[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
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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
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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.
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\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
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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.
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\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
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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\
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\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).