent. And 
subprime, which was never part of FHA, was 30.6.
    Mr. Stevens. But that particular table is designed to 
highlight the fact that Senator Dodd just emphasized, is that 
we aren't really a subprime portfolio, and by showing subprime 
delinquencies, it allows us to create that distinction between 
the two books.
    Senator Merkley. I see. Well, that helps explain, because I 
thought you had insured some subprimes. I misinterpreted this 
chart, because this chart is labeled, ``Characteristics of FHA 
Insured Mortgages,'' and then it shows subprimes.
    Chairman Dodd. That is what they have been trying to do for 
a long time, and that was the point I made this morning, that 
it really is closer to the prime rate. Actually, it was much 
better.
    Mr. Stevens. I apologize for creating that confusion. That 
is our fault. We will relabel that chart so it is clear. These 
are complex data charts. That is really our fault and we 
shouldn't do that, because we deal in an esoteric world and you 
shouldn't have to try to figure that piece out.
    Senator Merkley. I have so many more questions for you, but 
I see I am over my time.
    Mr. Stevens. I am always available to you, Senator.
    Senator Merkley. Thank you.
    Chairman Dodd. Thanks, Senator, very much.
    Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. Thank you for 
holding the hearing. And, Mr. Stevens, we certainly will take 
you back in Denver, Colorado, whenever you want to come. But in 
the meantime, you are doing important work here that I want to 
congratulate you on.
    I want to underscore something Senator Merkley said and you 
have heard here. The interest, I think, in this Committee about 
being able to see the stress testing you are doing of the 
models I think springs from a sense among some of us that the 
oversight here was not so good either. And the idea that, you 
know, we were--not we, FHA and others were running loan 
portfolios without actually knowing what the underlying risks 
were, then Congress was not doing the oversight it should have 
been doing, leads us to want to learn from that and do a much 
better job. So I also would be very interested to see the 
product of your work.
    I wanted to ask you a few specific things. As the Chairman 
mentioned, I am cosponsoring the reform legislation that you 
have talked about today. In your testimony, the written 
testimony, you mention that FHA currently can only seek 
indemnification from 29 percent of its approved lenders in 
cases of fraud and improper loan origination. The new reform 
legislation would enable you to seek indemnification from any 
of the lenders in such cases.
    I wonder if you could talk a little bit about what you 
think that new authority could do for FHA's overall financial 
strength.
    Mr. Stevens. Senator, we have two designations for lenders 
within the FHA portfolio. LI lenders, which really are the 
largest lender insurance providers within our portfolio, the 
major banks. We have another designation called direct 
endorsement, DE lenders. These are often smaller institutions, 
historically have been less well capitalized. And, quite 
frankly, I think the oversight of them has not been as strong 
as it otherwise could have been.
    Broadly across the country, these institutions originated a 
lot of loans over the past few years, and as we said earlier, 
particularly in 2006 through 2008, after the collapse of Alt-A 
and subprime, a lot of rogue originators came to originate FHA 
loans without the scrutiny that should have necessarily been 
there.
    Our ability to get the enhancement to our authority to be 
able to require indemnification of DE lenders will go beyond 
fraud and misrepresentation. It will go to just loans that were 
manufacturing quality, as we call it, loans that were 
underwritten, insured, but they did not meet actually our 
qualifying guidelines. And under those scenarios, we actually 
have very limited authority to go back to these direct 
endorsement lenders and says, ``Guys, we are not paying your 
claim when the loan goes bad. You are paying it out of your own 
capital.''
    To quantify what we will be able to get out of it has been 
a challenge for us because, as we all know through this 
collapse of the market broadly in the housing system, many of 
these lenders have gone out of business. Many of them did not 
have enough capital to be in the business anyway. I have shut 
down 1,500 in the last year alone. I think the biggest year in 
history was in the 1930s or something like this. We have gone 
after this problem very aggressively. But it will allow us to 
at least go after the remaining companies, of which there are 
still many, that originated loans, that we can hold them 
accountable for loans that were outside of our policy and make 
them pay the claim. The quantity of that will become known once 
we start requiring them to pay claims to see if they have the 
money to actually pay them.
    Senator Bennet. Do you have a sense of the order of 
magnitude--was it 2006 through 2008? Is that the period that 
you are talking about?--order of magnitude what percentage of 
the portfolio would fall into that category, looking at it 
retrospectively?
    Mr. Stevens. Yes, let me give you just a couple of 
examples. Seller-funded down payment assistance loans, which 
were--I will not go through the program in depth but----
    Senator Bennet. The name says it all.
    Mr. Stevens. It is about 8 percent of the portfolio but 20 
percent of our defaults. Credit scores less than 580, which, as 
you know, is where we have drawn our new line, it is about 7 
percent of our portfolio but 22 percent of the defaults.
    The 2006 and 2008 books, just those 2 years, are 20 percent 
of our insurance but 45 percent of our defaults. So when you 
accumulate all this data, you know, really about three-quarters 
of the portfolio are based on those--in terms of our loss 
expectations, are based on that portfolio of those 2006 through 
2008 book years. But, fortunately, you know, the vast majority 
of our portfolio based on 2009-2010, about half of it now is 
originated in the most recent year. So we are bringing in 
better quality to reduce our overall exposure, but our real 
losses are coming from just these terrible portfolio years 
where I think lenders--and I was in the private sector at the 
time--just took unfair advantage of the FHA and, you know, now 
we are paying the price for that.
    Senator Bennet. When you got there, how did you call 
attention to the folks that were working in the agency? Did 
this require--do you have the same people doing this work? How 
do you change the culture of the place?
    Mr. Stevens. Well, it has been a huge culture change, as 
many of the team that is here with me today will tell you, that 
we have implemented a significant culture change in the 
organization to having, you know, a regime of risk reporting, 
to creating a risk office. I brought in a new general Deputy 
Assistant Secretary, Joe Smith, who is here with me today. But 
we also had--the career staff is outstanding at FHA. You know, 
their analytic skills, their educational pedigree, and their 
understanding of the portfolio is extremely valuable. It was 
just a matter of leadership, providing the direction to them to 
do the work that needed to be done.
    Literally my second week on the job, I called a meeting on 
one lender, Taylor, Bean & Whitaker, and I pulled everybody in, 
and we did a review on them; and from that meeting, over the 
next few weeks on the job, before I had done anything, we went 
after changes to our streamlined refinance program and minimum 
capital standards that I wanted to implement. And I just sort 
of went at it very aggressively from the onshoot in a way that 
was in an effort to utilize the resources of the organization. 
The whole team is behind it and the support from the career 
staff as well as the new team I brought in collectively, we 
have had a big impact on the organization.
    Senator Bennet. Well, I want to thank you for all that. My 
time is up, and I look forward to working with you on pushing 
this reform legislation through.
    Mr. Stevens. Thank you, Senator.
    Senator Schumer [presiding]. Well, thank you, Senator 
Bennet, and as the Acting Chair, I recognize Mr. Schumer.
    [Laughter.]

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Anyway, I want to thank Chairman Dodd and 
Ranking Member Shelby for holding today's hearing on the 
current condition of FHA. I have a brief statement and a 
question for Mr. Stevens.
    FHA, as you know, as we all know, helped stabilize both the 
single-family and multifamily housing market since the 1930s by 
insuring mortgages that meet specific eligibility criteria. In 
recent years, FHA's role has become more important than ever. 
During the housing boom, their share of the market was so 
small, some people thought we should get rid of FHA altogether. 
Now they guarantee almost 30 percent of all mortgages, and it 
is scary to think of what the housing market might be like if 
FHA were not around.
    But FHA is limited in its ability to help developers 
construct or to rehabilitate affordable rental housing in many 
urban areas--this is my focus, multifamily rental housing--
where the need for affordable rental housing is the greatest 
because of the limit on FHA multifamily loans, which is set 
well below the cost of construction in these areas. Let me give 
you an example.
    In New York City, the average construction cost for a high-
rise building--that is defined as 16 stories or taller--is 
$419,000 per unit. That is more than double the FHA limit. This 
makes it hard to secure affordable financing for multifamily 
rental development and rehab.
    In New York City alone, there are 14 developments with over 
2,000 units. That is a lot of construction jobs and a lot of 
housing units, and our population is growing. New York has 
grown from 7 million people in 1990 to 8.5 million, 
approximately, this census will show. And so we need this.
    FHA cannot help because we have tied their hands in a way 
that is unfair to high-cost areas like New York. Nationwide, 
there are 51 projects with 11,000 units stalled.
    That is why I introduced legislation, along with my 
colleague from across the Hudson River, Senator Menendez, 
called the FHA Multifamily Loan Limit Adjustment Act of 2010. A 
similar bill was championed in the House by Representative 
Weiner and actually passed the House in June, the contentious, 
partisan House, by a vote of 406-4 as part of FHA reform.
    The bill would provide the Secretary of HUD the authority 
to designate high-cost areas and extremely high-cost areas for 
FHA multifamily insurance, increase the loan limits in those 
areas from $183,000 per unit to $376,000 per unit. It doubles 
it.
    HUD already had had this authority, but only for Alaska, 
Hawaii, Guam, and the Virgin Islands. Our bill puts places like 
New York City, Chicago, Los Angeles, and Boston on an equal 
playing field. It would also increase the premium allowed for 
construction or rehab of rental high-rise buildings with 
elevators as compared to buildings without elevators from 10 to 
50 percent, in line with the actual difference in construction 
costs for elevator buildings.
    It is important to note my bill would not alter 
underwriting criteria or weaken taxpayer protections because it 
requires that FHA economists vet the credit quality of all 
borrowers before insuring a loan.
    The multifamily loan program is completely funded by its 
own premiums, separate even from FHA's single-family program 
which has been discussed this morning. And the multifamily 
program has not experienced nearly the same difficulties as the 
single-family program. Recent data from HUD shows that default 
rates are only 2.2 percent multifamily for 2008-09. The program 
has had a seriously delinquent rate of only 0.3 percent in 
2008. The delinquency rate for single-family homes in contrast 
is 7.9 percent. So actuarially it is in much better shape.
    Moreover, the bill would not raise the overall cap on the 
total amount of multifamily loans FHA can insure, so it does 
not present any risk to the taxpayer. The bill has been 
incorporated--and I appreciate this--in a broader set of 
reforms sponsored by Senator Begich, Senator Brown, and Senator 
Bennet, the latter two from this Committee. I would like to 
thank my colleagues for working with me in the reform package.
    So my question for you is simple, Mr. Stevens. Would FHA 
support this bill, my bill, to raise the multifamily loan 
limits for high-cost areas like New York as part of a broader 
legislative package sponsored by Senators Begich, Brown, and 
Bennet. I am not a sponsor because my name does not begin with 
a ``B.''
    [Laughter.]
    Mr. Stevens. Senator, we absolutely support the higher 
limit authority for multifamily. Without question, all the 
points you made are of great concern to us, particularly as we 
move into a housing economy where home ownership may drop. 
There is going to be an increased demand in having safe, 
affordable, accessible rental properties. And to your point, 
where land costs are high, it becomes very difficult to finance 
an FHA multifamily property in this country, and that affects 
about a quarter, roughly, of all our regional office areas that 
are impacted by having the lower limits today. So we do support 
it----
    Senator Schumer. So you support the legislation?
    Mr. Stevens. Absolutely.
    Senator Schumer. Thank you. And on that happy note, the 
hearing is adjourned. I thank all of the witnesses.
    [Whereupon, at 11:45 a.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]

               PREPARED STATEMENT OF SENATOR TIM JOHNSON

    Thank you, Mr. Chairman. Thank you, Administrator Stevens and Mr. 
Scire for testifying today as we examine ways to strengthen the 
financial condition of FHA and ensure that FHA has the tools to enforce 
loan requirements and protect taxpayers from fraud and 
misrepresentation.
    FHA serves an important and countercyclical role in our housing 
market to ensure that mortgages are available to qualified borrowers 
even in tight credit markets. From 2007 to 2009, the percentage of 
loans insured by FHA have significantly increased from 3 percent to 
approximately 30 percent of the market. Demonstrating the importance of 
FHA is the fact that the percentage of borrowers with credit scores at 
or above 720 has doubled compared to borrowers in 2007 and 2008. 
Without FHA, even credit worthy borrowers may not have received loans 
because of the contraction of available credit in the private market.
    While FHA fulfills this role, it is also experiencing the strains 
in the housing market and larger economy. Congress and the 
Administration have taken action to provide FHA with new tools to 
mitigate the impact of the economic downturn through additional loan 
requirements and greater flexibility for insurance premiums. I look 
forward to hearing more about how these changes are affecting FHA's 
balance sheet and what other changes are needed to ensure that FHA can 
continue to fulfill its mission while also protecting its long term 
financial stability and the taxpayers.

                                 ______
                                 
                 PREPARED STATEMENT OF DAVID H. STEVENS
  Federal Housing Authority Commissioner and Assistant Secretary for 
          Housing, Department of Housing and Urban Development
                           September 23, 2010

    Chairman Dodd, Ranking Member Shelby, and Members of the Committee, 
thank you for the opportunity to testify today on the progress the 
Federal Housing Administration has made towards strengthening its 
financial condition.
    As you know, last year we informed Congress of the independent 
actuary's findings that FHA's secondary reserves had fallen below the 
required level. Ten months later, while there is still much work to be 
done, FHA is on a predicted path that will put the agency in a stronger 
financial position for the future.
    Mr. Chairman, last year at this time the independent actuaries 
predicted that we would draw down $2.6 billion of capital resources 
over the first three quarters of this year to pay for rising claim 
expenses. As noted in our third quarter MMI Fund report to Congress, 
instead of decreasing by $2.6 billion, net income increased by $450 
million. Once we add interest earnings to core insurance income, our 
capital resources grew by $1.3 billion in the first three quarters of 
this fiscal year. While our actual performance to date has been 
significantly better than predicted by the actuary, the net budgetary 
actuals are in-line with projections in the President's Budget that was 
provided to the Congress in February.
    While economic conditions evolve and significant risk and short-
term house price volatility remain present, current trends indicate 
that as a result of the actions taken by the Administration and 
Congress, we are making progress in strengthening the FHA portfolio and 
rebuilding our capital reserves.
    The positive signs we are seeing are due, in large part, to the 
numerous reforms put in place and actions the FHA has taken over the 
last year, including an increase to insurance premiums in April and the 
suspension or withdrawal of approval for 1,500 lenders from doing 
business with FHA. This does not yet account for the additional 
authority to change our annual premium structure passed by Congress 
that will add an estimated $300 million per month to the FHA fund.
    Of course, we remain cautious, and the job is not yet done. With 
home prices uncertain, our continued vigilance in strengthening both 
loan quality and performance for future loans is particularly 
important. To that end, it is important to note that the early 
performance data of loans insured in FY2009 and 2010 are much stronger 
than previous years. While FHA is currently playing an important and 
temporarily elevated role in providing liquidity to the housing market, 
it is doing so responsibly.
    With the remainder of my testimony, I will explain our efforts in 
greater detail. In particular, I will describe the role FHA is playing 
in the market, the reforms FHA and the Congress have put in place, the 
early results these reforms are producing, and why our ability to 
protect the taxpayer for the future requires Congress to enact the 
broader, more comprehensive set of reforms we have proposed.

FHA's Current Role in the Housing Market
    I'd like to take a moment to outline the important countercyclical 
role FHA has played in our housing market during these difficult 
economic times. Created by President Franklin Roosevelt in 1934 at a 
time when housing prices had collapsed, the FHA was designed to provide 
affordable home ownership options that would keep our mortgage markets 
afloat during tough times.
    Indeed, when the market began its slow collapse 3 years ago, FHA 
comprised only about 2 to 3 percent of the housing market. But when 
private capital vanished at the end of 2008, it was the FHA that 
stepped in--insuring approximately 30 percent of purchases and 20 
percent of refinances in the housing market. Since January 2009, the 
agency has helped nearly 3 million Americans either purchase a home, or 
refinance into more stable, affordable mortgages. At the same time FHA 
has also helped more than a half million families at risk of 
foreclosure through 760,000 loss mitigation actions.
    The results of these extraordinary but necessary actions, combined 
with many others across the Administration, are clear. Home prices 
began to stabilize. And homeowner equity started growing again in the 
second quarter of 2009--to date, increasing over a trillion dollars, or 
close to $14,000 on average for the Nation's nearly 78 million 
homeowners.

FHA's Current Financial Condition
    Still, this heightened role comes at a cost. Last November, upon 
the final completion of FHA's independent actuarial review of fiscal 
year 2009, we reported to Congress that FHA's secondary reserves had 
fallen below the required 2 percent level--to 0.53 percent of the total 
insurance-in-force. Combined with reserves held in the Financing 
Account, FHA reported that it held more than 4.5 percent of total 
insurance-in-force in reserves--$31 billion set aside specifically to 
cover losses over the next 30 years.
    The Administration has taken very seriously its responsibility to 
ensure that FHA is operating on sound financial footing while 
minimizing risk to taxpayers. Since I took office as FHA Commissioner 
in July 2009, we have implemented a broad range of actions 
demonstrating steadfast stewardship of the fund, while carefully 
ensuring that we continue to serve communities nationwide.
    Specifically, over the past year, this Administration has announced 
and implemented the most sweeping combination of reforms to FHA credit 
policy, risk management, lender enforcement, and consumer protections 
in its history. These reforms have strengthened our financial condition 
and minimized risk to taxpayers as we continue to fulfill our mission.
    On behalf of Secretary Donovan and myself, I want to thank both 
chambers of Congress, and particularly the leadership of you, Chairman 
Dodd, and Ranking Member Shelby, for the partnership and cooperation 
exhibited in passing H.R. 5981, which provides FHA the authority to 
modernize its premium structure. As you know, this authority was 
granted through unanimous consent in the Senate and passed by voice 
vote in the House before being signed into law by President Obama on 
August 11, 2010. FHA has moved quickly to implement a new premium 
structure, which will take effect on October 4. Similar authority was 
included in H.R. 5072, the broader FHA reform measure, which passed the 
House of Representatives in June. While the swift work of Congress has 
allowed us to implement the premium change, which is important for 
FHA's ability to generate greater revenues for taxpayers in line with 
the President's Fiscal Year 2011 Budget proposal, we at HUD remain 
committed to comprehensive FHA reform which will provide the tools we 
need to continue our efforts.
    As you know, on January 20th of this year, FHA proposed taking a 
series of administrative steps to mitigate risk and augment the Mutual 
Mortgage Insurance (MMI) Fund's capital reserves. These proposals 
included: increasing the mortgage insurance premium (MIP); imposing a 
firm floor on allowable credit scores; requiring a higher down payment 
for borrowers with lower credit scores; further tightening the minimum 
credit score required for borrowers with low down payments; reducing 
the maximum permissible seller concession to match the industry norm; 
and implementing a series of significant measures aimed at increasing 
lender responsibility and enforcement. We have followed through with 
each of these reforms, which I will discuss in this testimony.
    In conjunction with updated down payment and credit score 
guidelines published on September 3, the changes to FHA's premium 
structure are projected to result in an additional $4.1 billion in FHA 
receipts in Fiscal Year 2011.
    With the 2010 fiscal year coming to a close, the independent 
actuary is in the process of completing its annual study and 
projections of the capital reserve ratio of the FHA MMI Fund. We expect 
to deliver the finding of this independent study to Congress in 
November, which will include the official measure of the capital 
reserve ratio.
    In the interim, I am pleased to inform you that tangible, 
measureable progress is being made to improve loan quality and 
performance compared to past years. The independent actuary projected 
that more than 71 percent of FHA's losses over the next 5 years will 
come not from newly insured loans, but loans already on our existing 
books when this Administration took office.
    Indeed, the early period delinquency rates for FY2009 and FY2010 
loans are much lower than the early period delinquency rates for loans 
insured in FY2007 and FY2008. This improvement suggests that ultimate 
claim rates on loans endorsed in FY2009 and FY2010 should be markedly 
better than the ultimate claim rates of loans endorsed in FY2007 and 
FY2008.
    As detailed in FHA's third quarter report to Congress, it was clear 
that FHA's loan characteristics and financial performance are better 
than had been forecast in the FY2009 actuarial review.

Highlights of FY2010 Q3 Report to Congress
    On August 2, FHA delivered its third quarter report to Congress 
highlighting the status of the single family MMI Fund programs 
(enclosed in appendix). As mentioned above, FHA has conducted rigorous 
analytical reviews, established new reporting protocols and procedures, 
and announced some of the most extensive policy changes in its history. 
Under the supervision of our new Chief Risk Officer, these changes have 
been made to better protect the safety and soundness of the MMI Fund 
while continuing to serve our mission and support the stabilization of 
the housing market.
    As part of our commitment to increased transparency and to provide 
Congress with better information and data on the performance and 
operations of the MMI Fund, we enhanced our quarterly report to include 
the financial status of MMI Fund cash flows, early payment 
delinquencies and serious delinquency rates.
    As I noted earlier, the third quarter report shows that many 
aspects of the fund are in better shape. Specifically, the amount of 
cash reserves in the fund is nearly $3 billion higher than forecasted 
in last year's actuarial report.
    There are other positive signs as well. FHA's portfolio shows the 
average credit score on current insurance endorsements has risen from 
634 in 2007 to nearly 700 today. Loan performance, as measured by 
serious delinquency and early period delinquency rates, has improved 
significantly, with the first year-over-year decline in new 90-day 
delinquencies in years. And actual claim payments to date are $3.7 
billion lower than had been projected by the independent actuary 
although this is somewhat offset by lower than projected property 
recoveries.

Additional Reforms--Progress to Date
    The two key ways in which we have strengthened FHA fund solvency 
have been to increase revenues and engage in better risk management. 
Therefore, we have been focused on restructuring our mortgage insurance 
premiums and putting in place mechanisms and policies to protect the 
FHA for the future.
    In October of 2009, we hired the first Chief Risk Officer in the 
organization's history. On July 28, 2010, we received Congressional 
approval to formally establish this position and create a permanent 
risk management office within FHA, for which the Risk Officer is now 
Deputy Assistant Secretary. With this new office and additional 
staffing, we have begun to expand our capacity to assess financial and 
operational risk, perform more sophisticated data analysis, and respond 
to market developments.
    Additionally, FHA introduced policy changes and improved lender 
oversight and enforcement to increase the quality of FHA insured loans. 
From my first day as FHA Commissioner, I began a thorough review of our 
loan practices and organizational capacity and gaps. Over the past 12 
months we have introduced a number of new policies and taken several 
steps within our existing authority, all aimed at strengthening the 
quality of FHA-insured loans while focusing on ways to improve our 
operations.
    In April, we published Final Rule (FR5356-F-02) ``Federal Housing 
Administration: Continuation of FHA Reform--Strengthening Risk 
Management Through Responsible FHA-Approved Lenders.'' Most 
significantly, this rule eliminated FHA approval for loan 
correspondents and increased net worth requirements for lenders, 
thereby strengthening FHA's counterparty risk management capabilities.
    On April 5 of this year, FHA raised its upfront mortgage insurance 
premium from 175 basis points to 225 basis points across all FHA 
product types (purchase, conventional to FHA refinances, and FHA to FHA 
refinances).
    Subsequently, passage of H.R. 5981 granted us the authority to 
adjust the FHA annual premium. As stated in previous testimony and 
noted in the proposed budget, once this authority to adjust FHA's 
annual premium was granted, we would move to lower the upfront premium 
simultaneously with an increase to the annual premium.
    Effective October 4, 2010, FHA will reduce upfront premiums from 
225 basis points to 100 basis points and increase the annual premium to 
85 basis points from 50 basis points for loans with loan-to-value 
ratios (LTV) up to and including 95 percent and to 90 basis points from 
55 basis points for LTVs above 95 percent.
    We are confident this new premium structure is sound policy, more 
in line with private mortgage insurers' pricing, and will facilitate 
the return of private capital to the mortgage market. In addition, the 
estimated value of this change is approximately $300 million per month 
of additional income to the MMI Fund.
    Our Mortgagee Review Board, which I chair, meets monthly and has 
uncovered numerous violations of FHA origination and underwriting 
requirements. We have found false certifications and omissions, such as 
failures to verify the borrower's income and creditworthiness increased 
mortgagee review board actions. We've suspended some well-known FHA-
approved lenders and withdrawn FHA-approval for over 1,500 others. In 
addition, we imposed over $4.27 million in civil money penalties and 
administrative payments to noncompliant lenders.
    Beyond steeply increasing lender enforcement, we've strengthened 
credit and risk controls--toughening requirements on our Streamlined 
Refinance program, making several improvements to the appraisal process 
and to condominium policies, and publishing a final rule in the Federal 
Register outlining new down payment and credit score requirements.
    Specifically, FHA implemented a ``two-step'' FICO floor for FHA 
purchase borrowers, which will reduce both the claim rate on new 
insurance as well as the loss rate experienced on those claims. A 
minimum down payment of 10 percent is now required of purchase 
borrowers with FICO scores below 579, and a minimum down payment of 3.5 
percent is required for those with FICO scores at 580 and above. In 
addition, applicants with credit scores below 500 are no longer 
eligible for FHA insurance.
    Currently, we have a proposed rule in the Federal Register which is 
in the comment period to reduce the maximum permissible seller 
concession from its current 6 percent level to 3 percent, which is in 
line with industry norms. The current level exposes the FHA to excess 
risk by creating incentives to inflate appraised value. FHA's 
experience shows that loans with high levels of seller concessions are 
significantly more likely to go to claim. Experience to date on loans 
insured from FY2003 to FY2008 suggests that claim rates on high-
concession loans are 50 percent higher or more than those on low-
concession loans. We anticipate the final rule to be published before 
the end of this calendar year.
    Within our Single Family operations, we have made significant 
progress in our postendorsement review process. This year we 
implemented a new algorithm for selecting recently insured loan files 
for postendorsement technical reviews. This enhancement gives us a more 
precise way to conduct quality control reviews. Today, loans are 
selected for review based on a cascade of loan level characteristics 
that target risk, making our efforts much more effective and efficient.
    To address system and staff constraints, we have been working with 
Congress to increase staff and technical capacity to handle the 
increased volume and market dynamics we currently face. We are focused 
on technology modernization and have teams in place working to upgrade 
our technology systems. We have a long way to go, but we successfully 
delivered FHA's first comprehensive technology transformation plan to 
Congress last September, which we have been implementing throughout 
this year. In addition, we recently awarded contracts to begin 
upgrading our risk and fraud tools. We are well underway to awarding 
additional contracts, and we continue to make progress modernizing 
FHA's technology infrastructure.
    Finally, Mr. Chairman, since I arrived in July 2009, we have added 
118 net new hires to Housing's payroll, and I have implemented an 
aggressive training and human capital development plan that includes 
managerial and technical skill building training as well as on-the-job 
mentoring.

Commitment to Comprehensive FHA Reform
    Of course, the job is far from over. As important as the new 
premium authority established under H.R. 5891 is, Secretary Donovan and 
I remain committed to comprehensive FHA reform legislation that 
enhances FHA's lender enforcement capabilities and risk management 
efforts critical to our ability to monitor lender performance and 
ensure compliance. As already mentioned, we hope Congress will pass 
comprehensive FHA legislation before the end of the year.
    FHA remains committed to working with Congress to enact the full 
breadth of reforms introduced in H.R. 5072 and S. 3704, sponsored by 
Senators Begich and Brown. In addition to provisions strengthening 
FHA's lender enforcement ability, the legislation also includes 
technical clarifications that will allow for third party loan 
originators to close FHA insured loans in their name. This third party 
provision is particularly important to ensuring that several hundred 
community banks are able to continue originating FHA loans.
    Additionally, HUD is seeking Congressional authority to extend 
FHA's ability to hold all lenders to the same standard and permit FHA 
to recoup losses through required indemnification for loans that were 
improperly originated and for which the error may have impacted the 
original loan decision, or in which fraud or misrepresentation were 
involved. FHA currently has this authority for loans originated through 
the Lender Insured (LI) process, which accounts for 70 percent of FHA 
loan volume, but only 29 percent of FHA-approved lenders. FHA is asking 
that Congress grant explicit authority to require indemnification for 
loans that were improperly originated for the remaining 71 percent of 
FHA-approved lenders. FHA is simply requesting that Congress permit FHA 
to hold all lenders to the same standard; FHA is not asking for 
expansion of authorities beyond those already granted to FHA to oversee 
lenders participating in the LI program. Moreover, this legislation 
will enable FHA to prevent lenders who have demonstrated poor 
performance in one area of the country from engaging in FHA lending 
nationwide, because it is often only a matter of time before a lender 
that has shown it is unable or unwilling to engage in prudent lending 
in one geographic region exhibits the same recklessness and 
irresponsibility somewhere else.

Facilitating Our Recovery and Protecting the Taxpayer
    Chairman Dodd and Ranking Member Shelby, as you can see, we have 
proposed a comprehensive set of reforms to improve loan performance, 
hold lenders accountable, and increase revenues to the FHA fund, while 
also ensuring that FHA continues to support the overall recovery of the 
housing market and fulfill its mission of providing home ownership 
opportunities for responsible borrowers.
    However, shoring up the FHA won't solve all our housing challenges, 
which is why the Administration is working to produce a more balanced, 
comprehensive national housing policy that supports home ownership and 
rental housing alike, providing people with the options they need to 
make good choices for their families.
    Further, as important as the FHA is at this moment, I want to 
emphasize that the elevated role it is playing is temporary--a bridge 
to economic recovery helping to ensure that mortgage financing remains 
available until private capital returns. Thus, while we must remain 
mindful that qualified, responsible families need the continued ability 
to purchase a home, the changes and legislative requests that we have 
announced are crafted to ensure that FHA steps back to facilitate the 
return of the private sector as soon as possible.
    So, Mr. Chairman, while FHA must remain a key source of safe 
mortgage financing at a critical moment in our country's history, we 
recognize the risks that we face and the challenges of this temporary 
expanded role that we play in today's market. The bottom line is this: 
the loans FHA insures must be safe and self-sustaining over the long-
term. With these reforms the Administration is committed to ensuring 
that they are today--and into the future. We look forward to working 
with Congress closely on all these issues and hope to gain your support 
for our legislative requests to further reduce risks to the American 
taxpayer.
    Thank you again for this opportunity to testify. I would be glad to 
respond to any questions.

                 PREPARED STATEMENT OF MATHEW J. SCIRE
   Director, Financial Markets and Community Investment, Government 
                         Accountability Office
                           September 23, 2010

































        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
                     FROM DAVID H. STEVENS

Q.1. What steps has the FHA taken to implement the PTFA?

A.1. In conjunction with the Office of Public and Indian 
Housing, FHA issued a Federal Register Notice (Docket No. FR-
5335-N-01) on June 24, 2009, to provide general direction to 
participants in HUD programs regarding the requirements of the 
PTFA. A second Federal Register Notice (FR-5427) was published 
on October 28, 2010, which expands upon the Department's 
initial guidance and includes additional information regarding 
the updated PTFA provisions resulting from P.L. 111-203.
    Additionally, FHA is presently drafting a Mortgagee Letter 
that will address the changes issuing from P.L. 111-203, as 
well as provide administrative guidance regarding the Occupied 
Conveyance Program and the impacts of the updated PTFA on its 
implementation. FHA expects to publish this Mortgagee Letter by 
February 1, 2011.

Q.2. Have these steps been fully implemented, including 
updating all notices to tenants and directions to FHA and 
contractor employees?

A.2. The pending Mortgagee Letter will provide amended notices 
to occupants. Mortgagees servicing FHA-insured mortgages are 
required to follow all Federal, State, and local legal 
requirements for both foreclosure and eviction actions. 
Mortgagees are expected to comply with the timeline provisions 
afforded by the PTFA for bona fide tenants before issuing a 
notice to vacate and proceeding with an eviction action.

Q.3. What steps does FHA plan to take to ensure that all 
renters in FHA-held properties are guaranteed their rights 
under the PTFA?

A.3. FHA is committed to ensuring that all tenants of FHA-held 
properties are afforded the full measure of their rights under 
the PTFA. Since the issuance of the PTFA, most tenant occupied 
properties that have been conveyed to HUD have been held by 
mortgagees until the period of time granted to tenants by the 
PTFA has elapsed. After providing any bona fide tenant the 
requisite time before issuing a notice to vacate, the mortgagee 
then conducted any required eviction and conveyed the property 
to FHA vacant. There have been several situations where a 
servicer contacted FHA and advised that a bona fide tenant had 
a lease of 12 months or more and requested permission to convey 
a property to FHA occupied. For the cases that were conveyed 
occupied, FHA has required that the contractor that manages the 
Department's real estate owned inventory not list the property 
for sale and expect the tenant to continue paying rent as 
required by the existing lease until it expires. FHA has not 
initiated eviction against any occupant of a HUD-held property 
since the issuance of the PTFA.

Q.4. FHA Monthly Interest Charges. Why is an FHA borrower 
charged interest through the end of the month regardless of 
when an FHA mortgage is actually paid off, either at the time a 
home is sold, or when an FHA loan is refinanced?

A.4. Interest on FHA insured mortgages is calculated on a 
monthly rather than per diem basis. Originally, this policy was 
designed to give FHA approved lenders adequate time to 
anticipate prepayments, develop close-out balances and arrange 
for reinvestment of prepayment funds. However, most of these 
time constraint concerns have been resolved by the lending 
industry's use of advanced technology. Nonetheless, there 
remain certain benefits to borrowers in calculating interest on 
a monthly rather than per diem basis. These benefits are 
explained in greater detail below.

Q.5. Does the FHA have regulatory authority to change this 
practice and, if so, would you consider making such a change? 
If you are not inclined to change this practice, why not?

A.5. FHA does have regulatory authority to change this. 
However, in the current market, the impact on lenders and 
servicers who are in the midst of managing tremendous 
challenges in the mortgage industry, the timing for such a 
change to FHA related business processes and systems would only 
compound those challenges and stretch resources even more 
thinly. Additionally, in a review of potential impact, which is 
based on FHA experience and discussions with lenders, FHA has 
considered the following:

    The monthly interest calculation provides FHA 
        borrowers a grace period (generally 30 days) in which 
        to make mortgage payments without incurring late 
        payment fees and additional interest. This flexibility 
        is a benefit to FHA borrowers who typically have fewer 
        resources than conventional borrowers.

    The overall cost to the borrower of loans with 
        interest calculated monthly is less than that for loans 
        with interest calculated daily.

    Lenders are aware of the concern regarding the 
        requirement for a full month's interest even after the 
        loan is paid off and most address this concern by 
        closing FHA insured mortgages at the end of the month, 
        thereby minimizing the impact on borrowers at the time 
        of loan payoff. Making a dollar value assumption of 
        prepayment interest collections based on the number of 
        FHA loan originations would not be accurate.

    A change to per diem interest to accommodate only 
        those who pay off their mortgage at the beginning or in 
        the middle of the month would effectively create an 
        increase in the cost of borrowing for all FHA borrowers 
        as lenders would most likely make up the loss by 
        increasing interest rates.

    The change would require substantial changes to 
        lender, servicer, and FHA systems and loan 
        documentation.

    The aforementioned analysis is not meant to imply that FHA 
is unwilling to change its practice of utilizing a monthly 
interest calculation in favor of a per diem calculation, but is 
offered to show that there are considerations other than 
alignment with the industry that apply specifically to FHA 
borrowers, lenders and servicers and must be taken into account 
with regard to this issue.
    FHA acknowledges that, although the Federal Reserve has 
determined that the payment of interest beyond the payoff date 
on FHA insured mortgages does not constitute a prepayment 
penalty and therefore does not violate Regulation Z, it is 
still reviewing this issue and could change that determination 
in the future. However at this time, for the reasons stated 
above, FHA does not plan to pursue a change to the interest 
rate calculation.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                     FROM DAVID H. STEVENS

Q.1. Early Term Delinquencies. What threat do early term 
delinquencies, those mortgages which default in the first 18 to 
24 months after origination, pose to FHA?

A.1. Generally, early term delinquencies demonstrate that 
borrowers did not meet loan eligibility requirements at the 
time the loan was approved. Borrowers with early payment 
delinquencies are often unable or unwilling to meet their debt 
obligations, which results in a higher risk of foreclosure. If 
a lender forecloses on an FHA-insured loan, FHA is obligated to 
pay the claim. If the claims on aggregate exceed projections, 
it may impact the FHA Mutual Mortgage Insurance Fund.

Q.2. What do you think about a proposal which would require the 
FHA to establish a program which would review all early term 
delinquencies and require that the FHA indemnify any mortgages 
that were originated fraudulently and further examine the loans 
of the company that made those loans?

A.2. As of October 4, 2010, FHA began to review all loans 90 
days delinquent within the first 6 payments. In addition, FHA 
actively monitors lenders for excessive early term 
delinquencies, fraud and other risks to the FHA Mutual Mortgage 
Insurance Fund. FHA uses these performance measures to 
determine which lenders FHA will select for compliance reviews. 
As a result of deficiencies cited during these compliance 
reviews, FHA may seek indemnification against losses on loans 
with fraud or material misrepresentation.

Q.3. Why shouldn't Congress require that all mortgages found to 
be originated fraudulently or not to FHA requirements be put 
back on the company that originated the loan?

A.3. FHA takes very seriously any misconduct or deception on 
the part of participants in its programs. Such violations 
undermine public trust and negatively affect the housing 
industry and consumers. FHA is committed to its mission to 
stabilize the housing market, maintain and expand home 
ownership, and operate with a high degree of public and fiscal 
responsibility. Accordingly, all FHA-approved lenders must 
comply with applicable laws and regulations. Lenders that 
violate HUD program statues, regulations, and requirements are 
subject to appropriate sanctions, including, invalidating the 
contract of insurance for those loans originated or 
underwritten with fraud or material misrepresentation. The 
expanded indemnification authority currently being sought by 
FHA would greatly assist the Department in ensuring that 
lenders who violate FHA requirements bear the consequences of 
their recklessness, and that FHA's insurance funds are better 
protected against unnecessary losses.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                      FROM MATHEW J. SCIRE

Q.1. Mr. Scire, in your testimony you recommend that, 
``Congress should consider establishing a minimum time frame 
for restoring the capital ratio to 2 percent and clarifying a 
number of statutory provisions concerning the FHA's 
administration of the Fund.'' Do you think that should be a 
hard deadline? How much time should Congress give the FHA to 
rebuild the capital ratio once it dips below 2 percent?

A.1. Congress would need to weigh FHA's financial soundness 
with its public purpose in establishing a time frame for FHA to 
restore the capital ratio to 2 percent. A shorter time frame 
with a rigid deadline would place greater weight on the 
financial health of FHA's insurance fund. A longer time frame 
with a more flexible deadline would place greater weight on 
FHA's role in supporting the mortgage market during periods of 
economic distress. To inform its decision making on this issue, 
Congress may find it instructive to consider what occurred in 
1990, when the 2 percent requirement was enacted. Then, as now, 
the capital ratio was below 1 percent and FHA accounted for a 
significant share of the mortgage market. At that time, 
Congress gave FHA 10 years to achieve a 2 percent capital 
ratio, and the agency reached it in 5 years.

Q.2. Please detail which other statutory provisions require 
clarification and how should they be clarified?

A.2. We identified three statutory provisions regarding FHA's 
management and reporting of the Fund's condition that Congress 
should consider clarifying.

    First, a provision in the Omnibus Budget 
        Reconciliation Act of 1990 defined the capital ratio as 
        the economic value of the Fund divided by the 
        ``unamortized insurance-in-force,'' which is generally 
        understood as the initial insured loan balance. (12 
        U.S.C. 1711(f)(4)(B)). However, another provision in 
        the Act defines unamortized insurance-in-force as the 
        remaining loan balance, which is generally understood 
        to describe the amortized insurance-in-force. (12 
        U.S.C. 1711(f)(4)(D)). To avoid confusion about the 
        meaning of these provisions, we believe that Congress 
        should consider making them consistent. We believe that 
        the amortized insurance-in-force is the appropriate 
        measure of the Fund's potential liability and should be 
        used for purposes of defining the capital ratio.

    Second, a provision in the Housing and Economic 
        Recovery Act of 2008 (HERA) states that if the 
        Secretary of HUD determines there is a substantial 
        probability that the Fund will not maintain its 
        ``established target subsidy rate,'' the Secretary may 
        make programmatic or premium adjustments. (12 U.S.C 
        1708(a)(6)). However, neither HUD nor Congress has 
        established a target subsidy rate for the Fund. FHA has 
        interpreted the term to mean the capital ratio, but it 
        could also be interpreted as a credit subsidy rate (a 
        budgetary measure of the estimated lifetime cost of 
        each annual loan cohort). While FHA's interpretation is 
        consistent with the legislative language that HERA 
        amended, we believe that Congress should replace 
        ``target subsidy rate'' with a less ambiguous term.

    Third, HERA requires FHA to provide quarterly 
        reports to Congress that include ``updated projections 
        of [the Fund's] annual subsidy rates to ensure that 
        increases in risk to the Fund are identified and 
        mitigated . . . and the financial soundness of the Fund 
        is maintained.'' (12 U.S.C. 1708(a)(5)(E)). Because 
        credit subsidy rates generally are only updated 
        annually, FHA has reported the same subsidy rate 
        information in multiple reports. If the purpose of the 
        reporting requirement was to provide Congress with 
        current information on factors that may affect subsidy 
        rates, we believe that Congress should specify more 
        clearly the nature and extent of the information that 
        it is seeking. In our report, we cited cohort-level 
        delinquency trends and changes in economic forecasts as 
        examples of the types of information that Congress may 
        find useful.

Q.3. The FHA has asked Congress for the ability to indemnify 
mortgages that are found to be fraudulent. Should the FHA be 
required to indemnify those mortgages or should it be left to 
the discretion of the Commissioner whether or not to indemnify 
fraudulent mortgages?

A.3. We have not conducted work on FHA's indemnification 
authority and therefore have not explored whether or not there 
are circumstances under which the Commissioner would require 
discretion to effectively exercise this authority.

Q.4. What threat do early term delinquencies, those mortgages 
which default in the first eighteen to twenty four months after 
origination, pose to FHA? What do you think about a proposal 
which would require the FHA to establish a program which would 
review all early term delinquencies and require that the FHA 
indemnify any mortgages that were originated fraudulently and 
further examine the loans of the company that made those loans?

A.4. Early default rates are an important gauge of the strength 
or weakness of recent loan cohorts. They are also an indicator 
of potentially unsound underwriting practices (including fraud) 
that can lead to foreclosures and FHA insurance claims. 
Therefore, we believe that early defaults and lenders with 
relatively high proportions of such loans should be subject to 
close review and oversight. Important factors to consider in 
evaluating a proposal to review all early defaults are the 
capacity of FHA's workforce to conduct such reviews and how the 
reviews would fit in with FHA's existing oversight and 
enforcement efforts, which include onsite examination of lender 
loan records and sanctions against lenders with high early 
default and claim rates. At the request of the Chairman and 
Ranking Member of the Senate Committee on Banking, Housing, and 
Urban Affairs, we are currently reviewing FHA's capacity to 
oversee lenders and other program participants.

Q.5. Should the FHA continue to allow borrowers to finance 
mortgage insurance premiums and closing costs? As you state in 
your testimony in some cases this results in a mortgage loan 
over the value of the home. What risk does that expose the 
taxpayers to given that they ultimately stand behind 100 
percent of the value of the loan insured--a very real exposure 
given the FHA is currently below its mandatory 2 percent 
capital ratio requirement?

A.5. Although FHA requires borrowers to make a cash investment 
of at least 3.5 percent of the home's purchase price, FHA's 
policy of allowing borrowers to finance their upfront insurance 
premium and some closing costs results in an effective loan-to-
value (LTV) ratio of close to 100 percent for some FHA-insured 
mortgages. We and others have reported on the importance of the 
LTV ratio as a predictor of default. \1\ The higher the LTV 
ratio, the less cash borrowers will have invested in their 
homes and the more likely it is that they may default on 
mortgage obligations, especially during times of economic 
hardship. Not allowing FHA borrowers to finance upfront 
premiums and closing costs would reduce FHA's financial risk 
(all other things being equal) but also would make it more 
difficult for some borrowers to qualify for mortgages. Any 
changes to FHA's current policy would need to consider this 
tradeoff.
---------------------------------------------------------------------------
     \1\ GAO, Mortgage Financing: Actions Needed To Help FHA Manage 
Risks From New Mortgage Loan Products, GAO-05-194 (Washington, DC: Feb. 
11, 2005).

Q.6. Should the FHA continue to insure 100 percent of the value 
of the loan? How does this compare to the structure of private 
mortgage insurance? Does the FHA's structure create an 
incentive for mortgage originators to prefer FHA insurance to 
---------------------------------------------------------------------------
private mortgage insurance?

A.6. In a 2007 report, we discussed a number of options for 
increasing FHA's operational flexibility, including authorizing 
FHA to insure less than 100 percent of the loan value. \2\ At 
that time, private mortgage insurers offered several levels of 
insurance coverage up to a maximum of 40 or 42 percent 
(depending on the company) of the value of the loan. Since most 
FHA insurance claims are offset by some degree of loss 
recovery, some mortgage industry observers have suggested that 
covering 100 percent of the value of the loan may not be 
necessary. While lower coverage could cause a reduction in the 
volume of FHA-insured loans and a corresponding decline in 
income from premiums, it could also result in reduced losses 
and ultimately have a beneficial effect on FHA's insurance 
fund. However, partial FHA coverage may lessen FHA's ability to 
stabilize local housing markets when regional economies decline 
and may increase the cost of FHA-insured loans as lenders set 
higher prices to cover their risk. We have not examined the 
extent to which FHA's insurance structure affects incentives 
for mortgage originators.
---------------------------------------------------------------------------
     \2\ GAO, Federal Housing Administration: Modernization Proposals 
Would Have Program and Budget Implications and Require Continued 
Improvements in Risk Management, GAO-07-708 (Washington, DC: June 29, 
2007).

Q.7. Have you examined whether or not the solvency of the FHA's 
fund would benefit from increasing the minimum down payment 
requirement from 3.5 percent to 5 percent? If so, what did you 
---------------------------------------------------------------------------
learn?

A.7. We have not examined this particular question. However, 
our prior work indicates that lower LTV ratios (i.e., higher 
down payments) and the absence of down payment assistance 
reduces FHA's financial risk, all other things being equal. \3\
---------------------------------------------------------------------------
     \3\ See, GAO-05-194 and GAO, Mortgage Financing: Additional Action 
Needed To Manage Risks of FHA-Insured Loans With Down Payment 
Assistance, GAO-06-24 (Washington, DC: Nov. 9, 2005).
