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



 
TRANSPORTATION AND HOUSING AND URBAN DEVELOPMENT, AND RELATED AGENCIES 
                  APPROPRIATIONS FOR FISCAL YEAR 2011

                              ----------                              


                         THURSDAY, MAY 13, 2010

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 9:32 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Patty Murray (chairman) presiding.
    Present: Senators Murray and Bond.

              DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

                     Federal Housing Administration

STATEMENT OF HON. DAVID H. STEVENS, COMMISSIONER
ACCOMPANIED BY KENNETH M. DONOHUE, INSPECTOR GENERAL

               OPENING STATEMENT OF SENATOR PATTY MURRAY

    Senator Murray. Good morning. This subcommittee will come 
to order.
    This morning we welcome Commissioner Stevens to his first 
appearance before our subcommittee as we examine the Federal 
Housing Administration and its role in the housing market.
    As we sit here today, millions of Americans are out of work 
and many more are struggling with unaffordable mortgage 
payments, negative home equity, or foreclosure. During the 
housing boom, millions of Americans achieved the dream of home 
ownership, but for far too many Americans, these dreams were 
based on false premises and fueled by investors and lenders 
that were chasing profit while ignoring risk. The consequences 
of these risky behaviors have rippled through the national and 
global economies with mounting foreclosures, a crippled housing 
market, and a financial sector in turmoil. We continue to clean 
up the mess created by predatory lenders and Wall Street greed.
    Fulfilling the same role as it did when it was created 
during the Great Depression, the FHA has stepped forward to 
help provide liquidity and restore stability to the housing 
market. FHA's increased role in the housing market is as 
critical as it is daunting. As recently as 2007, when this 
subcommittee held the first in a series of annual hearings on 
FHA, its share of the market was only 3 percent. Today FHA 
represents nearly 30 percent of all new home sales. FHA has 
played a critical role supporting the housing market while 
private financing has been nearly frozen.
    However, FHA has been plagued by longstanding management 
challenges, challenges that continue to raise concern about its 
ability to manage its outsized role in stabilizing the market. 
Commissioner Stevens, you have acknowledged the challenges you 
inherited when you took over the agency and have moved quickly 
to assess and seek solutions to the problems facing FHA. The 
most glaring of these are antiquated information technology 
systems and an inadequate workforce, both of which are critical 
to equipping the agency to meet the challenges that face us. A 
well functioning FHA is vital to maintaining the solvency of 
the Mutual Mortgage Insurance Fund and protecting the American 
taxpayers from having to pay for risky or fraudulent mortgages. 
This subcommittee provided additional resources to help FHA 
address its shortcomings both in 2009 and 2010. We provided 
funding to help FHA modernize its IT systems and hire 
additional staff to better manage and oversee a growing 
portfolio.
    Equally important to these new tools is fostering a culture 
at FHA focused on risk. Commissioner Stevens, one of your first 
actions after taking office was to appoint FHA's first chief 
risk officer. This position was long overdue and sends an 
important signal to lenders, borrowers, and taxpayers that FHA 
understands the risks it faces and is working to mitigate them. 
I am pleased that the FHA is increasingly using its authority 
to investigate lenders that are not playing by the rules. It 
must be absolutely clear to lenders engaging in fraudulent and 
risky practices that they are not welcome in FHA programs and 
will not be supported by taxpayer dollars.
    Despite some important progress, FHA still faces 
significant challenges. Foreclosures have taken their toll on 
FHA's finances, leaving the capital reserve fund below the 2 
percent required by Congress. This is a cause for concern since 
any significant setbacks in the housing market could result in 
additional and possibly unaffordable losses to the fund.
    In an effort to strengthen the agency's finances and 
protect itself from future risk, HUD has proposed a series of 
reforms, including increasing premiums, setting minimum FICO 
scores, increasing downpayment requirements for riskier 
borrowers, and expanding enforcement authorities. Some of these 
changes are already underway but others will require 
legislation.
    Today I will have questions about these reforms, what they 
mean for fulfilling FHA's mission to provide access to 
affordable mortgages, as well as how they impact the solvency 
of the MMI Fund as we look to the future. It is clear that the 
solvency of the MMI Fund and the strength of FHA depend on the 
recovery of the housing market. This is evident by CBO's re-
estimate of receipts that FHA is expected to generate in 2011. 
Continued uncertainty about the housing market, as well as 
lingering doubts about FHA's ability to realistically assess 
its risks, resulted in CBO's much more conservative estimate of 
$1.9 billion in receipts instead of the $5.8 billion projected 
by the administration.
    The concerns expressed by CBO are real. Relatively stable 
home prices and increasing home sales suggests the market is 
stabilizing. Yet, large segments of the housing market remain 
fragile and there are looming problems that could undermine the 
progress we have made. Over 2 million homes are currently in 
foreclosure and that number is expected to grow through 2010.
    To date, the administration's Home Affordable Modification 
Program has had limited success in stemming the tide of 
foreclosures. There have only been 230,000 permanent 
modifications made under this program far short of the 3 
million to 4 million homeowners expected. And as banks and 
servicers determine whether a modification is in their best 
interest, many families are left waiting as they face the 
agonizing prospect of losing their home. I continue to hear 
that servicers are unresponsive to borrowers and in some cases 
unwilling to explain why modifications are denied. Americans 
trying to get assistance are frustrated and rightfully so. They 
have watched as banks have received billions of dollars in 
taxpayer assistance and yet many of these same banks are 
unwilling to assist homeowners facing foreclosure. This cannot 
be tolerated. Servicers must be held accountable. At the very 
least, servicers must communicate with those trying to receive 
assistance and provide an explanation if borrowers are not 
approved.
    The success of HAMP was also limited because it failed to 
address two of the major problems facing troubled borrowers 
today: unemployment and negative equity. I have seen this 
tragic combination devastate families firsthand in communities 
across my State. In Clark, Snohomish, and Pierce Counties, 
communities are struggling with both unemployment and 
foreclosure, and unfortunately, home prices have yet to 
stabilize in Washington State, so families are continuing to 
see the equity of their homes decline. Nearly 16 percent of all 
Washington homeowners are under water and they are not alone. 
Over 11 million families in the country today are under water 
on their mortgages as a result of falling home prices and 
growing debt. That represents nearly one out of every four 
mortgages.
    Just a few months ago, the administration announced plans 
to change HAMP in order to address these problems. The plans 
include offering increased relief for unemployed borrowers as 
they look for work and get back on their feet, as well as 
incentives for lenders to permanently write down the principal 
of these mortgages instead of addressing interest rates. These 
changes were necessary to more effectively address the 
foreclosure crisis, but I remain concerned that since this 
program is voluntary, it will fail to meet its goal.
    So I expect the administration to compel lenders to provide 
real aid to families that want to and, with a fair deal, could 
stay in their homes. As part of these announcements, FHA's 
refinance program is also set to be expanded. This is an 
important tool that will assist homeowners to get into a truly 
affordable mortgage through incentives and write-downs of both 
first and second liens. While these loans will be subject to 
FHA underwriting standards, there is still an increased risk 
associated with those loans. In order to mitigate the effects 
of these riskier loans on the health of FHA's insurance fund, 
the administration has set aside $14 billion in TARP funds.
    However, many of the details surrounding this proposal are 
still being worked out, and I am concerned this could result in 
additional losses to the MMI Fund, losses the fund simply 
cannot absorb. So I will have questions today about the design 
of this program and how we can be assured this program will not 
cost American taxpayers anything more than what was already set 
aside from the TARP funds.
    Amidst all these efforts to modify mortgages so families 
can stay in their homes, there are a growing number of 
homeowners deciding to strategically default. Many of these 
homeowners can afford their mortgage payments, but because of 
the severe negative equity, they feel it is in their financial 
interests to simply walk away. The potential impact of this on 
home values and market stability would be devastating.
    There is also the very real concern about what is called 
the ``shadow inventory.'' These are houses that are facing 
foreclosure or have already been repossessed by the bank but 
are not yet on the market. Hopefully the impact of these will 
be lessened by an increase in permanent modifications, but if a 
large number of homes were to suddenly flood the market, all of 
our gains in home values could be erased.
    These issues demonstrate how fragile the housing market 
remains, but we are beginning to test its stability. The 
Federal Reserve ended its purchase of mortgage-backed 
securities at the end of March and the homebuyer tax credit 
ended last month. Even as we watch with some anxiety as these 
supports are withdrawn, it is clear the Government cannot 
continue to play the outsized role in the housing market it has 
taken on over the past 2 years. The long-term health of the 
housing market and the economy depend on the return of the 
private market.
    It is also clear we must address the future role of Fannie 
Mae and Freddie Mac in the housing market. There is no doubt 
that the GSEs had a hand in exasperating the housing crisis, 
and just as there needs to be consequences for Wall Street, 
there must also be consequences for the GSEs. The spigot of 
taxpayer dollars flowing into the GSEs cannot stay on 
indefinitely. As the administration debates the future of the 
GSEs, I like most Americans are growing impatient and my 
impatience only increases as the cost to the American taxpayers 
grows with no end in site.
    The administration must put forward a real plan on how to 
reform the GSEs. GSEs currently provide important support to 
the housing market, and so this plan has to be thoughtfully 
done with care not to reverse the hard-won progress made to 
date. The plan must include a clear understanding of how any 
changes will impact the housing market and Americans' ability 
to buy a home for their families, but it is simply not enough 
to say it is complicated and we have a plan soon. It is not 
easy. It deserves an honest and open dialogue about its future, 
but there needs to be a sense of urgency that has been lacking 
so far.
    As we try and tackle the complex set of challenges facing 
the housing market today, the Federal Government must play a 
role in supporting the market but it must also protect the 
taxpayers.
    Commissioner Stevens, this has been your task since taking 
on the FHA, and I want to commend your commitment to addressing 
the challenges at FHA while working to ease the recovery of the 
housing market. I look forward to hearing your testimony today.
    And with that, I turn it over to my partner and ranking 
member, Senator Bond, for his opening statement.

            OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND

    Senator Bond. Good morning, Madam Chair.
    And thank you very much, Commissioner Stevens, for being 
with us today.
    The chair has outlined the very significant problems that 
we have in the whole area of housing, not just in FHA, but I 
found her comments on the GSEs very similar to my concerns. We 
are in a real problem, and your efforts with FHA and your 
guidance on other things may be of help to us in trying to find 
a way out.
    We are pleased to have on the front row Ken Donohue, the 
HUD inspector general. Over the years, he in particular has 
been a true partner working with me and others to eradicate 
fraud and abuse in the mortgage market. And that is not to 
diminish all the hard work both he and his staff perform in 
their oversight capacity in the Office of the HUD inspector 
general. This may be our last time to have a little gathering 
like this, Mr. Donohue, but you have my sincere thanks for 
being the uninvited guest at the garden party at so many of 
these hearings where you have had to tell the truth, and I am 
just lucky that you--we are both lucky that you did not get 
tarred and feathered for having warned us in advance of the 
problems we are facing. Now that we are seeing those problems, 
we can call you a guru, I guess, for having warned of many of 
the problems.
    Well, with that beginning, Mr. Commissioner, as you know, 
FHA's history is marked by longstanding challenges in balancing 
the financial risk to FHA which we are seeing is significant 
and also very important is the goal of expanding home 
ownership, especially for low-income and first-time home 
buyers. This is the promise of FHA.
    Unfortunately, much of the financial risk in the housing 
market, which is a risk to all of us as taxpayers, is 
uncertain. It is especially problematic since FHA still faces 
many challenges and is still evolving to limit FHA's financial 
exposure. Additional reforms we need to discuss, and I am still 
concerned the FHA is a powder keg that could explode, leaving 
the taxpayers on the hook for another bailout. To borrow the 
term from the gulf and the recovery efforts there, I think you 
are trying to put a cap on the well. We just hope it is more 
successful than the ones they have tried in the Gulf of Mexico.
    As recently as 2007--okay, I stretched it a little bit. 
Okay, all right. I know when I get that look from the chair she 
is saying where is he going with this one. That is off the 
record. You can scratch that.
    As recently as 2007, FHA accounted for less than 4 percent 
of the single family housing market, whereas FHA, as we all 
know, now dominates market with a share of about 30 percent of 
new mortgages and another 20 percent of refinances. While this 
market share may help the Federal oversight of home purchases, 
there is nothing predictable in FHA's enhanced role in the 
market for assessing the potential for financial risk to the 
FHA, the Mutual Mortgage Insurance Fund, the MMIF that has 
already been referred to, and those of us as taxpayers.
    There is no guarantee the housing market is on the rebound 
or that it will not collapse again, even though prospects are 
certainly more encouraging than they were a year ago. But with 
continuing high unemployment as well as the explosive and 
escalating Federal debt, I think the problems have not gotten 
much less severe. One of the essential questions we must ask is 
are we digging a grave with spending or filling one in.
    As recently as late last year, FHA was unable to meet its 
statutory requirement of holding capital reserves equal to 2 
percent of FHA's insurance in force. I am a born optimist and I 
could be optimistic that FHA will be able to meet this 
requirement in the future, but there remains wide disagreement 
as to the health of FHA's MMIF, with OMB's budget estimate for 
FHA receipts in 2011 at some $5.8 billion, as the chair 
indicated, which is about $4 billion more generous than the 
CBO's re-estimate. This disparity both underlines the 
unpredictability in the future of the overall housing market, 
as well as uncertainty as the financial risk to FHA's single 
family mortgage insurance programs.
    The CBO re-estimate also means we will likely have to 
tighten our belts with regard to other programs within the 
jurisdiction of the THUD appropriations subcommittee. Let me 
assure you that others coming in here before us have grand 
schemes of how much money they want to spend, but there is a 
lot of money in this area we have to spend. So we need to get 
an idea of how much we will be called upon to produce.
    Nevertheless, Mr. Commissioner, I believe you are moving 
FHA in the right direction, as I told you earlier, and 
particularly HUD and FHA currently are proposing some 
significant changes to shore up the FHA single family mortgage 
insurance program by including an increase to annual premiums, 
as well as implementing a credit-related risk assessment. That 
assessment, as I understand it, would allow borrowers with a 
FICO score of 580 and above to make a 3.5 percent downpayment 
while home buyers with a FICO score of between 500 and 580 
would be required to make a minimum downpayment of 10 percent. 
Borrowers with FICO scores below 500 would be ineligible for 
FHA mortgage insurance.
    Some people are better off renting until they have the 
downpayment, and that is a point we have made before. We need 
to make sure rental housing is available so that people who 
cannot afford to buy a house do not get pushed into buying a 
house that they cannot afford. This has been a mistake that has 
been endemic in policymakers for the last 20 years in 
Washington. I will not cite the list of Members of Congress who 
pushed for it. I would say that it has been bipartisan at the 
administration level, and for 8 years, I fought the Bush 
administration pushing for the American dream no-downpayment 
home, which I characterized then, with some little guidance 
from the inspector general, as being a recipe for turning the 
American dream into the American nightmare.
    But I think that the changes you are implementing, while 
they continue to promote home ownership, should lower the risk 
of financial exposure to the Federal taxpayer and the Federal 
Government. I know you have proposed a number of other reforms 
designed to protect the integrity of FHA and MMIF, including 
reforms to the appraisal process and a proposal to increase net 
worth requirements for FHA lenders.
    These are controversial, but I am a firm believer that our 
financial system will be much stronger if people up and down 
the line; borrowers and securitizers and everybody else, has 
skin in the game. You look at Canada; they require a lot of 
skin in the game. They have a higher percentage of home 
ownership and much lower problems than we do because people 
there have to have skin in the game, which is the name of 
business.
    Reforms are important but FHA still faces many challenges. 
I am concerned about the programs for default mitigation. We do 
not want to leave homeowners behind unless the financial 
criteria demand such an approach. If there is no way they can 
get out, we need to resolve it as humanely as possible and move 
on.
    What role is HUD expecting to play over the next few years 
with regard to the administration's foreclosure mitigation 
policies and how will HUD reforms impact these policy efforts?
    And while FHA seems to have been the administration's 
initial choice for implementing the administration and 
Congress' foreclosure mitigation strategies--congratulations on 
getting the ball on that one--much of the emphasis now seems to 
have shifted to Treasury and the GSEs, especially Fannie Mae 
with their GSE losses buried in TARP payments. It would be very 
helpful for us to understand Fannie and Freddie's new role in 
the mortgage crisis, especially since the GSEs recently 
reported fourth quarter losses, I believe, totaling $18 billion 
with an overall request of some $76 billion from Treasury's 
unlimited credit line. That is a number that should scare all 
of us. Last Monday, Fannie reported losses of another $8.4 
billion. That is beginning to mount up to real money.
    We cannot fool ourselves that these are just losses from an 
old book of business. Instead, Freddie was directed by the 
administration to buy back troubled loans from investors and 
obviously is taking losses on these mortgages. In fact, this 
policy appears to bail out lenders on their risky investment 
but it does little to save a home with a risky loan for a 
homeowner. And I am asking myself and others why. Why are we 
bailing out investors? That to me is a major concern.
    As of last month, the opportunities to forestall housing 
foreclosures were virtually limited to wishful thinking where 
families could receive test funding for foreclosure mitigation 
but where the majority of these families would not qualify for 
mortgage reform and more permanent mortgage reform options.
    Despite the administration's more optimistic view, without 
more options by the administration, families are destined to 
fall deeper in debt and be unable to meet the needed 
qualification for the mortgage reform permanent option. In 
other words, it is extremely unlikely that more than a 
scintilla of homeowners with looming mortgage foreclosures and 
high debts will qualify for the more permanent, long-term 
program.
    That is bad news. The worse news is the longer we wait, the 
worse it will get. I think there are a number of other issues 
that have to be investigated somewhere, and I guess that we are 
about the only ones interested in it. There have been a number 
of articles that claim the affordable housing program under 
which Fannie and Freddie were required by law to invest in low-
income housing helped to destabilize the GSEs. More troubling 
were Congressman Frank's efforts to tax Fannie's and Freddie's 
profits at more than $1 billion annually to benefit favored 
nonprofits and I would mention the infamous ACORN. These 
legislative requirements I think reinforce losses and undermine 
the financial credibility of the GSEs in the financial markets.
    Most important, we need to know the administration's 
overall plan for revitalizing the housing industry and what 
will be the overall menu of tools for addressing the mortgage 
default crisis under FHA, the GSEs, Treasury, as well as other 
entities.
    Finally, not everyone will be eligible for foreclosure 
mitigation relief, especially those without permanent 
employment or other income. Nevertheless, as we move forward, 
it is important that we all understand the contours of the 
various foreclosure mitigation programs and the potential 
exposure for additional financial losses in the housing 
marketplace both to the Federal Government as well as to other 
entities, families, and individuals.
    I am very interested in how many homeowners we are likely 
to help and how many are likely to lose their homes. The answer 
is likely to be very troubling, as evidenced by a very negative 
report in March by the National Association of Homebuilders in 
its index which tracks home purchases.

                        FHA STAFFING SHORTFALLS

    In addition, I am anxious to hear how FHA is addressing its 
staffing and expertise shortfalls as well as its plans to 
update fully the FHA IT systems. While there have been a number 
of comprehensive briefings with congressional staffs on these 
issues with FHA recently submitting a comprehensive staffing 
plan to Congress on its progress toward hiring an additional 
118 FTEs for FHA-related activities, much remains to be done. 
The sooner we understand fully HUD's capacity and funding needs 
in these areas, the better we will able to respond through 
appropriations to the needs of HUD and FHA.
    Finally, congratulations on your efforts on the mortgage 
and the mortgage insurance fraud. We cannot understate the fact 
that enforcement against mortgage fraud remains an area of 
overall weakness throughout the Nation, the mortgage market and 
likely FHA. I understand, however, FHA is making substantial 
progress with reforms in its mortgage programs, especially by 
eliminating the participation of bad lenders in the FHA program 
that should not be there.
    In the predecessor to this subcommittee, the VA, HUD 
subcommittee, Senator Mikulski and I learned that these reforms 
are likely to be the tip of the iceberg, and now I would urge 
HUD and the HUD inspector general to continue to work with the 
Department of Justice and Treasury, along with other agencies, 
to develop a set of coordinated plans to put predatory lenders 
who are criminally at fault in prison. Seeing some of these 
people in orange jumpsuits may be one of the best remedial 
actions we can take.
    Now not only does FHA require larger net worth requirements 
for all of its FHA lenders, it is also reviewing lender 
enforcement activities. In particular, as your written 
testimony indicates, since July 2009, FHA has referred some 365 
cases of mortgage fraud or negligence to the Mortgagee Review 
Board. These investigations have resulted in the withdrawal of 
approval to underwrite FHA loans for some 354 lenders and the 
suspension of underwriting authority for another 6 lenders. It 
would be helpful to know what additional legislative 
authorities may be needed by HUD and the HUD inspector general 
to stop mortgage fraud and abuse around the Nation, including 
the laws that require jail sentences when some form of mortgage 
fraud is the subject of criminal action.
    With that pessimistic statement, I look forward with 
optimism and enthusiasm to hearing your testimony, Commissioner 
Stevens.
    Senator Murray. Thank you very much, Senator Bond.
    Mr. Stevens, we will turn to you for your opening 
statement.

                   STATEMENT OF HON. DAVID H. STEVENS

    Mr. Stevens. Thank you, Chairwoman Murray and Ranking 
Member Bond. And thanks for the opportunity to be here to 
testify about the Federal Housing Administration's recent 
reforms, legislative proposals, contributions to the 2011 
budget, and any other subjects that may be of interest.
    I also do want to recognize, as you did, Senator, the 
involvement of the inspector general. He has been a very 
valuable advisor to me coming into this role with all the 
challenges we face, and we have had some great opportunities to 
partner. I share the zeal for enforcement on fraud and other 
issues, not just in the single family area, but the inspector 
general has been helpful in advice on multifamily issues and 
health care issues as well. So it is a critical partnership 
that I value very highly.
    I appear before you at a moment when it is clear that the 
housing market has made significant progress toward stability. 
With the past year's record-low mortgage rates, thanks in large 
part to the administration's initiatives, more than 4 million 
homeowners have refinanced their mortgages to more affordable 
levels. This helped save homeowners more than $7 billion last 
year. More than 1 million families are saving an average of 
$500 per month through the administration's mortgage 
modification program, otherwise known as HAMP. Home equity has 
increased on average by more than $13,000 for homeowners in the 
last three quarters of 2009, and these efforts have begun to 
restore the confidence we need to get the economy moving, 
creating 290,000 jobs last month, the largest monthly increase 
in 4 years.

                                  FHA

    There is also encouraging news relating to foreclosures. 
Just this morning, RealityTrac released its latest monthly U.S. 
foreclosure report which shows foreclosure activity actually 
decreased 9 percent in the month of April. And FHA's second 
fiscal quarter numbers show our early delinquencies are better 
than expected. The number of loans in early default and claims 
has declined 15 percent since December, a strong indicator that 
the loan quality is improving.
    The FHA has been essential to the improved outlook in the 
housing market. In the past 18 months, FHA protected 650,000 
families from foreclosure, enabled more than 1.1 million 
homeowners to refinance into stable, affordable, fixed-rate 
mortgages, and insured 1.4 million new purchase loans, more 
than 80 percent of which were first-time home buyers. Indeed, 
as access to private capital has contracted in these difficult 
times, borrowers and lenders flocked to FHA, and the increased 
presence of FHA has help support liquidity in the purchase 
market, helping us ride through these difficult times until 
private capital returns.
    During that time, Fannie and Freddie under conservatorship 
have also played an important role in stabilizing the market. 
The administration strongly supports the need for reform of the 
Government-sponsored enterprises and looks forward to working 
with Congress to enact meaningful reform in a manner that does 
not disrupt the Federal housing markets, nor increase the cost 
and reduce the availability of mortgages for American 
households. Toward this goal, we strongly support efforts to 
require thoughtful and thorough review, public commentary, and 
final study of reform options going forward.
    While progress is clearly being made on many fronts, we 
continue to see challenges. The administration's strategies to 
address the housing crisis has evolved because our challenges 
have evolved. On March 26, we announced the FHA refinance 
option in conjunction with provisions to the HAMP modification 
program to tackle the challenge of underwater borrowers, one of 
the biggest threats to our continued recovery. The FHA 
refinance option will provide more opportunities for lenders to 
restructure loans for families who owe more than their home is 
worth due to price declines in their communities. These 
adjustments support principal reduction efforts already 
underway in the private market and offer incentives to expand 
their reach. The vast majority of the burden of writing down 
these loans will fall where it belongs, on lenders and 
investors, not the taxpayer. It is because FHA is in a stronger 
position today that we are able to facilitate these efforts to 
help more struggling homeowners.
    With FHA's increased role, however, there is risk and 
responsibility. In addition to several policy changes that I 
have made since taking office on January--or we have made since 
January 20 of the year, we proposed several reforms to mitigate 
risk and replenish FHA's capital reserves. Some of these steps 
require legislative authority.
    Thank you for the opportunity to explain these proposals in 
more detail in conjunction with the contributions to HUD's 
budget for the fiscal year 2011.
    These policy changes have three guiding principles that we 
are balancing in all of them. First is how does it improve the 
capital reserves of FHA. Second, how does it impact the broader 
housing market and the recovery? And third, how does it impact 
FHA's role to provide opportunities for the underserved?
    So first, we are asking Congress for authority to 
restructure FHA's mortgage insurance premiums. We would like to 
reduce the up-front premium to 100 basis points and increase 
the annual premium to 85 or 90 basis points, depending on the 
LTV. To more substantially increase FHA's reserves and 
facilitate the return of private capital to the mortgage 
market, these changes are needed.
    We greatly appreciate the cooperation of Congress in 
support of these reforms, and on April 27, the House Financial 
Services Committee passed H.R. 5072, the FHA Reform Act, on a 
voice vote. The bipartisan authorizing bill would enable FHA to 
enact these proposed changes, which will further strengthen 
FHA's reserves and overall stability. And we look forward to 
working with this subcommittee and the Senate Banking Committee 
to enact similar legislation in the Senate as quickly as 
possible. If these changes are adopted during this current 
fiscal year, they would increase the value of the MMI Fund by 
approximately $300 million per month, which would replenish 
FHA's capital reserve even faster than if the authority was 
provided through the annual appropriations process.
    Second, FHA is producing a two-step FICO floor for FHA 
purchases. Purchase borrowers with FICO scores of 580 and above 
would be required to make the minimum 3.5 percent downpayment. 
Those with FICO scores between 500 and 579 would be required to 
make a 10 percent downpayment. Anything below 500 would not be 
allowed.
    Some have suggested that FHA raise the minimum requirement 
to 5 percent across-the-board as a way to improve loan 
performance. As you can see, we have gone further to 10 percent 
for low FICO scores to ensure that we are only insuring 
responsible loans. We determined, after extensive evaluation, 
that an across-the-board 5 percent proposal would be inadequate 
to control risk for some borrowers and excessive to control 
risk for responsible borrowers, which would adversely impact 
the housing market recovery. Increasing minimum downpayments to 
5 percent across-the-board would translate to 300,000 fewer 
responsible first-time home buyers having access to home 
ownership and would have significant negative impacts to the 
broad housing market recovery. It would forestall the recovery 
of the housing market and potentially lead to a double dip in 
home prices by significantly curtailing demand. The policy 
changes that FHA has instead proposed in the 2011 budget would 
contribute an additional $4.1 billion in additional receipts to 
FHA and continue to support the broader housing market 
recovery.
    The third policy change we are proposing is to reduce 
maximum seller concessions from its current 6 percent to 3 
percent, which is in line with industry norms.
    Our fourth proposal is to increase lender enforcement. In 
our 2009 fiscal year actuarial review, the independent actuary 
projected more than 71 percent of FHA's losses over the next 5 
years will come from loans already on our existing books. That 
is why we have renewed our focus on enforcement and 
accountability, and since 2009, we have taken more action on 
more than six times the number of lenders than FHA had done in 
the past decade.
    This year, we are requesting an appropriation of $250 
million for FHA's reverse mortgage product. The HECM program 
provides seniors with a means to access their home equity to 
make ends meet and provide funds to pay for long-term health 
care and afford necessary home repairs and housing expense. We 
have conducted extensive analysis to identify the maximum 
policy changes we could perform to reduce risk to the taxpayer 
and maintain viability of the program. Without the budget 
request, we would be forced to reduce the amount of funds that 
would be available to seniors by more than 30 percent, which is 
an average of $23,000 to $27,000 in impact. Given the value of 
the program in assisting this critical population, HUD has 
requested an appropriation to maintain viability of the program 
for seniors while we are evaluating a broader range of program 
changes that may be necessary to ensure the success of HECM for 
the long term.
    Finally, as you know, the CBO released its re-estimate of 
the 2011 budget, including the review of the FHA changes. 
Although the CBO estimate includes a significantly more 
conservative assessment of how these new changes made through 
the FHA's MMI Fund will perform in the coming years, both CBO 
and the administration forecast that with our proposed FHA 
changes, such credit activity will result in net receipts to 
the Government. We differ, however, on the amount. While the 
President's budget forecasts $5.8 billion in receipts, CBO re-
estimated those net savings at $1.9 billion. In addition, CBO 
agreed with our forecast that Ginnie Mae and our GI SRI fund 
will result in roughly $1 billion more in net receipts.
    While recognizing such a difference with CBO complicates 
budget resolution development, it is important to note that the 
$5.8 billion in receipts forecast in the President's budget 
will determine any receipts transferred to FHA's capital 
reserves. This will help the fund get back on track to be 
capitalized with the statutorily mandated 2 percent of 
insurance in force. I would also note that we remain confident 
in our forecast.

                          PREPARED STATEMENTS

    I have submitted a more detailed testimony for the record, 
but Madam Chairwoman, 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, continues to serve its mission 
of providing home ownership and financial opportunities for 
responsible borrowers and seniors. We look forward to working 
with Congress closely on all the issues and hope to gain your 
support for our budget proposal and legislative requests to 
further reduce the risk to the American taxpayer.
    And with that, I am happy to answer questions.
    [The statements follow:]

              Prepared Statement of Hon. David H. Stevens

    Chairwoman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for the opportunity to testify today regarding 
the Federal Housing Administration's (FHA's) recent reforms, 
legislative proposals, and contributions to the HUD fiscal year 2011 
budget request. FHA remains focused on providing access to home 
ownership, while minimizing the risk to the American taxpayer is of the 
utmost importance.

                HELPING PREVENT AN ECONOMIC CATASTROPHE

    As you know, when this administration took office just over 15 
months ago, the economy was hemorrhaging over 700,000 jobs each month, 
housing prices were in free fall, residential investment had dropped 
over 40 percent in just 18 months, and credit was frozen nearly solid. 
Many respected economic observers warned that a second Great Depression 
was a real possibility, sparked of course by a crisis in the housing 
market. Meanwhile, communities across the country--from central cities 
to newly built suburbs to small town rural America--struggled to cope 
with neighborhoods devastated by foreclosure, even as their soaring 
jobless rates and eroding tax base crippled their ability to respond.
    As we move beyond the peak of the recent global financial crisis, 
though there is still a long way to go, it is clear that the Nation's 
housing market has made significant progress toward stability. Through 
the combination of coordinated efforts by Treasury, HUD, and the 
Federal Reserve to stabilize the housing market, we are seeing real 
signs of optimism.
    As measured by the widely referenced FHFA index, home prices have 
significantly stabilized since last April. As recently as January 2009 
house prices had been projected to decline by as much as 5 percent in 
2009 by leading major macro-economic forecasters. This housing 
stabilization is all the more surprising since most forecasters had 
underestimated the rise in unemployment that has occurred over the past 
year.
    Homeowner equity started to grow again--increasing by over $1 
trillion by the end of December, or $13,000 on average for the Nation's 
nearly 75 million homeowners, and helping our economy grow at the 
fastest rate in 6 years in the fourth quarter of last year.
    And mortgage rates which have been at or near historic lows for 
more than a year have spurred a refinancing boom that has helped nearly 
4 million borrowers in 2009--freeing up an additional $7 billion 
annually, some of which will be spent in local economies and 
businesses, generating additional revenues for our Nation's cities, 
suburbs, and rural communities.

                       FHA--FACILITATING RECOVERY

    While there remains uncertainty about whether this progress will 
continue at this pace going forward, what is not in doubt is that the 
FHA has been central to much of this improvement.
    Created by President Franklin Roosevelt at a time when two million 
construction workers were out of work and housing prices had collapsed, 
the FHA was designed to provide affordable home ownership options to 
underserved American families and keep our mortgage markets afloat 
during tough times.
    And by insuring almost 30 percent of purchases and 20 percent of 
refinances in the housing market, FHA is certainly doing so today.
    We know the critical role first-time home buyers are playing in the 
market, including purchasing REO and vacant properties, helping 
stabilize home prices and communities alike. More than three-quarters 
of FHA's purchase-loan borrowers in 2009 were first-time home buyers, 
and nearly one-half of all first-time buyers in the housing market in 
the second half of last year used FHA loans.
    FHA provides mortgage insurance to help lenders reduce their 
exposure to risk of default. This assistance allows lenders to make 
capital available to many borrowers who would otherwise have no access 
to the safe, affordable financing needed to purchase a home.
    As access to private capital has contracted in these difficult 
economic times, borrowers and lenders have flocked to FHA and the ready 
access it provides to the secondary market through securitization by 
Ginnie Mae. The increased presence of FHA and others in the housing 
market, including Fannie Mae and Freddie Mac, has helped support 
liquidity in the purchase market, helping us ride through these 
difficult times until private capital returns to its natural levels.
    And with 51 percent of African Americans home buyers and 45 percent 
of Hispanic families who purchased homes in 2008 \1\ using FHA 
financing, FHA is far and away the leader in helping minorities 
purchase homes.
---------------------------------------------------------------------------
    \1\ Federal Financial Institutions Examination Council (FFIEC) 2008 
Home Mortgage Disclosure Act (HMDA) data. Published on December 23, 
2009, this is the most recent data available.
---------------------------------------------------------------------------
    FHA has stepped up to fulfill its countercyclical role--to 
temporarily provide necessary liquidity while also working to bring 
private capital back to credit markets. Indeed, the FHA has in the past 
year alone helped more than 800,000 homeowners refinance into stable, 
affordable fixed-rate mortgages.
    At the same time FHA has taken steps to reverse falling home 
prices, it has also worked to help families keep their homes, deploying 
its loss mitigation tools to assist a half million families at risk of 
foreclosure.
    Not only is FHA ensuring the availability of financing for 
responsible first time home purchasers, it is also helping elderly 
homeowners borrow money against the equity of their homes through the 
Home Equity Conversion Mortgage (HECM). This program has grown steadily 
in recent years, to a volume of $30.2 billion in fiscal year 2009.
    And finally, FHA is playing an important role in protecting 
homeowners and helping prospective homeowners make informed decisions. 
It is providing counseling to homeowners to help them avoid falling 
into unsustainable loans. And it is fighting mortgage fraud vigorously 
on all fronts, having taken enforcement actions on more than six times 
as many lenders since fiscal year 2009 than those over the fiscal year 
2000-2008 period combined.
    The central role of housing in the U.S. economy demands that 
Federal agencies involved in housing policymaking rethink and 
restructure programs and policies to support housing as a stable 
component of the economy, and not as a vehicle for over-exuberant and 
risky investing.
    With that in mind, the President's budget for 2011 represents a 
careful, calibrated balancing of FHA's three key responsibilities: (1) 
providing home ownership opportunities to responsible borrowers, (2) 
supporting the housing market during difficult economic times and (3) 
ensuring the health of the FHA Mutual Mortgage Insurance (MMI) fund.
    With this budget, HUD is projecting that FHA will continue to play 
a prominent role in the mortgage market in fiscal year 2011. 
Accordingly, it requests a combined mortgage insurance commitment 
limitation of $420 billion in fiscal year 2011 for new FHA loan 
commitments for the Mutual Mortgage Insurance (MMI) and General and 
Special Risk Insurance (GI/SRI) funds. The proposed total includes $400 
billion under the MMI Fund, which supports insurance of single family 
forward home mortgages and reverse mortgages under HECM; and $20 
billion under the GI/SRI Fund, which supports multifamily rental and an 
assortment of special purpose insurance programs for hospitals, nursing 
homes, and title I lending. The budget requests a direct loan 
limitation of $50 million for the MMI fund and $20 million for the GI/
SRI fund to facilitate the sale of HUD-owned properties acquired 
through insurance claims to or for use by low- and moderate-income 
families.
    The budget also includes $88 million for the Housing Counseling 
Assistance program, which is the only dedicated source of Federal 
funding for the full spectrum of housing counseling services. With 
these funds we also plan to continue our work to expand the number of 
languages in which counseling is available. In addition, the budget 
continues FHA's Mortgage Fraud initiative ($20 million) launched in 
fiscal year 2010 as well as implementation of sweeping reforms to the 
Real Estate Settlement and Procedures Act (RESPA) which began in 
January 2010 and the Secure and Fair Enforcement (SAFE) for Mortgage 
Licensing Act beginning in June 2010.

                   REBUILDING FHA'S CAPITAL RESERVES

    As important as FHA is at this moment to our Nation's economy, FHA 
has not been immune to the hard times for the housing sector. Late last 
year, 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. However, when combined with reserves held in the 
Financing Account, FHA reported with its fiscal year 2009 actuarial 
review that it holds 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.
    As such, the independent actuary concluded that FHA's reserves will 
remain positive under all but the most catastrophic economic scenarios.
    Further, while its Capital Reserve Account has decreased too 
quickly, FHA is not ``the next subprime'' as some have suggested.
    Subprime delinquencies are 240 percent higher than FHA's for a 
reason--subprime loans had much weaker underwriting standards than FHA. 
While others participated in investor-owned markets or were exposed to 
exotic mortgages such as option-ARMs and interest-only loans, and while 
some tolerated lax underwriting standards, FHA stuck to the basics 
during the housing boom: 30-year, fixed rate traditional loan products 
with standard underwriting requirements. Unlike subprime lenders, FHA 
requires that borrowers demonstrate they can pay their mortgage by 
verifying their income and employment.
    All of that said, Madam Chairwoman, we've learned from recent 
history that the market is fragile, and we have to plan for the 
unexpected. That uncertainty is complicated by an organization we 
inherited that, to be honest, was simply not properly managing or 
monitoring its risk.
    Credit and risk controls were antiquated. Enforcement was weak. And 
our personnel resources and IT systems were inadequate.
    Little of this may have been obvious when FHA's market share was 3 
percent as recently as 2006. But when our mortgage markets collapsed, 
and home buyers increasingly turned to the FHA for help, the potential 
consequences of these lapses in risk management became very clear.

                            REFORMS TO DATE

    From my first day as FHA Commissioner, I began a thorough review of 
our loan practices and organizational capacity and gaps. We have 
already taken several steps within our existing authority to shore up 
the FHA and continue to improve our operations to ensure that taxpayers 
are not put at risk.
    In addition to steeply increasing lender enforcement, we've 
strengthened credit and risk controls--toughening requirements on our 
Streamlined Refinance program, made several improvements to the 
appraisal process, and published a final rule in the Federal Register 
on April 20 to increase net worth requirements for all FHA lenders.
    Long overdue, FHA hired its first Chief Risk Officer, Robert Ryan, 
to provide the most comprehensive and thorough risk assessment in the 
organization's history--and ensure that the assumptions going into our 
modeling reflect the most current economic conditions.
    In addition, with Congress' help, we are working to increase 
staffing and technical capacity and upgrade our technology systems--and 
though we still have a long way to go, we delivered FHA's first 
comprehensive technology transformation plan to Congress in September. 
We have continued to make progress on both fronts. We recently issued 
and received several responses to a Request for Information to begin 
upgrading our risk and fraud tools and we delivered a FHA Staffing 
Report to Congress, which outlines our significant progress toward 
hiring the 118 FTEs that we thank Congress for appropriating to FHA in 
fiscal year 2010, along with details on an aggressive training and 
human capital development plan that includes managerial and technical 
skill building training as well as on-the-job mentoring.
Lender Enforcement
    Under the Obama administration, FHA has significantly increased its 
lender enforcement activities to protect the MMI Fund, consumers, and 
address a number of bad actors that were previously not held 
accountable.
    Since July 1, 2009, the Mortgagee Review Board (MRB) has 
investigated 365 cases, resulting in withdrawal of approval for 354 
lenders and suspension of an additional 6 lenders. The number of cases 
that have been investigated by the MRB since July 2009 are greater than 
those investigated in the years 2002-2008 combined.\2\ We take our 
responsibility to oversee lenders with the utmost seriousness. I would 
also like to emphasize that FHA's intent is to protect the Fund through 
a commitment to lender enforcement, but FHA in no way intends to punish 
responsible lenders. We are working closely with lenders to identify 
best practices and share them among the lending community, proactively 
identify problem situations and identify means to improve performance, 
to the benefit of lenders, consumers, and the FHA.
---------------------------------------------------------------------------
    \2\ See Appendix for Historical Data on Mortgagee Review Board 
Actions.
---------------------------------------------------------------------------
         JANUARY POLICY ANNOUNCEMENTS AND LEGISLATIVE REQUESTS

    On January 20 of this year, I proposed taking the following steps 
to mitigate risk and augment the MMI Fund's capital reserves: increase 
the mortgage insurance premium (MIP); impose a firm floor on allowable 
credit scores, and further tighten the minimum credit score required 
for borrowers with low down payments; reduce the maximum permissible 
seller concession to match the industry norm; and implement a series of 
significant measures aimed at increasing lender responsibility and 
enforcement. Thank you for the opportunity to explain these policies in 
more detail.
    I would like to be clear that many of these reforms were long 
overdue as FHA did not respond effectively to changes in the 
marketplace that happened during the housing boom and the subsequent 
decline--inaction was and is not an option. In addition to the 
Congressional mandate to take action to bring FHA's capital reserves 
back up above 2 percent, FHA also has a responsibility to protect 
consumers from irresponsible lending practices, protect the taxpayer 
from excessive claims on the MMI fund, and facilitate the return of 
private capital to the mortgage market. We take these responsibilities 
seriously, as evidenced by the series of policies that we have already 
enacted and those that we request Congressional authority to enact.
    FHA conducted an exhaustive review of loan performance in its 
portfolio and a thorough policy development process to ensure that 
these policy changes balance three guiding principles: (1) improve FHA 
loan performance and capital reserves, (2) continue to support the 
broader housing market and recovery, and (3) preserve FHA's role in 
providing home ownership opportunities to responsible underserved 
borrowers. Each one of our policy changes fulfills these three 
priorities. Additionally, FHA evaluated several dozen other policy 
options which ultimately were not chosen as they did not strike the 
appropriate balance. With these factors, in mind, FHA has proposed a 
series of balanced policy proposals that fulfill our responsibility to 
the American taxpayer and recognizes the important role that FHA is 
currently playing in the recovery of the housing market.
Restructuring FHA Mortgage Insurance Premiums
    First, insurance revenues from single family loan guarantees will 
grow by increasing the upfront premium to 225 basis points across all 
FHA forward product types (purchase, conventional to FHA refinances, 
and FHA to FHA refinances). The upfront premium increase was 
implemented by mortgagee letter issued on January 21, 2010 and became 
fully effective in the market for all applications received on or after 
April 5, 2010. I would like to thank Congress for providing FHA with 
the flexibility to increase the upfront premium to a maximum of 300 
basis points through passage of the Housing and Economic Recovery Act 
(HERA) in 2008. While we have not chosen to increase the upfront 
premium to the maximum, this flexibility has enabled FHA to take 
immediate action to begin rebuilding our capital reserves. Similarly, 
we request flexibility in our legislative proposal to increase the 
annual premium to 150 basis points although we have not proposed to 
increase the annual premium to that level in our fiscal year 2011 
budget proposal.
    As noted in the proposed budget, while HUD is moving to increase 
the upfront premium to 225 basis points we are ultimately planning to 
reduce that premium to 100 basis points, offset by a proposed increase 
in the annual premium to 85 basis points for loans with loan-to-value 
ratios (LTV) up to and including 95 percent and to 90 basis points for 
LTVs above 95 percent.
    This change to the annual premium will require legislative 
authority. We are extremely grateful that the House Financial Services 
Committee recently passed H.R. 5072--the FHA Reform Act of 2010--which 
provides this authority as well as several other provisions to further 
strengthen FHA. This legislation is now awaiting passage by the full 
House of Representatives. Given the importance of these issues to FHA's 
ability to facilitate our housing recovery while protecting the 
taxpayer, we hope that the Senate will similarly move to pass this 
legislation as expeditiously as possible.
    We believe this new premium structure is sound policy--more in line 
with GSE and private mortgage insurers' pricing, and is intended to 
facilitate the return of private capital to the mortgage market.\3\ 
Indeed, if these changes are adopted during the current fiscal year, 
the estimated value to the MMI fund would be approximately $300 million 
per month, which would replenish FHA's capital reserves even faster 
than if this authority was provided through the annual appropriations 
process.
---------------------------------------------------------------------------
    \3\ See Appendix for detailed information about the effect of 
proposed premium rate changes on home buyers.
---------------------------------------------------------------------------
    This restructuring of FHA's mortgage insurance premiums will 
accomplish two very important goals: (1) increase the homeowner's 
equity in each mortgage transaction and reduce the risk to the FHA 
fund; and (2) facilitate the return of private capital to the mortgage 
market.

            Increasing Equity in FHA Loans
    As stated earlier, if granted legislative authority to increase the 
annual mortgage insurance premium, FHA proposes to reduce the upfront 
mortgage insurance premium from 225 basis points to 100 basis points. 
Borrowers typically finance the upfront mortgage insurance premium in 
their loan balance, increasing the effective loan-to-value and reducing 
the amount of equity in their home. The reduction of the upfront 
premium will lower the loan balance as well as add an additional 125 
basis points of equity to each loan purchase.

            Facilitating the Return of Private Capital to the Mortgage 
                    Market
    As noted, the elevated role FHA is currently playing in the market 
is temporary. In addition to being more equitable for borrowers and 
generating more receipts for FHA, this change to the FHA premium 
structure brings FHA's pricing more in-line with the private mortgage 
insurance industry and enables more robust private competition. In 
fact, in response to FHA's announced policy changes, MGIC, the largest 
U.S. private mortgage insurer, announced on February 23 that it would 
be adopting a new pricing scale.\4\
---------------------------------------------------------------------------
    \4\ ``MGIC Lowers Rates to Compete With U.S.-Backed Mortgage 
Insurers,'' Bloomberg, February 23, 2010.
---------------------------------------------------------------------------
Updating Credit Score/Downpayment Guidelines
    FHA is also proposing a ``two-step'' FICO floor for FHA purchase 
borrowers, which would reduce both the claim rate on new insurance as 
well as the loss rate experienced on those claims. Purchase borrowers 
with FICO scores of 580 and above would be required to make a minimum 
3.5 percent down payment; and those with FICO scores between 500-579 
would be required to make a minimum down payment of 10 percent. 
Applicants below 500 would be ineligible for insurance. FHA plans to 
publish the two-step FICO proposal in the Federal Register soon, with 
implementation planned later this fiscal year.
    Careful analysis of the existing FHA loan portfolio shows a clear 
performance difference between loans that were made below the proposed 
FICO/LTV guidelines. Loans below the guidelines are currently more than 
four times as likely to be seriously delinquent than loans above the 
guidelines. Loans below the guidelines demonstrate a seriously 
delinquent rate of 31.1 percent, while loans above the guidelines 
currently demonstrate a seriously delinquent rate of 7.6 percent. Of 
the total FHA loan portfolio, approximately 6 percent of loans fall 
under the proposed guidelines; however, due to improved quality of 
recent FHA loans, only 1.5 percent of loans endorsed in fiscal year 
2009 would be excluded under the proposed guidelines.

                                     LOAN PERFORMANCE BASED ON PROPOSED UPDATED CREDIT SCORE/DOWNPAYMENT GUIDELINES
                                                                      [In percent]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                             Seriously
         Proposed Two Step Rule             Outstanding       30-Day          60-Day          90-Day      In Foreclosure   In Bankruptcy    Delinquent
                                               Loans                                                                                         (90-Day+)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Excluded................................             6.2            12.1             6.7            19.9             8.1             3.0            31.1
Still Qualify...........................            93.8             5.0             2.1             4.9             2.0             0.7             7.6
                                         ---------------------------------------------------------------------------------------------------------------
      Total.............................           100.0             5.5             2.4             5.9             2.4             0.8             9.1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: U.S. Department of HUD/FHA; February 2010.

    If implemented, in combination with the proposed mortgage insurance 
premium structure, the updated FICO/LTV guidelines are projected to 
result in the $4.1 billion in additional offsetting FHA receipts as 
reflected in the President's budget.

            Minimum Downpayment for FHA Loans
    Some have suggested that FHA raise the minimum required downpayment 
to 5 percent across the board and also remove the option of financing 
the upfront insurance premium into the loan balance for all 
transactions as a means to increase homeowner equity. We share the goal 
of increasing equity in home purchase transactions, but determined 
after extensive evaluation that such a proposal would adversely impact 
the housing market recovery.
    To determine the impact of requiring a minimum 5 percent 
downpayment for all transactions, FHA evaluated the loan files of a 
large sample of past endorsements to identify the number of borrowers 
who had sufficient assets at time of loan application to contribute the 
additional 1.5 percent of equity at closing. As illustrated in the 
table below, such a policy change would reduce the volume of loans 
endorsed by FHA by more than 40 percent, while only contributing $500 
million in additional budget receipts. This translates to more than 
300,000 fewer first-time home buyers and would have significant 
negative impacts on the broader housing market--potentially 
forestalling the recovery of the housing market and potentially leading 
to a double-dip in housing prices by significantly curtailing demand. 
In contrast, the combination of policy changes proposed by FHA in the 
fiscal year 2011 budget would contribute an additional $4.1 billion in 
additional receipts to FHA while having a much more moderate impact on 
the broader housing market.

   IMPACT OF FISCAL YEAR 2011 POLICY OPTIONS ON FHA RECEIPTS AND LOAN
                                 VOLUME
                        [In billions of dollars]
------------------------------------------------------------------------
                                                             FHA Loan
              Policy Option                FHA Receipts    Endorsements
------------------------------------------------------------------------
Baseline without policy changes.........             1.7             246
Minimum 5 percent downpayment for all                2.2             139
 transactions...........................
Fiscal Year 2011 Budget Proposal with                5.8             223
 all proposed policy changes............
------------------------------------------------------------------------
Source: U.S. Department of HUD/FHA; February 2010.

    Furthermore, downpayment alone is not the only factor that 
influences loan performance. The combination of downpayment and FICO 
score is a much better predictor of loan performance than just one of 
those components alone. For instance, loans with a loan-to-value (LTV) 
above 95 percent and a FICO score above 580 perform better than loans 
with LTV below 95 percent and a FICO score below 580, while loans with 
a LTV above 95 percent and a FICO score below 580 perform significantly 
worse than all other groups, as illustrated below.

   FHA SINGLE FAMILY INSURED LOAN CLAIM RATES RELATIVE EXPERIENCE BY LOAN-TO-VALUE AND CREDIT SCORE VALUES \1\
                  [Ratios of each Combination's Claim Rate to that of the Lowest Risk Cell \2\]
----------------------------------------------------------------------------------------------------------------
                                                                      Credit Score Ranges \3\
           Loan-to-Value Ratio Ranges            ---------------------------------------------------------------
                                                      500-579         580-619         620-679         680-850
----------------------------------------------------------------------------------------------------------------
Up to 90 percent................................             2.6             2.5             1.9             1.0
90.1-95 percent.................................             5.9             4.7             3.8             1.7
Above 95 percent................................             8.2             5.6             3.5             1.5
----------------------------------------------------------------------------------------------------------------
\1\ Based on experience of the fiscal year 2005-fiscal year 2008 insurance cohorts, as of February 28, 2010.
  These ratios represent averages of the cell-level ratios in each cohort.
\2\ Claim rates in the first row and last column are the low-risk cell and are represented by a ratio value of
  1.00. Values in all other cells of this table are ratios of the cell-level claim rate to the claim rate of the
  low-risk group.
\3\ Loan-level scores represent the decision FICO scores used for loan underwriting. This analysis includes all
  fully-underwritten loans, purchase and refinance, but excludes streamline refinance loans.

Source: U.S. Department of HUD/FHA; March 2010.

    It is for these reasons, rooted in a thorough review of actual FHA 
loan performance data, that FHA has decided to reduce the upfront 
mortgage insurance premium, which is financed into the loan balance in 
the vast majority of transactions, and increase the annual mortgage 
insurance premium, which is paid over time and not financed into the 
loan balance, which is more aligned with the premium structure of 
private mortgage insurance companies.
    In particular, we have proposed to permit loans to borrowers with 
FICO scores above 580 with a minimum 3.5 percent downpayment and loans 
to borrowers with FICO scores between 500 to 579 with a minimum 10 
percent downpayment. It is also worth noting that these downpayment 
guidelines are minimums and many borrowers do in fact have 
significantly lower LTVs--in the fourth quarter of fiscal year 2009, 
more than 21 percent of endorsed loans had a LTV lower than 90 percent.
Reducing Seller Concessions
    We are also proposing a third policy measure 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. As seen in the table below, 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 
fiscal year 2003 to fiscal year 2008 suggests that claim rates on high-
concession loans are 50 percent higher or more than those on low-
concession loans.

   FHA SINGLE-FAMILY INSURANCE TO-DATE CLAIM RATE COMPARISON LOW (0-3 PERCENT) VS. HIGH (3.1-6 PERCENT) SELLER
                                                 CONCESSIONS \1\
                                            [As of December 31, 2009]
----------------------------------------------------------------------------------------------------------------
                                                                        Low            High
                     Endorsement Fiscal Year                        Concessions     Concessions   Ratio High/low
                                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
2003............................................................             6.5            10.7            1.65
2004............................................................             6.6            11.6            1.76
2005............................................................             7.2            11.2            1.54
2006............................................................             6.5             9.5            1.46
2007............................................................             4.6             6.3            1.36
2008............................................................             1.0             1.5            1.60
----------------------------------------------------------------------------------------------------------------
\1\ As a percentage of the home price. This analysis is only for home purchase loans.

Source: US Department of Housing and Urban Development, Federal Housing Administration; January 2010.

Increasing Lender Enforcement
    In its fiscal year 2009 Actuarial Review, the independent actuary 
projected that more than 71 percent of FHA's losses over the next 5 
years will come from loans already on our existing books, rather than 
from newly insured loans. That's why an important step we can take to 
minimize losses to capital reserves in the near term is to step up 
enforcement and make lenders more accountable. As mentioned earlier, we 
have renewed our focus on enforcement and lender accountability.
    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 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.
    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 continue to 
serve its mission of providing home ownership opportunities for 
responsible borrowers. 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.

                              CBO SCORING

    On March 5, the Congressional Budget Office released its re-
estimate of the President's 2011 budget. Although the CBO re-estimate 
includes a significantly more conservative assessment of how new loans 
made through FHA's MMI Fund will perform in coming years, both CBO and 
the administration forecast that such credit activity will result in 
net receipts to the Government. We differ, however, on the amount. 
While the President's budget forecast $5.8 billion in net receipts 
resulting primarily from insurance premia and other fees assessed on 
FHA loans, CBO re-estimated those receipts at $1.9 billion. 
Accordingly, CBO's scoring suggests our policies will cost $3.9 billion 
more than we estimated in our submission to you.
    While recognizing that such a difference with CBO complicates 
budget resolution development, we remain confident that the $5.8 
billion in receipts forecast in the President's budget will be realized 
and transferred to FHA's Capital Reserve Account. This will help that 
fund get back on track to be capitalized with the statutorily mandated 
2 percent of insurance in force.

                 HOME EQUITY CONVERSION MORTGAGE (HECM)

    This year, we are requesting an appropriation of $250 million to 
support FHA's reverse mortgage product--the Home Equity Conversion 
Mortgage, or HECM, program. The HECM program provides seniors with a 
means to access their home equity to make ends meet. A survey conducted 
by AARP in 2006 showed that the product provided seniors with much-
needed financial relief and was primarily used to pay for long term 
healthcare, enable home repairs, and provide piece of mind that housing 
expenses could be met.\5\ Another study, conducted by the National 
Council on Aging in 2005 showed how the program can help seniors access 
in-home healthcare services, an arrangement that allows households to 
``age in place'' rather than undergoing disruptive transitions into 
nursing homes or other types of public facilities to receive health-
related assistance. Keeping seniors in their homes and communities, 
close to familiar support networks, puts less pressure on our Nation's 
overextended nursing home infrastructure and the public resources that 
support it.
---------------------------------------------------------------------------
    \5\ ``Reverse Mortgages: Niche Product or Mainstream Solution? 
Report on the 2006 AARP National Survey of Reverse Mortgage Shoppers,'' 
AARP Public Policy Institute Paper #2007-22. and ``Use Your Home to 
Stay at Home,'' National Coalition on the Aging, 2005. http://
www.ncoa.org/news-ncoa-publications/publications/
reversemortgagereportpublications.pdf.
---------------------------------------------------------------------------
    We have performed considerable analysis to perform the maximum 
policy changes that we could perform to reduce risk to the taxpayer and 
maintain the viability of the program, which is why we have proposed 
for fiscal year 2011 an increase in the annual mortgage insurance 
premium from 0.50 percent to 1.25 percent and a further reduction in 
the principal limit factors (PLFs) of approximately 1 to 5 percent 
depending on the age of the borrower, on top of the 10 percent 
reduction in PLFs that was implemented at the beginning of fiscal year 
2010.
    Without the budget request, we would be forced to reduce the PLFs 
by an additional 21 percent in fiscal year 2011. This would 
significantly reduce the amount of funds that would be available to 
seniors (more than 30 percent), which is on average a $23,000 to 
$27,000 impact.
    Any additional steep cut to the PLFs will result in serious decline 
in program level as HECMs would no longer be viable to many seniors who 
need to access their home equity while staying in their homes. It is 
important to note that the need for this type of program is greater now 
than it's ever been, due to increasing medical costs, declining 
employment/incomes, and less ``savings'' in various types of pension 
funds/retirement accounts.
    Forecasts suggest that future house prices will grow more slowly 
than in the past, and the HECM program costs are very sensitive to 
future house prices. As such, we have also assembled a working group 
with the Department to see what other kinds of broader program changes 
could be made going forward to make the program more viable even under 
stressful economic times.
    Given the value of this program in assisting this critical 
population, HUD has requested an appropriation to maintain the 
viability of this option for seniors while we evaluate the range of 
broader program changes that may be necessary to ensure the success of 
the HECM program into the future.

     HUD'S CENTRAL ROLE IN PREVENTING FORECLOSURES AND STABILIZING 
                             NEIGHBORHOODS

    On March 26, as part of the administration's continued efforts to 
assist homeowners to avoid foreclosure, HUD announced adjustments to 
the FHA program, referred to as the FHA refinance option, that will 
allow lenders to provide additional refinancing options to those 
borrowers who owe more on their home than it is worth if combined with 
a principal write down by their lender or mortgage investor. These 
adjustments will provide more opportunities for qualifying mortgage 
loans to be responsibly restructured and refinanced into FHA loans as 
long as the borrower is current on the mortgage and the lender reduces 
the amount owed on the original loan by at least 10 percent. We have 
also expanded the FHA loan modification program, known as FHA HAMP, to 
provide incentives for servicers to modify loans insured by the FHA. 
With the issuance of new rules on March 26 (Supplemental Directive 10-
03), TARP-funded incentives will be available to borrowers and 
servicers whose loans are modified under the FHA-HAMP guidelines, 
corresponding to the pay-for-success HAMP incentive structure. In 
addition to efforts to improve the execution of the administration's 
Making Home Affordable program, HUD is utilizing long-existing 
mechanisms as well as additional authority provided in recently enacted 
legislation to aid distressed homeowners and to address community 
blight resulting from foreclosed and abandoned properties.
    FHA Refinance Option.--To address the challenge of underwater 
homeowners, we have made adjustments to Federal Housing Administration 
(FHA) programs that will permit lenders to provide additional 
refinancing options to homeowners who owe more than their home is worth 
because of large falls in home prices in their local markets. These 
adjustments will provide more opportunities for qualifying mortgage 
loans to be responsibly restructured and refinanced into FHA loans as 
long as the borrower is current on the mortgage and the lender reduces 
the amount owed on the original loan by at least 10 percent. This 
option will be made available in the market in early fall.
    The new FHA loan must have a balance less than the current value of 
the home, and total mortgage debt for the borrower after the 
refinancing, including both first and any other mortgages, cannot be 
greater than 115 percent of the current value of the home--giving 
homeowners a path to regain equity in their homes and an affordable 
monthly payment. By requiring a meaningful principal write-down in 
conjunction with the newly refinanced loan, borrowers will have a more 
sustainable loan that will be more affordable. Additionally, borrowers 
will have an opportunity to refinance into current interest rates, 
which remain low.
    The new loan must conform to FHA's underwriting requirements, so 
performance would likely fall within acceptable risk thresholds for 
FHA. That being said, there is reasonable concern that there may be a 
performance differential--these loans may perform worse than refinanced 
loans that were not previously underwater. As such, loans that conform 
to all guidelines of the FHA refinance option will be counted 
separately toward lender performance monitoring through Credit Watch--
the system by which FHA suspends or terminates lenders for high default 
rates. Originating these loans will not hinder a servicer's ability to 
pursue other lines of business, mitigating a potential barrier to 
servicers' and investors' willingness to offer principal writedowns to 
borrowers.
    Of the $14 billion of TARP funds allocated to support the FHA 
refinance option, a portion will be made available to provide coverage 
for a share of potential losses on these loans, mitigating detrimental 
impacts to FHA's capital reserve from facilitating the private sector 
to provide principal writedowns to underwater borrowers in conjunction 
with these refinancings. No TARP funds will go to the FHA itself for 
any loans.
    This refinancing will help homeowners by setting monthly payments 
at affordable levels and decreasing the mortgage burden for families 
owing significantly more than their homes are worth. Keeping more 
responsible families in their homes should support the continued 
recovery of the housing market.
    Established FHA Loss Mitigation Efforts.\6\--Homeowners of FHA-
insured loans have long been eligible for a variety of loss mitigation 
programs to help protect them from foreclosure. In 2009, more than 
450,000 families were assisted through a variety of methods, including 
forbearance, partial claim, loan modification, pre-foreclosure sale, 
and deed-in-lieu of foreclosure. In the first quarter of fiscal year 
2010, FHA assisted more than 122,000 through these programs. Servicers 
of FHA-insured loans are required to notify delinquent homeowners about 
the option(s) that are available to help them make their monthly 
payments and to implement loss mitigation efforts before they take the 
final step of initiating foreclosure proceedings.
---------------------------------------------------------------------------
    \6\ See appendix for description of FHA's loss mitigation programs.
---------------------------------------------------------------------------
    FHA-Home Affordable Modification Program (FHA-HAMP).--When 
initially introduced to the public, the Making Home Affordable program 
excluded FHA-insured mortgages and stated that FHA would develop its 
own stand alone program. On July 30, HUD announced final rules 
implementing the FHA's program--the FHA Home-Affordable Modification 
Program (FHA-HAMP)--which is an important complement to MHA and 
provides homeowners in default (or at-risk of imminent default) with 
greater opportunity to reduce their mortgage payments to a sustainable 
level. All servicers were expected to begin offering FHA-HAMP by August 
15. This new loss mitigation program was authorized under the ``Helping 
Families Save Their Homes Act of 2009,'' signed into law on May 20, and 
allows FHA to give qualified FHA-insured borrowers the opportunity to 
obtain assistance under terms roughly comparable to borrowers in other 
segments of the market, without increasing costs to the taxpayer. This 
program allows HUD to permanently reduce a family's monthly mortgage 
payment to an affordable level by offering a partial claim of up to 30 
percent of the unpaid principal balance. This defers the repayment of 
the mortgage principal reduction through an interest-free subordinate 
mortgage that is not due until the first mortgage is paid off.
    At the initiation of FHA HAMP in August 2009, it was projected to 
provide assistance to over 45,000 households over the next 3 years. As 
of January 31, 2010, lenders have sent over 15,000 trial plans and over 
10,000 borrowers have made at least 1 payment on their trial plan. FHA-
HAMP loan volume is currently above projections for the 3 year 
milestone and all but one major lender has borrowers under a trial 
program.
    Pay for success payments were included for borrowers and servicers 
that utilized the conventional HAMP. However, at the time of its 
announcement, FHA-HAMP did not include Pay for Success payments for 
servicers or mortgagors that made on time payments as it required 
regulatory action to be eligible for FHA-insured mortgages. We have 
worked diligently to complete this process and FHA issued a mortgagee 
letter that enables FHA-HAMP borrowers and servicers to be eligible for 
Pay for Success payments. Consequently, it is expected that demand for 
FHA-HAMP will increase.
    Assistance for Borrowers Facing Imminent Default.--On January 22, 
2010, FHA announced that it was exercising authority granted to it by 
Congress through the Helping Families Save Their Home Act of 2009 to 
use its loss mitigation tools to assist FHA borrowers avoid foreclosure 
to include those facing ``imminent default'' as defined by the 
Secretary. Homeowners with FHA-insured mortgage loans who are 
experiencing financial hardship are now eligible for loss mitigation 
assistance before they fall behind on their mortgage payments. 
Previously, these homeowners were not eligible for such assistance 
until after they had missed payments. Now servicers will have 
additional options for those borrowers who seek help before they go 
delinquent, which increases the likelihood that the borrower will be 
able to retain their home.
    The borrower must be able to document the cause of the imminent 
default which may include, but is not limited to, one or more of the 
following types of hardship:
  --A reduction in or loss of income that was supporting the mortgage 
        loan, e.g., unemployment, reduced job hours, reduced pay, or a 
        decline in self-employed business earnings. A scheduled 
        temporary shutdown of the employer, (such as for a scheduled 
        vacation), would not in and by itself be adequate to support an 
        imminent default.
  --A change in household financial circumstances, e.g., death in 
        family, serious or chronic illness, permanent or short-term 
        disability
    Improving Servicer Outreach and Performance in Preventing 
Foreclosures.--FHA is working closely with lenders and servicers to 
improve their outreach and performance in assisting borrowers to avoid 
foreclosure. In February 2010, FHA's Office of Single Family Asset 
Management and the FHA National Servicing Center began conducting 
lender visits to identify best practices that could be shared with the 
broader servicing community to improve foreclosure mitigation across 
the industry. The visits were conducted with five overall objectives: 
(1) better understand in specific detail the process variations that 
exist at each lender for providing a delinquent FHA borrower with 
options to avoid foreclosure; (2) discuss specific borrower trends the 
lenders are experiencing; (3) identify borrower circumstances that 
prevent them from being qualified for various foreclosure prevention 
options; (4) receive suggestions from the lender that might improve the 
process for FHA loss mitigation; and, (5) understand the differences in 
default/foreclosure statistics as compared to national averages. 
Several findings have already been identified and FHA has begun to 
share them with servicers, while continuing to meet with additional 
lenders to identify additional best practices that will enable 
underperforming servicers to improve their success with preventing 
foreclosures. It is worth noting that these best practices are not 
limited to the FHA population, and HUD's efforts in this area will 
benefit all homeowners, not only those with a FHA-insured mortgage, by 
collaborating with the servicer community to improve their foreclosure 
prevention activities across the entire industry.
    Counseling.--HUD is utilizing its vast network of counselors and 
other nonprofits to provide critical assistance to the record number of 
homeowners at-risk of foreclosure. It is estimated that more than one-
half of all foreclosures occur without servicers and borrowers ever 
engaging in a discussion about potential options to prevent 
foreclosure. That is why we have directed HUD-approved counselors to 
educate homeowners about their various options, promote the MHA program 
in local communities, and assist distressed homeowners with navigating 
the system so they can reach servicers and obtain assistance to avoid 
foreclosure.
    HUD-approved counselors are located across the Nation and provide 
distressed homeowners with a wealth of information. The counselors 
provide assistance over the phone and in person to individuals seeking 
help with understanding the Making Home Affordable program, explain 
options available to FHA-insured homeowners, and often work with 
borrowers eligible for the administration's refinance or modification 
program to compile an intake package for servicers. These services are 
provided free of charge by nonprofit housing counseling agencies 
working in partnership with the Federal Government and funded in part 
by HUD and NeighborWorks America. In addition, HUD, working with 
Treasury and the Homeownership Preservation Foundation, encourages 
distressed borrowers to contact the Homeowner's HOPE Hotline at 866-
995-HOPE to receive counseling and advice on avoiding foreclosures. The 
24 hours a day, 7 days a week hotline utilizes many HUD-approved 
counselors who can also help the homeowner reach and resolve issues 
with servicers.
    Neighborhood Stabilization Program (NSP).--HUD recognizes that 
concentrated foreclosures can wreak havoc on once-stable communities 
and is working to insure that the nearly $6 billion appropriated by 
Congress for NSP plays the intended role of helping to stabilize 
housing markets and combat blight through the purchase and 
redevelopment of foreclosed and abandoned homes and residential 
properties. NSP is starting to generate real results and is emerging as 
a vital resource in facilitating the transformation of foreclosed homes 
into affordable housing and other useful properties. HUD continues to 
monitor program activities, identify strategies that produce real 
results, and work to make program modifications that will help ensure 
that this funding is deployed quickly, wisely, and effectively. 
Additionally, FHA and HUD's Office of Community Planning and 
Development have created a working group to assist NSP grantees to 
better coordinate the use of NSP funds for the purchase of FHA REO 
properties.

         FACILITATING OUR RECOVERY, BUT PROTECTING THE TAXPAYER

    Madam Chairwoman and Ranking Member Bond, shoring up the FHA won't 
solve all our housing challenges--one reason 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.
    That means that 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 FHA steps back to facilitate the return of the private sector as 
soon as possible. Until the private sector can step back up, they need 
the FHA--and so does our housing market.
    So, Madam Chairwoman, 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 
role that we play in today's market. And the bottom line is this: the 
loans FHA insures must be safe and self-sustaining for the taxpayer 
over the long-term. With these reforms the administration is committed 
to ensuring that they are today--and into the future. Thank you.

                                           APPENDIX.--MORTGAGEE REVIEW BOARD HISTORICAL ACTIONS BY FISCAL YEAR
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                         2000     2001     2002     2003     2004     2005     2006     2007     2008     2009     2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total Number of Cases................................       61       92       14       63       47       38       21       18       95      593      360
Fact Based Cases.....................................       61       92       14       63       47       38       21       18       30       21       40
Recertification Cases................................  .......  .......  .......  .......  .......  .......  .......  .......       65      572      320
Actions Taken:
    Withdrawal of Approval...........................       15       29        2        4        8       10        3        3       27      268      314
    Suspension.......................................        1        1  .......  .......  .......  .......  .......  .......        1        6        1
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Fact Based Cases.--Are those referrals to the board as a result of 
a review of the lenders origination, underwriting and/or operations; 
primarily the result of the Single Family Quality Assurance Division's 
lender monitoring reviews, but the board also receives referrals from 
the OIG, Multi-Family, etc.
    Recertification Cases.--Are referrals to the MRB from the Office of 
Lender Activities Lender Recertification branch and are the result of a 
lender's failure to follow our annual renewal process. The addition of 
this new category in fiscal year 2008 was primarily due to the new 
requirements issued from the decision by HUD's Administrative Law Judge 
in fiscal year 2008 that all lenders that do not comply with FHA's 
annual renewal requirements must go before the Board for administrative 
action.
    Withdrawal of Approval.--Terminates the FHA-approval of a lender, 
e.g. lenders lose their FHA Approval Status and have no authority to 
originate and/or underwrite FHA loans.
    Suspension.--Temporarily suspends an FHA-approved lenders ability 
to originate and/or underwrite FHA loans. It does not terminate their 
FHA Approval, just the ability to use it.

  FHA SINGLE FAMILY INSURANCE EFFECT OF PROPOSED PREMIUM RATE CHANGES ON HOME BUYERS WHO MAKE THE MINIMUM CASH
                                                   INVESTMENT
----------------------------------------------------------------------------------------------------------------
                                   With Current    With Interim     Difference     With Proposed    Difference
 Home Price and Mortgage Payment    MIP Values      225/55 MIP     from Current     100/90 MIP     from Current
           Components                (175/55)          Plan           Values           Plan           Values
----------------------------------------------------------------------------------------------------------------
House price--Average Value......        $176,000        $176,000  ..............        $176,000  ..............
Base Loan Amount (96.5 percent          $169,840        $169,840  ..............        $169,840  ..............
 LTV)...........................
Loan Amount with UFMIP..........        $172,812        $173,661            $849        $171,538         -$1,274
Interest Rate (percent).........            5.50            5.50  ..............            5.50  ..............
FHA upfront MIP rate (percent)..            1.75            2.25  ..............            1.00  ..............
FHA annual MIP rate (percent)...            0.55            0.55  ..............            0.90  ..............
Principal and Interest payment..            $981            $986              $5           $ 974             -$7
PITI payment \1\................          $1,355          $1,360              $5          $1,348             -$7
PITI + FHA Mortgage insurance             $1,434          $1,439              $5          $1,475             $42
 payment (full mortgage payment)
----------------------------------------------------------------------------------------------------------------
\1\ This assumes that property taxes and hazard insurance payments (TI) amount to 2.55 percent of the property
  value. This figure is backed into from the difference between the average mortgage payment ratio of FHA-
  insured borrowers and the payment without the TI portion. PITI refers to principal, interest, taxes, and
  insurance.

Source: U.S. Department of HUD/FHA; February 2010. Average values are for FHA-insured home-purchase borrowers,
  October-December 2010.

           DESCRIPTION OF HUD'S LOSS MITIGATION PROGRAM TOOLS

Formal Forbearance
    A short term repayment plan to postpone, reduce, or suspend payment 
due on a loan for a limited and specific time period. A formal 
forbearance is normally entered into when a borrower is in imminent 
default or early delinquency and can be as simple as a promise-to-pay.
Special Forbearance
    A long term repayment plan that may provide for periods of reduced 
or suspended payments when there is reasonable likelihood the borrower 
can resume normal or increased payments.
Mortgage Modification
    Provides a permanent change in the monthly mortgage payment by 
capitalizing the accumulated arrears and establishing a new mortgage 
term of up to 30 years.
Partial Claim
    A promissory note and subordinate mortgage to cover the advance for 
delinquent mortgage payments is issued in the name of the Secretary of 
HUD. Mortgagee advances funds on behalf of the Mortgagor in the amount 
of the Partial Claim advance to reinstate the delinquent loan.
FHA-HAMP
    FHA-HAMP allows qualified FHA-insured borrowers to reduce their 
monthly mortgage payment to an affordable level by permanently reducing 
the payment through the use of a partial claim combined with a loan 
modification. The partial claim defers the repayment of a portion of 
the mortgage principal through an interest-free subordinate mortgage 
that is not due until the first mortgage is paid off. The remaining 
balance is then modified through re-amortization and in some cases, an 
interest rate reduction.
Pre-foreclosure Sale
    Homeowner sells the property at a price less than the outstanding 
mortgage balance and HUD pays an insurance claim to the mortgagee for 
the resulting loss.
Deed-in-lieu of Foreclosure
    Voluntary transfer of property title to the lender or directly to 
HUD.
                                 ______
                                 
                Prepared Statement of Kenneth M. Donohue

    Chairman Murray, Ranking Member Bond, and members of the 
subcommittee, thank you for inviting me to submit written testimony 
today. I very much appreciate the opportunity to speak on the 
importance of the role of the Federal Housing Administration (FHA) in 
addressing the housing crisis currently confronting our Nation. It was 
a year ago, when I last testified before you on this topic and much has 
transpired during the intervening time as well as some aspects, such as 
the stagnancy of the housing market, unfortunately remaining the same. 
We have not yet weathered the economic storm but hopefully in its 
aftermath we will see some clearer skies and renewed prosperity. This 
much is known 1 year later however--the current degree of FHA 
predominance in the market still is unparalleled.

                               BACKGROUND

    The mission of the Department of Housing and Urban Development 
(HUD) is to increase home ownership, support community development, and 
increase access to affordable housing free from discrimination. The FHA 
provides mortgage insurance to private lenders that finance single 
family homes, multifamily projects, healthcare facilities, loans for 
property improvements and manufactured homes. The FHA has provided 
mortgage insurance to over 37 million single family homes and over 
51,000 multifamily projects since its inception over 75 years ago. Most 
of the industry has adhered to the FHA and industry standards in 
assisting the American home buyer. Unfortunately, there are those that 
seize upon the opportunity for ``greed'' in exploiting the system.
    As I stated previously, the last number of years have seen enormous 
and damaging developments in the mortgage market: the dissolution of 
the subprime and Alt-A loan markets; dramatic drops in housing prices 
in most areas of the country; a concomitant rise in default and 
foreclosures arguably drawing comparisons to levels of distress 
experienced in the Great Depression; financial insecurity in the 
mortgage-backed securities markets represented by the Government 
takeover of Fannie Mae and Freddie Mac; the collapse of credit markets; 
and, as a primary vehicle to address these issues, an urgent reliance 
on the FHA to bolster the mortgage market.
    The FHA was established under the National Housing Act of 1934 to 
improve housing standards and conditions, to provide an adequate home 
financing system by insuring mortgages and rental projects, and to 
stabilize the mortgage market after the devastation of the Depression 
and massive losses of home ownership during that time. It was created 
to be the standard setter and the standard bearer for the mortgage and 
housing communities in areas such as underwriting standards and ethical 
behavior. It had, in my estimation, as history will attest, abdicated 
this important role--too often slow on the upside, as we saw during the 
recent expansion of FHA in the marketplace, and slow on the downside. 
It had a responsibility which frankly it sidestepped.

                         HISTORICAL PERSPECTIVE

    The FHA Commissioner in his testimony a number of weeks ago 
regarding policy and legislative reforms, stated that ``. . . many of 
these reforms were long overdue as FHA did not respond effectively to 
changes in the marketplace that happened during the housing boom and 
the subsequent decline.'' In his view ``. . . inaction was and is not 
an option.'' I applaud these remarks and state for the record that in 
my 8 years as HUD inspector general, this FHA Commissioner has tried to 
do more in the last year than I saw in all the previous years combined. 
As you know from my many years of testimony before this subcommittee 
and others, I agree with his statement that the ``organization they 
inherited was simply not properly managing or monitoring its risk.'' 
Many of his proposals and initiatives are long overdue and meritorious. 
That said, we still have much to do and have much uncertainty facing 
this Department--some within the control of departmental officials and 
some outside their sphere of influence. While it is difficult to 
predict the future--as an old adage goes if you have five economists in 
the room you'll have eight different forecasts--I am not as optimistic 
as some are with where we are today or even going in the near future 
but I do agree that the program is attempting to move ahead in a good 
direction.
    In late 2008, a BusinessWeek article generated a buzz with a 
picture of a wolf on the cover representing the pernicious side of the 
mortgage industry coming at the FHA. I was quoted at the time 
expressing my concern about the groundswell of loans that were going to 
come in to the program and the types of loans that might be coming with 
the onslaught of new lenders. The FHA disputed my statements. Also 
quoted in the article was Michael Ashley, a chief official of a New 
York mortgage lending firm who had switched its strategy from subprime 
to FHA-backed mortgages. The article reported that in 2008 alone the 
company, Lend America, made $1.5 billion in loans and Ashley is quoted 
as stating that the ``FHA is a big part of the future.'' I was 
perturbed reading his blatant bravado regarding how the FHA had become 
his meal ticket because of our open investigation of him and his 
company at the time and our previous prosecution against him years 
earlier for engaging in similar activity.
    When I highlighted this case to you in previous testimony, I was 
frustrated with the vulnerabilities in the FHA approval system that 
allowed Mr. Ashley to come back into the program and to publicly and 
brazenly brag about his participation. I am pleased to state, however, 
that we did receive an injunction against Mr. Ashley banning him 
permanently from ever engaging in Federal mortgage programs. A local 
newspaper reported when we took initial action against him that there 
was a Mercedes Benz car in the company parking lot with a license plate 
``RefiFHA.'' Hopefully, with the actions that the FHA is trying to put 
into place today we will not see such bombastic industry behavior. I am 
also pleased that this Commissioner has recently taken action against 
over 300 lenders sending a very distinct message to the lending 
community. I had highlighted in reports that the Department's Mortgagee 
Review Board was broken and I applaud his action to reinvigorate the 
process. I do think that this Commissioner is dealing with the 
consequences of departmental inactions that took place prior to his 
tenure and that our perceptions at the time have, despite the agency's 
attempts then at refutation, come to pass in terms of volume, types of 
participants, and ramifications to the portfolio.
    For example, another recent OIG case underscores large fraud 
schemes and losses to the program. At Taylor Bean and Whitaker (TBW) 
Mortgage Corporation and Colonial Bank we uncovered various schemes. 
Federal search warrants were simultaneously executed at both TBW and 
Colonial Bank. The FHA then suspended TBW from participation and the 
company filed for bankruptcy. Colonial Bank was taken over by the FDIC 
and then sold to BB&T Bank. HUD's suspension was based on TBW failing 
to submit an audited financial statement, misrepresenting that there 
were no unresolved issues with an independent auditor and its failure 
to disclose it was the subject of two examinations into its business 
practices. At the point of seizure, TBW was servicing Federally insured 
and guaranteed loans with a remaining principal balance of about $26 
billion.
    Lastly, I had said that, through the multitude of our work in 
auditing and investigating many facets of the FHA programs over the 
course of many years, we have had, and continue to have, concerns 
regarding FHA's systems and infrastructure to adequately perform its 
current requirements and services. This was expressed by the OIG to the 
FHA through audits and reports regarding a wide spectrum of areas prior 
to the current influx of loans coming into the program and prior to the 
consideration of the numerous proposals that expanded its reach. Some 
of these were long-standing concerns that went back to unresolved 
issues highlighted in our work products from as far back as the early 
1990s.

                         THE CURRENT LANDSCAPE

    The past 2 years have certainly produced a lot of changes and 
initiatives. In response to increasing delinquencies and foreclosures 
brought about by the collapsing subprime mortgage market, the FHA 
Secure program to refinance existing subprime mortgages, the Housing 
and Economic Recovery Act's (HERA) Hope for Homeowners program, the 
Helping Families Save Their Homes Act, and The Making Home Affordable 
Program were created to assist homeowners.
    As we turn to today's environment, the size of the Single-Family 
FHA-insured loan portfolio has enlarged by nearly 50 percent from $466 
billion in fiscal year 2008 to over $697 billion in fiscal year 2009. 
During the month of March of this year, the FHA's total mortgage in 
force was over $6.1 million with an aggregate outstanding balance of 
over $800 billion. Single-Family market comparisons from the first 
quarter of fiscal year 2010 show that FHA's total endorsements have 
increased to 74 percent of the insured mortgage market which includes 
both home sales and refinances. As recent FHA testimony states, the FHA 
program is insuring almost 30 percent of purchases and in the past year 
alone helped more than 800,000 homeowners refinance.
    I still remain concerned that the FHA will be challenged to handle 
its expanded workload or new programs that require the agency to take 
on riskier loans than it historically has had in its portfolio. The 
surge in FHA loans is overtaxing the current infrastructure, making 
careful and comprehensive lender monitoring difficult. Through our 
cases we see the consequences of allowing in dubious lenders who then 
inflicted the program with problematic loans. In addition, our 
experience in prior high FHA volume periods (such as from 1989-1991 and 
1997-2001) shows that the program was vulnerable to exploitation by 
fraud schemes, most notoriously flipping activities, that undercut the 
integrity of the program. I support many of the recent initiatives 
proposed by the Secretary and the FHA Commissioner, of which I will 
elaborate on later, and a new departmental attitude to address these 
issues head on.
    We testified last year that the FHA had to contend with a 
significant and complex situation in balancing the risks to, and fiscal 
vitality of, the Mutual Mortgage Insurance (MMI) Fund against the need 
to assure financial mortgage markets continue to function properly 
during the downturn of the economy. Among the issues we spoke to were 
the adequacy of resources available to FHA for staffing, training, 
oversight, and system enhancements. We cited the increasing risks the 
FHA faced that needed to be addressed by both its front-end risk 
assessment processes as well as its back-end monitoring and corrective 
action processes.
    Since that time the FHA has undertaken a number of actions to 
mitigate some of those risks and protect reserve fund balances. The FHA 
has banked on the accuracy of its actuary's projections in assessing 
the health of the Fund and has faith that it is experiencing improved 
performance with its 2009 and 2010 portfolio. Economists cannot agree 
the direction the economy is going and I equally am not a proficient 
prognosticator. We are in a fluid and dynamic situation that too often 
has not been predictable or readily knowable. The FHA, like the average 
American, is still searching for clearer horizons and a break in the 
tempest.
    The FHA's latest report shows that for last quarter, the net losses 
on claims were averaging close to 60 percent which is 13 percent higher 
than was predicted. In layman's terms, the FHA is recovering only 42 
cents on the dollar (i.e., what it loses after it pays a claim and 
sells foreclosed property). In the State of Michigan, however, it is 
only recovering 16 cents on the dollar. It currently has approximately 
45,600 properties at a value of $5.7 billion in the real estate owned 
(REO) inventory. Moreover, its credit subsidy rate is one-half percent 
which after adjustment for present value means revenues are a one-half 
percent ahead of claims. That's positive but by a very slim margin. The 
FHA is taking a number of steps to mitigate losses and keep the fund 
positive.
    While the FHA's confidence in actuarial numbers brings it hope, we 
believe vigilance is needed until the marketplace has stabilized. Like 
any American family in today's uncertain times, the FHA will have to 
continuously monitor its financial position and take proactive steps to 
keep ahead of the curve when reality dictates corrective action is 
required. The FHA has a number of tools at its disposal to increase 
revenue or to reduce losses accomplished through mechanisms such as 
loss mitigation or vigilant oversight of lenders and brokers. Most of 
the major actions proposed to mitigate risk will not go into effect 
right away so we need to understand that such actions may have little 
effect on loans already in the portfolio. With the current state of the 
economy, will there be enough new loans to bail out the old loans? This 
is where due diligence today is imperative as well as an overall 
proactive approach.

       FHA POLICY CHANGES TO ADDRESS RISK AND STRENGTHEN FINANCES

New Loan-to-value and Credit Score Requirements
    Loans to borrowers with a credit score of less than 580 will 
require a minimum 10 percent down payment. Loans to borrowers with a 
credit score of 580 or above will require the traditional minimum of 
3.5 percent down payment. This change, if approved, will go into effect 
this summer after going through the Federal Register notice and comment 
process.
    We are in general agreement with the move to strengthen down 
payment requirements. We, however, believe there are some caveats. 
While this requires borrowers with the riskiest loans (below 580) to 
put more, to quote an earlier comment by Senator Bond, ``skin in the 
game,'' this will more than likely have minimal impact on the Fund in 
terms of bringing in additional premiums. Loans for borrowers with 
credit scores below 580 are less than 1 percent of new activity. So 
these additional requirements may likely end most activity in this 
category. It might, however, reduce future claims but the volume of 
these loans will not bring in a significant amount of premium payments 
to cover current losses. The chart below from LPS Applied Analytics 
shows the proportion of FICO credit scores over the last 23 months.




    As seen in the lowest color segment of the bar chart for FICO 
scores below 620, the percentage of loans that would be potentially 
subject to the new 10 percent down payment requirement has steadily 
decreased to less than 1 percent. This is both good news and bad news 
because it shows that from a financial perspective the FHA's riskiest 
business is falling off but from a social perspective the potential 
homeowners that it traditionally has served may be priced out of the 
market. Importantly, we are also seeing defaults and claims affecting 
higher credit score loan holders and there are some vocal advocates who 
think a higher down payment may be required for a wider spectrum of 
credit score categories. Further, the 580 credit score threshold is 
well into what is traditionally considered subprime territory in the 
conventional marketplace with 620 being the usual demarcation for 
subprime. We believe that to have a higher down payment requirement at 
the 620 level may have a more meaningful impact due to the larger 
volume of loans at this level.
    In assessing the most recent year's book of business, it needs to 
be understood that underwriting is like a three-legged stool. FICO 
scores are only one leg--the other two legs are the value of the 
property and the future employment of the borrower. While it is true 
that FICO scores have risen from an average of 626 in fiscal year 2008 
to 695 in the first quarter of fiscal year 2010, we should also note 
that the loan-to-value ratios have also gone up during this timeframe. 
In FHA's recent Quarterly Report, the loan-to-value ratio for the 96-98 
percent category had risen from 48.8 percent of the loans written in 
the first quarter of fiscal year 2009 to 69.1 percent in the first 
quarter of fiscal year 2010. This may mean that any gains realized from 
reduced risk for having higher FICO scores may be offset by the 
increased risk of higher loan-to-value ratios. In other words, 
borrowers are putting less of a down payment into purchased homes. As 
we said in previous testimony opposing seller-funded down payment 
assistance plans, less ``skin in the game'' often means that there are 
increased chances for the owner to walk away if delinquencies occur. 
Further, any benefit from the increase in the average FICO scores may 
be tempered by a commensurate rise in claims generated from those 
loans.
    So while the FHA believes that they may have an improved book of 
business in terms of increased volume and FICO scores, the jury is 
still out if the additional cash generated by the new book of business 
will be sufficient to cover the unknown amount of losses in the short 
term or if the premise that high FICO scores are equivalent to soundly 
underwritten loans still holds. Economic instability is creating 
counter-intuitive trends in consumer behavior.
Up-front Mortgage Insurance Premium Increased to 2.25 Percent
    The FHA is pursuing legislative authority to increase the statutory 
cap on the annual Mortgage Insurance premium. OIG supports this change 
in the premium structure. Any business needs to be able to adjust its 
pricing in order to continue to operate efficiently. The FHA needs the 
ability to adjust premium prices without requiring legislative action 
each time that may impede its ability to react quickly. The FHA will 
need, however, to ensure that a process is developed to link future 
insurance premium changes to actuarial forecasts.
Reduce Allowable Seller Concessions From 6 Percent to 3 Percent
    The FHA is seeking an action to conform to industry standards and 
to reduce potential value inflation. It is anticipated to go into 
effect this summer after appropriate notice and comment time. The OIG 
supports this measure. We believe that the FHA needs to be consistent 
with industry practices so as to avoid pressure to raise prices to 
cover seller concessions.

Increase Enforcement Efforts to Ensure Compliance With FHA Guidelines 
        and Standards
    The FHA: (a) Will use a scorecard system to evaluate and report 
lender performance to compliment current information available from 
Neighborhood Watch data (this was implemented in Mortgagee Letter 2010-
03); (b) will enforce indemnification provisions through section 256 of 
the National Housing Act and cover those loans found to contain 
material errors in underwriting (this is anticipated to go into effect 
this summer after posting and comment periods); (c) asked for 
legislation to apply section 256 to require indemnification provisions 
for all direct endorsement lenders in order that all approved 
mortgagees assume liability for the loans originated and underwritten 
by them; and (d) will move to increase capital requirements from $250 
thousand to $1 million in 1 year, and then to $2.5 million after the 
final rule is published, and hold the lender responsible for the final 
underwriting.
    We support the FHA's decision to enhance risk management by, among 
other things, hiring a senior level risk management officer. Its 
decision to use a scorecard system will certainly assist it in 
uncovering problem companies. We note that the FHA has returned to 
conducting a 5 percent sample of lender endorsement reviews by its 
contractors. The number had slipped to 2 percent last year because it 
could not keep up with the volume. We also support FHA's request for 
legislative authority to create separate areas for the purpose of 
review and termination under the Credit Watch Initiative.
    The FHA's intent to strengthen enforcement of its indemnification 
provisions in section 256 is important to an overall enhanced 
enforcement strategy. OIG reviews of indemnifications found recovery 
was hampered by firms going out of business, thereby rendering some 
indemnifications worthless. In a recent OIG Inspection and Evaluation 
report, we found that the FHA serviced $187.5 million of 
indemnification and civil money penalty debt due from lenders for the 
period fiscal year 2005 through fiscal year 2008. The FHA collected 
$124.4 million or a 66 percent recovery rate (a collection rate that 
compares favorably with that of the Veterans Administration's Housing-
Guaranteed and Insured Loans program and private collection agencies), 
however $8.7 million was uncollectable primarily the result of the 
debtor lender going out of business.
  --OIG Concerns Regarding Anti-flipping Waiver.--One change the FHA 
        recently instituted this year was the decision to waive its 
        anti-flipping provisions for 1 year. This action was not vetted 
        with us through normal departmental clearances and we, 
        unfortunately, had no opportunity to opine on the matter. While 
        we understand the underlying reasoning to turnaround foreclosed 
        properties in a quicker manner, we believe its imposition may 
        open a new round of fraud-related flipping abuse and we would 
        have liked to express our concerns or to press for more 
        compensating controls.
      Current housing market conditions have created a bulge in HUD's 
        real estate owned inventories that provide a ready source of 
        properties for potential flipping schemes. To eliminate 
        inventories, lenders and the FHA's own contractors often 
        significantly discount the sales price from acquisition costs 
        and appraisal values in a more normal housing market. The 
        discounts provide the necessary margin for flipping 
        opportunities, legitimate as well as illegitimate. 
        Historically, the illegitimate flip involved a conspiracy 
        between investors, loan officers and appraisers, allowing for 
        the financing of the re-sale to be done at an inflated value, 
        justified by market conditions of increasing housing values.
      When the anti-flipping rule had been originally promulgated, the 
        FHA, primarily at the request of the OIG, sought to protect the 
        MMI Fund from this vulnerability by prohibiting financing of 
        property re-sales until 90 days had elapsed after the purchaser 
        acquired the property. This waiting period effectively 
        protected the FHA from flip abuses such as ``double escrows'' 
        and same day closings. The FHA states the waiver is designed to 
        help reduce REO inventories. There is, however, a real risk 
        that the waiver could serve as an invitation to investors 
        willing to engage in abusive schemes or to try to skirt the 
        rules. Indeed, we almost immediately saw discussions on the 
        Internet among investors. Moreover, with the increase in the 
        FHA's loan limits to greater levels, high-end, as well as 
        traditionally low-end, properties could be targeted by the 
        unscrupulous.
      While an attempt was made by the FHA to mitigate improper 
        activity by requiring an explanation of any price increase over 
        20 percent, as a law enforcement agency we know that it can be 
        just as easy to fabricate documents for this as it can be to 
        inflate the appraisal itself. We see little to deter the wide-
        scale flipping that occurred before the practice was stopped by 
        a 90 day waiting period. While we recognize that keeping the 
        status quo may delay closing, we believe that it is preferable 
        to the alternative risk that such an action may unleash. A 
        safer approach may be to limit the wavier to GSE-held 
        properties or to those sold through State and local 
        rehabilitation programs such as the Neighborhood Stabilization 
        Program where closer scrutiny of rehabilitation costs can be 
        made.
  --Enhanced Up-front Reviews.--We believe it is important that the FHA 
        become more aggressive in the areas of monitoring and detection 
        and analysis of red flags. We endorse FHA's Mortgage Fraud 
        Initiative which seeks to use fraud detection technology to 
        identify loans likely to contain fraudulent information. We 
        have stated previously our belief that FHA needs to take 
        advantage of commercial off-the-shelf pre-screening loan 
        software. We have also long voiced our concerns that the 
        process to become an FHA approved lender and correspondent was 
        not rigorous enough to keep out the known bad actors. When the 
        conventional markets started to decline, we expressed our 
        concern that the same individuals and companies that 
        precipitated the conventional market collapse would seek 
        shelter in the FHA markets and use similar tactics that led to 
        poor underwriting. We believe that this did in fact occur.
      In the case which I referred to earlier in this testimony 
        regarding the New York company Lend America, Michael Ashley, 
        who carefully did not place himself as a principal in the firm 
        but as a business strategist, had had a long history of legal 
        troubles (including with the HUD OIG) and was working as a top 
        manager for one of the most rapidly growing lenders in the 
        FHA's portfolio. Court filings show that Ashley fostered an 
        environment that encouraged sales staff to originate FHA loans 
        even when the borrowers were not eligible. Sales staff could 
        make 10 times the commission on FHA loans than on standard 
        mortgages and almost 4 times the commission than on a subprime 
        loan.
      Mr. Ashley pled guilty in 1996 in Federal court to two counts of 
        wire fraud relating to a mortgage scam at another company his 
        family once owned. He was sentenced to 5 years probation and 
        ordered to pay a fine and his father was sentenced to nearly 4 
        years in prison. He appealed his suspension and debarment with 
        HUD which later was reduced to a ban that expired in 1998. Once 
        served, the FHA allowed him to resume operations. He then went 
        to another firm that again HUD issued a notice of violation. 
        After leaving that firm, he became affiliated with the most 
        recent company. Although this case is still open, it is clear 
        to say that the Federal court would not have permanently banned 
        Mr. Ashley if it were not concerned about the current 
        operations of his affiliated company. The President of the 
        company was also debarred at the same time but for a specific 
        period of time--in this case 18 months.
      This again calls for the establishment of a new mindset at the 
        FHA to know your participants and not just the entity. It can 
        be a very arduous process for the OIG acting as the 
        investigators for the Department of Justice to work to get a 
        court-ordered injunction. Mr. Ashley was quoted in the press as 
        grumbling that the inspector general's office tried its best to 
        constantly go after him and put him out of business. Although 
        he was complaining to the judge at the time, his quote is 
        revealing in that we had to keep following him from one dubious 
        enterprise to another. It can be frustrating. If current 
        regulations and statutes are impeding the FHA's ability to 
        create a watch list or to know its providers complete 
        backgrounds or to keep out permanently those from entering whom 
        it does not want to participate in its program--it has a duty 
        to let Congress know it needs legislative relief to enhance its 
        administrative remedies (i.e., more permanent debarment 
        authority, enhanced civil monetary penalty fines) in order to 
        accomplish this goal. I do not believe in years past, when it 
        was striving to increase its market share, that this was a 
        goal. But I do believe that with the large influx of loans and 
        lenders coming at the program recently it may now see how 
        imprudent such inaction can be.
      A systemic weakness revealed in this case and others showed that 
        FHA-related monitoring and oversight reports typically cited 
        the lending firm without naming the individuals associated. The 
        FHA had argued that without specific citations against 
        individuals it could not link principals of a defunct company 
        to those same individuals who would go on to form new entities. 
        We see this type of maneuver too often and it makes the FHA 
        program too easy a target for those intent on abusing the 
        program. We recommend that FHA ensure in a more significant way 
        that those individuals affiliated with lender entities (either 
        as principals or as staff) are clear of indictment, conviction, 
        debarment and suspension, limited denials of participation and 
        unpaid Federal debt before applications are approved.
      The FHA should also consult with other HUD offices to determine 
        whether applicants are subject to unresolved findings and 
        ensure that application fees received are reconciled with the 
        related applications. More importantly, if the Mortgagee Review 
        Board concludes that a company has participated in improper 
        activities and recommends removing the company's ability to 
        participate in the FHA loan program, the Board also needs to 
        recommend permanent removal of the principals and other 
        individuals involved from any future FHA and HUD programs. I 
        know in my conversations with the Commissioner this is an area 
        on his radar screen.
      The Commissioner testified at his recent hearing, and I lauded 
        earlier in my testimony, that over the last year the FHA has 
        withdrawn 300 licenses from poor performing lenders. We believe 
        that many of these could have been screened more vigorously at 
        the time of their application before the consequences of their 
        admission came to bear in terms of losses or resources applied 
        to investigate and to prosecute. Only time will tell how many 
        more significant failures are yet to be uncovered but we do see 
        more on the horizon. We believe that more stringent 
        requirements, in addition to enhanced net worth requirements, 
        are needed to keep predatory firms and individuals from 
        conducting FHA business.
      I would like to take the opportunity to also draw a parallel 
        issue with the Government National Mortgage Administration 
        (Ginnie Mae) approval process. We believe Ginnie Mae equally 
        needs to strengthen its approval process. While the funding 
        level for its reserves are in a better financial position than 
        that of the FHA, it too has experienced increasing default 
        rates and has suffered unusual substantial losses due to the 
        failure of Taylor, Bean and Whitaker and Lend America. More due 
        diligence needs to be done by Ginnie Mae in approving and 
        recertifying its issuers and I look forward to seeing 
        meaningful recommendations for statutory and regulatory 
        improvements akin to what the FHA has recently proposed. It 
        also has to shift its mindset away from a business-oriented 
        mentality to let problem issuers remain in the program while 
        they work out the details. This attitude toward the industry is 
        no longer feasible unless it wants to absorb large losses. I 
        will speak more to my concerns with Ginnie Mae later in the 
        testimony.
      We commend the FHA for endeavoring to expand its enforcement and 
        note that it has very much needed to implement a more robust 
        early warning system that would alert FHA to precipitous sales 
        price increases. We also see the need for FHA to enhance its 
        Neighborhood Watch system (i.e., allow for tracking of 
        information relating to loan officers, loan processors, and 
        real estate agents) and the Credit Watch Termination 
        Initiative.
  --Lack of Affirmative Certification Statement.--In this same vein, we 
        would like to update the subcommittee on a matter we brought 
        before you a year ago. At the time, I shared with the members 
        an exhibit showing the current application form to become an 
        approved FHA lender or Ginnie Mae issuer. I pointed out to the 
        subcommittee that unlike the Ginnie Mae section which contained 
        an affirmative statement that required the applicant to attest 
        that they had not knowingly made a false statement and could be 
        subject to applicable civil or criminal penalties, and despite 
        the large volume of new applicants coming into the FHA program, 
        the FHA certification and recertification inexplicably 
        contained no such requirement. Even more puzzling is the FHA's 
        response from the Director of the Office of Lender Activities 
        to my recommendation in an audit of the lender approval 
        process. The FHA stated it did not agree with the finding and 
        stated that ``the OIG has not sufficiently demonstrated that 
        because of its certification language FHA is unable to 
        successfully take legal action against lenders violating its 
        program requirements'' and requested its removal from the 
        audit.
      The Department of Justice as chair of the National Procurement 
        Fraud Task Force has recommended that all agencies put in 
        language for grantees of Federal funds the requirement that the 
        participant certify that the statements made in the application 
        are true and correct and that it understands that any false 
        statements made as a part of these certifications can be 
        prosecuted.

Requirements to Better Manage Brokers Such as New Rules for Audited 
        Financial Statements and Adequate Capitalization
    OIG supports this initiative. We also believe that the annual 
financial statements for lenders lag too far behind to be useful. We 
believe there should be quarterly unaudited financial statements 
similar to the SEC's publicly-traded company requirement and suggest 
that there also be an effective review process of these statements. 
Billions of dollars flowing through the FHA are riding on the financial 
health of these firms. Timeliness of information is essential in making 
decisions and we would encourage such a change.

                           OPERATION WATCHDOG

    On January 12, 2010, FHA Commissioner Stevens and I jointly 
announced a new OIG initiative focusing on mortgage companies with 
significant claim rates against the FHA mortgage insurance program. 
This initiative was prompted in part by the Commissioner who was 
alarmed by the incidence of excessive default rates by a number of poor 
performing FHA lenders and reached out to the HUD OIG for assistance. 
Our office served subpoenas to the corporate offices of 15 mortgage 
companies in 11 States across the country demanding documents and data 
related to failed loans which resulted in claims paid out by the FHA 
fund. We identified these direct endorsement companies from an analysis 
of loan data focusing on companies with a significant number of claims, 
a certain loan underwriting volume, a high ratio of defaults and claims 
compared to the national average, and claims that occurred earlier in 
the life of the mortgage. These may be key indicators of problems at 
the origination or underwriting stages. The firms were not selected for 
indications of wrongdoing on their part but we will aggressively pursue 
indicators of fraud if they should be uncovered during the analysis. We 
are a principal member of the President's Financial Fraud Enforcement 
Task Force and this initiative reflects our commitment to seek 
information on red flags that may arise from data analysis.
    While we are still in the data recovery and analysis phase, and 
cannot discuss at this time the initial results of our review, we do 
believe that this initiative will continue. We will carry out our line 
of inquiry until we have conclusive results to provide to the FHA, to 
the Congress and to the American taxpayer. It is important to know for 
the long-term viability of the FHA program whether these skewed high 
claims and default rates are a result of a weak economy or if companies 
are ignoring, or even purposefully violating, FHA regulations. We want 
to send a very distinct message to the industry that as the mortgage 
landscape has shifted, we are watching very carefully, and that we are 
poised to take action against bad performers. The American taxpayer 
demands, especially after the lessons of the subprime collapse, that 
oversight and monitoring must be rigorously implemented. While we may 
disagree from time to time with some of the actions the FHA has taken, 
we both share a common resolve to preserve home ownership at the same 
time as protecting the American taxpayer from further economic 
instability.
    In an audit on Single Family insurance claims, we found that the 
Department received and paid claims on loans for which the lender did 
not show the borrower was able to make the required monthly payments, 
made the minimum investment in the property, and was creditworthy. It 
paid the claims and did not review the loan files for compliance with 
requirements, fraud, and/or misrepresentations. Our initial review 
under Operation Watchdog reinforces the concerns we found in this 
claims audit. The Department should review claims for eligibility and, 
if feasible, independently determine that loans comply with program 
requirements and seek, from lenders, recovery or adequate support for 
final costs associated with those claims.
    Loan Binder Retention.--One issue that has arisen in our reviews of 
these poor performing lenders is the ramifications of the prior 
administration's policy to allow lenders to maintain original records. 
Through the issuance of a Mortgage Letter in 2005, the FHA enabled 
certain direct endorsement lenders to endorse FHA loans without a pre-
endorsement review and generally relieved those lenders from the 
responsibility of submitting loan origination case binders to the FHA. 
The Federal Bureau of Investigation (FBI) and the HUD OIG, vigorously 
opposed the FHA's directive (as did HUD's own General Counsel at the 
time) to allow lenders the ability to retain documents. As a law 
enforcement and auditing agency, we were concerned that such a 
relaxation of control would hinder our ability to gather information 
for evidence if documents were tampered with or destroyed. Further, the 
guidance allowed lenders to maintain the files for only 2 years after 
closure. Statutes of limitations run 5 years in criminal fraud and 
generally 6 to 10 years in civil fraud matters.
    Unfortunately, our fears expressed then in testimony and in a 
letter-writing campaign are indeed coming to fruition today. As we 
proceed with Operation Watchdog, we have had difficulty obtaining files 
from a number of these lenders including encountering instances of 
missing case files despite OIG subpoena demands. We strongly recommend 
that the FHA again revisit this directive to ensure information 
critical to the loan origination and underwriting process is available 
for detection of issues and/or potentially fraudulent activity. In a 
time when the American public demands our mortgage industry is free of 
waste, fraud and abuse, such a policy change is essential.

                        FHA FINANCIAL CONDITION

    The results of the latest actuarial study produced last fall show 
that HUD has sustained significant losses in its Single Family program 
making a once fairly robust program's reserves smaller. The study shows 
that the FHA's Fund to cover losses on the mortgages it insures is 
contracting. As of September 30, 2008, the fund's economic value was an 
estimated $12.9 billion, an almost 40 percent drop from over $21 
billion the year before. By September 30, 2009 the reserve level 
dropped below the statutorily mandated 2 percent requirement to 0.53 
percent. The Fund's economic value was $3.64 billion compared to the 
$685 billion of outstanding insurance in force.
    Since its inception in 1934, FHA has been self-sustaining and 
premiums paid to the fund have covered the losses due to fluctuating 
defaults and foreclosures. We testified last year that given the 
current economic conditions, it is critical that the assumptions used 
to derive the current estimate of the health of the fund be supportable 
and not overly optimistic. We stated to the FHA during our audit of its 
financial statement that the model embraced by the FHA should include 
the study of past and current delinquencies and the ultimate resolution 
as to cures or claims. The current model is designed for long term 
claim projections and is based on historical claims paid experience. 
Therefore, the model does not reflect recent delinquency development 
and lacks the corresponding adjustment to the claims paid. We 
recommended that the FHA expand its financial cash flow model 
validation to include seriously delinquent aged loans data, case level 
historical recovery data, and other leading indicators; and to track 
reasons for default and determine whether other economic indicators, 
such as unemployment claims, may be useful to support near term 
estimates for claim payments.
    An assessment of the first quarter of fiscal year 2010 shows some 
trends that merit examination. With FHA's greatly increased Single-
Family insured volume (a 24 percent change from the prior year and 
currently at more than three-fourths of a trillion dollars in 
insurance) comes an increasing default and claims paid rate. Add to 
this an increasing inventory of real estate owned properties that are 
managed by the FHA--with a falling recovery rate that has FHA now only 
recovering slightly more than 40 cents on the dollar and a ``days in 
inventory'' average of close to 200 days--and the picture becomes more 
disquieting. A significant problem facing the FHA, and the lenders it 
works with, is the fallout from decreasing home values. This increases 
the risk of default, abandonment and foreclosure, and makes it 
correspondingly difficult for the FHA to resell its REO properties.
    Approximately 8.8 percent of FHA loans are currently in default 
(i.e., more than 90 days non-payment status, foreclosure or 
bankruptcy), an increase from the prior fiscal year to date. A major 
concern is that even as FHA endorsement levels meet or exceed previous 
peaks in its program history, FHA defaults have already exceeded 
previous years. Claim rates have also increased and though numerically 
still quite small, it must be noted that many of the new defaults are 
still in the pipeline. We may see increasing claim rates on the 
horizon. The Secretary and the Commissioner hope to stave off the 
consequences of this trend with new approaches to business, but the 
congressional and executive branch budget offices' disagree with the 
impact of these approaches.
    In our estimation, this only reinforces the importance for FHA-
approved lenders to maintain solid underwriting standards and quality 
control processes in order for the FHA to withstand severe adverse 
economic conditions. Another extensive problem confronting the FHA has 
been its inability to upgrade and replace legacy (developed in the 
1970s and 1980s) application systems that had been previously scheduled 
to be integrated. The FHA systems environment remains at risk and must 
evolve to keep up with its new demands though there has been increased 
funding and new plans formulated. I know in my conversations with 
congressional staff that they are frustrated with the amount of 
resources expended and the pace with which such replacement plans have 
proceeded over the years.

                         INCREASED RISKS TO FHA

    Mortgage Fraud.--Last year during testimony before this 
subcommittee, I highlighted a variety of traditional mortgage fraud 
schemes impacting both the FHA and the conventional loan market 
including schemes in areas such as appraisal fraud and loan origination 
fraud, and identity theft as well as new forms of fraud such as rescue 
or foreclosure fraud (to include equity skimming and lease/buy-back 
plans), bankruptcy fraud, and Home Equity Conversion Mortgage (reverse 
mortgage) fraud (to include schemes involving flipping, annuity sales, 
unauthorized recipients, and onerous fee payments/consumer fraud). As 
the Department of Justice recently testified, all types of mortgage 
fraud are on the rise and we are working closely with other agencies in 
the President's Financial Fraud Enforcement Task Force and as part of 
the National Mortgage Fraud Team. We currently have over 2,290 case 
subjects involving Single Family investigations. We have also recently 
created a more robust civil fraud enforcement initiative to assist the 
Department of Justice in enhancing civil mortgage anti-fraud 
prosecutions. For example, we recently assisted the Department of 
Justice in filing a complaint against Capmark Finance Inc, a large 
originator of HUD-insured loans, for making false statements in 
connection with applications used to acquire two nursing home 
facilities (a discussion of nursing home issues appears later in this 
testimony). The following represents a sample of a few of the criminal 
fraud cases we have recently pursued:
  --In Operation Mad House, we conducted an undercover investigation to 
        deal with the problem of escalating mortgage fraud in the 
        Chicago area that had consistently placed it as one of the top 
        five geographic areas for fraud. We received allegations that a 
        number of mortgage operatives were involved in loan origination 
        fraud including the creation of fictitious bank statements, 
        false employment and inflated appraisals and we targeted an 
        organized group of real estate industry professionals at all 
        levels. We tracked the inflated appraisal and phony origination 
        as well as the closing proceeds and how it was distributed. 
        This investigation resulted in 22 individuals in 9 separate 
        indictments being charged with multiple counts of fraud and a 
        spin off whereby 4 new subjects were indicted late last year. 
        All told, 26 principals in the mortgage industry including 
        attorneys, brokers, loan officers, loan processors, appraisers, 
        recruiters, and accountants have been charged.
  --Earlier this month in Atlanta, three members of a reverse mortgage 
        fraud ring were indicted by a Federal grand jury for altering 
        real estate records, using fake documents, and posing as 
        realtors in an abuse that took money away from qualified 
        seniors. The defendants in this case faked required down 
        payments by senior citizens to establish the equity needed in 
        the home to qualify for the reverse mortgage. They did this by 
        using bogus gift letters in amounts between $50,000 and 
        $105,000 and using fake HUD-1 Settlement Statements reflecting 
        the sale of non-existent assets closed by fictitious law firms 
        to show the source of the required down payments. All the down 
        payments were actually supplied by the defendants, not the 
        senior citizens, to be returned to the defendants upon the 
        reverse loan closings along with profits far in excess of the 
        true sales prices of the properties. Such payments were 
        disguised as seller proceeds or lien payoffs and all the 
        mortgages contained fraudulently inflated appraisals.
  --In another reverse mortgage case, on April 13, 2010, in Kansas 
        City, Missouri, the Jackson County Prosecutor charged an 
        individual with financial exploitation of an elderly/disabled 
        person and forgery related to a fraudulent HECM (home equity 
        mortgage conversion) loan. Our investigation revealed that the 
        defendant allegedly obtained a quit claim deed on a Kansas City 
        property belonging to an elderly man suffering from Alzheimer's 
        disease and subsequently took out a fraudulent reverse mortgage 
        in the victim's name. As a result of the scheme, the defendant 
        deposited, by means of a forged Power of Attorney, reverse 
        mortgage proceeds into a personal bank account as well as 
        obtained a loan against the victim's life insurance policy.
  --In February of this year, the former president of a mortgage 
        company was sentenced in Federal court in California to 156 
        months in jail, 5 years probation and ordered to pay almost $30 
        million in restitution to victims for a fraudulent loan 
        origination scheme that knowingly caused loan applications 
        containing fraudulent documents to be submitted to various 
        lenders for FHA insurance so that unqualified mortgagors would 
        appear qualified. His actions caused over 900 fraudulent loans 
        to be FHA insured and subsequently default resulting in a 
        substantial loss to the program.
    Nursing Homes/Section 232.--The FHA insures mortgage loans (section 
232) to facilitate the construction and rehabilitation of nursing 
homes, intermediate care facilities, board and care homes, and assisted 
living facilities. It also allows for the purchase or refinancing of 
existing projects not requiring substantial rehabilitation. It insures 
lenders against the loss on mortgage defaults. As of the end of 
calendar year 2009, HUD had 2,327 projects with an outstanding 
principal balance of $14.6 billion. This represents close to a 36 
percent increase in projects receiving initial endorsements from the 
previous year. As we noted in last year's testimony, the current 
section 232 regulatory agreement does not prevent transfer of the 
Transfer of Need associated with the property; does not include 
receivables in any security documents (which is a significant asset to 
the properties and can limit HUD's loss when retained); and does not 
require a lessee operating the project to abide by the same 
requirements as the owner. This allows lessees to use project funds for 
non-project expenses to the point of default with no recourse.
    With such a vulnerable population involved, the OIG has been 
recommending for years in numerous audits and investigations that the 
regulatory agreement needs to be changed. This status has not changed 
since approximately the fall of 2006. It is our hope that this can be 
done expeditiously.
    Appraiser Oversight.--Our review of the FHA appraiser roster 
identified critical front-end weaknesses as evidenced in the quality 
control review and monitoring of the roster. The roster contained 
unreliable data including the listing of 3,480 appraisers with expired 
licenses and 199 appraisers that had been State sanctioned. In a 
further review, we found that HUD's appraiser review process was not 
adequate to reliably and consistently identify and remedy deficiencies 
associated with appraisers. The FHA's current Single Family insured 
exposure totals over $800 billion representing over 6 million in FHA 
insured mortgages. Inflated appraisals correlate to higher loan 
amounts. If the properties foreclose, the loss to the insurance fund is 
greater.
    With significant increases in volume and new responsibilities in 
the mortgage marketplace, and appraiser fraud a significant problem 
highlighted in national studies, we do believe it may be time for the 
Department to return to an FHA Appraiser Fee Panel similar to the one 
dismantled by statute in 1994. It is essential if the mortgage industry 
wants to overcome perceptions regarding its integrity and its role in 
the current economic crisis that it ensures true market values are 
correctly estimated. Such a move would relieve pressures on appraisers 
to return predetermined values and would change a system based on 
misplaced incentives. A study indicated that 90 percent of appraisers 
had felt pressure ``to hit the number'' provided (i.e., on the sales 
contract). The old FHA Fee Panel was rotational and guaranteed work as 
long as the appraiser met certain HUD requirements. As can be deduced 
from the many cases and problematic issues discussed in this testimony, 
inflated appraisals often are at the heart of the scheme or of the 
questionable arrangement.
    Late Payment Endorsement Requirements Changed.--Last year, we 
testified on results from a number of other key audits that have noted 
significant lender underwriting deficiencies, inadequate quality 
controls, and other operational irregularities. We spoke to an audit in 
which we analyzed the impact of FHA late endorsement policy changes 
affecting FHA insured loans. Unfortunately, this still remains an issue 
and bears repeating. On May 17, 2005, the Federal Housing Commissioner 
issued Mortgagee Letter 2005-23, which significantly changed the 
requirements for late endorsements for Single Family insurance. A 
request for endorsement is considered late whenever the loan binder is 
received by the FHA more than 60 days after mortgage loan settlement or 
funds disbursement, whichever is later. The Mortgagee Letter removed 
the prior 6-month good payment history requirement for these loans and 
provided an additional 15 days grace period before the current month's 
payment was considered late.
    We conducted a review of this rule change and found that, although 
FHA asserted the change did not materially increase the insurance risk, 
FHA did not perform a risk analysis to support this determination. Our 
review of the performance of loans from seven prior OIG late 
endorsement audits (i.e., Wells Fargo, National City Mortgage, Cendant, 
etc.) found a three and one-half times higher risk of claims when loans 
had unacceptable payment histories within the prior 6 months. Since the 
issuance of the Mortgagee Letter, we found that the default rate for 
loans submitted late had increased and was significantly higher than 
the default rate for loans submitted in a timely manner. The HUD 
Handbook itself acknowledged the risk of unacceptable payment histories 
by stating that ``Past credit performance serves as the most useful 
guide in determining a borrower's attitude toward credit obligations 
and predicting a borrower's future actions.''
    In 2006, we recommended that HUD rescind the Mortgagee Letter until 
appropriate rule changes could be designed that were supported by an 
adequate risk assessment. The FHA disagreed with our audit report and 
declined to implement the recommendations. We referred this matter to 
HUD's Deputy Secretary who concurred with our recommendations on 
February 27, 2007 and ordered the FHA to immediately rescind the 
Mortgagee Letter.
    Initially, the FHA agreed to implement the Deputy Secretary's 
directive but failed to take action, instead taking efforts to again 
dispute our audit results. This continued until April 2008, when the 
Deputy Secretary's office again intervened, at our request, and 
instructed the FHA to publish the proposed rule change in the Federal 
Register reinstating the 6 month payment history requirement for late 
endorsements. In June 2008, the proposed rule change was published in 
the Federal Register for comment.
    Although the final rule rescinding the Mortgagee Letter was never 
published, FHA nevertheless closed the audit recommendation. In a 
memorandum dated March 18, 2009, we informed the FHA that, given the 
amount of time that had lapsed and the absence of a corrective action, 
the OIG would report this in our next Semi-Annual Report to Congress. 
Given the current mortgage crisis, concerns over losses to the 
insurance fund, and requirements for transparency, we believe that this 
is an important recommendation that should not be dismissed.
    Capturing Key Information in, and Upgrading, Data Systems.--Another 
major concern, touched on previously in testimony, is the integration 
and upgrading of FHA legacy systems which bears repeating since our 
original premise has not been acted on. While there has been much 
discussion of an overall plan, and what particular types of systems are 
needed to go forward, it would be useful at this juncture to reposition 
the discussion to ascertain which data should actually be collected, 
and maintained, in the system in order to control the new demands 
placed on the program. Our audit work and our investigative ``Systemic 
Implication Reports'' transmitted to the Department over the years, 
makes it clear that, at a minimum, we need the system to track 
identifying information on key individuals involved in the transaction 
such as the originating loan officer, loan processor, and real estate 
agent.
    The loan officer, for example, is central to the origination of the 
loan where due diligence should be exercised on the application 
material (i.e., credit scores, appraisal information, etc.). It would 
be useful to record the person's name and corresponding identifying 
information (i.e., license) in the same system the FHA uses to track 
underwriter and appraiser details. This will allow the FHA and OIG to 
key in on a vital part of the loan process--origination--where fraud 
typically can occur. If the system could also capture information on 
other key players such as the real estate agent for the seller and 
buyer, and other parties to the transaction, that too would be helpful 
for purposes of increasing integrity in the processes in our 
investigative and audit functions. It would also be valuable to the FHA 
in strengthening its risk management and monitoring efforts.
    Further, it could be beneficial for the FHA to participate more 
significantly in a unified lender oversight consortium with Fannie Mae, 
Freddie Mac, the Federal Deposit Insurance Corporation (FDIC), and 
Ginnie Mae in order to, among other things, create standardized forms 
that could produce common machine-readable data fields with consistent 
information as well as to leverage existing data systems.
    Earlier in the testimony, we described the TBW case and the 
weaknesses that it exposed in the FHA and the Ginnie Mae programs. As 
we are discussing the need for Federal entities to come together in a 
more unified manner, we would also like to highlight an issue that came 
to forefront in this case. Ginnie Mae mortgage-backed securities (MBS) 
are the only MBS to carry the full faith and credit guaranty of the 
United States. If an issuer fails to make the required pass-through 
payment of principal and interest to MBS investors, Ginnie Mae is 
required to assume responsibility for it. Typically, Ginnie Mae 
defaults the issuers and assumes control of the issuer's MBS pools.
    The FDIC temporarily froze the Ginnie Mae custodial bank accounts 
at Colonial Bank as well as the bank's mortgage payment lock box 
account. As a result, Ginnie Mae was forced to make an approximately $1 
billion pass-through payment (principal and interest) to investors. 
There needs to be better coordination between the FDIC and other 
Federal Government agencies so that losses absorbed because of its 
action can be mitigated by more cooperative and forward-thinking 
behavior. We are also very concerned with the extent that future bank 
failures and bankruptcies could have on the Ginnie Mae program. The 
FDIC stated in a recent report that over 200 banks are predicted to 
fail this coming year.
    The other disconcerting aspect of the TBW case involves the fact 
that Fannie Mae became aware of some unsettling practices at TBW, made 
it replace some loans and then stopped doing business with it. TBW then 
sold their servicing rights to another company and started doing 
business with Freddie Mac. Then, down the line, Ginnie Mae accepted 
pools from TBW. It appears that Fannie Mae's only interest was self-
interest. A number of years ago, I testified before the House of 
Representatives regarding a case called First Beneficial in which 
Fannie Mae did not tell other entities of its discoveries at First 
Beneficial and then, by its silence and inaction, caused losses to the 
Ginnie Mae program. There needs to be mandated requirement of 
notification and penalty for failure to notify or we will continue to 
see instances of fraud cases being perpetrated on unknowing 
securitizers.

                          CONTINUING CONCERNS
 
   Though there have been incremental increases in funding to the FHA 
for a variety of staffing and system needs, including a planned 
increase of over 100 FTEs from fiscal year 2010 to fiscal year 2011, we 
believe there remains a need for either more, or a proper placement of, 
resources to the FHA in light of the dramatic percentage of increased 
loan volume and of its increased relevance to the eventual 
stabilization of the conventional mortgage marketplace. We would like 
to see more personnel dedicated to the Home Ownership Centers, which 
are responsible for monitoring loan origination and servicing 
practices, setting underwriting standards, and overseeing the 
disposition of HUD-owned properties, as well as to headquarters systems 
and technology until the IT infrastructure can be put in place in order 
to manage the program changes, and away from such activities as 
marketing since FHA has already proclaimed it wants to retreat from 
such a prominent place in the marketplace.
    We still remain concerned that increases in demand to the FHA 
program are having collateral implications for the integrity of Ginnie 
Mae. Like FHA, Ginnie Mae has seen an augmentation in its market share. 
For example, in December 2009, its Single Family issuances totaled 
nearly $40 billion and it had a remaining principal balance of over 
$880 billion. By comparison, its balance in December 2007 was exactly 
one-half at slightly over $440 billion. It too has stretched and 
limited resources to adequately address this increase.

                               CONCLUSION

    Mortgage industry behavior was a precipitating factor in the 
present economic turmoil. As the Department has written about in its 
assessment of the foreclosure crisis, industry participants encouraged 
borrowers to take riskier loans with a high risk of default due to the 
high profits associated with originating the loans and packaging them 
for sale to investors. These lenders had little or no risk in the loan. 
There were many factors that made it possible for the mortgage market 
to make so many miscalculations and missteps. A primary factor was 
development during this period of the growth of the asset-backed 
securities market, which shifted the primary source of finance from 
Federally regulated institutions to mortgage banking institutions that 
acquired funds through the broader capital markets and were subject to 
much less regulatory oversight.
    Clearly the regulatory structure was not changing rapidly enough to 
keep with the pace of growth. Fraud may have had a significant 
contribution and analysis shows that there was a lack of adequate 
underwriting controls by lenders to oversee brokers' activities. The 
general regulatory structure did not work to provide adequate oversight 
to oversee the origination and financing of mortgages. The consequences 
were high risk lending and a resulting surge in delinquency and 
default. The lessons of the conventional side of the industry should 
not be lost on that of the FHA and Ginnie Mae programs as they too are 
now experiencing increasing delinquencies, defaults and claims. And it 
should not be lost on those tasked with rectifying the vulnerabilities 
that clearly came to the foreground regarding the lapse in oversight of 
the Fannie Mae and Freddie Mac Government sponsored enterprises.
    The conventional mortgage market is going back to the basics. It is 
embracing full underwriting standards including accurate verifications 
of income, employment and appraisal; it is demanding adequate cash down 
payments from borrower's own funds; and it is seeking rational debt-to-
income ratios. Observations of current historic contagions of risk 
suggest that, in the marketplace today, yesterday's lower 600's FICO 
score is now today's higher 600's FICO score and that FHA's floor may 
be set too low. Nevertheless, this has to be weighed against the FHA's 
traditional mandate to assist homeowners that are low to moderate 
income and who may have poorer FICO scores. It also suggests that even 
high FICO borrowers with significantly distressed properties still 
default because of the rational choice to prevent years of principal 
payments just to break even. This makes it all the more important to 
have an active risk management department to monitor and rapidly 
develop policies as the traditional ``black-boxes'' adapt to the 
``new.''
    Finally, we remain concerned that, although not within the control 
of the FHA, the fact that our nationwide mortgage lending system is 
fragmented with separate players embracing differing requirements 
creates opportunities for waste, fraud and abuse that a more unified 
approach could potentially ameliorate. We have not seen enough progress 
or initiative to try to overcome the vulnerability that lapses in 
coordination among Federal entities creates. Of one thing, however, we 
are sure--those intent on unscrupulous behavior know full well how to 
exploit the weaknesses in the system and to profit from such disorder. 
We do very much look forward to the implementation of many of the 
Secretary's efforts designed to mitigate many of the difficulties we 
have been highlighting in the last number of years and to working with 
him and the Department to try to improve programs so increasingly 
relied on by our citizenry during these trying economic times.
    As Chairman Murray has stated, stabilizing and improving the 
housing market is critical to the Nation's economic recovery but FHA's 
participation must be done in a way that it can effectively manage the 
loans that were made during the height of the housing boom so that it 
can provide a much-needed boost of liquidity to the market. We thank 
you for the opportunity to relay our thoughts on these important issues 
based on the body of our work and of our experience, and greatly 
appreciate the activities of the Congress to protect the Department's 
funds from predatory and improper practices and to ensure an effective 
response on oversight at this critical time.

                                MMI FUND

    Senator Murray. Thank you very much, Mr. Stevens.
    Let me just start. This is your first appearance before our 
subcommittee, but FHA has been the subject of annual hearings 
since I have become chairman here. And together, Senator Bond 
and I have sounded the alarm on FHA and the solvency of the MMI 
Fund, and because of our concern, we did provide FHA with 
additional resources both for IT improvements and for increased 
staffing in order to give FHA the tools that they needed to 
protect the agency from fraud and risk and make sure that 
taxpayers never have to subsidize these mortgages.
    So I am, obviously, very concerned that FHA's capital 
reserve account has now fallen below the mandatory 2 percent 
required by Congress. In your testimony, you outlined several 
reforms that are designed to recapitalize the reserve fund and 
protect the solvency of the MMI Fund, some of which you said 
are already in place.
    But I would like you to share with us what is the current 
state of the MMI Fund and how does it compare with the 
projections that were set forth in the audit that Congress got 
last fall.
    Mr. Stevens. Thank you for the question.
    Let me just start with the--we released to you the first 
quarterly report of the fiscal year to Congress a month and a 
half or so ago. The second quarterly report will be released 
here in the next few weeks, so you will get some detailed 
information on the status of the MMI Fund.
    In particular, the current total reserves are actually 
higher than we reported when we announced that we had fallen 
below the 2 percent statutory level for the capital reserve 
fund. So today we are sitting at about a little over $32 
billion. When we reported in the fall, it was about $31 
billion. So they have actually increased.
    I will tell you that there are a couple of key drivers that 
will impact the fund the most. The first are, obviously, the 
real foreclosure numbers that will impact the real actual 
reserves in the fund. We are actually behind what was 
forecasted for the year at this point in time, but we did 
forecast that we would have 125,000 total defaults for the 
fiscal year, and given the trend line, I believe we still will 
be on track to hit the 125,000 number, based on the trend line 
that we are seeing now. But I do not expect us to exceed that 
number.
    The other impact to the fund will be the severity rate or 
the recovery rate, however you look at that. While we have some 
concerns in that area, the current recovery rates are generally 
remaining on track with what was forecasted.
    So in total right now, I would tell you that the overall 
dollars in the fund are growing, not shrinking, but we still 
remain on track with everything that was projected by the 
actuary when we released it in the fall.
    Senator Murray. Do you know when you are going to hit that 
2 percent level?
    Mr. Stevens. The forecast for the 2 percent level was 
forecasted to be in 2013, I believe. As you know and as I would 
strongly caution, there are so many moving parts in the market 
that go into these forecasts, that we could hit that sooner or 
later, obviously depending on market conditions.
    One example I would give you. In our actuarial forecast, 
our home price index expected roughly a 9 percent drop in home 
prices in the first quarter of the 2010 fiscal year. That has 
not been realized. However, there is still enough instability 
in the market that we do not know when the new actuarial study 
is done for the next upcoming fiscal year, what the home price 
forecast will look like. And if stability is on the horizon, we 
could end up having a better view of when the capital reserve 
will be hit. If the forecast is worse, it could put in jeopardy 
our existing forecast, and those are critical components that 
we are watching closely.

                           RECOVERY OF LOSSES

    Senator Murray. You noted in your testimony that most of 
the expected losses are the results of mortgages from previous 
years, and while you are limited in your ability to effect the 
performance of older loans obviously, you can hold lenders 
accountable for losses on FHA mortgages that were improperly or 
fraudulently underwritten. How successful have you been in 
recovering losses from some of those mortgages?
    Mr. Stevens. I think this is a real challenge, part of 
which is there are some limitations to what FHA is allowed to 
do. Fortunately, the inspector general has some additional 
authorities which have been implemented. I would tell you at 
this point that some of the measurements of that are the number 
of institutions that we have either withdrawn approval from or 
suspended completely. As was noted, there were 300 institutions 
in the fiscal year. There have actually been another 200 on top 
of that, in total well over 500 institutions that are no longer 
allowed to originate loans in the FHA.
    Our ability to go after performance on previous book years, 
borrowing fraud or misrepresentation or violations of the law, 
continues to be somewhat limited, and that is why we are asking 
for additional approvals to go after institutions whether they 
are DE lenders or LI lenders to be able to require 
indemnification at the institution level and that will help 
greatly. I do commend the inspector general.
    Senator Murray. That will take legislation.
    Mr. Stevens. That will take legislation.
    But addressing fraud issues has been a significant concern 
of mine, and we have a lot more work to do going forward. 
Obviously, we made some great visibility with companies like 
Taylor, Bean & Whitaker, shutting them down in the first few 
weeks while I was on the job, and Lend America, which really 
required partnership with the inspector general to get done. 
And these were stand-out institutions, but what people do not 
see are the little institutions committing fraud like the 
reverse lender in Hawaii who was taking reverse mortgages out 
for seniors and investing them in their own annuity investment 
fund which they owned and operated. Well, we got them too. 
That's just not a big headline-maker.
    And so it is a big job and it requires a lot of work. And 
that is why the first investment we are making on the 
technology front is in the fraud tools area. We released our 
RFP last week and it is a 30-day process. So we have bids 
coming in right now for that work, and that will be in the 
market hopefully as quickly as possible.

                              GSES REFORM

    Senator Murray. Well, as we now work to reform Wall Street 
and the financial sector and prevent any future housing crisis, 
it is really clear that we have to address the future of the 
GSEs. During the housing boom, Fannie Mae and Freddie Mac kind 
of lost sight of their primary mission of facilitating 
liquidity for safe and affordable mortgages. Instead we saw 
their zeal for profit drive them to take some unnecessary 
risks.
    So we know reform is necessary and there has to be a clear 
plan for ending this unlimited taxpayer assistance for Fannie 
and Freddie. I think we need a very thoughtful approach as we 
do this. We have to protect our American taxpayers, but 
thoughtful deliberation cannot turn into delay or inaction. And 
we need to see the administration recognize the urgency of 
reforming GSEs.
    So I wanted to ask you, when can we expect to see the 
administration's plan for reforming the GSEs?
    Mr. Stevens. Senator, what I would respond by saying is to 
reiterate what you said in your opening statement, that this 
needs to be thoughtfully done with care not to disrupt the 
housing market, and we completely agree with that.
    We strongly agree with the need for reform. We all 
recognize that the housing system and the role of the GSEs or 
whatever structure exists going forward will not be the same as 
it was coming into this crisis. That is clear.
    And we support Senator Dodd's recommendation strongly to do 
a study with recommendations early next year.
    So to that extent, everything we do now has to be very 
carefully balanced with the need not to disrupt the markets 
because the GSEs are playing a critical role in the issuance of 
mortgages and mortgage-backed securities to keep the market 
stable under the current format.
    Senator Murray. Well, any kind of radical change in the 
role of the GSEs could also mean a dramatic change for FHA and 
Ginnie Mae, and I am concerned about the prospect of FHA taking 
on significant increase in new business, given all the current 
challenges we have.
    How do you see FHA fitting into this debate?
    Mr. Stevens. Without question, the needs in the future of 
the housing finance system under any normal view would have to 
consider all the participants that in some way, shape, or form 
have involvement by the U.S. Government, whether that is 
Federal Home Loan banks, FHA, Ginnie Mae, Freddie Mac, Fannie 
Mae, and whatever other solutions ultimately get considered.
    So the fundamental belief we have for FHA is in isolation. 
FHA plays a critical role, as it always has since the 
Depression, when it was first created. It is a countercyclical 
role. It has been consistent in the marketplace when other 
financing vehicles have not been available. Its role is too big 
today. It is unhealthy to run at 30 percent market share as it 
currently does. The emergence of private capital to be 
sustainable in a recovery market is absolutely the most 
important step to help FHA's role in the market begin to shrink 
back to more normalized levels.
    Senator Murray. Thirty percent is too much. We all agree 
with that. What do you think the market share for FHA should 
be?
    Mr. Stevens. You know, I think targeting a market share for 
FHA is something that gets any institution in trouble, but I 
will say that 2 percent was also an unhealthy level. That was a 
sign of subprime mortgages and option ARMs and private label 
securities wrapped by rating agencies and sold into various 
debt obligations to unknowing investors. That was an unhealthy 
world as well.
    So if you look back through normal times, going back 
through the decades of FHA, during traditionally stabilized 
markets, it typically runs in the 10 percent range, maybe low 
teens, and that is sort of the range where I think FHA would be 
shown as a healthy participant in the mortgage context.
    Senator Murray. How long would it take us to get from 30 
down to 10--low teens?
    Mr. Stevens. Well, I think that is why the dialogue is so 
frustrating, as you said in your opening comments, and both of 
you have articulated this concern about even decisions around 
the GSEs. We are in a very unique period now. Freddie Mac, 
Fannie Mae, and FHA are consuming about 95 percent of the 
mortgage finance system for single family housing, and we need 
private capital to emerge. The first sign, as you said, Senator 
Bond, in your comments, was that--or Senator Murray. I cannot 
remember whose comments--who made the point. But as the Fed 
steps out of buying mortgage-backed securities out of the 
market which have kept interest rates low, that range of 
movement in mortgage spreads will be a clear indication of the 
private sector's interest in getting back into the mortgage 
markets. And we will see. We have a variety of thought leaders 
that we have talked to.
    Senator Murray. So we do not know what the withdrawal of 
these supports is going to be. Yet, we are all kind of looking 
out there. Do you have a guess what it is going to do to----
    Mr. Stevens. Guessing is a dangerous game. I have been in 
this industry for 3 decades.
    Senator Murray. How about a thoughtful----
    Mr. Stevens. Here is my thoughtful view, Senator. I 
actually do not expect mortgage rates to back up as 
significantly as some of the extreme negative views are when 
the Fed steps out. That will be the first sign of health. The 
first-time home buyer tax credit ends here. The last 
applications are at the end of the month. It expires at the end 
of June completely. That will be an interesting move because 
2.2 million Americans filed for tax benefits under the First-
Time Homebuyer Tax Credit Act. And so that will be a next test.
    Redwood Trust has already issued one mortgage-backed 
securitization in the private sector in the last couple of 
weeks. They are getting ready to do another one. The trade 
levels of those trusts we are looking at very closely.
    Each of these are indicators to me as to what will happen. 
Having been through a lot of--I lived in the oil patch crisis 
in Colorado and had branches in Missouri at the time many, many 
years ago working for a bank, and I do recall the impacts of 
going through that kind of cycle. You know, it takes confidence 
for investors to return. Private capital will come back when 
they believe there is strong regulation, that the rules of the 
road are clear, and that they believe that home prices are past 
the point of severe instability. There will always be 
variations, but stability is what people will invest in. The 
markets do not like instability whether it is in the equities 
markets or in the housing market.
    Senator Murray. Thank you very much.
    Senator Bond.

                               FHA LOSSES

    Senator Bond. Thank you very much. Your questions and your 
responses raised a whole bunch of interesting areas.
    Let me start off. What are the current losses that FHA is 
realizing under the MMI Fund? How does it compare to last year, 
and what is your projection for the future?
    Mr. Stevens. If you give me just a moment, I would like to 
be as accurate as possible.
    Senator Bond. Okay.
    Mr. Stevens. So through the end of March, we have actually 
seen current delinquency rates have dropped for January--or 
excuse me--for February and March, we saw delinquency rates 
drop fairly significantly, 15 percent, over where they were in 
December. So while we are seeing delinquency rates drop, we are 
seeing foreclosures, actual, real foreclosures increase. And so 
what we expect to have occur for the year is 125,000 
foreclosures with an expected severity rate on each of those 
losses of somewhere in the range of 50 percent. And so, the 
specific losses to the fund at year end--and George, I do not 
know if you know the number that is in the MMI.
    Speaker. No, but like you said earlier, the capital 
resources have been increasing.
    Mr. Stevens. Yes. I mean, the reality is our capital 
resources have been increasing. So let me step back. We reserve 
very differently than a bank does. A bank under a Basel 
standard will hold for loan loss reserves for anywhere from 2--
sometimes 1 year to a 3-year period they will hold for loan 
loss reserves. So the FHA's reserves function is we hold 
capital in reserves for a full 30 years' worth of losses. Much 
of that loss expectancy will not hit until peak default 
periods, 2, 3, 4, or 5 years into the amortization of a 
mortgage.
    So when we reported that we were below our 2 percent 
capital reserve, it was not our total capital, Senator. It was 
our secondary loss reserve, which is an additional loss reserve 
above our primary reserve account. And the two combined reserve 
accounts are actually in excess of about 4.5 percent of total 
capital. The 2 percent reserve requirement is based on the 
secondary account, which contributes to that. That is what had 
fallen below 2 percent, but our primary reserve account 
actually continues to grow simply because we are not seeing the 
losses that were fully expected when the actuarial audit was 
done.
    So without trying to sound evasive, the reality is that we 
are not seeing the real losses as yet. Our actual reserves are 
growing. The forecast is that under the existing book of 
business, we will exhaust the entire amount down to that 
remaining capital reserve of .53 percent. That forecast assumed 
that we do not originate any new loans. So as we continue to 
originate new loans of such high quality, the fund is actually 
rebuilding faster with better assets offsetting that loss 
reserve.
    Senator Bond. Have you got a number? How many billions will 
you experience in loss this year?
    Mr. Stevens. In this year?
    Senator Bond. You must have some forecast.
    Mr. Stevens. Do we have a forecast, George?
    Speaker. We are not forecasting.
    Mr. Stevens. Yes. So we forecast the reserve number. We do 
not forecast this current year number. But, Senator, if it 
would be all right, I would like to give you a more thoughtful 
answer.
    Senator Bond. Yes, we would like to know because we need to 
get a handle on this somewhere. We have got reserve accounts 
and reserve accounts are growing, but losses are out there. 
There is no question that there are losses out there, and we 
need to have a handle on where all this is going.
    Mr. Stevens. Senator, if I may, I would tell you that we 
would expect by year end that the fund would be either about 
where it is now or higher. The actual reserves will be about 
where they are now. What it will impact, unfortunately, from a 
budget standpoint will not be our actual losses. It will be 
what is forecasted in what we have to reserve against. So those 
will be very different numbers in terms of how we look at it. 
But I will submit to you a more thoughtful response to that 
question.
    Senator Bond. Okay. You mentioned that you are still 
confident in the official $5.8 billion estimate or whatever it 
was that OMB came up with. CBO came in with a $1.9 billion in 
receipts. What is the difference? How do we resolve this? We 
are kind of looking at hither and yon, but we need to have 
where we are rather than hither and yon.
    Mr. Stevens. So the challenge is both analyses are based on 
views on various performance characteristics. The difference in 
the CBO score, in particular, can be mostly isolated into two 
variables. One is they assumed much higher prepayment speeds on 
our portfolio than was in the OMB estimate. Interestingly, 
prepayment speeds are a derivative of interest rates. If 
interest rates drop dramatically, you get much higher 
refinancing and loans will pay off earlier. If interest rates 
remain stable or rise, you would actually expect prepayment 
speeds to be slower. And so depending on that forecast, you are 
going to have an impact to prepayment speeds, that combined 
with default rates.
    So that is one variable that is very different, and I would 
question the prepayment speed assumptions, but I am sure they 
are based on rational logic.
    The other one is the severity rate. So on your losses, you 
know, what is going to be percent of loss on each actual unit 
of real estate that goes into foreclosure. And the CBO score 
expects higher severity rates than the OMB score does. In that 
particular measure, I would say there is probably a little 
truth to both, and we will look at that very closely.
    But it is interesting that the prepayment speed issue--if 
you assume you are going to have losses and worse severities 
over the long term, you would assume that the market is 
worsening. My own internal logic would say that if interest 
rates are dropping, you are probably going to have increasing 
volumes of new home sales which may actually level or spur 
recovery.
    So while there may be some natural conflict there, I think 
both are based on rational input. Both expect positive receipts 
from FHA in either case. The amount differs because of those 
two variables.
    Senator Bond. You said in your first element was the 
prepayment, and that if interest rates go down, prepayment goes 
up. So you get better returns. But I do not see how, with the 
problems we have, which are too much like Greece's problems 
with our debt with an unending series of spending and declining 
tax revenues, somewhere those interest rates are going to go 
up. And I do not see--even though the Federal Reserve has been 
accommodative, perhaps overly accommodative, I do not see any 
prospect that interest rates are going to get lower. Are you 
predicting lower interest rates rather than higher?
    Mr. Stevens. I am not predicting lower interest rates. I 
think we would have to ask the CBO what variables they assumed 
for faster prepayment speeds on our portfolio than the OMB view 
was, or quite frankly, our own independent actuary had as well 
similar prepayment speeds to OMB.
    Senator Bond. I tell you what. We probably are not going to 
hash this out.
    Mr. Stevens. Yes.
    Senator Bond. I have got a staff that loves to get into 
those things, and maybe they can work with your staff and we 
can see if we can find some way to resolve those. And we will 
ask the inspector general and your actuary and everybody to get 
together and have a whole lot of fun working those things out.
    Mr. Stevens. That sounds great.
    Senator Bond. If you do not mind.
    Mr. Stevens. That is wonderful.

                            FINANCIAL REFORM

    Senator Bond. Now, while we are asking easy questions, as 
you have indicated and the chair has indicated, as you know, we 
are debating a financial regulation bill on the floor, and from 
what I have learned--and granted, some of it comes from the 
book, The Big Short--the problem of shaky subprime mortgages 
was exacerbated in Wall Street by creating mirror derivatives 
based on the subprime securitized mortgages. And these--I call 
them computer game shadow derivatives--magnified the impact. In 
other words, Wall Street was making a whole bunch of money on 
derivatives that mirrored the subprime but these were not 
actually based on the subprime loans themselves. But when the 
subprime loans went down, all of the value of those 
derivatives, which for some reason were successfully marketed 
to people who were willing to go out on a limb--is that an 
accurate assessment of what happened in the financial system?
    What kind of regulation would be necessary to rein in the 
risk that the excessive Wall Street manipulation of derivatives 
will not impose in the future the same kind of serious risks to 
the financial marketplace we have seen not just in America, but 
we managed to poison a lot of the world's economic systems?
    Mr. Stevens. Which question was easier, this one or the 
last one?
    Here is just a view that I would articulate, that the 
financial reform bill is critical. The risk retention 
component, just as one example, clearly under any of the 
amendments that are being offered, would require risk retention 
for those kinds of programs. Looking back at how these products 
were created and manufactured and being in the private sector 
and watching that occur, there was clearly a lack of alignment 
on incentives, short-term gain based on models that were not 
tested, and there was no recourse or skin in the game for that 
creation.
    I think to that end, whatever ultimately comes of the 
amendments on sort of vanilla programs or things offered by the 
Landrieu amendment or some of the other amendments that have 
been offered, I think one of the most critical values that will 
come of financial reform, if it gets passed, which I strongly 
encourage, is that without question, no one is carving out the 
products that you address. I think to that end, having to hold 
capital against loss is clearly--and you made that point about 
capital reserves that we are requiring at an institutional 
level. In my opinion, capital reserves on risk assets, putting 
a risk-based weighting against those, is the clearest way to 
require that skin in the game and interest in making sure that 
your evaluations of risk are appropriate to the real risks that 
you ultimately see.
    Senator Bond. I have run over my time.
    But the SEC has now come in full force in going after 
these. But it is my understanding that they or--I think they 
are the ones that should have been regulating these. And I 
heard a great Texas country band called Asleep at the Wheel 
recently and I was thinking about how that might be a good 
moniker for what went on in the regulatory agencies. Is the 
regulation of risk an SEC function? What agency should be doing 
this?
    Mr. Stevens. Without going back to the past and the 
multiple regulators----
    Senator Bond. Okay. Going forward, who ought to----
    Mr. Stevens. Going forward, one of the things that I think 
is also important about the financial reform bill is the 
creation of a CFPA, having a single regulator to oversee 
mortgage products that are directed to consumers. You know, I 
think to some degree you have articulated a very important 
point. When you have multiple regulators, specific ownership of 
specific risk attributes may become murky. And I am not sure 
that is the case in the past. I have personal opinions, but I 
know that Secretary Donovan and Secretary Geithner would have 
clear statements to that effect. But I would say that that is 
another value proposition in the financial reform bill to get 
this through, is to identify a single regulator responsible for 
regulating mortgage products.
    Senator Bond. Thank you, Madam Chair.

                     MAKING HOME AFFORDABLE PROGRAM

    Senator Murray. Thank you. Thank you very much.
    About a year ago, the administration launched their Making 
Home Affordable to help homeowners with foreclosure. One of the 
programs is this HAMP, Home Affordable Modification Program, 
was designed to make mortgages more affordable, lower interest 
rates, spread mortgages out, now by writing down principal. We 
were told that that program was supposed to help 3 million to 4 
million families by 2012, but as of the end of March, only 
about 230,000 homeowners had received any kind of permanent 
modification, which is far short, I think, of expectations.
    Can you tell us at what rate do we need to see permanent 
modifications occur in order to reach that 3 million to 4 
million goal?
    Mr. Stevens. So if I may, I would just like to back up to 
the initial program and kind of where we are today. When the 
program was first rolled out, we all know that adoption was 
slow in the program. Bank readiness to manage the HAMP program 
was not developed at a pace that was acceptable to the 
administration.
    In July of last year, both Secretaries Geithner and 
Donovan, asked in what became the infamous fly-in where all the 
CEOs of the banks involved in HAMP flew into Washington, and a 
lot of pressure was put on to get the program up and going and 
the announcement of the scorecard at that point.
    From July until the end of the year, there was a rapid 
ramp-up in trial modifications. Unfortunately, a lot of the 
initial modifications done by some of the institutions were 
modifications first without getting the appropriate 
documentation to ensure that they would be sustainable into 
permanent mods.
    And so what we may see is a relatively higher cancellation 
rate of that initial population.
    Since then, through a learned process, we have transitioned 
to where documentation and qualification is now going to be 
done up-front at the trial modification period, and we believe 
that there will be a high transition from trial to permanent 
mod on all mods going forward.
    So I just wanted to put that out there. We just this week 
had another fly-in with the executives of all the institutions 
in HAMP and reiterated and went through the details of the new 
process. I left with the feeling of confidence that at least 
that portion is done. We will not have that high fallout.
    I would say that we still have well over a million 
homeowners saving $500 a month in trial modifications, of 
which, to your point, the 230,000 have converted to permanent 
mods. We have 108,000 more that have accepted a permanent mod 
and are waiting to sign documents. You will see some rapid 
activity over the next 60 days because the institutions all 
involved in HAMP have pledged to clear out their pipelines of 
backlogs from that initial phase over the next couple of 
months. So we will see a big transition there.
    Senator Murray. So by the end of the summer, we will see 
better numbers?
    Mr. Stevens. I think we will see some interesting numbers 
for the next couple of months, as we see the backlog of 
nonpermanent modifications either go permanent or go into 
portfolio modifications that are not part of HAMP or perhaps 
pure cancellation. So there will be some noise there as they 
clean out the pipelines.
    We will then see, I believe, a regaining of activity on 
trials and permanence. That, combined with our enhancements to 
HAMP, which we just recently announced and the FHA program we 
believe will remain on track to hit the 3 million to 4 million 
homeowners that the administration committed to by 2012.
    Senator Murray. All right.
    At home I am hearing from a lot of counselors and 
homeowners about the problems that they are facing in getting 
permanent mortgage modifications. It is very frustrating. In 
fact, it is actually anger, especially when we hear about the 
profits that a lot of these banks are making in large part due 
to Federal taxpayer assistance. Since a lot of these banks have 
received direct or indirect Government assistance, is there 
anything the administration is doing to make sure that they are 
working in good faith now to assist these troubled homeowners?
    Mr. Stevens. There are several things that have occurred 
and I would be eager to follow up with either of your offices 
with additional information, but let me just say a couple of 
things.
    One is, I think you are all aware we have the Making Home 
Affordable Web site. We also have the Making Home Affordable 
hotline where consumers can call in, if they are not getting 
the response they think they need from their banks, and we have 
teams that will triage those and respond to them fairly 
quickly. So they do have a direct, non-institution channel if 
the point of frustration comes. So that is a backstop at the 
point where they are probably already frustrated.
    On the front end, that was one of the----
    Senator Murray. My front desk in my Seattle office would 
tell you that that is not working very well.
    Mr. Stevens. The hotline is not working?
    Senator Murray. Yes.
    Mr. Stevens. Okay, that is good feedback. I would love to 
hear more about that. We actually talked about that in our 
meeting this week.
    You know, the other issue that has gone on with the HAMP 
program is the banks did not staff up. People would call 
initially. They could not get someone on the phone. They would 
send in packages. We have heard stories of lost documents. We 
have done several things to try to address that environment.
    Senator Murray. Banks not returning phone calls forever.
    Mr. Stevens. That is right. And I get a lot of personal e-
mails and phone calls from just consumers that I have to get 
involved with, just as I am sure your offices do, and their 
frustration level is very high.
    There are several things we are working on in the banks. 
One, from a readiness standpoint, they are clearly better off 
today than they were even 60 days ago. So we are hopeful that 
will happen; that they are onboard. We have made them all 
designate a czar or a head of the HAMP program within their 
institutions that is solely accountable for HAMP and has the 
authority to make decisions around HAMP. That was a directive 
of the meeting this week.
    Senator Murray. Will we know who those people are so we can 
direct our constituents to them?
    Mr. Stevens. I will work with that office, and we will try 
to make sure that list is made public for you.
    Senator Murray. If it is just one more phone number that 
they call that they cannot get to, it is not going to be very 
helpful.
    Mr. Stevens. Right, I recognize that.
    This is a directive. So we have asked them to identify that 
individual, make it clear. We want to assemble who the head of 
that is, and we are going to have a much increased frequency of 
meetings between the Treasury Department and HUD to meet with 
these heads for all the institutions to make sure they are 
staying onboard with the HAMP process.
    We have changed documentation standards. We have done field 
checks. We have gone out and done individual field visits with 
each of the institutions to investigate their process. We are 
sharing best practices.
    But without question, the frustration is real. The lack of 
activity and readiness was absolutely there. They were not 
ready. They continue to get ramped up and onboard from an 
operational standpoint. And then there are a lot of issues in 
just getting access to the homeowners, having them understand 
the paperwork involved from the trial modification to 
transition to the permanent modification.
    So all of these are real challenges, Phyllis Caldwell, who 
is heading up the office for Treasury, is a great resource and 
is very focused on it on a full-time basis solely on HAMP to 
try to make sure that these problems are resolved, but without 
question, I mean, quite frankly this was a huge program that 
was implemented. It has never been done before. The banks did 
not get ready quick enough. We have all collectively learned 
about what was not working through the process. I think a lot 
of----
    Senator Murray. Well, I guess from my point of view, I want 
to know that the banks are working to do this rather than doing 
everything they can to make it not work or stall it or not get 
involved.
    Mr. Stevens. We agree, and we made that point. I can assure 
you that the meeting that was held this week, which was 
attended by mostly CEO levels of all the major lenders--
Assistant Secretary Herb Allison was very direct on that 
subject, as were all of us at the table about their needing to 
be ready to stop these customer responses, these consumer 
responses that are so frustrated. And I have personally spoken 
to them myself as well, and I feel without question their 
frustration and pain. They have committed to going there. They 
all acknowledge there are still going to be some missed--just 
because of the vast number of people, but we need to do as much 
as we can to eliminate that frustration.
    If it would be okay, I would actually like to have Phyllis 
Caldwell draft a response for you on this question----
    Senator Murray. I would really like that.
    Mr. Stevens [continuing]. To lay out with specificity what 
is going on so that if there are questions or concerns you have 
from there, we can respond further.
    Senator Murray. Okay, and to give her our feedback that 
this is a huge frustration for a lot of our constituents right 
now.
    Mr. Stevens. Yes. And she knows it and we have had meetings 
with many Senators and Members of the House on this issue. We 
all get it. We all know the score now, and the pressure has to 
be on these banks to get ready to view this as the same 
priority as they would originating a new loan through their 
sales force. They have pledged their commitment. They re-
pledged it at a meeting that we made them fly in for this week. 
It was a very stern discussion on the subject. So we share your 
concern. We share the frustration, and it is a full court press 
from both Secretary Donovan and Secretary Geithner.
    Senator Murray. It may take more than being stern.
    Mr. Stevens. It might.
    Senator Murray. Also in my last few seconds of my time, 
there is an FHA HAMP program which applies only to FHA 
mortgages, and that is the one you have just been talking 
about. Okay.
    And if you want to, please comment on that, and I will turn 
it over to Senator Bond.
    Mr. Stevens. Yes. The HAMP program I was referring to was 
not FHA. It was the broader HAMP program, but that does include 
the FHA numbers. The FHA HAMP numbers are actually very small. 
They are in the low thousands, and I think the reason for that 
is FHA has a loss mitigation program that has been so 
successful and has been in the market for many, many years. We 
have just a greater experience with dealing with loss 
mitigation, and to that extent, we have addressed over 600,000 
in-distress homeowners in the last year on our own outside of 
HAMP. And I would be glad to report the resolution numbers on 
those, if you have interest.
    Senator Murray. That would be good.
    Mr. Stevens. Okay.
    Senator Murray. Thank you.
    Senator Bond.
    Senator Bond. Thank you, Madam Chair. That was an area that 
I wanted to explore, and you have done that, and we thank you 
very much, Commissioner, for your comments on it.
    Let me ask in a related area. It is my understanding 
Freddie Mac was directed to buy back troubled loans from 
investors, taking the losses on the mortgage. It seemed to me 
that that policy was designed to bail out lenders on their 
risky investments but did little to save a home with a risky 
loan for the homeowner. Am I missing something here? You want 
to keep the investors happy, but if they are losing their skin 
in the game, should we be bailing them out?
    Mr. Stevens. I apologize. I do not have the specifics on 
that. I will tell you that in meetings with Freddie Mac and 
Fannie Mae, which we have had, this week, the vast majority of 
their efforts are not there. The vast majority of their efforts 
are in working on the HAMP initiatives and modification and 
HAFA, the refinance program, and very little on the buybacks. I 
could guess, but I would rather not guess for you and get 
specifics back on what assets they bought. I do not know the 
size of it.

            HUD INSPECTOR GENERAL EFFORTS ON FRAUD AND ABUSE

    Senator Bond. We are interested in getting a handle on this 
because, as you have indicated, there are so many moving parts 
in this that we want to try to get a handle on as many as 
possible.
    We talked about the fraud and abuse efforts. Is there a 
joint oversight program with Justice, Treasury, HUD inspector 
general, and other agencies? You talked about 365 cases have 
been referred to the Mortgage Review board. Do you know how 
many of those cases have--question No. 1, is there a joint 
effort? Question No. 2, how many criminal indictments? Do you 
know offhand?
    Mr. Stevens. Senator, I would probably defer to the 
inspector general who is playing a huge leadership role in the 
fraud joint task force. So I would encourage----
    Senator Bond. Maybe we could invite Mr. Donohue to come to 
the table, if you do not mind, just briefly on this one.
    Mr. Donohue. First off, may I thank you very much. I would 
be remiss, Senator, if I did not respond back to your first 
comments. I am so grateful to you for your support. I would be 
remiss in not mentioning Senator Mikulski and Senator Sarbanes 
and Senator Murray as well and John Kamarck of your staff and 
Megan from yours, Senator Murray.
    This is not possible. You mentioned seller down payment 
assistance. I think if seller down payment continued, we would 
be having a different discussion here today. It is a result of 
your leadership that that is possible in support of that 
effort.
    We are very heavily engaged with the Department of Justice. 
We are involved in a major Federal fraud task force that I sit 
in with Attorney General Holder and his deputy staff. We had 
three summits recently: one in Miami, one in Detroit, and one 
in Phoenix, Arizona. And we had a chance to have people come in 
from the industry, people who are victims and talk about some 
of their concerns and also the law enforcement community as 
well.
    The reason I mention that, getting back to Senator Murray's 
concern, you were talking about the counseling which is very 
important to you. One of the things I do want to mention to you 
when you spoke to that is what we are finding and the concern 
to us is that we are finding fraudulent counseling going on----
    Senator Bond. Oh, really.
    Mr. Donohue [continuing]. Where people are going back out 
and being contacted and being approached to give certain fees 
of sorts. And of course, that person disappears in the night or 
continues on the fraudulent activity. That came out in all 
those three summits very actively. So it is not just the 
challenge of--the statements that the Commissioner made, but 
also we are seeing a significant amount of fraudulent activity 
as well.
    As far as our cases are concerned, we have about 2,400 
civil investigations on right now with regard to cases specific 
to the FHA fraud activity. We have created a civil fraud 
initiative. And you mentioned about the other agencies working 
together. I was on the National Bank Fraud Working Group back 
in the RTC days. And I think what we are seeing now is a 
collaboration of law enforcement working together.
    I think it is a great challenge, sir. I think that these 
regulatory agencies talking to each other, working with them 
collectively--I have spoken to the Commissioner about setting 
up a consortium with Fannie and Freddie and the other GSEs. The 
best practice. I would like to see standard forms applying with 
regard to this mortgage activity. I have spoken to that in my 
testimony.
    So we are very active. We are working well with regard to 
law enforcement agencies and, like yourself I share the same 
sentiment. I would like to see a lot more people in orange or 
red suits as much as I could on these cases.
    Senator Bond. I know by the fall of 2008, I was following 
very closely my home area. The Eastern District of Missouri 
U.S. Attorney had initiated three major actions with numerous 
parties involved. I have not had any follow-up or heard how 
many criminal prosecutions related to mortgage fraud. I do not 
know if they were all FHA--have been initiated, how many have 
been concluded with a successful conviction. Do you know that?
    Mr. Donohue. Well, sir, my semi-annual report I was just 
given, indictments and information from the period of April 1, 
2009 to September 30, 2009, 1,182 indictments and information; 
convictions, pleas, pretrial diversions, 847.
    Senator Bond. Good. That number needs to be publicized 
because that is the greatest prophylactic to let people know if 
they are going to do it.
    I was concerned to hear your comments about fraudulent 
counseling. A few years ago, Senator Dodd and I created a $180 
million foreclosure counseling effort. I talked with people all 
over my State who were involved in the counseling, and they 
were having some success, minimal success. But the one thing 
they emphasized to me was foreclosure counseling is not good 
enough. There has got to be pre-purchase counseling before 
somebody buys a home. We have to have an independent and maybe 
not a fee-based counseling program set up to sit down with the 
family, potential home buyer, explain to them what their 
obligations are, and look at their finances to see if they can 
buy a home.
    Commissioner, obviously you have got some thoughts on that.
    Mr. Stevens. Yes. We share the concern. In fact, I have 
been hosting meetings with industry participants to talk about 
financial counseling particularly related to managing personal 
finances and mortgage finances before you make the decision to 
buy a home. We have had the help of members of the Housing 
Policy Council and others come in and show us and make 
recommendations of how we might go down that path. It is very 
complicated to institute a whole new way of doing pre-purchase 
financial counseling as opposed to what most housing counselors 
are doing today, to your point. Given the huge volume of 
foreclosures in the market, most housing counselors are 
overwhelmed with homeowners in distress. So the ability to 
transition into being able to have the time and scope to do 
pre-purchase sort of financial literacy becomes more 
challenging.
    The other thing is most of the agencies in Washington that 
deal anywhere in the financial area have some sort of financial 
literacy classes that are available on their Web site, and so 
there is some opportunity to consolidate those together. But we 
are working on that right now and hopefully will be able to 
report back on that sometime in the future.
    Senator Bond. Well, thank you. I think that is very 
important. Senator Murray and I are concerned a whole lot about 
what happens in Washington State and Missouri. And the people 
on the ground are the ones who really need to do it. In our 
State, NeighborWorks has been a very good partner. And we look 
forward to seeing those efforts expand and perhaps more 
assistance is needed in that pre-purchase counseling.
    Mr. Donohue, I am disturbed to hear that there are 
fraudulent counselors. But again, the best place for them is in 
Government-restricted housing. I wish you the best in assuring 
their placement in that kind of facility.
    Mr. Stevens. It is interesting. The President even spoke 
about this when he first came into office. But if you watch TV 
and see someone helping someone walk away from their home, I 
think that was one of the things covered on the recent piece on 
strategic defaults. They called themselves counselors. They 
charge a couple $1,000 to counsel a family in distress, and 
they are not authorized. Free counseling is available, and 
getting that information to distressed homeowners is the big 
challenge.

                               GSE LOSSES

    Senator Bond. One quick question. I do not know if you have 
the answer to this. On the GSEs, do you know how much of the 
losses are coming from their old books of business as opposed 
to the new business like foreclosure mitigation efforts like 
HAMP?
    Mr. Stevens. I recently just looked at some of their 
performance data, and Senator, like with the FHA portfolio the 
vast majority of these losses are on older books, 2006, 2007, 
and 2008 are just terrible portfolios. They are bad for FHA and 
they are bad for Freddie and Fannie. And it is those portfolios 
that we are going to be all experiencing losses on and paying 
the price for several years more to come.
    Senator Bond. Thank you very much. I hope that the new 
business does not catch up with the old business. Thank you 
very much.
    I have a commitment I have got to make, but I appreciate 
very much your testimony. We have got a lot of interesting 
follow-up that we are going to ask the staff to do.
    Thank you, Madam Chair.
    Senator Murray. Thank you very much, Senator Bond. And I 
would just say I have a financial literacy bill that we start 
teaching basic financial skills back in our elementary schools. 
You and I probably are the few here who remember our banking 
Fridays at school where we learned how to balance our 
checkbooks and how to read basic financial statements and that 
is lacking in education today.
    Senator Bond. The only thing I would add, I took a very 
high-level law school course on banking and bankruptcy. And I 
was having trouble with my checkbook, and the instructor said 
my checkbook never works out right. So I always take the bank's 
view from it.

                                  HAMP

    Senator Murray. A prevalent opinion today.
    Moving on, thank you very much, Senator Bond.
    I wanted to go back for a second to the HAMP program. 
Originally it was focused on reducing interest payments and 
spreading mortgages. The administration has changed that, 
focusing on principal write-downs and relief for unemployed 
borrowers and an expansion of the existing refinance program.
    In order to participate now, lenders are required to write 
down principal and make sure that a borrower's mortgage is 
affordable, as measured by total mortgage debt, including both 
their first and second liens. As I talked about in my opening 
statement, these mortgages do come with additional risk, and 
$14 billion in TARP funding has been set aside for that 
initiative.
    Commissioner Stevens, how much additional risk do you 
expect to find these refinanced mortgages to carry?
    Mr. Stevens. Senator, the way we are looking at the program 
is the allocation of the $14 billion in TARP funds will be to 
cover the incremental risk exposure on these loans. While we 
have modeled various paths of the loans that come in, the 
variability will be on seeing the actual loans as they are 
originated. So, for example, as you are aware, we allow a 
combined loan-to-value where a second lien holder can 
subordinate up to 115 percent. It is estimated that one-half of 
all negative equity loans in America have a second lien, but we 
do not know how many of those will come into the FHA portfolio. 
Those that have subordinated second liens are going to have a 
higher risk weighting on our portfolio, as we see them come in, 
than those that do not.
    Likewise, the FICO score distribution can have a wider 
range, and if the FICO distribution ends up being much lower on 
the scale, they will have a higher risk weighting than those 
that do not.
    So we have the $14 billion allocation from Treasury. We do 
not, but that will be assigned to offset the claims from the 
lenders. As the loan comes in, we will be evaluating that 
volume coming in. If it skews off the path, we have the ability 
in the program, as announced, to stop it with little notice. 
And our Chief Risk Officer, Bob Ryan, is tasked with managing 
that overview. We will have the data of all the loans coming in 
as they are being insured. So we will just watch the volume 
coming in, the distribution of all those attributes that can 
cause risk, what risk rating we assign to those, and we will 
stop the program at a point in time if the risk seems greater 
than what we originally foresaw.

                              DEFAULT RATE

    Senator Murray. What is the default rate that you are 
assuming?
    Mr. Stevens. Without giving specificity--and the reason why 
I am trying to avoid is there is a wide range of default 
expectations. There is a high default rate, which would be 
something similar to what we are seeing on some of our worst 
books of business from the past years. There are some estimates 
by some economists who think this is actually going to be a 
better performing book than even a standard refinance because 
the borrower incentives to come into the portfolio are that 
much higher. So to that extent, we know we have a bucket of 
risk mitigation dollars from TARP that will be available to the 
lenders to pay their claims, and that is why it is important to 
watch what comes in because the distribution could be from very 
low to very high.
    It is kind of like stochastic modeling where you are 
looking at a variety of outcomes. We just know that we are 
going to use those real loans coming in to identify what path 
they are coming in on, and that will help us forecast as to 
when the funds will be exhausted.
    Senator Murray. How much of the $14 billion will actually 
cover the costs that are expected to result from additional 
risk and how much will be used to provide incentives to lenders 
or help extinguish second liens?
    Mr. Stevens. The only incentives that are being provided at 
all are incentives for second lien extinguishment. There are no 
servicer incentives provided in the FHA solution, and there are 
no first lien principal write-down incentives whatsoever. So 
the private sector will bear all the costs of writing down the 
principal balance and refinancing that mortgage into a new FHA 
mortgage. So the only variable on the $14 billion will be the 
second lien, and without again trying to be evasive, because of 
the various paths and what our expectancy is on how many of 
these will have second liens versus those that will not, we 
have a wide range. I would say for a simplistic view, we expect 
the second lien extinguishment portion to be a relatively small 
percentage of the $14 billion because it only pays pennies on 
the dollar anyway, and the vast majority of the $14 billion 
will be to offset risk to the FHA portfolio.
    We have pledged to report these numbers and share them with 
a high level of frequency with the Department of the Treasury. 
We are both going to be reviewing the actual assets coming in 
carefully together because our primary focus is not to add 
incremental risk to the FHA portfolio through this initiative.

                           STRATEGIC DEFAULTS

    Senator Murray. In my opening remarks, I mentioned the 
concern I have about strategic defaults, people who are 
defaulting because they are just making that decision to do it 
not because they are personally not able to make their mortgage 
payment. I am concerned that this could provide some serious 
instability in the market, and I wanted to ask you, is there 
any good data today on how serious this problem is or something 
that you are seeing with FHA-insured mortgages?
    Mr. Stevens. We have done a great deal of research into the 
strategic default area. There is no history on this. Strategic 
default is a new anomaly for this recession. And as I am sure 
you are concerned and I am concerned--I was interviewed on 60 
Minutes on Sunday on this subject. There is a significant moral 
hazard that will pervade the mortgage finance system for 
decades to come should this become a real problem.
    Based on estimates we have gotten from independent third 
party analysts which include the GSEs' view as well as 
economists like Mark Zandi, it is estimated that real strategic 
default risk is in the single digits as a percentage of overall 
foreclosures. So somewhere between 7 and 9 percent are sort of 
the current estimates of what are real strategic defaults.
    Now, the issue ends up being that negative equity is highly 
concentrated in five key States, the sand States plus Michigan. 
And in those States--in Nevada, which is the worst hit, for 
example, if you look at all negative equity loans, which is 
somewhere between 11 million and 15 million loans that have 
negative equity, about one-half of those are either second 
homes or investor properties, and some small percentage of 
those are also super-jumbo, million-plus dollar homes. So when 
you isolate back down to the rest of the borrowers that have 
negative equity, you break that down into two categories. The 
greatest category will be those--our default risk will be those 
that are in distress that have lost their jobs, had income 
curtailment.
    Laurie Goodman of Amherst Securities suggests that negative 
equity could contribute 1 percent to the unemployment rate 
because people just cannot accept a job somewhere else because 
they cannot get out of their home without going into 
foreclosure. That is where the focus of our efforts is.
    But our solution with FHA does allow an investor, if they 
think a strategic defaulter is going to walk away, to write 
down their principal too and put them into a refinance, if they 
will stay. But we do need to track this carefully over time and 
see, to the extent this becomes a greater hazard because the 
ramifications, as I am sure you would agree, go far beyond just 
the foreclosure risk to those communities. It will affect how 
loans are priced in the future if that is considered a real 
risk.
    Senator Murray. And the other question I wanted to ask you 
about is the so-called shadow inventory. We obviously have an 
oversupply of housing right now, and there is a concern that 
with all the newer imminent foreclosures that are coming or 
banks that are holding repossessed homes if those start 
flooding back on the market, what kind of impact that would 
have. Could you talk a little bit about how big perhaps the 
shadow inventory----
    Mr. Stevens. Again, this is another where there is great 
research on it. In fact, I have a couple of good studies I 
would be glad to send to Megan or however you want me to get it 
back to you that have been done independently.
    The shadow inventory is real. And the in-foreclosure 
numbers are clearly higher than the actual foreclosure numbers. 
I know that in the FHA portfolio and I see it in the numbers at 
both of the GSEs. So there are a lot of reasons why that has 
been built up, part of which is just the overwhelming volume 
that hit many of these counties that have to process 
foreclosures, moratoriums placed in various States or areas 
where the courts put a freeze or bans on foreclosures for a 
period of time. Clearly the loss mitigation efforts by FHA 
through HAMP, even portfolio modifications have also slowed the 
process down, and banks are obviously being much more 
aggressive to try to delay the foreclosure if they can find any 
way to work out a borrower's situation in most cases. And so 
the inventory of in-default is clearly rising.
    Now, there are some estimates that based on some home price 
appreciation forecasts, even modest ones, that a good 
percentage of those foreclosure problem cases could be resolved 
just by some slight improvements to unemployment and some 
slight improvements to home values, in other words, that they 
are close enough to the line that they could back into an 
affordability with some involvement on either forbearance or 
modification efforts that are being done today.
    But it is still--without question, the numbers are large. 
At FHA, for example, our in-foreclosure numbers are about 
double what they were a year ago in foreclosure, but our actual 
foreclosures are not double of what they were a year ago. That 
is why, even though we are behind on actual foreclosures today 
based on our forecasts, I expect them to rise based on what I 
am seeing in this shadow inventory that is coming in.
    So we are looking at the data very carefully. And again, I 
would be glad to share at least some independent looks that I 
may have available with your office.
    Senator Murray. I would really appreciate that very much.
    With that, I want to thank both of you, especially 
Commissioner Stevens, for your input today. It has been very 
valuable.

                     ADDITIONAL COMMITTEE QUESTIONS

    There will be questions submitted by a number of our 
subcommittee members. We will leave the record open in order to 
have you respond to those.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

              Questions Submitted by Senator Patty Murray

                               FHA RISKS

    Question. As we have discussed, CBO recently came out with its re-
estimate of the receipts that FHA will generate from mortgages insured 
in fiscal year 2011. The result is a loss of $4 billion in anticipated 
receipts. This is not the first time that CBO had disagreed with OMB's 
assumptions for receipts. Do the current models appropriately account 
for risk?
    Answer. FHA spends a great deal of time and effort studying the 
credit risk of its insured portfolios. The valuation models used for 
the single family insured portfolio have been developed over a 20-year 
period and capture all of the essential factors needed to value a 
national portfolio. Those include borrower credit quality, downpayment 
rates, house price changes, and interest rate movements.
    For its scoring of the fiscal year 2011 budget, the CBO did not 
have a similar credit risk model for FHA. They are in the process of 
building such a model for scoring the fiscal year 2012 budget. CBO 
also, but not unlike OMB, prefers to err on the side of conservative 
judgments, especially when there is uncertainly involved. The nature of 
any disagreements on the value of FHA loan guarantees generally comes 
down to uncertainty with respect to future housing market conditions. 
There is no right answer. There are only informed judgments, and 
persons of goodwill can differ markedly in their preference for some 
risk-adjustment factor in forecasting.
    The direct impact of larger economic risk adjustments in a budget 
forecast is to lessen the expected budget receipts generated from the 
FHA insurance programs, and thus lower the overall receipts the 
Congress has when formulating a budget. The indirect impact is to 
increase the probability that, in future years, there will be 
beneficial budget re-estimates for the affected cohorts of loan 
guarantees, and lessen the probability of adverse re-estimates.

                     FHA PRIORITIES FOR INVESTMENTS

    Question. As I mentioned in my statement, improving the information 
systems at FHA are critical. As you know from coming from the private 
sector, the systems at FHA are outdated and are in some instances 
opening FHA to unnecessary risk. Last year, we provided HUD with 
significant resources to invest in IT systems. This included funding 
for immediate fraud detection and mortgage fraud tools as well as 
longer-term investments. How are you prioritizing these IT investments?
    Answer. With respect to prioritization for Combating Mortgage 
Fraud, fiscal year 2010 funds are being used to address a broad range 
of risk and fraud management efforts within the Department. FHA has 
worked diligently to put in place contract vehicles which provide 
access to industry leading tools and professional services that will 
greatly enhance the Department's capabilities related to fraud 
detection/prevention and risk mitigation. Specifically, we are focused 
on the following three functional areas:
  --Counterparty Risk Management Functionality
  --Analytical Consulting Services for risk and fraud tool evaluation 
        and selection
  --Consulting and Contracting Services for Loan-level File Review
    Through the acquisition process, HUD has focused on services that 
address the most critical and immediate areas of need within FHA to 
reduce the likelihood of insuring fraudulent and high risk loans, 
detect trouble spots among product types, improve targeting methodology 
for loans selected for review, significantly improve counterparty due 
diligence and review, and aggregate key information to make informed 
and reasoned decisions across the organization. To the extent feasible, 
these services are designed to have applicability across the FHA 
enterprise and may well reduce total organization contract expenditures 
on duplicative tools and services. However, the short-term application 
of this contract vehicle will be for the Single Family portfolio with 
downstream usage envisioned for multifamily and hospital financing.
    With respect to prioritization for longer-term FHA IT investments, 
the use of the Transformation Initiative funds for IT purposes requires 
detailed IT planning per Congressional requirements. Our modernization 
objectives align with the FHA IT Strategy and Improvement Plan (FHA IT 
Plan) submitted to Congressional committees in August 2009. As 
articulated in the FHA IT Plan, with many, if not all, of Housing's IT 
systems being old and outdated, our priority is to transform and 
upgrade FHA's infrastructure in line with modern financial services 
organizations. This initiative is being designed and planned to 
leverage the specific components of the Risk and Fraud initiative as 
they become a reality for FHA. This is how all of the Transformation 
work comes together. Tools selected through the Combating Mortgage 
Fraud Initiative will fit into the portions of the architecture that 
house aggregated capabilities for FHA. In addition, counterparty level 
information, required by the Risk and Fraud initiative, will flow into 
the front end of the FHA Infrastructure data area and provide valuable 
insight throughout the insurance lifecycle.
    Question. How quickly do you think you can make these IT upgrades?
    Answer. FHA has worked closely with internal (e.g., OCIO) and 
external (e.g., GAO, OMB) organizations to create measurable 6-, 12-, 
and 18-month deliverables for the FHA Transformation work. While our 
project planning materials indicate that this initiative will be a 
multiyear effort that spans longer than an 18-month timeframe, the 
initiative has been crafted to ensure that measurable value is 
delivered in as short a timeframe as possible.

                         NEW SHORT SALE PROGRAM

    Question. In the midst of all of the attempts being made to keep 
families in their homes, the administration recently announced its 
plans to implement a program to facilitate short sales. Through these 
sales, lenders and borrowers consent to take a loss by selling a home 
below the mortgage balance owed in order to avoid foreclosure. How much 
would this initiative cost?
    Answer. As this is an initiative led by the Department of the 
Treasury, it would be more appropriate that these questions be directed 
to that agency for response.
    Question. As with all of the housing programs, this would be a 
voluntary program, and lenders already have the ability to do short 
sales. Why do you believe that the relatively modest amount of 
incentive payment that would be offered will be enough to increase the 
number short-sales so that it has a real impact on the housing market?
    Answer. As this is an initiative led by the Department of the 
Treasury, it would be more appropriate if this question was directed to 
them for response.
    Question. Under this new program, participating owners would be 
required to sell their home if an offer is made at a pre-determined 
price. Under the proposal, this price would be determined by Real 
Estate agents. Given the inherent subjectivity of home value 
determinations, there is a concern that this program could be open to 
fraud and conflicts of interest. What protections will be put in place 
to mitigate these risks?
    Answer. As this is an initiative led by the Department of the 
Treasury, it would be more appropriate if this question was directed to 
them for response.
                  home affordable modification program
    Question. One of the problems with HAMP has been the capacity of 
servicers to process the claims. Do you think that servicers have the 
capacity to manage a significant increase in short sales?
    Answer. As this is an initiative led by the Department of the 
Treasury, it would be more appropriate if this question was directed to 
them for response.

                          SUBCOMMITTEE RECESS

    Senator Murray. Again, thank you so much, both of you, for 
your participation today.
    With that, this hearing is recessed, and this subcommittee 
will hold its next hearing on Wednesday, May 19 at 3:30 on the 
fiscal year 2011 budget request for the Washington Metropolitan 
Area Transit Authority.
    [Whereupon, at 11:09 a.m., Thursday, May 13, the 
subcommittee was recessed, to reconvene at 3:30 p.m., 
Wednesday, May 19.]
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