[Senate Hearing 112-468]
[From the U.S. Government Publishing Office]







                                                        S. Hrg. 112-468

 
  STATE OF THE HOUSING MARKET: REMOVING BARRIERS TO ECONOMIC RECOVERY

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

                                HEARING

                               before the

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

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

               EXAMINING THE STATE OF THE HOUSING MARKET

                               __________

                    FEBRUARY 9 AND FEBRUARY 28, 2012

                               __________

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




[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]





                 Available at: http: //www.fdsys.gov /







                                _____

                  U.S. GOVERNMENT PRINTING OFFICE

74-982 PDF                WASHINGTON : 2013
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 
20402-0001











            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director
              William D. Duhnke, Republican Staff Director
                       Charles Yi, Chief Counsel
                 Beth Cooper, Professional Staff Member
                   Glen Sears, Senior Policy Advisor
                 William Fields, Legislative Assistant
                 Andrew Olmem, Republican Chief Counsel
            Chad Davis, Republican Professional Staff Member
            Dana Wade, Republican Professional Staff Member
                       Dawn Ratliff, Chief Clerk
                     Riker Vermilye, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)















                            C O N T E N T S

                              ----------                              

                       THURSDAY, FEBRUARY 9, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                               WITNESSES

Mark Zandi, Chief Economist and Co-Founder, Moody's Analytics....     3
    Prepared statement...........................................    30
Christopher J. Mayer, Paul Milstein Professor of Real Estate, 
  Finance, and Economics, Columbia Business School...............     5
    Prepared statement...........................................    49
The Honorable Phillip L. Swagel, Professor of International 
  Economic Policy, University of Maryland School of Public Policy     6
    Prepared statement...........................................    59
    Responses to written questions of:
        Senator Toomey...........................................    67

              Additional Material Supplied for the Record

Statement of the National Association of Realtors'....    69
Statement submitted by Tim C. Flynn, CEO, National Value 
  Assurance, LLC.................................................    71

                              ----------                              

                       TUESDAY, FEBRUARY 28, 2012

                                                                   Page

Opening statement of Chairman Johnson............................    73
    Prepared statement...........................................   118

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................    74
    Senator Menendez.............................................    76

                               WITNESSES

Shaun Donovan, Secretary, Department of Housing and Urban 
  Development....................................................    76
    Prepared statement...........................................   118
    Responses to written questions of:
        Senator Shelby...........................................   183
Elizabeth A. Duke, Governor, Board of Governors of the Federal 
  Reserve System.................................................    98
    Prepared statement...........................................   128
Edward J. DeMarco, Acting Director, Federal Housing Finance 
  Agency.........................................................   100
    Prepared statement...........................................   157

                                 (iii)


 STATE OF THE HOUSING MARKET: REMOVING BARRIERS TO ECONOMIC RECOVERY--
                                 PART I

                              ----------                              


                       THURSDAY, FEBRUARY 9, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:03 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order. I thank our 
witnesses for joining us.
    Today's hearing is a continuation of our in-depth look at 
housing finance reform that we just started last year in a 
bipartisan fashion. Many of the previous hearings have examined 
the long-term structure of the Nation's housing finance system. 
In this hearing, we will focus on the current state of the 
housing market and its effect on the larger economy.
    In January, the Board of Governors of the Federal Reserve 
System released a white paper entitled ``The U.S. Housing 
Market: Current Conditions and Policy Considerations.'' In this 
paper, the Board stated that continued weakness in the housing 
market poses a significant barrier to a more vigorous economic 
recovery.
    The white paper documents the problems that so many 
families and communities are facing, such as: declining home 
prices and the loss of $7 trillion in home equity since 2006; 
millions of responsible homeowners are underwater on their 
homes through no fault of their own; excess supply of homes for 
sale at the same time that rents are rising; obstacles to 
refinancing at today's record low mortgage rates.
    The paper also discussed policy options for addressing what 
it identified as impediments to a housing--and ultimately 
economic--recovery. Such impediments include: the excess supply 
of homes for sale, tightened mortgage credit, and the flow of 
additional homes entering the foreclosure pipeline under 
current conditions. Many potential solutions are being offered 
by a wide range of interested parties. In recent weeks, the 
Administration has outlined administrative steps and 
legislative proposals for overcoming barriers to housing market 
recovery. An interagency group led by the Federal Housing 
Finance Agency has begun taking steps to address the large 
volume of real estate-owned properties held by the Government-
sponsored enterprises and Federal agencies, including pilot 
projects converting some of these properties to rentals. I look 
forward to hearing more from the Administration and FHFA about 
their proposals.
    Finally, this morning, we are expecting an announcement in 
the long-anticipated mortgage servicing settlement. I look 
forward to carefully reviewing the details of these agreements 
as part of the Banking Committee's continued oversight efforts 
to hold servicers accountable for their failures and protect 
homeowners from abuse. I agree with the Fed's assessment. 
Without an improvement in the housing market, the economic 
recovery will also continue to drag. We must do everything we 
can to help with economic recovery. This is important to me and 
my constituents. This means we must find ways to improve the 
housing market.
    Today, we explore potential solutions with three highly 
respected economists. I have invited our witnesses to share 
their insights on barriers to and solutions for housing market 
recovery. These witnesses have extensive experience analyzing 
the housing market and broader economy. I hope to learn from 
them practical solutions to improve the housing market, the 
economy, and the lives of millions of Americans.
    With that, I would turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Unfortunately, as we sit here today, I believe the only 
realistic assessment of the state of our housing market is that 
it is weak and has faced continued decline. Home prices 
declined nearly 5 percent in 2011. This was the fifth straight 
year of declines. Worse yet, some States saw declines of more 
than twice that rate. In Illinois, prices declined over 11 
percent; in Nevada, prices declined more than 10 percent.
    The troubled state of our housing market should be a call 
for Congress to take action. Traditionally, this Committee has 
acted in a bipartisan fashion to address pressing problems 
facing the Nation, and during my tenure on the Committee, which 
is 26 years, we have worked across party lines to pass 
important legislation to reform the GSEs and resolve the 
savings and loan crisis. But there is a lot of work to do. I 
believe we can and we should return to that practice.
    Some have speculated that Congress will fall into gridlock 
during the rest of the year. However, that does not have to be 
the path of this Committee. Given strong bipartisan support for 
helping homeowners, I believe that it is unfortunate that 
Congress has yet to devise a thoughtful and effective program 
to revive the housing market.
    As early as 2008, right here I warned that, to be 
effective, we needed to address the underlying fundamentals 
driving the housing market and the mortgage foreclosures. We 
have not done that. I warned that if we did not adopt such an 
approach, we would risk wasting a lot of taxpayer money. And 
perhaps we have. Unfortunately, the Administration has rolled 
out one ineffective homeowner assistance program after another.
    The Administration's latest proposal, as I understand it, 
reveals its unwillingness to provide the leadership necessary 
to make the tough choices required to really revive the housing 
market. This appears to be today now an ideal time for the 
Members of this Committee to step into the leadership vacuum. I 
have no illusions that this will be easy. However, we will 
never solve the problems with the housing market if we do not 
start working together to find a reasonable solution here.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Shelby.
    Are there any other Members who wish to make a brief 
opening statement?
    [No response.]
    Chairman Johnson. If not, thank you all. I want to remind 
my colleagues that the record will be open for the next 7 days 
for opening statements and other materials you would like to 
submit. Now I would like to introduce our witnesses here today.
    Dr. Mark Zandi is the chief economist at Moody's Analytics.
    Dr. Christopher Mayer is the Paul Milstein Professor of 
Real Estate, Finance, and Economics at the Columbia Business 
School.
    And the Honorable Phillip Swagel is a professor at the 
University of Maryland's School of Public Policy and the former 
Assistant Secretary for Economic Policy at the Treasury 
Department from December 2006 to January 2009.
    Dr. Zandi, you may proceed with your testimony.

   STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND CO-FOUNDER, 
                       MOODY'S ANALYTICS

    Mr. Zandi. Thank you, Mr. Chairman, Mr. Vice Chairman, and 
Members of the Committee. I am the chief economist at Moody's 
Analytics. My remarks, though, are not those of the Moody's 
Corporation. They are my own views. You should also know that I 
am on the Board of Directors of mortgage insurer MGIC. You 
should know that.
    I will make five points in my remarks.
    Point number one is that the housing crash is not over. 
Home sales and housing construction have hit bottom. They have 
stabilized. There are even some signs of life there. But house 
prices continue to decline. Since prices began declining 6 
years ago, they have fallen by about a third, and I expect more 
price declines in coming months.
    The key problem is the still large number of properties 
that are in the foreclosure process. Just to give you a number, 
there are 3.6 million loans that are in foreclosure or pretty 
close, 90 days and over delinquent. They are unlikely to cure, 
and they will likely go to foreclosure. So the share of home 
sales that are distressed, that are foreclosure and short, will 
likely rise later this year, and that means more house price 
declines.
    Point number two is that when house prices are falling, it 
is hard to be entirely enthusiastic about the economic 
recovery. The home is still the most important asset that most 
households own, most middle-income households. Many small 
business people use their home as collateral to get a loan. So, 
for example, when I started my company 20 years ago, I had to 
go get a loan, and I put my home up as collateral. I doubt I 
could do that in today's environment. Many local governments 
obviously rely on property tax revenue, which has been falling 
because of the decline in housing values.
    Most significantly, though, is the risk that we fall back 
into a vicious cycle that prevailed back in the recession; that 
is, price declines result in more homeowners that are 
underwater. By my calculation, there are 14.6 million 
homeowners that are in negative equity positions, half of which 
are underwater by more than 30 percent, and the average amount 
of negative equity per homeowner is about $50,000. So that is 
the fodder for more default; more default means more distressed 
sales and more price declines.
    This leads to point number three, and that is, I do think 
the policy response to the housing crash has been helpful and 
did, in fact, break that vicious cycle back in late 2008 and 
early 2009. There were a myriad of policy steps taken to break 
the cycle, everything from the Federal Reserve's quantitative 
easing efforts, buying mortgage securities to bring down 
mortgage rates, which has brought fixed mortgage rates to 
record lows, to temporarily raising conforming loan limits, to 
three rounds of housing tax credits; and, of course, the FHA, a 
yeoman effort to fill the void in mortgage lending left by the 
collapse of private mortgage lenders. So, in my view the policy 
response, while obviously not perfect and we can take umbrage 
with any individual aspect of the response, reasonable 
criticism, I think the totality of the response was pretty 
good.
    Point number four is at this point I think policy makers 
should remain supportive of the housing market and continue to 
provide temporary, modest support to housing so that we do not 
reignite that vicious cycle. We cannot allow that to occur 
because if it does, there will not be any good policy response 
and our economy will pay a price for it.
    The proposals put forward by the Federal Reserve Board and 
the Administration I think are pretty good. They focus on three 
things, and I think this is where you should focus.
    First is facilitating more marriage refinancing. I think 
that is a slam-dunk idea in the context of record low fixed 
mortgage rates. That is an immediate boost to these very 
stressed homeowners.
    The second thing is facilitating more loan modifications, 
particularly principal write-down mods that are very well 
targeted, and I think that dovetails very nicely with the 
mortgage settlement that we are going to be getting, hopefully 
today. I think facilitating that effort would be very helpful.
    And then third is promoting REO to rental. The GSEs, 
obviously--FHA has a lot of properties sitting in REO. We want 
to get that into rental before it hits the market and drives 
house prices lower. So anything that could be done--and there 
are lots of things that can be done--to address those--to 
facilitate those three policy steps.
    Finally, my fifth point is that this should not cost 
taxpayers money. These are things that can be done, I think, 
without any cost to the taxpayer. Some of the things will 
require some cost, particularly the principal reduction, if we 
juice up HAMP and increase the incentives there. But we have 
TARP money that has been budgeted for these purposes, and I 
think they should be used.
    Finally, let me say I think it is very important for 
Congress, the Administration, the FHFA, and other regulators to 
remain aggressive and vigilant, make sure that this housing 
crash definitively comes to an end, because until it does the 
recovery will not gain traction.
    Thank you.
    Chairman Johnson. Thank you, Dr. Zandi.
    Dr. Mayer, you may proceed.

 STATEMENT OF CHRISTOPHER J. MAYER, PAUL MILSTEIN PROFESSOR OF 
 REAL ESTATE, FINANCE, AND ECONOMICS, COLUMBIA BUSINESS SCHOOL

    Mr. Mayer. Good morning, Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee. My name is Chris Mayer. I 
am the Paul Milstein Professor of Real Estate at Columbia 
Business School.
    Despite record low interest rates, some signs of economic 
recovery, mortgage activity and house prices continue fall. 
Purchased mortgages last year were at the same level as in 
1992, according to data from the Mortgage Bankers Association, 
and refinancings were at the second lowest level since 2001. By 
comparison, new consumer lending for items like autos and 
credit cards is up 11 percent.
    In its recent white paper, the Federal Reserve observes, 
``Obstacles limit access to mortgage credit among creditworthy 
borrowers, barriers to refinancing blunt the transmission of 
monetary policy.''
    Unfortunately for taxpayers, homeowners, and the economy, 3 
years into the FHFA's conservatorship of the GSEs, Fannie Mae 
and Freddie Mac continue to act as profit-maximizing private 
firms determined to remain in the game for long-term profits 
through their near monopoly power in the mortgage market rather 
than making the market more efficient. The FHFA has taken a 
narrow, ineffective, and harmful approach to managing GSE 
activities.
    Conservatorship has failed to adequately address critical 
conflicts of interest between the two principal GSE businesses: 
providing mortgage guarantees and managing a large retained 
portfolio of mortgages and MBS. Examples abound of GSE actions 
that padded their portfolio profits even while restricting 
refinancing. Fannie Mae imposed new origination fees called 
LLPAs that could be 3 percent or more of the mortgage balance 
only weeks after the Federal Reserve announced its intention to 
purchase what would eventually be $1.25 trillion of GSE MBS. 
Freddie Mac followed suit 2 months later.
    LLPAs were applied to those refinancing existing mortgages 
even though lowering the payments for those borrowers would 
save Fannie Mae and Freddie Mac and the taxpayers money by 
lowering defaults. Existing borrowers with high loan-to-value 
ratios, those at the greatest risk of default, were locked out 
of refinancing altogether.
    The GSEs made it harder to refinance with another servicer 
despite borrowers' many complaints about poor service from 
their existing servicers. Consumers now pay three-quarters of a 
percent more per year for their mortgage to originators than 
they did before conservatorship due to limited competition to 
originate mortgages.
    The GSEs failed to address critical problems in mortgage 
insurance. The only seemingly plausible reason for policies 
that unduly restrict credit and, thus, raise defaults by 
existing borrowers is to protect high interest payments on 
assets held in the GSEs' portfolio.
    Reports by National Public Radio and ProPublica highlighted 
these conflicts of interest and how they may have influenced 
portfolio decisions at Freddie Mac. Instead of selling off its 
MBS, Freddie Mac created and help complex, highly leveraged, 
risky mortgage derivatives that had no value as a hedge. More 
recently, Freddie Mac created new and complex long-term 
financing for its mortgage-backed security positions called 
MLANs. Both types of transactions were structured so that the 
enterprise lost valuable interest payments if borrowers with 
very high interest rates refinance their mortgages, a policy 
that is substantially under the control of Freddie Mac. These 
transactions also make it harder to unwind Freddie Mac and its 
portfolio in the future, something all of us should be 
concerned about.
    While seemingly consistent with conserving and preserving 
assets, these policies appear to violate a number of the GSEs' 
other mandates under HERA to foster liquid, efficient, 
competitive housing finance markets and to operate in a manner 
consistent with the public interest.
    Finally, the GSEs need to reform their loss mitigation 
practices. Private portfolio lenders were the first to adopt 
widespread mortgage modification programs and principal 
reduction plans with their own loans and have also much lower 
redefault rates than the GSEs. The GSEs need to follow 
practices that portfolio lenders use for their own defaulted 
mortgages and work to attract private capital to purchase and 
manage nonperforming loans and REO.
    We must change the mandate of conservatorship. Legislation 
should mandate that an independent trustee wind down the GSEs' 
retained portfolio of MBS and require other steps to attract 
private capital. The GSEs should finally remove all of the 
obstacles limiting access to refinancing for existing GSE 
borrowers and address constraints on mortgage credit as 
identified by the Federal Reserve. Conservatorship as it stands 
now is laden with conflict of interest and is going to be 
incredibly difficult to unwind these institutions.
    I appreciate the opportunity to address you today and look 
forward to answering any questions you may have.
    Chairman Johnson. Thank you, Dr. Mayer.
    Professor Swagel, you may now proceed.

  STATEMENT OF THE HONORABLE PHILLIP L. SWAGEL, PROFESSOR OF 
INTERNATIONAL ECONOMIC POLICY, UNIVERSITY OF MARYLAND SCHOOL OF 
                         PUBLIC POLICY

    Mr. Swagel. Thank you, Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee. The housing market 
remains weak even as the job market improves. The latest 
housing proposals we are considering today largely expand on 
previous actions.
    My concern is that the proposals share a common feature of 
the previous actions, and that is their moderate impact, an 
impact that is in every case less than was advertised when the 
various policies were launched.
    It is useful to consider a specific example of why the new 
proposals will share this unfortunate feature. One proposal is 
a broad refinance for loans to be refinanced by the FHA, the 
Federal Housing Administration. The Administration's fact 
sheet--and that is all we have is a fact sheet--says there will 
be no red tape, no delays, no tax forms, no appraisals. The 
policy applies to owner-occupied homes and not to investors.
    Now, the problem is that the lenders have to verify that a 
home is owner-occupied. This is the case even if a lender is 
refinancing its own home because now it will be getting a 
Government guarantee. Without access to tax forms, without 
appraisals, it is not clear how the lender is supposed to do 
this. Are they supposed to send someone to the house and look 
in the window? So these implementation details matter greatly. 
And, again, we have no text for the legislative proposal. We 
just have a fact sheet, when these details are really crucial. 
It is 2 weeks after the proposal has been announced. I have 
serious doubts about whether it can actually be implemented in 
practice, and there is really no way to know.
    In general, what we have learned over the last 3 years is 
that the one-at-a-time nature of the transactions involved in 
dealing with the housing weakness is a considerable hindrance 
to implementing these proposals.
    Now, on their impact, I think it is clear that credit was 
too loose before the crisis during the housing bubble, and I 
think a good case can be made that now credit is too tight, and 
access to mortgage financing is too difficult for many 
homeowners.
    To me, the lessons is to get the standards right, not to 
have the standards be set by unelected and unconfirmed 
Government administrators, but to think about what are the 
right standards and let the private market decide how to deploy 
capital and what risks to take on that capital.
    I worry that there will be a modest impact from the new 
proposals in terms of avoiding incremental foreclosures. Many 
of these proposals might have made more sense in early 2009, 
but at that time the measures were considered not prudent, not 
a good ratio of benefits to costs. So here we are in 2012. If 
anything, as my written testimony explains in detail, the ratio 
of cost to benefits has gone up. There are fewer incremental 
foreclosures avoided for each dollar of taxpayer resources 
used.
    If these proposals work, to the extent they do, it will be 
mainly as economic stimulus, as writing checks from taxpayers 
to particular homeowners. I think it is fine if someone wants 
to make a case that we should have more fiscal stimulus. I 
think that will have a limited impact and is probably not 
needed in light of the improving economic data. But that debate 
should be made openly as stimulus and not as a housing policy 
or as pressure on a Government administrator.
    Another point, related, is that Government aid should 
probably be better focused. Rather than having the FHA 
refinance anyone's mortgage, it might be useful to look at 
which homeowners and which income levels. As I mentioned in my 
testimony, the White House has recently defined the middle 
class as topping out at $80,000 a year or $100,000 a year, and 
it might be useful to limit FHA to homeowners of that income 
level.
    There are actions that can be taken that will be useful to 
speed the housing adjustment. The REO initiative to move empty 
houses into rentals I think will be very useful, and that 
really should be the focus of policy, a focus on speeding the 
adjustment. We want a recovery in housing. We need the housing 
market to lift off the bottom. But, unfortunately, that does 
mean the housing market has to hit bottom so that it can lift 
off of it, and we want that to happen as quickly as possible. 
We want to end the legal and regulatory uncertainties that are 
now waiting on the market. Moving forward with housing finance 
reform, reform of the GSEs in particular, will be helpful for 
bringing private capital back to the market and moving the 
housing market forward.
    Thank you very much.
    Chairman Johnson. Thank you, Professor Swagel.
    As you mentioned at the outset, the long-anticipated 
mortgage servicing settlement has been reached. Although we may 
not have all of the details, I am interested to hear each of 
your thoughts on the impact of this settlement on the housing 
market. Dr. Zandi, we will start with you and go down with the 
panel in turn.
    Mr. Zandi. I think it will have a meaningfully positive 
impact on the housing market and the broader economy for three 
reasons:
    First, it provides a substantive amount of resources for 
more loan modifications, and it sounds like a fair number of 
those will be principal reduction modifications, which the 
servicers are already engaged in quite successfully. According 
to OCC data, roughly 20 to 25 percent of their current mods are 
principal reduction mods, so I think this will be helpful in 
that regard.
    And, by the way, the Administration proposal to triple the 
benefits to principal reduction mods in HAMP I think would 
dovetail beautifully with that settlement. And I think that is 
meaningful. I think you will get a half a million to a million 
homeowners that get substantive help here, and that will make a 
big difference in terms of that share of home sales that are 
distressed, and that will help to keep any future house price 
declines limited.
    The second reason is that I think this does help the 
banking system. One of the reasons the banking system has been 
slow to provide credit is the cloud hanging over it with regard 
to various legal, regulatory issues. There are still many, and 
there are still many clouds. But this was one significant 
cloud, and I think lifting it will be helpful, and it will 
allow the banking system to gain confidence and become more 
aggressive in extending credit, which is very key to the 
economic recovery.
    Third, I do think this is consistent with Professor 
Swagel's point about facilitating the foreclosure process. This 
will allow the foreclosure process to reaccelerate for us to 
move through the mountain of foreclosed property that is still 
plaguing the housing market. Many of these foreclosed 
properties are vacant. They are investor properties. They are 
blighting communities. We need to work through these 
properties; otherwise, we are not going to find a bottom. So I 
am hopeful that this leads to a clearer path toward more 
foreclosure--resolving more of these foreclosure issues and 
coming to the day when we find the bottom of the housing 
market. So I think this is a very encouraging development.
    Chairman Johnson. Dr. Mayer.
    Mr. Mayer. Yes, I agree with Dr. Zandi on many of these 
points. I think it does continue a practice which private 
lenders are doing with their own portfolios, which are 
principal modifications.
    What is unclear is how well we have bifurcated past actions 
versus future results. One of the problems has been there are 
many people who are not making their payments for 2 years or 
longer and are remaining in their properties, and we are 
starting to see in the data that people in judicial States 
where that is happening are defaulting relatively more relative 
to people in nonjudicial States. And so we should start to 
worry about that moral hazard, and if this presents a path for 
either modifying or foreclosing a home, we really need that. We 
cannot have people who stay, you know, years in homes without 
payments and without really having an ownership stake in where 
they are.
    The third is something that I think really highlights what 
Senator Shelby said at the beginning of this hearing, which is 
we are going to have a lot of stuff coming on the market, and 
given the current structure of both the GSEs and the lending 
market, we are not going to have the credit or the capacity to 
absorb this stuff. If we end up with a couple million homes 
that come on the market next year with the sale rate of, you 
know, under 5 million today, a third of those home sales are 
already cash sales; a third are home sales under contract; a 
third, brokers report that their sales fall apart because of 
credit problems. So it is critical for this Committee and for 
policy makers to address the issue of restoring a more normal 
credit standard in the market; otherwise, this flood of housing 
may well push prices down a lot more and push us into a 
situation where we have other problems.
    So I think this is a wonderful proposal. Lots of people, 
including myself, are talking about refinancing. But we also 
need to open up a reasonable standard for new mortgages, 
whether they be for people who are owner occupants, whether 
they be investors buying in bulk. And the GSEs at the moment 
are not accomplishing that goal, and I think that needs to 
change.
    Chairman Johnson. Professor Swagel.
    Mr. Swagel. I also welcome the settlement on the robo-
signing. Obviously, the robo-signing was outrageous, and 
illegal behavior should be--illegal actions should be punished.
    I think the positive impacts will be twofold: One is there 
will be some assistance for individual homeowners. I think the 
bigger impact on the overall economy and on the housing market 
is removing the uncertainty that is preventing banks from 
operating and from lending going forward. We have to remove 
that uncertainty to start origination going forward.
    We have to be realistic about the impacts, 17 or 37 
billion, somewhere in that range, in terms of principal 
writedowns. Those are big numbers, but there is $700 billion or 
more of underwater borrowers, negative equity. So the impact 
will be pretty modest relative to the scale of the problem.
    The original HAMP proposal was supposed to help 3 or 4 
million, and it has helped less than a million. It is just an 
indication that we should all be wary of these promises.
    The last thing to mention is that the market is moving. 
Lenders are paying homeowners to avoid foreclosure, and it 
makes sense, right? If it takes 24 to 36 months to actually 
foreclose on someone who is not even making their payments, it 
makes sense for lenders to pay that person to move out, and 
there is much greater dignity in that solution than in a 
foreclosure.
    So these adjustments are useful, and we want them to keep 
happening, but, again, I think the biggest impact, positive 
impact of the AG settlement is the certainty about market 
conditions going forward.
    Chairman Johnson. Dr. Zandi, we have heard arguments that 
the market should be left to hit bottom. I would like to hear 
your analysis of this issue. Do you see any barriers to the 
market healing itself? Are there any risks with remaining 
housing prices to fall further?
    Mr. Zandi. Well, I would make two points. First, I think 
house prices have fallen sufficiently to be consistently now 
with household incomes and effective rents, so effectively 
house prices are at bottom. They are at equilibrium. 
Affordability is very high, and you have fairly strong investor 
demand because rents have risen so considerably. So I think any 
further house price declines would be what you might call 
overshooting.
    Second--and this is more important, and this goes to my 
point about the vicious cycle--what concerns me or makes me 
nervous is that once house prices start falling, it is very 
difficult to see where that ends. We can get back into a very 
vicious cycle. Prices decline. You have 14.6 million homeowners 
underwater. When prices are falling, people think prices are 
going to fall in the future, that gives them less incentive to 
hold on. They default. The defaults lead to more foreclosures, 
short sales, more price declines, more negative equity 
homeowners, and you can see this dark vicious cycle taking 
hold. And we had to throw enormous resources at this vicious 
cycle in the recession to break it. And we did. If you look at 
prices, they have basically--they are soft, but they have 
basically stabilized since early 2009.
    So I do not think it is worth taking the chance to allow 
that possibility to occur. The tail risks, as you would say, 
are very enormous.
    So I think policy makers can do some things that are 
modest, do not cost taxpayers significant dollars, and mitigate 
that risk, and I think that is entirely appropriate.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Dr. Zandi, you estimated earlier in your testimony that an 
additional 6 million homeowners will lose their homes before 
the housing market recovers, and you also said that 
foreclosures will not return to normal levels until 2015.
    How could you rationalize--I know you are an economist. 
Sometimes economists are right, sometimes they are wrong.
    [Laughter.]
    Senator Shelby. How do you rationalize the housing market 
has bottomed out and so forth if you are going to have 6 
million more foreclosures and so forth? You know, I hope you 
are right, but I am not sure. Tell us why.
    Mr. Zandi. Yes, very good question.
    Senator Shelby. In other words, you are saying that the 
price of housing is not going to continue to decline, but that 
seems counterproductive to what we see.
    Mr. Zandi. Yes, it is a very good question. First, let me 
say there are three broad measures of the housing market:
    Home sales--that is, housing demand. That has hit bottom. 
It is actually starting to improve.
    Senator Shelby. How do you determine that has hit bottom? 
We hope it has hit bottom. What is your data?
    Mr. Zandi. Existing home sales from the National 
Association of Realtors, new home sales from the Census Bureau. 
If you take a look, they have basically been moving along the 
bottom for 3 years and are now starting to trend up a little 
bit.
    Housing construction, single-family, multi-family starts, 
also Census data, that is starting to rise--admittedly, at very 
low----
    Senator Shelby. But not everywhere, right?
    Mr. Zandi. No, of course not. I am talking nationally.
    Senator Shelby. OK.
    Mr. Zandi. But house prices, you are right, they are 
continuing to be weak, and I do expect more house price 
declines in the immediate future. But this is a very important 
point, and it refers to something Dr. Swagel said. The key to 
house prices is the change in the share of home sales that are 
distressed, foreclosure and short. You can still have a very 
high level of distressed sales, and we are because we have a 
lot of property in foreclosure, and it is going to take many 
years to work through that. But if you can start moving that 
share downward, you are going to get house price growth. And 
lots of good things will happen as soon as house prices are 
moving north.
    All I am arguing to you, sir, is that we are very close. We 
do not need to solve the $700 billion, by my calculation $750 
billion negative equity hole. We just need to get another half 
million or a million homeowners on solid footing, get that 
share of home sales that are distressed moving south, and we 
will start making progress on house prices.
    Senator Shelby. Do you have that same feeling in areas like 
Florida, Nevada, California, you know, some distressed areas 
where so many properties are underwater or is your language, 
your testimony, basically across the Nation?
    Mr. Zandi. Well, also a very good question. I so far have 
been speaking nationally, but obviously there is a great deal 
of variability across the country. Places like Florida, 
Atlanta, Arizona, Nevada, Central Valley of California, parts 
of Rhode Island, parts of the Midwest are encumbered with a 
great deal of foreclosed property, so price declines there are 
going to be more deep and longer. It is going to be harder to 
get that share of distressed properties moving south in those 
areas because the foreclosure problem is a bigger problem.
    Senator Shelby. Dr. Mayer, do you have a comment on this?
    Mr. Mayer. Sure. I am actually in the camp of prices have 
fallen further than equilibrium. In many parts of the country, 
house prices are below construction costs of comparable homes. 
And given where interest rates are----
    Senator Shelby. Is this an area where it is like Florida, 
California, Nevada, Arizona, where----
    Mr. Mayer. Yes, and Atlanta and Phoenix. You know, this is 
true in many parts----
    Senator Shelby. Where housing was overbuilt and oversold 
perhaps.
    Mr. Mayer. Yes, that is true. But the sort of question is 
where--if you sort of think about where we should be in 
equilibrium, that is the sort of analysis. Now, I think it----
    Senator Shelby. That is the ideal way. If demand and supply 
are in equilibrium, things are fine, right?
    Mr. Mayer. Right. The problem with that is that, on the 
other side of the coin, what is not working is access to 
credit, which is part of what is contributing to prices hanging 
below the market.
    One of the things I would point out is that I pay a lot of 
attention not necessarily to foreclosures but as well to sort 
of vacant houses, because if you take a family who leaves a 
home, they are going to go somewhere else, and someone else is 
going to move into the home that they have. And the question 
is, is there somebody--what determines house prices is, is 
there somebody who can sort of buy that home and either provide 
a rental or someone else who is going to occupy the property? 
And that sort of transition is a place that I think policy 
makers can and should be focusing on, which is: How do we make 
sure that when people leave these homes, whether through short 
sales, as Dr. Swagel talked about, or foreclosures, that there 
is somebody else who can acquire that property without a huge 
amount of distress and make it available for families to live 
in so it does not become vacant and get destroyed?
    The really big overbuilding is in a small number of parts 
of the country, and in many other parts of the country house 
prices are below construction costs, but we are not seeing it 
because of this transition challenge.
    Senator Shelby. Professor Swagel.
    Mr. Swagel. Yes, I also worry about the impact of the 
delayed foreclosures on house prices going forward. There is a 
sense in which we have put a bunch of foreclosures on hold, 
meaning millions of foreclosures on hold, but we have not 
prevented them, especially with the economy having been 
relatively weak over the last 3 years.
    Senator Shelby. Is one of the problems of delayed 
foreclosures that each State has a different law regarding 
foreclosures and the speed of them and so forth?
    Mr. Swagel. That is right, and judicial States take a lot 
longer. That is right. We have started to see lenders 
essentially paying homeowners considerable amounts to move out 
of their home and avoid foreclosure. It seems like the market 
then is finally starting to adjust.
    Senator Shelby. Professor Swagel and Dr. Mayer, I will 
refer this to you. In both of your testimonies, you cite the 
lack of GSE reform, Freddie and Fannie, as impeding the 
recovery of the housing market. So what will be the 
consequences to the housing market if Congress continues to 
neglect and push down the road GSE reform? Professor Swagel.
    Mr. Swagel. I would say it is very much an impediment to 
having the housing market recover, and it is an impediment to 
the policy debate today. We see everyone pounding on poor Ed 
DeMarco to adjust the refinancing standards. That should not be 
his line of business. It should be the market. But we need GSE 
reform for that to happen. It would be hard for private market 
participants to lend someone money for 30 years when the 
Government could change the rules entirely in a few years.
    So that is what I would want. Move forward with GSE reform 
and have private capital come in and take the risks.
    Senator Shelby. Dr. Mayer.
    Mr. Mayer. I am not as sanguine on the actions of the 
conservator in this regard. I think there----
    Senator Shelby. That we have now?
    Mr. Mayer. Yes, the current conservator of the FHFA. As I 
made comments, I think the conflicts of interest have been 
material. The GSEs under conservatorship have imposed new fees, 
new restrictions, and new things that never existed before 
conservatorship and are enormous impediments to the recovery of 
the mortgage market and can only be explained by the retained 
portfolio. And these are things that, in principle, the 
conservative could within his power adjust, but he has chosen 
not to. So the conservator could hand, without legislation, an 
independent trustee to manage and wind down the portfolio, but 
the conservator has chosen not to do that. The conservator 
could take many other steps that would reduce the losses and 
foreclosures and open up credit but has chosen not to do it. So 
while it does not require legislation----
    Senator Shelby. Isn't that going to make it worse in long 
run and harder to do and more costly?
    Mr. Mayer. Actually, it is counterintuitive, and, you know, 
this is based on work I have done with Dean Hubbard at Columbia 
Business School, Alan Boyce, and James Witkin. What the GSEs 
are doing is actually making it harder for them to be unwound. 
So the way they are managing their portfolio with issuing--they 
just put out 10-year debt. They have created these complex 
derivatives. These are not transactions that are sort of making 
it easier to unwind. They are actually making it harder to 
unwind. And the frictions in the market that they are creating 
are also making it harder to unwind them because nobody will 
sort of--this is not a market anybody wants to be in. When you 
sue your originator, same problem. The litigation creates a 
harder space for private capital to----
    Senator Shelby. Is this a philosophical design by the 
conservator?
    Mr. Mayer. I have had different views----
    Senator Shelby. It is not an unknown.
    Mr. Mayer. I would not want to speculate as to why the 
conservator has taken the actions that he has. I just look at 
the results of those actions. And I think as the manager of any 
institution, one of the critical things, you know, that CEOs 
have to deal with are conflicts of interest in an organization, 
and not managing those conflicts of interest effectively is 
something that a CEO should be held responsible for if they are 
not doing that. And so to my mind, that is the sort of critical 
question, and I do not want to--I cannot speculate. I do not 
know why these have or have not been----
    Senator Shelby. You might not speculate, but you can 
evaluate the real data.
    Mr. Mayer. Our report clearly--you know, I have done a lot 
of writing on this, some of which is in my testimony, more of 
which is written on a Web site that we have been maintaining. 
We have been arguing this, Dr. Hubbard and I, since September 
of 2008 when we saw the mortgage spreads go crazy and, you 
know, conservatorship not fixing things.
    Senator Shelby. Dr. Zandi, I know the time has eaten away, 
but in fairness, what is your view here?
    Mr. Zandi. Thank you. Yes, I think it is very important for 
Congress to resolve Fannie and Freddie, that as long as they 
remain in conservatorship, nothing good happens. Of course, you 
have many other moving parts that you need to nail down before 
you can actually resolve Fannie and Freddie. The private 
residential mortgage securities market is, as you know, dead in 
the water, and that needs to be revived before we can resolve 
Fannie and Freddie.
    But I agree with you. You know, the longer they are in this 
no-man's-land, it is a problem for everybody.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, gentlemen, for 
your excellent testimony.
    Dr. Zandi, longer term we have to do lots of things, but in 
the short term, I think that both you and to a degree Dr. Mayer 
are saying there are steps that the conservator could and 
should be taking right now. In fact, one of the recent 
Presidential proposals through HAMP, as you have noted, Dr. 
Zandi, for principal writedown modifications has given 
additional resources potentially to FHFA and the Fannie and 
Freddie to do that. And the question, I think, is why is it--it 
should be increasingly difficult for FHFA to argue that they 
cannot do it because of their obligation to preserve the 
portfolio, et cetera, et cetera, et cetera, when, in fact, 
there are resources available that will make the calculation 
positive.
    Just a final point, too. One of the themes that I sense out 
is that, first of all, this settlement today I think is very 
encouraging, but that essentially goes to the paper owned by 
the banking institutions.
    Mr. Zandi. Correct.
    Senator Reed. And as many have noted, banking institutions, 
good businessmen and women are making decisions about principal 
writedown mortgage modification not because they want to help 
the homeowner, but they are looking at their shareholders' 
bottom line. So the business logic here is to get FHFA to do 
what business is doing and use resources that have been 
recently made available to start principal writedown 
modifications and add further momentum. And that can be done 
instantaneously. They do not have to wait for new statutory 
authority. Is that accurate?
    Mr. Zandi. Yes, I think first I would like to say the 
principal goal of the conservator should be to preserve 
taxpayer money, right? I mean, we have ante'd up $160 billion 
for Fannie and Freddie, and this is getting to be very costly, 
and I think it is prudent that the regulator focus on that.
    But in that context, I think there are many things that can 
and should be done. I think, for example, mortgage refinancing, 
facilitating more mortgage refinancing--it perplexes me why 
FHFA is not being more aggressive here in trying to promote 
that activity.
    Now, we had HARP II, the juiced-up HARP, and that is 
progress. But even to this day, for example, I think HARP II 
rules--and we can describe what they are, but it facilitates 
more refinancing--should be extended to all Fannie and Freddie 
borrowers. But Freddie has different rules than Fannie, and it 
is just mucking up the process. This makes no sense and should 
be resolved, as an example.
    Moreover, REO to rental I think everyone agrees makes--you 
know, it is a slam-dunk thing, I think. And I know it is a hard 
process and we need to have pilot projects, and we are not sure 
exactly--and we do not want to give too much away to investors. 
I am on board with that. But it feels to me that this should be 
moving at a much greater pace.
    Moreover, the third point, to your point, I am perplexed. I 
have my models, and I look at this data very carefully--with 
the argument that Fannie and Freddie do not believe in 
principal writedown, they believe in principal forbearance. 
Well, under some circumstances, under reasonable assumptions, 
principal writedown works better than principal forbearance. 
Just to completely say we are not going to have any principal 
writedown in a targeted way so we do not have moral hazard 
issues, I mean, I understand that. I think that is just a step 
too far.
    So, as you can tell from my voice, I am frustrated. I am 
frustrated by it.
    Senator Reed. You are not alone because, you know, I have 
been arguing in REO, for example, for 2-plus, 3-plus years to 
move on that. That seems to be sort of something that is 
obvious. And I think, Dr. Mayer, you, too, feel that the REO 
issue is something that should be moved aggressively.
    Mr. Mayer. Yes.
    Senator Reed. It should have been done.
    Mr. Mayer. Right. I should say one thing, which is I do 
advise a group of a startup company that is working in the 
space of trying to acquire homes on the rental market. I should 
say that straight off. They are not actually deploying capital 
at the moment, but I do believe in this as a really, really 
important step to move the market forward.
    I would respond to your question and also that of Senator 
Shelby at the end about data and how to account for this. We 
have posted an incredibly detailed model that goes through the 
profitability of a mass refinancing program to all the various 
parties. This model is, I think, a state-of-the-art model and 
probably better than anything that we have seen out there in 
terms of analyzing the costs and benefits, because I agree with 
Dr. Zandi and Dr. Swagel, and I think the Members of this 
Committee, that, you know, conserving and preserving assets is 
an incredibly important goal.
    If the GSEs were to do a refinancing program where they 
added a modest increase in the G-fee--because many of the old 
G-fees were as low as 12 to 15 basis points. If they were to 
raise that G-fee on refinanced mortgages to 25 to 35 basis 
points, which would still leave enormous benefit for 
homeowners, a mass refinancing program would be enormously 
profitable for taxpayers and for the GSEs and would actually 
help wind down the process by reducing credit losses in the 
future.
    The problem is that that analysis is hard to do without 
also considering the portfolio. We have done very careful work, 
and if you sort of tell me that, gee, the portfolio has X, Y, Z 
bonds in it--and, of course, the conservator has never made 
public what kinds of bonds are sitting inside the portfolio. 
But if you did that and you told me, gee, you know, 25 basis 
points was not enough but 35 basis points would do it, given 
that many of these borrowers have a 6-percent mortgage and they 
could be refinancing in something below 4, there are 200 basis 
points of spread there. There has got to be a place that that 
is profitable for the GSEs, even considering their portfolio, 
profitable for taxpayers. In fact, we even go through and 
calculate the opportunity costs for the Federal Reserve because 
we also believe that we should look at this in a very holistic 
sense of the Government to include all the mortgages that the 
Federal Government holds.
    The other thing I would sort of say is I completely agree 
on the mortgage modification. If you look, for example, in 
2008, GSE modifications were about 40 percent less effective 
than private lenders in their own portfolio. In 2009, same 
thing. In 2010, the GSEs caught up, and their modifications 
started to have similar effectiveness to private portfolio 
lenders. In 2011, we are back to the GSEs' modifications being 
about 40 percent less effective; that is, the redefault rates 
are about 40 percent higher than what the private sector is 
doing with their own loan modifications.
    I think that is the best place to look, is when somebody 
owns a loan outright, what do they do with it? Well, oftentimes 
they sell it to special servicers whose job is to write down 
the loan, modify it, get the people out, pay them, do whatever 
they need to do to work forward. And the GSEs have consistently 
lagged behind the private market, which sort of tells me that 
what they are doing is not what is the state-of-the-art. And if 
they cannot do that themselves, they should be selling off some 
of those NPLs into the market and letting the private sector do 
the kinds of things the private sector would do well, which I 
suspect would get some of the principal modifications that many 
people hope for, but would also sort of, I think, get us out of 
the bureaucracy that we are in at the moment.
    Senator Reed. Well, thank you.
    Dr. Swagel, I must apologize because my time has long been 
exceeded, and my colleagues are waiting, and they have 
brilliant questions to ask, much more so than I. But just one 
point is everything you have talked about I think can be 
accomplished with the current authority of the conservator 
right now. In fact, my sense is you are arguing that this is 
really what he should be doing because of his obligations under 
the present law to, you know, stabilize and to recover as much 
assets and be as businesslike as possible. You are nodding your 
heads. I will take that as unanimous.
    Mr. Zandi. Yes.
    Mr. Mayer. Yes.
    Mr. Swagel. I would just make a very small point, if it is 
OK.
    Senator Reed. Can I just--go ahead, please.
    Mr. Swagel. It ultimately comes down to numbers and the 
costs. The Federal Reserve is a substantial owner of mortgage-
backed securities and would be affected by this. Mr. Garrett 
asked Chairman Bernanke last week, ``You are in favor of this. 
What is the impact on you?'' And the Fed has not done the 
calculation. It is just puzzling that they are affected and 
have not done the calculation. I wonder if there is a message 
there.
    Senator Reed. Hopefully they will do the calculation, and 
it will be the right calculation.
    Chairman Johnson. Senator Corker.
    Senator Reed. Thank you.
    Senator Corker. Thank you, Mr. Chairman, and I thank each 
of you for your testimony, and I appreciate your being here.
    I think that all three of you have said that Fannie and 
Freddie staying in their present state in perpetuity is 
probably not a very good thing, and in order for them to wind 
down from their dominant position, what we have to do is really 
bring the private sector back. They are on strike for lots of 
reasons, and what we have to do is build a mechanism to bring 
them back in and have a real TBA market on the private side and 
make sure that reps and warranties are actually there and there 
is actually the types of underwriting that they can expect to 
take place. And if we can figure out a way to do that, then we 
can really begin to diminish the amount of reliance we have on 
Fannie and Freddie. Is there general agreement on that? And 
that the longer they stay like they are, actually more mischief 
kind of comes into play.
    I would love to have your responses very briefly to 
Congress, for instance, for 2-month payroll tax adding a G-fee, 
if you will, to all Fannie and Freddie loans over the next 10 
years to pay for that. Is that something that is good for our 
housing industry? I think I get three noes.
    So I hope there is a way that--we have a bill out there 
that is just a marker for discussion. We want to attract one of 
our great friends on the other side of the aisle and know that 
changes have to be made to cause that to happen, and we only 
did that to begin conversation. We never offer a piece of real 
legislation until we have a Democratic cosponsor, but I sure 
hope you will weigh in on that.
    But let me move to another question. You know, we have this 
chart of underwater loans, and it is pretty interesting how 
they are concentrated more fully in a handful of States. Dr. 
Zandi, what is the reason for that? I mean California and 
Nevada and Arizona and Florida, why is the concentration so 
heavy there?
    Mr. Zandi. Well, as you know, that is where the housing 
bubble was its most significant.
    Senator Corker. Well, I know that, but why was that housing 
bubble predominantly in those States?
    Mr. Zandi. Well, a number of reasons. One key reason is 
that these markets generally are supply constrained. It is hard 
to build. So if you get any pick-up in demand for housing, 
because of the supply constraints house prices start rising 
very quickly. And once house prices start rising quickly, like 
any asset market, people start forecasting with a ruler, and 
they speculate.
    Senator Corker. Speculation, yes.
    Mr. Zandi. And then adding fuel to this fire was, of 
course, very easy credit, so private label, subprime lending, 
Alt-A lending, Option ARM lending provided the credit, the 
juice to speculate, and you saw this surge in prices.
    Senator Corker. I knew you were going to say that, and I 
thank you. So----
    [Laughter.]
    Mr. Zandi. Uh-oh, that sounds scary.
    Senator Corker. I enjoy so much working with you on the 
auto deal.
    Mr. Zandi. I got in some kind of trap.
    [Laughter.]
    Senator Corker. I say this to my friends from Colorado and 
Oregon and Virginia and Alabama and Rhode Island and South 
Dakota. I guess as I start looking at the principal reductions, 
I have supported what Dr. Mayer said from the very beginning 3 
years ago, that if Fannie and Freddie--if there were spreads 
there and there was an opportunity for people to refinance at 
lower rates, let us have at it within those institutions. It 
made them strong, it made the homeowner stronger.
    You start getting into principal reductions, and whether 
using existing TARP money, which, you know, our country still 
owns, or whether you are doing it through other mechanisms, in 
essence what we are doing is really creating a transference of 
wealth from Tennesseeans and Alabamans and Virginians and 
Oregonians and people from Colorado, a transference of wealth 
from their taxpayers to people in these States that speculated. 
Now, why would we do that? It just makes no sense to me that 
everybody has gotten on this bandwagon of principal reduction 
when the creation of this bubble was exactly what you said.
    Now, I want you to tell me how I go back home to Tennessee 
and say that this is a great policy for you to send a check up 
each year to the Treasury and let them write a check to Fannie 
and Freddie for losses because we are going to do principal 
writedowns.
    Now, explain to me how that makes sense and why maybe it 
would not be better just to say in California or Florida, in 
places where people did a lot of speculation--which, by the 
way, drove a lot of revenues for those States, I might add. 
Wouldn't it be better if those States themselves put up the 
money for those principal writedowns? I mean, it is a 
geographic issue. It is not a national issue. I do not 
understand why people have not thought about it in that way.
    I would love for you to respond to that.
    Mr. Zandi. Yes, you make very good points. This is a very 
difficult problem, and fairness is, you know, at the heart of 
it. You know, there are moral hazard issues. How do you do this 
so you do not set off a firestorm?
    Senator Corker. Right.
    Mr. Zandi. I hear what you're saying, and I understand what 
you are saying. This is not something that I would----
    Senator Corker. Well, tell the farmer in west Tennessee the 
answer to that question.
    Mr. Zandi. OK. I would say a couple things.
    The first thing I would say is that I would disagree a bit 
with your characterization that this is only a California and 
Florida----
    Senator Corker. No, it is not ``only.'' All of our States 
have those issues, but it is hugely disproportionate.
    Mr. Zandi. It is by my calculation, 14.6 million--and I can 
provide it for your State of Tennessee. It is not 
insignificant. There are a lot of homeowners in your own State 
that are underwater.
    Senator Corker. But most folks in other States played by 
the rules. They were not going and specking a housing bubble 
with almost no money down.
    Mr. Zandi. I am not so sure. Subprime lending was pretty 
widespread.
    Senator Corker. Well, tell me the answer for the west 
Tennessee farmer.
    Mr. Zandi. Let me get to the more fundamental point.
    Senator Corker. All right.
    Mr. Zandi. The more fundamental point is that I think we 
are very close to solving this problem, to putting an end to 
it, and getting house prices moving north. And if it requires a 
half million to a million principal reduction mods that are 
very well targeted and done by the banking system and some 
hopefully by the GSEs, then I think that is a reasonable cost 
to make a reasonable thing to do to get the housing market on 
solid footing, moving north, and our recovery engaging. And 
this will benefit all Americans, not just Floridians but people 
in Tennessee who are unemployed.
    You have to think about this--it is almost--you know, sort 
of the metaphor is if someone else's house is on fire and you 
are in the same block, you have to put that fire out because it 
is going to save your block. Same deal. I know that does not 
resonate particularly with the farmer in Tennessee, but the 
reality is, I think--it is my judgment--that that is----
    Senator Corker. Let me ask you another question. You know, 
I have really enjoyed working with you on numbers of things, 
and I always appreciate the input of all three of you. The 
other thing we are looking at doing, we are going to take--I 
understand about refinancing Fannie inside Fannie and Freddie 
inside Freddie. But the fact that we are now going to take 
private loans and banks and if they are going to be--let us say 
they are 5.5, 6 percent rate and they want to refinance, we are 
going to transfer those over to FHA, and the ones that are 
going to be transferred obviously are the ones that are 
problematic.
    Do you think that is a good idea, to take from private 
lending institutions, transfer them on to the Government's 
balance sheet? Do you think that is a good idea? I am just 
stunned by that.
    Mr. Zandi. Well, I would put that at the bottom of the list 
of things that I would be focused on. I think the most 
important thing is to facilitate more Fannie/Freddie 
refinancings and more FHA refinancings. If at the end of the 
day there is a long list of things that have been proposed 
here, I would put that near the bottom.
    Senator Corker. Well, now, that is one of the top-list 
things that is being proposed. I would love to have the input--
--
    Mr. Zandi. Well, can I say, by my calculation, if you look 
at the benefit of these various refinancing proposals, the 
biggest benefit is to refinancing more Fannie, Freddie, and FHA 
loans. That is where----
    Senator Corker. Within Fannie, Freddie, and FHA.
    Mr. Zandi. Exactly.
    Senator Corker. I agree with that. And I do not know why we 
would not do that. I agree that is an absolute no-brainer.
    Is it OK if the other two respond to taking private lending 
institutions and transferring them over to the FHA books as 
thinking that is good public policy?
    Chairman Johnson. Would you please make it brief?
    Mr. Swagel. I will be very short, yes. FHA is already about 
$50 billion under--is going to need a $50 billion or maybe a 
$100 billion bailout. I think it would be difficult to 
countenance transferring over more risk. A year ago the 
Treasury report on GSE reform said we should shrink the FHA 
from its 30-percent share back to 10 to 15 percent. And now 
they are going in the opposite direction. So it is puzzling.
    Mr. Mayer. Any such program that involved taking on the 
risk of loans from private lenders I think should be 
predominantly funded through the owners of those mortgages. 
There might be ways to do that, but I think that would be an 
important thing to look at in this regard.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and I appreciate 
the comments of my friend from Tennessee. I have enjoyed 
working with him, and I want to go back to his kind of somewhat 
similarly answering I think a really legitimate issue that you 
raised. As somebody on the principal reduction--and Lord knows 
as somebody who spent more time on the business side than I 
have on this kind of job, I absolutely start with the same 
premise that you start with. But I do kind of think it is more 
than just certain States' problems. We do have now $160 billion 
worth of taxpayer exposure. The notion that one of the tools in 
the toolbox, as long as it was narrowly defined that we would 
exclude that tool from being used, particularly when we see the 
private sector--and I think I go back to Dr. Mayer's comments, 
that the private sector is using that tool and has a more--is 
it a 40-percent lower redefault rate than the GSEs?--to me 
argues--as hard as I would say if somebody would match my 
capitalist credentials with you, you know, that we are in such 
a hole here, and this has such a potential effect on the 
overall national economy that I would not take that tool out of 
the toolbox. But, you know, you make a great--I think you make 
a very strong, strong case on the other side.
    I guess one of the things I want to start with here is that 
Senator Reed made mention a number of times about the fact that 
the conservator can go ahead and take more actions than he has 
taken at this point. It seemed to me, Dr. Mayer, that you were 
saying--and I also agree with, I think, Senator Shelby and 
Senator Corker that we need to move on fuller GSE reform. But 
one of the things that I think, Dr. Mayer, you were saying, I 
just want to make clear that you were saying perhaps as an 
interim step that we need to legislatively make clearer to the 
Administrator that you ought to not put these further 
impediments in terms of unwinding the portfolio, that they need 
to be--he needs to move more aggressively on the refinancing 
opportunities. Did I hear that in your testimony?
    Mr. Mayer. Yes, I think I fully appreciate the challenges 
we all have with trying to figure out what the future of the 
U.S. mortgage finance system is going to look like. That is an 
enormously challenging problem, and, you know, I am an 
economist, not a political scientist, but I know we have an 
election coming, and, you know, there are a lot of issues going 
on here.
    That said, I think there are a number of areas which should 
be in common ground across the parties that, unfortunately, 
would require legislation because of the existing impasse in 
the institutions. I liken it to the responsibility of a board 
of directors when the CEO does not step in on his or her own to 
manage an existing conflict of interest. That means that the 
board of directors, unfortunately, has to step in and manage 
that conflict of interest. And so I think----
    Senator Warner. The conflict, again, to be clear, you are 
saying implicitly, is the conflict between preserving taxpayer 
dollars at the end of the day and the macro goal of one trying 
to refinance and also trying to have overall economic health? 
Is that----
    Mr. Mayer. No, no. Actually, the conflict of interest is 
more mundane than that, so to speak, which is the conflict of 
interest is they are managing a portfolio of mortgages, of 
hundreds of thousands of dollars----
    Senator Warner. In Freddie's circumstance that was exposed 
recently by NPR.
    Mr. Mayer. Right. You know, but long before NPR, many 
people had been talking about these issues, and, you know, the 
conservator's comments were not to actually deny that there was 
a conflict of interest, only to sort of say that he instructed 
the GSEs in November of 2011 that they should not consider 
their portfolio. But that conflict of interest has existed for 
years, and I think it is still the only plausible explanation 
for some of the comments that Dr. Zandi made about restrictions 
on refinancing that exist today. And so I think, unfortunately, 
that requires legislation.
    Senator Warner. I would like to--again, I do not want to 
take beyond my time, but I would like to get Dr. Swagel and Dr. 
Zandi. It does seem to be that there is this common agreement 
that we would all agree, whether some of the Administration's 
new proposals merit or not, that the refinance opportunity, at 
least within the GSE portfolio, we ought to be moving more 
aggressively on it, and what else should we do--do you believe 
that it requires legislation? Or what else should we do to urge 
those actions to place? Dr. Swagel and Dr. Zandi.
    Mr. Zandi. Go ahead.
    Mr. Swagel. The refinance issue is a tough one. There are 
people who are paying a higher interest rate than it seems like 
they should. On the other hand, someone who has lost a job over 
the last 3 years of the weak job market, it is not clear that 
taxpayers should take on the additional risk.
    One other note is that the proposal from the Administration 
specifically is limited to people who have been essentially 
current on their mortgage for a year. So in terms of preventing 
incremental foreclosures, the impact will be modest because the 
proposal is restricted to people who look like they are doing 
OK.
    So that is what I mean, it is really a stimulus, it is 
writing people a check. That might be the right thing to do, 
but it is not foreclosure avoidance, mainly. It is mainly----
    Senator Warner. Wouldn't it be by definition, if they are 
current, then their chances of default would actually be less 
as well?
    Mr. Swagel. Absolutely. Absolutely.
    Mr. Zandi. Yes, I would disagree with Dr. Swagel. I think 
this is a slam-dunk. You should work very hard to facilitate 
more refinancing through Fannie, Freddie, and FHA loans. And I 
think the Administration's proposal to extend HARP 2.0 rules to 
all Fannie, Freddie, and FHA borrowers is a good one. It is not 
only--and I should say this means a lot to a lot of people. 
Just simple calculations, I think at least 5 million homeowners 
at current mortgage rates, say fixed mortgage rates stay around 
4 percent, about 5 million homeowners could refinance over the 
next couple of years. And I think that makes a tremendous 
difference to those households.
    Senator Warner. How do we make that urgent? And then I will 
stop now, but just do you think we just need to continue to 
make that point, or do you think, as Dr. Mayer said, you 
actually need legislative direction?
    Mr. Zandi. I think at this point I would go down the path 
of writing legislation and hopefully the FHFA, you know, 
engages. So, for example, there is a piece of legislation I 
have seen floating around--Senator Franken, I believe--trying 
to require that Freddie adopt the rules that Fannie has adopted 
with respect to refinancing. Something along those lines. That 
is getting really into the weeds, and you would hope that, you 
know, this would be done administratively, not legislatively, 
because once you do legislation, things get complicated, right? 
You do not want to do that. But I think I would start moving 
down that path, and hopefully that lights a fire.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you all 
for your presentations.
    The perspective that folks bring to my town hall is that 
the Government intervened with enormous support for our major 
financial institutions, and as we know, a few months ago that 
included additional support from the Fed--and I am including 
the Fed as part of the definition of ``Government'' here--of 
trillions of dollars of loans, more than $1 trillion. It rolled 
over several times, which is what led us to that $7.7 trillion 
figure. And folks say, you know, if the Government can 
intervene with so much help and such low interest rate money to 
help our major financial institutions, why can't they intervene 
in that manner to help ordinary citizens wrestling with a 
housing market that was put into a bubble by policies that 
allowed predatory loans and teaser rates and steering payments, 
if you will, kickbacks, an enormous set of Government policies 
that drove that bubble?
    I raise this because I think it is important to return to 
that framework, and as we think about this question of 
refinancing, it is helpful to have that citizen's voice in our 
mind. It is easy for us to talk about those loans that are 
currently guaranteed by the Government by chance; that is, when 
someone comes into our casework team and says, ``Would I 
qualify for what is going on?'' do you have a Fannie or Freddie 
mortgage? Because if you do, then you may be able to get 
refinanced. But they have no idea where their loan has been 
sold until we help them find out.
    So you have so many families out there at higher interest 
rates who are wondering, well, why should it just be a matter 
of the lottery, that if my loan happened to be acquired by 
Fannie and Freddie, I qualify for this improved HARP program, 
but otherwise not? And given we have been so generous in 
helping financial institutions--I mean, let us not just look at 
the economy from the top. Let us look at it through the success 
of families. And certainly the economy in Oregon depends upon a 
successful home ownership market.
    We sell grass seed, which is down the tubes without people 
buying homes. We sell nursery stock. We sell lumber. We sell 
insulated doors and windows. And that is true for virtually 
every State. A piece of their economy is driven by the housing 
market.
    I have listened to the conversation about let us focus on 
those loans that happen to be with Fannie and Freddie, but the 
rest, well, maybe we just leave those people adrift, I feel a 
little bit of pushback that I wanted to share with you.
    I do feel indeed like the conversation about the conflict 
of interest, Mr. Mayer, that you have been pointing out with 
Fannie and Freddie, where they have resisted financing because 
they have high-interest loans. Well, this is an argument that 
one can also make on the other side of the non-Fannie/Freddie 
world and part of why exactly home modifications have been so 
difficult to achieve. Maybe you would just like to share a 
little bit about that.
    Mr. Mayer. So, first, I share your concern about the 
seeming unfairness of how the mortgage market and the economy 
have worked at the moment, and I think that that is a very, 
very deep concern, and I hear it a lot because I, you know, do 
talk shows and NPR and other kinds of things, you know, and I 
talk to a lot of people--not as many as you do, certainly, or 
as any of the Committee Members do, but I share that, and I 
have relatives who are locked into these situations as well. So 
I feel that very deeply. The challenge is how to do that within 
the existing structure.
    I think there are ways that we could think more creatively 
that fund something a little bit like the Home Owner Loan 
Corporation, for example, or some other sort of structure where 
the funding does not necessarily have to come from taxpayers, 
but may also come from mortgage holders or other kinds of--you 
know, I think there are some creative structures that one could 
build to do this in a way that would encompass more people but 
at the same time be respectful of taxpayers' obligations as 
well. And I do think we have an obligation to think harder 
about those things, so I think the Administration bringing this 
up is important. I am not sure about a bank tax--how I would 
fund it. I would like the incidence of this to be on the 
holders of the mortgages so they understand their cost to that.
    I would also sort of say that I think there are other--we 
could help those people also by doing other kinds of reforms in 
the market that help stabilize housing and that bring private 
capital in as well. There is no single tool that is going to 
fix this. It is going to be a variety of things. But I do think 
that there are going to be ways, if there is bipartisan 
support, to move this forward in a way that is respectful of 
taxpayers but is inclusive of a broader group of people, and I 
think those are both important concerns.
    Senator Merkley. The 5 minutes disappears magically, so 
quickly. So thank you. The HOLC model, there are many, many 
variants of it. The President has put out one variant of it. 
There are many other ways to tackle this, but I feel like time 
is passing; that is, efforts that should have been concluded 
and put in place very quickly 2 to 3 years ago, we still have a 
window now, and we should get it done.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. And let me thank 
several of you who have appeared before our housing 
Subcommittee and given a lot of great insights, and I 
appreciate it, as do the Members.
    You know, I have, as the Subcommittee Chair, been listening 
to a lot of our colleagues, and there seems to be a pretty 
strong universe of those for the refinancing camp. And, you 
know, I fully appreciate the question of the conservator's 
challenge in conserving and preserving assets. The question is 
whether you do that for a foreclosure or refinancing to a large 
degree, because it is, you know, very well if it is a default 
option, it is going to be one of those, too.
    And so I do not get it when you could create a large base 
of continuing responsible borrowers at the end of the day and, 
therefore, solidify a significant part of the housing market 
and have an economic stimulus, because if I have been patching 
the roof because I cannot afford to, you know, get a new one 
and now my mortgage rate is down and I have some extra money I 
am going to go ahead and get the new roof, and that means that 
there is going to be a stimulus in the economy as well as a 
foundation for the housing base.
    So that makes me wonder, then, and I would like to ask you, 
Dr. Mayer, when I hear about Freddie Mac having investments--
some call it ``bets''--against the homeowners that are contrary 
to the interests of homeowners, is that one of our challenges 
here? Because I do not think people make investments to then go 
against their investments.
    Mr. Mayer. Right. I do agree that this is a very serious 
concern. In my written testimony, I go through in fairly good 
detail, particularly in the conclusion, how it is that that 
ended up in a situation where well-meaning people ended up 
doing things that present an enormous appearance of, you know, 
a significant conflict of interest and a bet against 
homeowners. And I think you do not have to have--you know, you 
could believe, as I think was reported in that story, that 
paying $2.5 million salaries to the people that created those 
instruments might well have been involved in the process. I 
know many Members of Congress have been very critical of the 
salaries paid to, you know, some of the executives in those 
organizations.
    But I think there are--the conflict of interest of an 
organization that controls an outcome and also holds securities 
that are dependent on that control make it very, very difficult 
to manage the portfolio, because if you try and sell those 
bonds, people in the market look and say, ``But I do not want 
to buy them because the only reason you are selling them is you 
are about to refinance them 10 minutes later.'' And history 
says that Fannie Mae and Freddie Mac--particularly Freddie 
Mac--actually did that.
    Senator Menendez. So do you think these investments that 
influence Freddie's policies may very well have discouraged 
homeowners with high-interest mortgages from refinancing?
    Mr. Mayer. Yes, I think they have to do, and I go through 
the logic in my written report. I would not follow the 
conservator's argument that this is $5 billion in a $600 
billion portfolio so who cares, this cannot really have driven 
anything. I think that argument is not right because, one, 
these are derivatives that are based on probably, you know, $26 
to $30 billion of mortgages, not $5 billion. You never value 
derivatives based on the value of the derivative. You value it 
based on the value of the underlying.
    But the second is that almost surely many of the other 
mortgages in their portfolio look exactly--MBS--look exactly 
like these. And so without disclosure of what the whole 
portfolio looks like, I really think it is--we cannot conclude 
that that conflict of interest is----
    Senator Menendez. Do we know if Fannie or Freddie have 
other investments or financing arrangements that are contrary 
to the interests of homeowners?
    Mr. Mayer. I think the mortgage-linked amortization notes 
that I talked about earlier give Freddie Mac the same economic 
interest, which is they finance over a 10-year period holdings 
of high-interest rate mortgages, leaving them with a strip or a 
spread which is 3.96 percent that lasts only as long as the 
refinancing does not occur or default does not occur.
    Senator Menendez. Well, this is a real concern to me 
because I do not understand why you make a bet that you can 
largely control the outcome of and want your bet to lose. I 
think that is against human nature. So I am not quite sure 
these firewalls exist in a way that are not affecting policies, 
and that is a problem.
    Let me ask any one of you, do you think the $25 billion 
State-Federal foreclosure settlement is a good deal? Do you 
think that that is the right amount? There is a lot of angst 
out there in the country that says $25 billion fell short of 
the mark.
    Mr. Zandi. Well, I do not know what is appropriate in the 
context of the misdeeds that were done. I do think $25 billion 
is substantive and can make a difference in terms of responding 
to the housing crisis. I think if $15, $20 billion go to 
modifications and some additional refinancing, I think that is 
substantive, particularly if it is executed over the next 12 to 
18 months. So is $25 billion the right number? I do not know. 
But it is a substantive number.
    Senator Menendez. Do any of you have a view on that?
    Mr. Swagel. I would just say we should expect a modest 
impact and it will help some people. The biggest value is 
removing the uncertainty and having the housing market move 
forward and origination restart.
    Senator Menendez. One last question. We talked a lot about 
refinancing. I have been pursuing and am introducing 
legislation today that creates a pilot program at the FHA and 
the FHFA that would reduce principal writedowns to 95 percent 
loan to value in exchange for the bank or the investor getting 
a share of the profits when the home is sold or refinanced down 
the line, generally known as ``shared appreciation mortgages.'' 
I think it takes away some of the concerns that Senator Corker 
was talking about. It is not a complete question that we raise 
very often here about the moral line. You are getting a 
writedown, but you are also giving up the possibility of 
appreciation in return for the writedown.
    What do you think of that as a concept?
    Mr. Zandi. I think that is an excellent idea. I wish I had 
thought of that in my response to Senator Corker. But I do 
think that that is appropriate, that there should be shared 
appreciation of any principal writedown, and perhaps clawback 
provisions, too, if homeowners do not execute in the way that 
they are contracted to do in the principal reduction 
modification. So, I think there are a lot of moving parts here, 
and I am sure you know this may not work out as you would hope 
for because there are just so many things going on. But I think 
given that we have got this issue for the next 3, 5, 7 years, I 
think this is entirely appropriate to do. Hopefully we will 
learn from this and this will become part of the toolkit going 
forward.
    Mr. Mayer. I would support the idea of trying to look for 
ways that--as you pointed out, the private sector are already 
managing these mortgages, and we know some of them are using 
shared appreciation mortgages. And I think in legislation, as I 
note in the written comments, we should actively call for such 
pilot programs modeled off of private sector initiatives.
    The other thing I would sort of just point to in that 
process is one thing that might help in this legislation would 
be taxpayers could, in fact, have a clawback over a longer 
period of time, which is to say homeowners could promise a 
share of not only the appreciation of the existing home but 
future homes to help pay for that. That could be done through 
the existing Tax Code which has a deferral of certain capital 
gains on homes and would be a way of making such a proposal 
even more profitable or break even for taxpayers as well.
    Mr. Swagel. I would just say that the shared appreciation 
mortgage might be useful for some people. Again, I would worry 
about a limited impact. People just do not like to share their 
home with the bank or the taxpayer. We have some experience 
with the so-called Hope for Homeowners program that was in the 
2008 legislation, and there are more people in this room than 
were helped by that program. So it is just a limited----
    Senator Menendez. I appreciate it. Ocwen is doing this as 
one servicer who is doing this pretty successfully, and we 
think it can be, as referred to, a tool within a larger--thank 
you, Mr. Chairman.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman. And thanks for your 
testimony today.
    I know the President recently released his plan to help 
responsible homeowners and heal the housing market, and one 
pillar of this plan is to establish a broad-based refinancing 
plan for responsible homeowners. I understand that in both 
public and private refinance plans there has been a problem 
with take-up and lenders will present borrowers with 
refinancing plans that would lower their interest rates and 
monthly payments, but that some borrowers are simply not 
choosing to sign up.
    Can you shed any light, any of you, on this problem and 
provide your thoughts on what might be done to remedy it?
    Mr. Zandi. Well, you are absolutely right, I think there is 
a problem with take-up, even when it ostensibly makes sense 
from a financial perspective for the homeowner to engage in the 
refinancing.
    I do think that part of the problem in the take-up is that 
people are just very nervous that if they come forward, they 
are not sure what else in their financial lives is going to be 
uncovered and what other kind of damage could be done to their 
finances as a result. So I think it is very important, when 
servicers go to try to execute on these refinancings, that they 
make it very clear that, you know, they just want to make sure 
you have a job and that is it. So you have to be very, very 
clear that there are no other strings attached. All we want to 
do is make sure you have got a job, you are getting paid. If 
that is the case and you are current and you meet these other 
very limited restrictions, then you are good; we are going to 
refinance you.
    The other thing is I think financial literacy obviously is 
a very significant problem. People are just confused. They do 
not know, they do not understand. And so I think anything that 
could be done to really educate people as to, this is really 
going to help you and make it very clear on one piece of paper, 
this is your mortgage, this is your monthly payment, this is 
exactly what is going to happen, you email it to them or you 
put it in their mailbox, then, you know, hopefully that will 
increase the take-up.
    So I think it is a matter of communication and transparency 
with respect to----
    Senator Hagan. And how would you go about doing that?
    Mr. Zandi. Well, I think when Fannie and Freddie and the 
FHA sit down with the mortgage servicers and talk about how 
they are going to execute on this plan, if, in fact, we move 
forward on it, then these are the kinds of things that they 
discuss. How are we going to do this so that we do get more 
take-up?
    Mr. Mayer. I agree that take-up is an issue, but I actually 
think that the right approach is one word: competition. We did 
not ever have to sort of push people to take mortgages. You 
know, in 2002 and 2003, there were 35 million new mortgages 
originated in this country. Those were predominantly not 
subprime loans. Some of them involved cash-out refinancing. But 
what drove that was competition among servicers for the 
businesses, and I think one of the most significant barriers to 
the take-up and one of the reasons that HARP in all its 
incarnations, including potentially this one, do not work is 
because you lock the existing servicer and you give them a big 
advantage relative to other servicers.
    So what you need is not only the servicers who are in that 
room, but people who want to start a business as servicers who 
are not sitting in that room should have the opportunity to 
enter and take the business of the existing parties if they do 
not serve their customers well, of which there is some evidence 
is not happening. They are going to find lots of ways to reach 
people that is not just by mail. They are going to advertise on 
the Internet. They are going to be on late-night TV. They are 
going to figure out ways to do it because it is in their 
financial interest to do it, and that competition is also going 
to drive down these incredibly high spreads between retail and 
wholesale mortgage rates.
    So my view is that we should be doing everything we can to 
open this up to competition. We should put out a list 
protecting privacy of borrowers who have Fannie and Freddie 
loans. Your mortgage is already a public record in virtually 
every State in the country. That should be available to any 
servicer, existing or not, who wants to come and say, ``These 
are people who are eligible for this program, and I will jump 
in.'' My bet is that somehow those existing servicers will 
really quickly discover how to refinance their existing people 
if they think they are going to lose that servicing business.
    Senator Hagan. Thank you.
    Mr. Swagel. I would just add very briefly, it is a tough 
issue. A borrower in trouble is being pounded by the bank, you 
know, ``Pay up, pay up,'' and then gets a call, ``OK, now we 
want to help you,'' and it is hard to know. So nonprofit 
counselors have been a big success story, a big part of the 
solution.
    Just the other small thought is that it is a difficult 
issue just because of the screening, trying to get the right 
people to help, the more kind of screening you do to get just 
the right people limits the effectiveness, and that is in my 
written testimony as a concern I express about the White House 
fact sheet, the announcement, is that they are trying to say, 
OK, we want this to be no red tape, no hassles, but also no tax 
forms, but only owner occupied, and those things do not go 
together. You cannot make sure it is owner occupied if you do 
not have tax forms and you do not have an appraisal.
    So I just worry about the ability to implement the proposal 
that the White House has proposed.
    Mr. Zandi. Senator, could I say one other thing? Just one 
other plug for the Administration's proposal, which is very 
similar to the Federal Reserve's proposal, and this dovetails 
with what Dr. Mayer is saying. The way this is designed is that 
it is going to relax some of the reps and warranty features of 
the refinancings, also the mortgage insurance companies, most 
of them have given up rescission rights. This is very important 
to the mortgage lenders, the servicers, and it is a reason to 
believe that they are going to engage in a lot more competition 
and do the kinds of things that Dr. Mayer has suggested.
    So in the design of the proposal, there are a lot of good 
reasons to believe that you will get more take-up because you 
will have more competition. So just another reason why I think 
you would want to execute on this.
    Senator Hagan. Thank you. And, Mr. Zandi, your comment on 
financial literacy is near and dear to my heart. When I was in 
the State Senate, I mandated that financial literacy be taught, 
at least a portion, in civics and education class in high 
school, and it is certainly something that I am adamantly in 
support, that you look at the financial crisis that hit, I 
think we have got to do a better job educating our young people 
in particular on financial literacy and the skills. You cannot 
get by in the country today without understanding debt. You 
really need to work on that.
    Mr. Zandi. In my high school education, I learned how to 
make a really good omelet. I had no idea what a mortgage was.
    [Laughter.]
    Mr. Zandi. I am not sure that makes any sense at all--
although I really make a good omelet.
    Mr. Mayer. In my high school, the omelets were on the 
ceiling.
    [Laughter.]
    Senator Hagan. Then I had one other question, Mr. Chairman. 
Mr. Zandi, in your testimony you mentioned that Fannie and 
Freddie have historically not engaged in bulk foreclosure sales 
to investors or entered into agreements with property managers. 
Do you believe that a properly constructed--any of you--REO to 
rental program would reduce taxpayer exposure to Fannie and 
Freddie?
    Mr. Zandi. Yes, I think this is also a very fruitful area 
for addressing the housing crash. I think that if you look at 
property in REO, more than half now, and rising quickly, is at 
Fannie, Freddie, and the FHA, and increasingly the share of REO 
that is going to be Fannie, Freddie, and FHA is going to rise. 
So anything that they can do to facilitate moving that REO to 
rental as opposed to moving it through to a distressed sale is 
really very positive for the economy.
    The one problem is they have no experience with it and, 
thus, it is taking them time to really get going. But Congress, 
I think, should really be pushing this and asking FHFA to 
really engage because this could reap enormous benefit.
    And one other quick point. Again, this is a problem that is 
going to be with us for a number of years, 5, 6, 7 years. So I 
think we should--even if it does not reap benefit 6 months from 
now or a year from now, this is something that should be 
pursued very aggressively.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Johnson. I would like to thank all of our 
witnesses for your this and for being here with us today. A 
strong, robust housing sector recovery is not just vital to our 
country's homeowners; it is vital to our country's economic 
strength. This Committee will continue to search for consensus 
solutions to help responsible borrowers in these difficult 
times.
    This hearing is adjourned.
    [Whereupon, at 11:37 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                    PREPARED STATEMENT OF MARK ZANDI
           Chief Economist and Co-Founder, Moody's Analytics
                            February 9, 2012


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


               PREPARED STATEMENT OF CHRISTOPHER J. MAYER
    Paul Milstein Professor of Real Estate, Finance, and Economics, 
                        Columbia Business School
                            February 9, 2012
    Good afternoon Chairman Johnson, Ranking Member Shelby, and Members 
of the Committee. Thank you for inviting me to speak today. My name is 
Christopher J. Mayer. I am the Paul Milstein Professor of Real Estate 
at Columbia Business School. I have spent the last 18 years studying 
housing markets and credit while working at the Federal Reserve Bank of 
Boston and serving on the faculties of Columbia Business School, the 
University of Michigan Business School, and the Wharton School of the 
University of Pennsylvania. I also serve as Visiting Scholar at the 
Federal Reserve Bank of New York.
    The Federal Reserve recently issued a white paper documenting many 
of the frictions in the housing finance system and suggesting how such 
frictions have had a negative impact on the housing market and the 
economic recovery. The Federal Reserve points out that ``Obstacles 
limiting access to mortgage credit even among creditworthy borrowers 
contribute to weakness in housing demand, and barriers to refinancing 
blunt the transmission of monetary policy to the household sector.''
    Despite record low interest rates, mortgage activity has fallen 
precipitously. According to the Mortgage Bankers Association, the 
dollar volume of mortgages originated to purchase homes in 2010 (the 
last full year of data) has fallen to the same level as in 1992 (see, 
Figure 1, at the end of this testimony). Although one might have 
expected large numbers of refinancings because of low rates, 
refinancing activity in 2010 was, in fact, at the second lowest annual 
level since 2001 (Figure 2). So far, through the 3rd quarter of 2011, 
mortgage lending is down almost 19 percent from the same period in 
2010. By comparison, according to Equifax Origination Credit Trends, 
new consumer lending is up 11.1 percent on a year-to-date basis in 
November 2011 from the previous year, showing increases in nearly every 
category including auto lending, credit cards, consumer finance, and 
student loans.
    Other housing data released since the white paper was published 
continue to highlight the negative picture of the housing market that 
the Federal Reserve discusses relative to the rest of the economy. S&P/
Case-Shiller indexes for 20 cities in November fell 1.3 percent from 
October and 3.7 percent for the full year, both larger decreases than 
anticipated and stoking fears that home prices might start falling 
again if foreclosures pick up, as they inevitably must. Lender 
Processing Services reports that 8.15 percent of mortgages are 
delinquent and 4.12 percent of mortgages are in some stage of 
foreclosure; both numbers that are nearly identical to June 2011. The 
share of mortgages that were current 6 months earlier but seriously 
delinquent now is higher than it was in June 2011. In other words, even 
as the labor market has started to improve, the housing market remains 
mired in difficulties.
    Stepping back, it is important to understand the role of Government 
interventions in the housing market and the unintended consequences. 
After housing prices went into a free fall in 2007, private mortgage 
credit collapsed shortly afterwards. Newly issued private first 
mortgage securitizations, which once were nearly a trillion dollars per 
year, fell to almost zero. Government sponsored entities Fannie Mae and 
Freddie Mac (the GSEs) along with the Federal Housing Administration 
(FHA) quickly came to dominate the market. Yet soon the bond market 
became leery of lending to the GSEs, which did not have an explicit 
guarantee on their debt. With their solvency in doubt, the Federal 
Government backstopped the GSEs by putting them in conservatorship in 
September 2008. The Federal Housing Finance Agency (FHFA), an 
independent Government agency and previously the GSE's regulator, 
became the conservator, taking over management of the GSEs. As well, 
the Government provided an explicit guarantee on their debt. The 
Government began further backing the GSEs when the Federal Reserve 
announced at the end of 2008 that it was beginning the purchase of what 
eventually became nearly $1.25 trillion of GSE securities.
Fannie Mae and Freddie Mac Under Conservatorship
    In 2008, Congress passed the Housing and Economic Recovery Act 
(HERA). Under HERA, which tasked the Director of the FHFA to ensure the 
GSEs meet a number of conditions, including: \1\
---------------------------------------------------------------------------
     \1\ See, H.R. 3221-11. I have abbreviated the rules to focus on 
the relevant parts of the legislation for this testimony. This is not a 
complete list of all legislative requirements.

  1.  ``each regulated entity operates in a safe and sound manner . . . 
---------------------------------------------------------------------------
        ''

  2.  ``the operations and activities of each regulated entity foster 
        liquid, efficient, competitive, and resilient national housing 
        finance markets . . . ''

  3.  ``the activities of each regulated entity and the manner in which 
        such regulated entity is operated are consistent with the 
        public interest.''

    Soon after taking over conservatorship of the GSEs, Director James 
Lockhart restated the agency's mission: \2\
---------------------------------------------------------------------------
     \2\ FHFA Strategic plan, 2009-2014.

        Provide effective supervision, regulation and housing mission 
        oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan 
        Banks to promote their safety and soundness, support housing 
        finance and affordable housing, and support a stable and liquid 
---------------------------------------------------------------------------
        mortgage market.

    As well, GSEs were required to start to reduce the size of their 
retained portfolio of mortgages and mortgage-backed securities (MBS). 
While many critics and observers also expected or hoped that FHFA 
conservatorship would set the stage for the eventual wind down and 
replacement of the GSEs, no such mandate was given to the FHFA. In 
fact, Director Lockhart noted the strategic goal under conservatorship, 
``FHFA preserves and conserves the assets and property of the 
Enterprises, ensures focus on their housing mission, and facilitates 
their financial stability and emergence from conservatorship.'' Nowhere 
was there a goal to eliminate the GSEs.
    Unfortunately for taxpayers, homeowners, and the economy, in the 
more than 3 years since FHFA has taken over conservatorship of the 
GSEs, the enterprises have continued to act as profit maximizing 
private firms, taking advantage of their market power in the mortgage 
market to earn profits rather than working to make the market more 
efficient. In doing so, the GSEs have taken a very narrow, and 
arguably, ineffective and harmful approach to managing their 
activities. These actions have resulted in enterprises that are 
arguably no easier to wind down today than they were 3 years ago. This 
is despite the fact that almost all commentators and policy makers have 
suggested that the GSEs as currently constructed do not represent an 
attractive way to finance U.S. housing in the future.
    Maybe the single biggest problem with the ongoing operation of the 
GSEs has been to failure to adequately address critical conflicts of 
interest in their operations. The evidence suggests that the conflict 
of interest between the businesses of providing mortgage guarantees and 
managing a large retained portfolio of mortgages and MBS have led to 
the obstacles to normal credit conditions. This conflict of interest 
was raised in recent reporting by National Public Radio and ProPublica. 
\3\ In its white paper, the Federal Reserve noted that `` . . . easing 
some of these obstacles could contribute to the gradual recovery in 
housing markets . . . '' Even without considering the overall economy, 
GSEs should be concerned with the health of the housing market, since 
they now hold the risk for more than one-half of all outstanding 
mortgages. Thus, absent a conflict of interest, it would appear to 
directly benefit the GSEs to remove some of the obstacles the Federal 
Reserve discusses.
---------------------------------------------------------------------------
     \3\ See the recent story from National Public Radio and 
ProPublica, http://www.propublica.org/article/freddy-mac-mortgage-
eisinger-arnold.
---------------------------------------------------------------------------
    There are plenty of examples of how this conflict of interest might 
have led the GSEs to take actions that padded their portfolio profits, 
even while harming the mortgage market and the larger economy. Many 
credit market decisions by the GSEs seem to be driven by a desire to 
block refinancing. \4\ Fannie Mae raised up-front fees on all new loans 
just weeks after the Federal Reserve announced its MBS purchase 
program, with Freddie Mac following suit two months later. These new 
fees applied even in cases where borrowers' mortgages were already 
guaranteed and their refinancing not impose any additional risk. The 
GSEs have taken steps to reduce competition between servicers, despite 
borrowers' many complaints about poor service by their existing 
servicers. Shrinking lending, increasing legal liability, and other GSE 
policies appear to have contributed to a lack of competition to 
originate mortgages, leading to retail spreads on mortgages that remain 
near at all-time highs. The GSEs have failed to address critical 
problems in the mortgage insurance industry, leaving many consumers 
locked into high interest rate mortgages and making mortgage 
modification more challenging and less effective. Since refinancing and 
mortgage modification as well as lower retail spreads on mortgages 
reduce the cost of mortgage guarantees by reducing defaults, the only 
seemingly plausible reason for such policies is to protect high 
interest payments on mortgages and MBS held in the GSE's portfolio.
---------------------------------------------------------------------------
     \4\ In response to recent allegations of conflicts of interest, 
the FHFA has pointed out that refinancing represents a large portion of 
the GSEs overall business. As I discuss below, this fact is not 
inconsistent with the allegations of a conflict of interest. Many of 
the restrictions on refinancing did not impact all borrowers, but 
instead reduced refinancing by borrowers with high mortgage rates that 
may also be held in GSE portfolios.
---------------------------------------------------------------------------
    The reports by National Public Radio and ProPublica highlighted how 
these conflicts of interest may also have influenced portfolio 
decisions at Freddie Mac. Instead of selling off the MBS that it 
inherited when it entered conservatorship, Freddie Mac appears to have 
created and held complex, highly leveraged mortgage derivatives that 
are risky and nearly impossible to sell. In addition, Freddie Mac 
created new and complex long-term financing for its MBS positions 
(called Mortgage-Linked Amortization Notes, or MLANs) rather than 
choosing to sell these securities into the open market and reduce the 
size of its portfolio business. \5\ These transactions highlighted the 
appearance of a conflict of interest since the transactions were 
structured so that the enterprise lost valuable interest payments if 
borrowers with very high interest rates were able to refinance their 
mortgages, a policy that is substantially under the control of Freddie 
Mac. Whether intended or not, these transactions also make it harder to 
unwind Freddie Mac and its portfolio in the future.
---------------------------------------------------------------------------
     \5\ http://www.businessweek.com/news/2012-01-17/freddie-mac-sees-
selling-40-billion-of-debt-tracking-mortgages.html
---------------------------------------------------------------------------
    While seemingly consistent with the strategic goal listed above of 
conserving and preserving assets to emerge as an ongoing entity, the 
policies described above appear to violate a number of the GSE's other 
mandates, which are to ``foster liquid, efficient, competitive, and 
resilient national housing finance markets'' and to operate in a manner 
``consistent with the public interest.'' From the first quarter of 2008 
to the first quarter of 2011, the market share of the top five mortgage 
originators has grown from 56 percent to 65 percent. As well, according 
to Bloomberg (Figure 3) the spread between retail and wholesale 
mortgage rates has widened by at least 0.75 percent (75 basis points) 
between its average from 2000 to 2007 and its level at the end of 2011. 
These facts suggest that conservatorship has resulted in less 
competitive and less efficient mortgage markets.
The Dueling Business Interests of the GSEs: A Conflict of Interest?
    To better understand these issues, it is important to look at the 
historical context in which the enterprises arrived into 
conservatorship. When the FHFA took over the management of Fannie Mae 
and Freddie Mac (GSEs), the enterprises had two principal businesses: 
mortgage guarantees and portfolio management. The mortgage guarantee 
business involves collecting premiums and insuring bondholders against 
credit losses. When a borrower defaults on a mortgage, the GSEs must 
buy the mortgage out of a pool at par, so bondholders are made whole. 
The portfolio business involves owning and managing a large balance 
sheet made up of mortgage-backed securities (MBS) and mortgages. Both 
businesses were considered to be in serious financial trouble when the 
GSEs entered conservatorship.
    The guarantee and portfolio businesses have always involved an 
inherent conflict of interest--the GSEs know more about the mortgages 
in the MBS than other parties. One study by researchers at the 
University of California at Berkeley and Barclays argued that the 
mortgage-backed securities market was a market for lemons. \6\ The 
article showed that securities that Freddie Mac sold to the market were 
of lower quality than those it didn't sell. Traders have always 
recognized that the GSEs were more informed than they were and market 
prices reflected this friction. Financial economists would note that 
the existence of some traders using nonpublic information inherently 
leads to less liquid and efficient markets, as other traders must 
account for adverse selection when bidding on securities.
---------------------------------------------------------------------------
     \6\ Downing, Chris, Dwight Jaffee, and Nancy Wallace. 2009. ``Is 
the Market for Mortgage-Backed Securities a Market for Lemons?'' Review 
of Financial Studies, 22(7):2457-2494.
---------------------------------------------------------------------------
    Most public policy concern about the growth of the GSEs portfolio 
was not about conflicts of interest, however, but risk. During the 
2000s, the retained bond portfolio grew rapidly, taking advantage of 
their implicit guarantee by taking on additional risk on behalf of 
taxpayers. The GSEs even began to purchase securities with risky 
subprime mortgages that were specially designed for them to acquire.
    In 2008, the FHFA inherited the management of firms with $1.1 
trillion of MBS, hundreds of billions in mostly failed mortgages, and a 
bankrupt guarantee business. As well, with the demise of private 
securitization and the fragile state of the financial services sector, 
the GSEs and the FHA were guaranteeing more than 90 percent of new 
mortgages, a condition that continues today. Without competition in new 
mortgage origination, the conflict of interest between mortgage 
guarantees and portfolio management once again rose to the forefront. 
After all, actions that might lead to even a small percentage change in 
the value of the portfolio would have a material impact on profits of 
these formerly semi-private companies.
    Soon after conservatorship, in December 2008, Fannie Mae announced 
LLPAs (loan level pricing adjustments), up front fees that would be 
paid by all borrowers on newly originated mortgages. These fees, when 
combined with adverse market delivery charges, could equal more than 
three percent of the mortgage amount, to be paid up front. Freddie Mac 
soon followed with its own fees, although it never posted its fees 
online the way Fannie Mae did.
    While such fees have sometimes been defended as an attempt to add 
risk based pricing to mortgage originations, they were also applied on 
an equal basis to borrowers who were refinancing mortgages that the 
GSEs already guaranteed. The Federal Reserve white paper referred to 
such fees as ``hard to justify'' when applied to refinancing their own 
mortgages. As well, imposing new, large up-front fees in the middle of 
a serious recession and stock market decline when down payments were 
scarce had the practical effect of reducing demand for mortgages among 
affected borrowers. A seemingly preferable alternative would have been 
to increase the annual guarantee fee (so-called ``g-fee'') on mortgages 
for new purchases, which would likely have had a smaller negative 
impact on demand. A fee structure that decreased demand for new 
mortgages also would have cut the demand to purchase homes, helping to 
contribute to a further decline in home prices. Falling home prices 
materially increased losses in the GSE's mortgage guarantee business. 
However, from the perspective of the portfolio, an equivalent increase 
in the g-fee rather than a higher up-front borrowing cost (LLPAs) might 
have allowed a much larger wave of refinancings, possibly leading to 
portfolio losses. These large up-front fees were not a market outcome 
nor were they mandated in any way by conservatorship, but were a 
barrier imposed by the GSEs themselves, seemingly designed to protect 
their own portfolios from prepayments, the very outcome that the 
Federal Reserve's MBS purchase program sought to create.
    The high up-front fees when applied to mortgages they already 
guaranteed was just one of many steps the FHFA and the GSEs have taken 
since conservatorship that have had the effect of preventing 
refinancing of many mortgages. As early as September 2008, Glenn 
Hubbard and I have argued for the Government to facilitate widespread 
refinancing to reduce defaults, help stabilize the housing market, and 
stimulate the economy. \7\ In our own analysis, Alan Boyce, Glenn 
Hubbard, James Witkin and I have shown how a slightly higher g-fee on 
refinancings would create a structure whereby the GSEs could more than 
recoup any portfolio losses. David Greenlaw (Morgan Stanley), Mark 
Zandi (Moody's Analytics), Bill Gross (Pimco), and many economists made 
similar arguments in the intervening years, but with little success.
---------------------------------------------------------------------------
     \7\ See a history of our research on widespread refinancing along 
with our current proposals on our Web site: http://
www4.gsb.columbia.edu/realestate/research/housingcrisis.
---------------------------------------------------------------------------
    In March 2009, the President announced the HARP (Home Affordable 
Refinance Program). The program was an attempt to streamline 
refinancings, but eventually resulted in fewer than one million 
refinancings over a period of nearly 3 years. While HARP officially 
applied to borrowers with a loan-to-value ratio (LTV) of up to 125 
percent, technical barriers prevented take-up by all but a few 
borrowers with LTVs above 105 percent. And up-front GSE fees (LLPAs) 
still applied to HARP mortgages. As well, under HARP, only the 
borrower's existing servicer could effectively pursue a new 
refinancing. Even today under the new so-called HARP 2.0, existing 
servicers have a large advantage over new servicers in pursuing a HARP 
refinancing for a given borrower.
    HARP also excluded borrowers with LTVs of less than 80 percent. 
While some such borrowers might have had an easier time pursuing a 
refinancing, many of these borrowers were still subject to up-front 
fees and other barriers. LLPAs were charged for borrowers with LTVs in 
excess of 60 percent and FICO scores below 760. Reps and warranties 
liabilities likely prevented many such borrowers from getting 
attractive quotes from other lenders. Also, many borrowers with 
seemingly low LTVs had second liens, so that these borrowers would 
likely have an elevated risk of default and thus could benefit from 
lower mortgage payments.
    Finally, all of the exclusions from HARP had an additional negative 
effect on taxpayers and the overall economy. For example, Joseph Tracy 
and Joshua Wright of the Federal Reserve Bank of New York point out 
that refinancings are not simply a zero sum game and might instead `` . 
. . stabilize the housing market and support economic growth.'' \8\
---------------------------------------------------------------------------
     \8\ http://libertystreeteconomics.newyorkfed.org/2012/01/why-
mortgage-refinancing-is-not-a-zero-sum-game.html
---------------------------------------------------------------------------
    From the perspective of the mortgage guarantee business, it is 
difficult to understand why the GSEs would limit refinancing on 
mortgages that they already guaranteed. A widespread refinancing 
program that lowered payments for risky mortgages would almost surely 
reduce defaults. \9\ In fact, from the perspective of the mortgage 
guarantee business, one might have expected the GSEs to go out of their 
way to refinance the riskiest borrowers, who would otherwise be at 
greatest risk of default. Yet the barriers imposed by the GSEs had 
exactly the opposite effect, severely limiting refinancing by the 
riskiest borrowers. The fees on refinancing were highest on mortgages 
where the borrower had a low FICO score or high LTV. Mortgages with 
high loan-to-value ratios were locked out of refinancing altogether.
---------------------------------------------------------------------------
     \9\ Early research on the HAMP program showed the mortgage 
modifications that lowered mortgage payments had a strong impact on 
reducing defaults. See, Federal Reserve Bank of New York Staff Report 
#417, originally published in December 2009, for example.
---------------------------------------------------------------------------
    Looking back, the costs of these actions have become clear. 
According to my own calculations using data from Lender Processing 
Services, about one-sixth of all GSE guaranteed mortgages with a 
mortgage rate above 6 percent in 2009 defaulted, compared to defaults 
by about one in fifty mortgages with rates below 5 percent. Almost 
surely a program to refinance high mortgage rate borrowers would have 
lowered this default rate for this population, saving the GSEs from 
some large losses from their mortgage guarantee business and reducing 
the number of foreclosures and short sales that have contributed to 
falling house prices and thus even larger future costs from mortgage 
guarantees. In fact, the Congressional Budget Office's recent paper on 
found that about for every 1,000refinancings that took place, 38 
defaults would be prevented. \10\ According to the CBO, such a program 
would have saved the GSEs billions of dollars in lower guarantee costs. 
A program that facilitated millions of refinancings might have 
prevented hundreds of thousands of defaults.
---------------------------------------------------------------------------
     \10\ http://www.cbo.gov/ftpdocs/124xx/doc12405/09-07-2011-Large-
Scale_Refinancing_Program.pdf
---------------------------------------------------------------------------
    It appears only possible to understand this behavior by looking at 
the GSEs' portfolio management business. In fact, the CBO pointed to 
possible portfolio losses when considering the costs and benefits of a 
widespread refinancing program. While the GSEs have never disclosed 
much detail about their portfolio holdings, many of their purchases of 
mortgage-backed securities seem to have taken place in the mid-2000s. 
The mortgages in these mid-2000s pools have mortgage rates that are 5.5 
percent or above. These loans have much lower mortgage balances, which 
indicate lower income households, and may be more likely to be under 
financial stress. In other words, many of the mortgages inside the 
securities held in GSE portfolios may also have been those at the 
greatest risk of default. Refinancing mortgages for responsible 
borrowers who were current on their mortgages, but also at great risk 
of default, might well have imposed losses on the GSE portfolios while 
saving significantly more for their credit guarantee businesses.
    Let me put the hypothesis directly. The possibility of protecting 
their portfolios explains why the GSEs have been so resistant to 
refinancing certain mortgages. If not for the conflict of interest 
between the portfolio and mortgage guarantee businesses, why else would 
the GSEs have imposed so many barriers to refinancing?
Did Freddie Mac ``Bet Against Refinancing?''
    Last week, National Public Radio and ProPublica reported that 
Freddie Mac created risky securities called Inverse IO Floaters that 
had the appearance of betting against household refinancing. These 
securities involve creating a concentrated risk position that pays off 
only as long as the underlying mortgages continue making payments. If 
the mortgages refinance, the payments stop and the securities lose 
significant value.
    The FHFA responded with a statement arguing against the premise of 
the story. It claimed that ``Freddie Mac's retained portfolio 
investment in inverse floaters did not have any impact on the recent 
changes to the Home Affordable Refinance Program (HARP). In evaluating 
changes to HARP, FHFA specifically directed both Enterprises not to 
consider changes in their own investment income as part of the HARP 
evaluation process.'' As well, it argued ``Of Freddie Mac's $650 
billion retained portfolio, only $5 billion is held as inverse 
floaters.'' As well, FHFA points out that about 80 percent of its 
recent business is refinancing mortgages.
    It is important to understand what the statement says and what it 
does not. This statement does not imply that Freddie Mac's credit 
decisions prior to HARP 2.0 in November 2011 were unaffected by its 
portfolio. In other words, the statement does not deny that the 
conflict of interest between lending and portfolio management might 
have impacted Freddie Mac's past practices. In fact, as argued above, 
the retained portfolio appears to be the only plausible reason to 
impose many of the lending restrictions that the GSEs have imposed over 
time. What remains puzzling, as well, is why Freddie Mac and not Fannie 
Mae imposed new and harsher restrictions on refinancing some mortgages 
under HARP 2.0. If not for the portfolio, why would Freddie Mac impose 
new restrictions on HARP 2.0 refinancings?
    A recent posting by Alan Boyce on the Web site www.zerohedge.com 
helps explain why FHFA's statement might be true but that the conflict 
of interest might still have materially impacted lending. \11\ For 
example, Mr. Boyce shows how the Freddie Mac might have simultaneously 
been refinancing some borrowers while also protecting its portfolio. 
The highest rates of refinancing have been for borrowers with 
relatively low mortgage rates, large loan balances, high FICO scores 
and low LTVs originated between 2009 and 2011. These loans were made 
after conservatorship and at a time that Freddie Mac was reducing it's 
MBS holdings. Refinancing such mortgages may be good business, but it 
does not change the GSE risk profile much, because these mortgages are 
already unlikely to default. But, of course, Freddie Mac may not own 
many securities that contain recently originated mortgages.
---------------------------------------------------------------------------
     \11\ http://www.zerohedge.com/contributed/qa-alan-boyce-freddie-
mac-and-inverse-floaters
---------------------------------------------------------------------------
    NPR/ProPublica identified $3.4 billion of inverse IOs, which were 
backed by the interest payments on about $19.5 billion of mortgages. 
FHFA said that these risky derivatives were in fact larger, amount to 
$5 billion in size, which could have been backed by $26 to $30 billion 
of loans. The FHFA notes that inverse IO floaters represent only a 
small portion of Freddie Mac's portfolio, implicitly suggesting that 
such a small stake cannot possibly drive their lending restrictions. 
These trades took place in a 6 month time period and had the effect of 
reducing the total balance sheet of Freddie Mac by almost exactly the 
amount required by Congress, not an insignificant sum. In addition, 
FHFA does not describe the characteristics of the rest of Freddie Mac's 
$224 billion holdings in its own MBS. Is the remainder of Freddie Mac's 
portfolio also composed of high interest rate mortgages that Freddie 
Mac has spent more than 3 years imposing restrictions and prohibitions 
on refinancing? The entire Agency MBS market is trading at a premium, 
which means that every bond is well above par. It cannot be the case 
that taking an illiquid and highly levered position in inverse IOs can 
provide any hedge value for the rest of their portfolio. In fact, such 
a position would represent additional risk, in the same direction as 
its other holdings. Portfolio holdings may also explain why Fannie Mae 
has pursued refinancing restrictions that are nearly as strict as 
Freddie Mac. Fannie Mae owns nearly as much MBS as Freddie Mac.
Mortgage Modifications Under Conservatorship
    Rather than pursue a widespread refinancing program to help reduce 
credit losses, the GSEs have attempted to manage the defaults of risky 
mortgages once they occur. The problem has been that the GSEs have also 
been slow and less effective at adopting loss mitigation practices that 
the private sector has identified.
    Private lenders, at least those who service mortgages in their own 
portfolio, were first to adopt widespread mortgage modification 
programs and have much lower redefault rates than the GSEs. (This is 
not to say that the industry responded quickly; only that the industry 
responded more quickly than the GSEs.) Consider data from the latest 
OCC Mortgage Metrics Report. \12\ In 2008 and 2009, the redefault rate 
on mortgage modifications by the GSEs was almost 50 percent higher than 
mortgage modifications pursued by lenders on their own mortgages. In 
2008, for example, the 12-month redefault rate was about 58 percent for 
GSE modifications versus 40 percent for private lender modifications on 
their own portfolio loans. In 2009, the GSEs performed even worse on a 
percentage basis for the same measure (42 percent versus 25 percent for 
portfolio loans). By 2010, the GSEs 12 month redefault rate had caught 
up to that of portfolio loans. But in 2011, redefault rates for GSE 
modification are once again much higher than modifications of portfolio 
loans.
---------------------------------------------------------------------------
     \12\ http://www.occ.gov/publications/publications-by-type/other-
publications-reports/mortgage-metrics-2011/mortgage-metrics-q3-2011.pdf
---------------------------------------------------------------------------
    In looking at the recent data, one striking feature stands out. 
Many portfolio lenders, as well as private servicers, have turned to 
principal reductions to better manage defaults. Understanding what 
private investors and lenders do with their own loans is very 
instructive because it helps set a benchmark for behavior that is 
unaffected by the many conflicts of interest in securitization. \13\ 
According to the OCC data, portfolio lenders pursue principal 
reductions for more than 18 percent of mortgage modifications on their 
own portfolios. The FHFA still refuses to allow any principal 
reductions based on its calculations that more progressive modification 
and principal reduction programs will cost taxpayers money.
---------------------------------------------------------------------------
     \13\ See, for example, Tomasz Piskorski, Amit Seru, and Vikrant 
Vig. 2010. ``Securitization and Distressed Loan Renegotiation: Evidence 
From the Subprime Mortgage Crisis'', Journal of Financial Economics 97, 
369-397.
---------------------------------------------------------------------------
    In addition to the fact that private lenders often pursue principal 
write-downs with their own funds at risk, other studies also support 
the value of principal write downs that reduce LTVs as a tool for 
modifying mortgages. A 2009 study by the Federal Reserve Bank of New 
York concluded ``The data indicate that the redefault rate declines 
with the magnitude of the reduction in the monthly payment, but also 
that the redefault rate declines relatively more when the payment 
reduction is achieved through principal forgiveness as opposed to lower 
interest rates. \14\ As well, a recent study by Laurie Goodman supports 
the same conclusion, noting ``Controlling for payment relief, we find 
that principal reduction modifications are more effective than either 
rate modifications or capitalization modifications. These differences 
by modification type are larger for modifications on prime/Alt A/option 
ARM loans than for subprime loans.'' \15\
---------------------------------------------------------------------------
     \14\ http://www.newyorkfed.org/research/staff_reports/sr417.pdf
     \15\ Amherst Mortgage Insight, 12/01/2011.
---------------------------------------------------------------------------
    Another problem with all of these studies, and an issue that does 
not appear to be explicitly modeled by the FHFA analysis, is the risk 
of moral hazard. Private portfolio lenders are certainly be aware of 
this risk and have developed ways of minimizing moral hazard. 
Nonetheless, Government backed lenders like the GSEs may face a higher 
risk of moral hazard than private lenders would. This would be a place, 
once again, where the GSEs might benefit from examining the practices 
of private portfolio lenders.
    For some GSE mortgages, the existence of mortgage insurance (MI) 
appears to be a barrier to principal write-downs. However, the value of 
such MI is likely dubious. The GSEs have as much as $150 billion of 
insurance from various MI companies, but more than 80 percent of those 
potential claims are underwritten by MI companies that are either 
insolvent or have a credit rating of BB- or worse. The suspect nature 
of these receivables gives the GSEs incentives to delay loss 
resolutions as much as possible and may impact the extent to which the 
GSEs efficiently manage losses and foreclosures.
Why Not More Private Capital and Expertise for the GSEs?
    Another concern about the current process of how the GSEs have 
managed the housing crisis has been the lack of steps to bring in 
private capital and expertise in their businesses. It is important to 
note that the existing mandates for conservatorship do not require or 
even suggest that the GSEs bring private capital into their businesses. 
Of course there is a mandate to reduce risk, but that could be done 
without sharing the risks with private firms.
    Nonetheless, the GSEs have not taken advantage of places where 
private capital and expertise might be valuable in reducing losses or 
helping to stabilize housing markets. For example, the fact that 
private portfolio lenders appear to have much lower redefault rates on 
mortgage modifications of nonperforming loans (NPLs) suggest that the 
GSEs might profitably sell NPLs to specialized servicers. Private 
portfolio lenders sell certain NPLs to such specialized servicers. One 
might have expected the GSEs to do the same.
    It is critically important to examine new ideas to help attract 
private capital and ideas to address the housing crisis. In my 
testimony before the Senate Subcommittee on Housing, Transportation, 
and Community Development of this Committee I detailed a number of such 
proposals, including how to sell non performing mortgages and why sales 
of REO to long-term businesses dedicated to building a business in 
renting single family homes. \16\ I also discussed the potential for 
shared appreciation mortgages to help resolve the current glut of 
seriously delinquent mortgages.
---------------------------------------------------------------------------
     \16\ Chris Mayer serves as an advisor to Pathway, a start-up firm 
in the business of purchasing houses for long-term rental.
---------------------------------------------------------------------------
Conclusion
    I believe that the largest failure of conservatorship has been the 
unwillingness of the FHFA to adequately address the conflicts of 
interest it inherited when it took over management of the GSEs.
    Consider the problem of how the GSEs would have managed a portfolio 
of MBS with above-market interest rates--securities that might sell at 
a price above the par value of the securities. For example, a pool of 
MBS with a 6 percent coupon might sell for $1.10 for each $1 of 
principal with such a high coupon. Given that the GSEs had more 
information than buyers about their own intentions with regard to 
refinancing, as well as greater information about the underlying 
mortgages and their expected performance, buyers might be quite wary of 
purchasing MBS at market prices from the GSEs. Buyers could be 
concerned about the potential that the GSEs might then turn around and 
take action that would result in widespread refinancing. Buyers might 
also be worried that mortgages inside the MBS were at imminent risk of 
default. In either case, the securities would pay off at par ($1.00), 
leaving the buyer with an appreciable loss ($0.10). Aware of the 
conflict of interest, buyers might appropriately diminish their bids 
for agency MBS sold by the GSEs above par.
    Under conservatorship, the FHFA could have appointed an independent 
trustee to manage the sale of the MBS over time, with the explicit 
mandate to maximize the returns for taxpayers. If the trustee were 
truly independent, this plan would have mitigated the conflict of 
interest and maximized the sale proceeds from the pool of MBS. Put 
differently, taxpayers likely would have received higher proceeds from 
the sale of MBS had the GSEs turned over management of their portfolio 
to an independent, third party because buyers would have paid more for 
the MBS absent a potential conflict of interest. \17\
---------------------------------------------------------------------------
     \17\ Some might argue that it is necessary to have an investment 
portfolio to ensure the solvency of the guarantee business. However, 
since the GSEs are insolvent, the U.S. Treasury already serves the role 
of liquidity provider under conservatorship. As the GSEs return to 
solvency, they may want to acquire assets that help meet capital and 
liquidity needs. However, there is no reason for the GSEs to make such 
investments in their own MBS, which only amplifies the GSEs exposure to 
various mortgage market risks. The trustee would use the proceeds from 
the sale of the assets of the GSEs (MBS) to pay down the GSE's 
liabilities.
---------------------------------------------------------------------------
    Of course, the GSEs might have instead tried to earn even higher 
profits by keeping their portfolio and imposing frictions on 
refinancing. Even if imposing mortgage market frictions were to have 
maximized short-run profits on their portfolio, effectively conserving 
and preserving assets, it would have had other consequences in making a 
less efficient, less competitive, and more illiquid mortgage market and 
working against the public interest.
    Nonetheless, such a policy would have ignored another option--
widespread mortgage refinancing--that can and should have been a 
profitable business. My own analysis, conducted with Alan Boyce, Glenn 
Hubbard, and James Witkin, shows that refinancing should be profitable 
for the GSEs. By charging a slightly higher guarantee fee and creating 
a small fund to cover any possible losses from reps and warranties 
relief, refinancing could have been a way to help recapitalize the GSEs 
and help minimize taxpayer losses. Combining mortgage refinancing with 
an independent trustee would result in a win-win for taxpayers, 
mortgage borrowers, homeowners, and the larger economy.
    It is not too late to achieve that win-win scenario. The FHFA still 
has the authority to follow such a prescription. However, current 
policies do not make such a policy shift appear likely.
    Instead, Congress should consider changing the mandate of 
conservatorship to address its flaws. Legislation should mandate that 
an independent trustee be appointed to wind down the GSE's retained 
portfolio of MBS. The GSEs could continue to retain nonperforming loans 
that they have bought back from securitizations as is necessary to 
perform their mortgage guarantee business. Independent management of 
the retained portfolio will make the eventual privatization or 
replacement of the GSEs considerably easier. Legislation should also 
mandate other steps to move towards attracting private capital into the 
mortgage market, including ideas such as trial programs for the sale of 
NPLs to third party servicers, the sale of REO to private investors, 
and provisions that allow the GSEs to provide responsible amounts of 
leverage for owners of single-family home portfolios in the rental 
business on a temporary basis. \18\ Legislation should also ensure that 
the GSEs remove all of the obstacles limiting access to mortgage credit 
as identified in the Federal Reserve white paper. All borrowers should 
have access to refinancing without restrictions or qualifications other 
than being current on their mortgage and any refinancing programs 
should be available to be offered by any qualified originator to any 
qualified borrower.
---------------------------------------------------------------------------
     \18\ Any loans made available on portfolios of single-family homes 
might have a sunset provision so that lending is reduced over time as 
the private lending market recovers.
---------------------------------------------------------------------------
    Until we fix the housing market, it will be hard for the economy to 
fully recover. In this testimony, I have addressed a number of reasons 
that the lack of GSE reform continues to hold back the housing market 
and the economic recovery. I believe that immediate action is necessary 
to address fundamental flaws in the structure of the GSEs. 
Conservatorship as it now stands is laden with conflicts of interest 
between lending and portfolio management and holds back the 
reintroduction of private capital. These steps can occur now, even 
without a consensus on what the future of the U.S. housing finance 
system will look like.
    I appreciate the opportunity to address you today and look forward 
to answering any questions that you might have.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



         PREPARED STATEMENT OF THE HONORABLE PHILLIP L. SWAGEL
  Professor of International Economic Policy, University of Maryland 
                        School of Public Policy
                            February 9, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify on housing policy 
and the state of the housing market. I am a professor at the University 
of Maryland's School of Public Policy and a faculty affiliate of the 
Center for Financial Policy at the Robert H. Smith School of Business 
at the University of Maryland. I am also a visiting scholar at the 
American Enterprise Institute and a senior fellow with the Milken 
Institute's Center for Financial Markets. I was previously Assistant 
Secretary for Economic Policy at the Treasury Department from December 
2006 to January 2009.
    The continued weak state of the housing market and the toll of 
millions of foreclosures already, millions more families still at risk 
of losing their home, and trillions of dollars of lost wealth all 
reflect the lingering impact of the collapse of the housing bubble and 
ensuing financial crisis. A range of policies have been undertaken over 
the past several years aimed at the housing market--a recent summary 
from the Department of Housing and Urban Development lists 10 separate 
policy actions. \1\ These can be grouped into two broad categories. 
What might be seen as ``backward-looking'' policies seek to avoid 
foreclosures on past home purchases through actions such as incentives 
for mortgage modifications and refinancing. By avoiding foreclosures, 
these policies both assist individual families and help reduce the 
supply of homes for sale (and in the overhang of the so-called ``shadow 
inventory'') and thus reduce downward pressures on home prices that in 
turn affect household wealth and the broad economy. In contrast, 
``forward-looking'' policies seek to boost demand for home purchases, 
such as with the first time homebuyer tax credit and the Federal 
Reserve's purchases of mortgage-backed securities (MBS).
---------------------------------------------------------------------------
     \1\ See the appendix of the January 2012 HUD-Treasury Housing 
Scorecard: http://portal.hud.gov/hudportal/documents/
huddoc?id=JanNat2012_Scorecard.pdf.
---------------------------------------------------------------------------
    The common feature of these housing policies is their limited 
effectiveness. To be sure, these policies have done something: MBS 
purchases resulted in lower interest rates for families buying a home 
or refinancing a mortgage; some 930,000 homeowners have benefited from 
permanent mortgage modifications through the HAMP program; and so on. 
But relative to the scale of the weakness in home prices and housing 
market demand, and especially compared to the tragically huge number of 
foreclosures, the set of housing market policies to date appears to 
have underperformed compared to expectation set at each policy 
unveiling. Moreover, these programs have involved considerable costs 
for taxpayers, with the benefits accruing mainly to a relatively small 
group of recipients. And on top of the millions of foreclosures not 
prevented by the policies of the past several years, there is likely 
another huge wave of foreclosures set to take place in the next year or 
two, with many of these representing foreclosures that were delayed but 
not ultimately prevented by policies to date.
    This experience is important to keep in mind as the Congress 
contemplates a range of new and expanded housing policy proposals from 
the Administration, along with a white paper from the Federal Reserve 
that covers similar ground. Broadly speaking, the proposed actions look 
to provide homeowners with reduced monthly payments through Government-
assisted refinances; to lower principal mortgage balances; and to speed 
the pace at which vacant homes become rentals. The goal, as with all 
policies throughout the crisis, is to have fewer foreclosures and 
stronger consumer spending. These policies are well-intentioned.
    Unfortunately, there is every reason to believe that the new policy 
proposals for streamlined refinancing and principal reduction are 
likely to have the same modest impact--and at an even worse tradeoff in 
terms of cost to taxpayers for each foreclosure avoided than for the 
policies to date. Simply put, we have learned that mortgage 
modification programs are difficult to implement and execute because of 
the intrinsically one-at-a-time nature of the transactions involved. 
And the expansions of some programs, such as considerably increased 
payments from the Government to motivate reductions in mortgage 
principal, face less promising conditions now for being effective than 
was the case when many of these policies were launched in early 2009. 
Three years of a weak job market have forced many of the borrowers who 
might have been helped by reduced payments or a lower mortgage balance 
into foreclosure.
    There are other approaches that can be taken to help heal the 
housing market and speed the recovery of home prices and construction 
while reducing the pain for American families. This testimony first 
provides a critical analysis of recent policy proposals and then 
discusses alternative steps that the Congress might consider. The goal 
of these policies is for the housing sector to once again contribute 
positively to the U.S. economy and to American society--to have a 
housing system that works for families looking to buy homes, for 
investors with funds to lend, and for taxpayers who deserve a stable 
financial system and protection from another expensive bailout.
Mass Refinancing Proposals
    It is useful to consider a specific example that raises the 
question of whether the latest policy proposals from the Administration 
will perform differently than previous initiatives. The White House 
fact sheet for the Administration's refinancing proposal for a single 
family, owner-occupied principal residence promises that there will be 
``no barriers and no excuses'' (top of page 3) and no new appraisal or 
tax forms involved in enabling eligible homeowners to refinance their 
mortgages into an FHA-guaranteed loan with lower monthly payments. 
Without access to tax forms, however, it is not clear how lenders are 
meant to verify that a home is indeed owner-occupied--the natural 
mechanism would be to look at the address on the homeowner's 1040 tax 
form. Indeed, the lender could even just examine the address on the IRS 
form 4506 by which the borrower requests that a copy of the tax return 
be sent to the lender; this would be less intrusive than having the 
lender examine the 1040 itself but is again off-limits in the new 
proposal. A lesson of the past several years is that unverified 
mortgage applications (so called ``no doc loans'') are convenient but 
do not end well for either lender or borrower.
    The alternative of having the lender send someone out to the home 
also runs counter to the stated policy proposal--there are to be no 
appraisals, and the need for possibly repeated site visits to confirm 
the owner-occupied status seems to be exactly the barriers and red tape 
that are not allowed (not to mention the intrusiveness of having 
someone peek through the windows to figure out who is living inside).
    On the other hand, lenders clearly will not be willing to allow 
borrowers to simply attest that they are refinancing an owner-occupied 
property. After all, this was a common misrepresentation during the 
housing bubble and it would be outrageous for lenders not to check 
carefully for loans receiving a Government-backed guarantee such as 
with the new refinancing proposal involving the Federal Housing 
Administration (FHA). Moreover, the Administration has launched an 
investigation into possible abusive behavior in mortgage origination 
and servicing; presumably this investigation and the similar effort 
launched in 2009 will deter lenders from allowing potential fraud. But 
this leaves the problem of how to comply with the contradictions 
between the proposed policy and the rhetoric by which it has been 
introduced.
    This is just one type of hurdle that implementation of the latest 
proposal for refinancing of non-GSE loans is likely to face--the 
desired ease of the refinancing is defeated by the conditions of the 
proposal itself. Perhaps there is some workaround in the offing for 
this and the other inevitable problems of implementation that have 
plagued past efforts, but it is now more than 2 weeks since the 
proposals were launched by the President in his State of the Union 
address and there is no legislative text to consider these important 
details. Similarly, the Fed's white paper on housing proposals includes 
a broad discussion of the possible beneficial impacts of widespread 
refinancing, but does not get into the operational details that are 
crucial to achieve actual policy outcomes. \2\
---------------------------------------------------------------------------
     \2\ This is in some ways reminiscent of the 2008 Hope for 
Homeowners program that likewise had only modest impact in reducing 
foreclosures.
---------------------------------------------------------------------------
    The lower monthly payments for homeowners that would result from 
the proposed FHA-based refinancing scheme for non-GSE loans and the 
expansion of the previous HARP (Home Affordable Refinance Program) for 
GSE loans announced in October 2011 are meant to both reduce 
foreclosures by improving affordability and to boost the economy 
through increased spending by families with greater free cash flow as a 
result of lower mortgage payments. That is, refinancing would be a sort 
of stimulus analogous to sending a monthly check to qualifying 
households. It is clear that mortgage credit was too easily available 
in the run-up to the crisis, and a good argument can be made that the 
pendulum has swing too far in the other direction now so that some 
creditworthy borrowers do not have access to mortgages for home 
purchases or refinancing. An important lesson of the current situation, 
however, is to highlight the problem of having the Government so 
intricately involved in setting mortgage standards. It would be 
preferable for private suppliers of capital to fund housing and to take 
on the risks and rewards of credit decisions. This provides an 
important motivation for moving forward with housing finance reform. 
With Fannie Mae and Freddie Mac in Government control under 
conservatorship at present, it is inevitable that public officials will 
be involved in the choice of credit standards. The driving force for 
these decisions should be to find the appropriate balance between 
protection for taxpayers against overly risky loans while maintaining 
access to credit for homebuyers and rebuilding a responsible private 
mortgage market--and not to have these decisions motivated by a desire 
to implement a backdoor fiscal stimulus.
    Indeed, stimulus is likely the best way to view the impact of the 
two mass refinancing proposals involving HARP 2.0 for GSE-backed 
mortgages and the FHA for non-GSE loans. Both refinancing proposals 
would benefit borrowers with high loan-to-value (LTV) mortgages, 
including underwater borrowers whose mortgage balances are greater than 
the value of their home and who thus have an incentive to walk away 
from their home and allow a foreclosure. The current proposals, 
however, are restricted to borrowers who have been in their homes since 
at least mid-2009 and have been nearly current on their payments for a 
year (6 months with no late payments and no more than one 30-day late 
payment in the preceding 6 months). In other words, the refinancing 
assistance would go to borrowers who have shown that they want to stay 
in their home and have done so for several years in the face of 
declining home prices and a weak job market. To be sure, these 
borrowers will benefit from the lower mortgage payments. But the 
targeted population for the refinancing has already shown that they are 
resistant to foreclosure, meaning that the program will avoid 
relatively few incremental foreclosures per dollar of taxpayer expense. 
This leaves stimulus as the main motivator for mass refinancing.
    As noted in the Fed's white paper and in recent analysis provided 
by the FHFA in a letter to Representative Elijah Cummings, both 
refinancing proposals involve costs to taxpayers because the U.S. 
Government is a beneficial owner of mortgages through MBS holdings of 
both the Federal Reserve and the GSEs. This is not to say that U.S. 
Government asset holdings should come before homeowners--not by any 
means. The point is that the costs of the refinancing proposal must be 
weighed against the benefits, keeping in mind that the principal 
benefit is through a relatively targeted fiscal stimulus going to 
particular homeowners (and not to renters, who tend to have lower 
incomes than homeowners). One could imagine policy makers calling for 
another round of taxpayer-funded fiscal stimulus such as through 
providing checks or other tax benefits, but this should be debated 
openly. It is hard to imagine that a new stimulus would involve the 
relatively narrow targeting of the population of homeowners with high 
LTV's who bought homes at a particular time period and who have been 
able to afford their monthly payments.
    In a time of tight fiscal constraints, one could also imagine 
seeking to focus costly Government programs on homeowners who could be 
seen as most in need of assistance and for whom refinancing programs 
might be most effective. The refinancing proposals are limited by the 
amount of the mortgage but one could further restrict this Government 
assistance to people with desired income ranges. The White House has 
recently defined the middle class as households with the median income 
plus or minus 50 percent. \3\ With median household income around 
$52,000, this would imply limiting the refinancing program to 
households with incomes of no more than around $78,000--the top of the 
White House definition of middle class. Alternately, one could use the 
approximately $64,000 median income of family households (that is, 
leaving out individuals, who tend to have lower incomes). This would 
give a maximum income for the middle class as defined by the White 
House as $96,000--rounding up would then give $100,000 as the maximum 
income limit for eligibility for the Administration's FHA refinancing 
proposal. One could imagine applying this income limit to all FHA 
programs in order to best focus the taxpayer-provided subsidy implicit 
in FHA activities to households most in need.
---------------------------------------------------------------------------
     \3\ See, http://www.whitehouse.gov/sites/default/files/
krueger_cap_speech_final_remarks.pdf.
---------------------------------------------------------------------------
    It should be noted as well that the February 2011 report to 
Congress on ``Reforming America's Housing Finance Market'' by the 
Treasury Department and HUD stated that the ``FHA should return to its 
precrisis role as a targeted provider of mortgage credit access for 
low- and moderate-income Americans and first-time homebuyers.'' \4\ The 
report notes that the FHA market share (around 30 percent in early 
2011) is already substantially above what Treasury and HUD see as the 
historical norm of 10 to 15 percent. The Administration's refinancing 
proposal thus represents a policy reversal that both goes in the wrong 
direction for housing finance reform and increases the taxpayer 
exposure to losses by the FHA when recent analyses indicate that the 
agency is likely to require a taxpayer bailout of $50 billion or more 
as a result of its existing obligations. \5\
---------------------------------------------------------------------------
     \4\ See, http://portal.hud.gov/hudportal/documents/
huddoc?id=housingfinmarketreform.pdf.
     \5\ See, Joseph Gyourko, ``Is FHA the Next Housing Bailout?'' 
November 11, 2011. http://www.aei.org/papers/economics/financial-
services/housing-finance/is-fha-the-next-housing-bailout/
---------------------------------------------------------------------------
    The Administration proposes to offset the costs of the FHA 
refinancing proposal with a tax on large banks. As Treasury Secretary 
Geithner noted at a press conference last week, ``there are pockets 
where credit is tighter than it needs to be, including mortgage finance 
and small business.'' The bank tax would expand these pockets, with 
costs of the tax passed through to borrowers in the form of higher 
interest rates and reduced availability of credit.
    It is the case, as noted in a recent analysis from the Federal 
Reserve Bank of New York, that foreigners have meaningful holdings of 
U.S. mortgages in the form of mortgage-backed securities and would bear 
some of the cost of the refinancing proposals. \6\ Given the U.S. 
fiscal imbalance and ongoing current account deficit, it is likely that 
the United States will rely on inflows of foreign capital for the 
foreseeable future. Policies that are seen as unexpected or unfair to 
foreign investors might then result in reduced demand for Treasury 
securities and other dollar assets and thus higher financing costs for 
American borrowers including the United States Government. This is not 
a reason to avoid a refinancing proposal, but the potential impact on 
future interest rates should be taken into account in evaluating the 
costs and benefits.
---------------------------------------------------------------------------
     \6\ See, Joseph Tracy and Joshua Wright, ``Why Mortgage 
Refinancing Is Not a Zero-Sum Game'', January 11, 2012. http://
libertystreeteconomics.newyorkfed.org/2012/01/why-mortgage-refinancing-
is-not-a-zero-sum-game.html
---------------------------------------------------------------------------
    Similar considerations apply to domestic suppliers of capital for 
housing finance. Buyers of mortgages and mortgage-backed securities 
plainly take on refinancing risk--the compensation demanded for this 
risk accounts for part of the spread between yields on GSE-backed MBS 
and Treasury securities. Continued expansions of refinancing proposals, 
however, could give rise to the belief that mortgages going forward 
have embedded in them a new feature that gives borrowers easier access 
to a downward adjustment of interest rates than was believed to be the 
case in the past. This regime change would then translate into market 
demands for higher yields on mortgage-related securities and thus 
higher interest rates going forward. In other words, current homeowners 
would benefit from refinancing but future ones would pay more. This is 
akin to the impact of so-called ``cramdown'' proposals that would 
change the bankruptcy code to allow reductions in the principal balance 
of mortgages: current homeowners would benefit from having reduced debt 
but future homeowners would face higher interest rates and reduced 
availability of credit. Relatively risky future borrowers, who tend to 
have lower incomes, would be most adversely affected.
    As noted above, there are reasons for concern about the impact and 
cost-benefit calculus of mass refinancing programs. Nonetheless, it is 
possible for the Administration to move forward with some aspects 
without Congressional action. The expanded HARP refinancing is moving 
forward though financial firms' computer systems are reportedly not yet 
fully ready for the new program. Some FHA guidelines could be adjusted 
as well to streamline the appraisal process and include some additional 
mortgages (though the expansion to underwater loans would require 
Congressional action). In other words, there are steps that could be 
taken without waiting for the inevitable rejection of the proposed bank 
tax.
Expansion of the Home Affordable Modification Program (HAMP)
    The HAMP program involves Government payments to incentive mortgage 
modifications that lower homeowner payments and thus seek to prevent 
foreclosures. Lenders (typically servicers acting on the behalf of the 
beneficial owners of mortgages) have an incentive to make such 
modifications to avoid the considerable costs involved with 
foreclosure, but many institutional features slowed the modification 
process--to widespread frustration, including at the Treasury 
Department when I served as Assistant Secretary. The difficulty with a 
modification is to find the right targeting, amount, and structure of 
the modification that balances effectiveness with cost. A lender will 
not want to modify a loan for a borrower who can afford their original 
payments or for a borrower who could not afford the lower payments 
resulting from a modification that has an economic value equal to the 
cost of foreclosure. The presence of underwater borrowers is an 
important consideration, since an underwater borrower has an incentive 
to walk away from a home even if the payments are affordable and the 
lender will not recover the full value of the loan in a foreclosure. 
But a modification involving principal reduction is especially costly 
for the lender and gives rise to important concerns about strategic 
behavior and spillover effects such as having other homeowners seek 
unnecessary principal reductions. A further complication is that the 
weak economy of the past several years has meant that some homeowners 
who could initially afford the lower payments of a modified loan might 
suffer an income decline such as from a job loss and then ``redefault'' 
on the modified loan (that is, default). It has been said that this 
combination of factors leaves a potentially narrow aperture through 
which to make a successful modification.
    HAMP uses taxpayer dollars to tip the balance toward increased 
modifications. Under certain conditions, the Treasury puts in money to 
pay for part of the cost of the modification. The selection criteria 
are crucial to the outcome of the policy and involve profound 
challenges. It is natural to focus taxpayer dollars as tightly as 
possible on incentivizing incremental modifications rather than 
providing a windfall for ones that lenders would have done on their own 
and to avoid as much as possible providing an incentive for homeowners 
to stop paying their mortgages in order to qualify for assistance. At 
the same time, implementing a tighter screening to focus on the right 
set of borrowers translates into fewer incremental modifications. \7\ 
These considerations presumably went into the cost-benefit calculations 
that were done with the original HAMP program, which was initially 
predicted to lead to three to four million modifications by the end of 
2012 but had chalked up somewhat less than one million permanent 
modifications through December 2011.
---------------------------------------------------------------------------
     \7\ For more discussion, see, Phillip Swagel, April 2009, ``The 
Financial Crisis: An Inside View'', http://www.brookings.edu/economics/
bpea//media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/
2009_spring_bpea_swagel.pdf.
---------------------------------------------------------------------------
    A key feature of the Administration's recent HAMP proposal is to 
substantially increase the taxpayer-provided payments to lenders that 
reduce principal as part of a modification for underwater borrowers. 
This is a relatively costly way of reducing monthly mortgage payments 
compared to reducing a borrower's interest rate. If the focus of 
modifications is on affordability, it would be more effective to extend 
the term of a loan and reduce interest payments rather than writing 
down principal. Still, one could justify a focus on principal reduction 
if the goal is to avoid foreclosures by homeowners who can pay their 
mortgage but choose not to because they are underwater. The key issue 
is whether this is a cost-effective approach.
    A concern about the expanded HAMP incentives recently announced by 
the Administration is that this is a policy that would have been much 
more cost-effective in terms of a lower cost to taxpayers for each 
foreclosure avoided in early 2009. Three years later, underwater 
borrowers who are still in their homes have demonstrated their 
attachment to it. To be sure, a principal reduction will benefit 
homeowners. But the cost to taxpayers will be much larger with the 
expansion of HAMP payments, and the impact in terms of foreclosures 
avoided is likely to be much modest than in 2009 given that the target 
population has made it this far. This leaves a high cost-benefit ratio 
from the HAMP expansion--presumably a much higher cost-benefit ratio 
than was judged to be prudent when the program was designed in 2009.
    A natural question then is to consider what is different today than 
in 2009 that results in the apparent imperative to reduce foreclosures 
in 2012 regardless of the cost effectiveness of the policy tools 
involved. This is a worrisome approach to policymaking and to the 
stewardship of taxpayer resources.
Pilot Program to Transition Real Estate Owned (REO) Property to Rental 
        Housing
    The aftermath of the bubble has left the U.S. economy with too many 
homes for sale or in the so-called ``shadow inventory'' of homes that 
will be for sale once prices firm. The announcement by the FHFA of a 
pilot program to transition REO properties to rentals is a welcome step 
to speed up the adjustment of the housing market to post-bubble 
conditions. Facilitating purchases of vacant homes by firms that can 
manage them as rentals will help speed up the market adjustment, at 
least modestly. This program will not be helpful in all parts of the 
country, but it will be most useful in areas in which foreclosures and 
vacant homes are especially acute. The inventory of REO properties held 
by Fannie Mae and Freddie Mac has been declining as properties are sold 
while inflows of new REO dwellings have slowed as the result of legal 
uncertainties surrounding the foreclosure process. But there is likely 
to be a wave of foreclosures in the pipeline and having this program 
ready will be useful. At the same time, it will be important to ensure 
that buyers of REO properties bring capital to the table rather than 
relying heavily on the GSEs for financing. With Fannie and Freddie 
under taxpayer control, this would constitute yet another Government 
involvement in the housing sector. GSE financing of institutional 
buyers would increase the firms' balance sheets and thus taxpayer 
exposure to risk.
    The importance of putting vacant homes to use can been seen in the 
combination of rising rental costs and declining prices for home sold 
under ``distress'' such as following a foreclosure. \8\ Overall indices 
of home prices such as the S&P/Case-Shiller index declined to post-
bubble lows in the most recent data for November 2011, while the FHFA 
purchase-only price index rose in November and has moved slightly above 
the low point of March 2011. Downward price pressures involved in 
distressed sales likely contribute to differences between these price 
indicators. This conclusion is bolstered by recent press reports citing 
RealtyTrac as calculating that bank-owned foreclosures and short sales 
sold at a discount of 34 percent to nondistressed properties in the 
third quarter of 2011.
---------------------------------------------------------------------------
     \8\ For longer discussions from which this is drawn, see, ``The 
Housing Bottom Is Here'' on http://www.calculatedriskblog.com/2012/02/
housing-bottom-is-here.html and Prashant Gopal, February 7, 2012, 
``Banks Paying Homeowners To Avoid Foreclosures'', Bloomberg News. 
http://www.bloomberg.com/news/2012-02-07/banks-paying-homeowners-a-
bonus-to-avoid-foreclosures-mortgages.html.
---------------------------------------------------------------------------
    As discussed in the Fed white paper, the use of short sales and 
deeds-in-lieu of foreclosure can reduce losses for lenders and provide 
a better financial outcome for borrowers (and with greater dignity than 
a foreclosure). Recent press reports indicate that use of these tools 
is growing, along with payments by lenders to homeowners willing to 
move out rather than go through the foreclosure process. With the 
foreclosure process taking 24 to 36 months in States with a judicial 
foreclosure process, quite large payments could be rational on the part 
of lenders. \9\ The Treasury's Home Affordable Foreclosure Alternatives 
(HAFA) program similarly provides modest payments to market 
participants (servicers, homeowners, and investors) to choose short 
sales over foreclosure. Given the substantial private incentives for 
these short sales to take place it is not clear that the HAFA program 
is needed.
---------------------------------------------------------------------------
     \9\ See, Gopal, op cit. http://www.bloomberg.com/news/2012-02-07/
banks-paying-homeowners-a-bonus-to-avoid-foreclosures-mortgages.html
---------------------------------------------------------------------------
Housing Market Adjustment and Alternative Policy Approaches
    Housing markets naturally adjust slowly because the typical 
homebuyer must sell their existing home at the same time that they buy 
a new one, while the stock of homes evolves slowly given that homes 
tend to last for 50 years or more. The adjustment has been especially 
slow in the wake of the crisis and recession as the result of reduced 
household formation that has diminished the natural growth in demand 
for housing.
    The goal of policy moving forward should be to facilitate the 
ongoing adjustment and quicken the recovery of both housing prices and 
construction. By definition, a recovery commences only after the market 
hits bottom. It is desirable to lift off the bottom quickly. Fostering 
a stronger overall economy is perhaps the most important element of 
this, since a stronger economy will boost housing demand, including 
through increased household formation. Other policies could be useful 
as well, notably actions that facilitate a more rapid market adjustment 
and that strengthen demand.
    Rhetoric about not wanting the market to hit bottom is a 
combination of empty and factually incorrect--after all, a housing 
market recovery by definition will start only after the market hits 
bottom. What is desirable is for the recovery to start immediately--
that is, for the bottom to have been reached already.
    In considering housing policy going forward, it is important both 
to avoid policies that will prolong the housing downturn or lengthen 
the time at which the market rests on the bottom. This implies that it 
would be valuable to resolve legal and regulatory uncertainty facing 
mortgage servicers and originators as quickly as possible. To be sure, 
past wrongdoing should be punished, notably including inappropriate 
foreclosures on servicemen and servicewomen. On the other hand, a 
lengthy period of uncertainty will affect the willingness of banks to 
take on housing-related risks. This concern has practical relevance for 
the Administration's recent proposals. Bank A, for example, will 
naturally hesitate to refinance a loan originally made by Bank B even 
with an FHA guarantee if there is a concern about the possibility of 
future litigation. The same applies to concerns about the ability of 
banks to foreclose on borrowers in default--if a mortgage is no longer 
a securely collateralized asset, then there would be widespread 
ramifications to the detriment of future homebuyers. Imagine the cost 
of financing a home purchase with an unsecured loan facility such as 
credit cards.
    There are important institutional and legal overhangs slowing the 
housing recovery, including lawsuits and regulatory actions involving 
the MERS title system, settlement discussions related to so-called 
robosigning, putbacks of bad loans to originators by the GSE, and 
perhaps others. Again, there should be appropriate consequences for 
past wrongdoing and steps to avoid repetition. But there is also a 
value in a rapid resolution of these uncertainties so that the mortgage 
financing system can once again operate effectively to the benefit of 
U.S. homebuyers and homeowners. A desire to punish the financial 
industry sits awkwardly with the desire for a housing recovery. It is 
important to keep in mind as well that some foreclosures are 
unavoidable--just as hundreds of thousands of foreclosures took place 
in years with a strong housing market before the recession. It is 
important to have a foreclosure process that is accurate and fair and 
that can move forward responsibly but without unnecessary delays. 
Foreclosures are difficult and tragic events for households. Yet some 
foreclosures are inevitable. A housing rebound ultimately requires that 
adjustments including unavoidable foreclosures take place.
    Government policies could also play a positive role in improving 
industry weaknesses that have been highlighted in the various judicial 
actions. The MERS titling system, for example, arose in part to 
compensate for the varying information systems by which property title 
information is kept, generally at the county level. A useful initiative 
would be to develop standard formats for these data. This would 
preserve local control over intrinsically local decisions and 
information, but facilitate nationwide transmittal and analysis of 
information. Similarly, better coordination of information regarding 
second liens would facilitate some additional modifications based on 
bargaining between owners of the primary mortgage and second lien.
    Finally, moving forward with housing finance reform remains vital 
for a sustained housing market recovery. It is now a year since the 
Treasury Department and HUD released a report on housing finance reform 
and concrete action is long overdue. Uncertainty about the future of 
the housing finance system, notably the role of the Government, will 
make private providers of capital hesitate to fund mortgages. This 
leaves Government officials to make crucial decisions regarding credit 
availability that are better left to market participants with 
incentives based on having their own capital at risk.
    I have written at length elsewhere about steps for housing finance 
reform, including the future of Fannie Mae and Freddie Mac. \10\ The 
steps involved in moving forward with reform involve a combination of 
several policy levers: bringing in private capital to takes losses 
ahead of taxpayers; reducing the scope of any guarantee; and increasing 
the price or reducing the quantity offered of the guarantee. Moving 
forward in these dimensions would help increase the role of the private 
sector in housing finance and reduce Government involvement and 
taxpayer exposure. Importantly, these steps could be taken without a 
firm conclusion about whether there will be a Government guarantee on 
housing at the end. Enough progress in utilizing these policy levers 
would eventually lead to a housing finance system that is entirely 
private, but the path to a private system would involve a mix of 
private capital and incentives backstopped by a secondary Government 
guarantee. This means that starting with reform that involves a 
secondary Government guarantee does not rule out ending up with a fully 
private housing finance system. The key is to move forward 
expeditiously in order to provide increased certainty about future 
market conditions and thereby bring private capital back into housing 
finance. A useful additional step would be to make transparent the 
budgetary impact of GSE activities. The use of the TARP to compensate 
the GSEs for costs related to the Administration's housing proposals, 
for example, obscures the underlying reality that the financial 
consequences of activities of both the TARP and the GSEs show up on the 
public balance sheet. H.R. 3581, the Budget and Accounting Transparency 
Act that passed in the House of Representatives earlier this week, 
provides a step forward in ensuring desirable clarity in budget 
treatment. \11\ It would useful as well for the GSEs to make available 
loan-level data that facilitates analysis of market conditions and 
helps private participants to enter the housing finance market.
---------------------------------------------------------------------------
     \10\ See, Phillip Swagel, ``The Future of Housing Finance 
Reform'', October 2011 paper for the Boston Fed Annual Research 
conference, http://www.bos.frb.org/economic/conf/LTE2011/papers/
Swagel.pdf, and Phillip Swagel, ``Reform of the GSEs and Housing 
Finance'', Milken Institute White Paper, July 2011. http://
www.milkeninstitute.org/pdf/HousingFinanceReform.pdf
     \11\ For more discussion, see, Chris Papagianis and Phillip 
Swagel, ``Put Fannie and Freddie on Federal Books'', Bloomberg View 
oped, January 22, 2012. http://www.bloomberg.com/news/2012-01-23/put-
fannie-and-freddie-on-federal-books-papagianis-and-swagel.html
---------------------------------------------------------------------------
    Recent news reports indicate that Freddie Mac is developing a pilot 
program under which private owners of capital would purchase a security 
that absorbs losses on a pool of loans ahead of Freddie Mac itself. 
This would have Freddie in a senior position and outside investors in a 
first-loss position. Such a structure would have the GSEs lay off 
housing risk on private market participants while obtaining a market-
based indication of the return market participants require to take on 
housing credit risk. Such a pilot program would thus test the appetite 
of the private market for first-loss risk on housing assets in exchange 
(presumably) for higher returns, indicate the market's assessment of 
the value of the Government guaranteed on mortgages, and illuminate the 
path leading to a reduced role of the Government in housing finance. We 
have learned that it is difficult for the Government to price its 
guarantee for taking on risk, making it extremely useful to have a 
market-based indication. One could imagine applying such a framework to 
FHA loans as well to reduce Government exposure and protect taxpayers 
compared to the current model under which the FHA does not share risk.
Conclusion
    A revitalized housing sector and an end to the sadly elevated 
number of foreclosures would mark salient progress in moving past the 
consequences of the housing bubble and financial crisis. Government 
policies can usefully contribute to the needed adjustment. But it is 
essential to be clear about the costs associated with proposals such as 
those from the Administration that would expand efforts to use taxpayer 
funds to avoid foreclosures. It is far from clear that these efforts 
will be effective and even less apparent that they will have a positive 
impact commensurate with the taxpayer resources involved. It would be 
better instead for Congress to consider steps that would hasten the 
housing market adjustment, facilitate the return of private capital 
into housing finance, and bring the housing sector more quickly to the 
point at which home prices and construction activity lift off the 
bottom into recovery.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                     FROM PHILLIP L. SWAGEL

Q.1. Last November, Congress passed legislation making loan 
limits for FHA-insured loans higher than the loan limits for 
privately insured loans purchased by the GSEs for the first 
time in history. In December, Congress increased the GSE 
guarantee fee by 10 basis points, which has the effect of 
making privately insured loans bought by Fannie and Freddie 
more expensive than loans insured by the FHA.
    Aren't these actions going to further move the FHA far 
beyond its core mandate of serving low to moderate income 
borrowers who otherwise would not have access to home 
ownership?

A.1. Yes, higher loan limits for FHA and higher fees on GSE-
backed loans both make FHA lending relatively more attractive. 
This is in addition to the lower downpayments required for FHA-
backed loans than for GSE-backed mortgages. Having FHA provide 
a guarantee for people buying homes with mortgages of up to 
$729,750 is far beyond its core mandate to serve low to 
moderate income borrowers. It is hard to understand why helping 
people buy homes with a mortgage of $729,750 is an appropriate 
use of Government resources.

Q.2. And in so doing, don't these moves supplant privately 
insured loans with FHA-backed loans, thereby driving private 
capital away from the housing market and putting taxpayers at 
risk for losses that otherwise would be borne by the private 
sector?

A.2. FHA guarantees mean risk for taxpayers; indeed, one of six 
FHA-backed loans is delinquent. Were it not for the increased 
FHA loan limits, the private sector would handle mortgages 
larger than the conforming loan limit for Fannie Mae and 
Freddie Mac. FHA activities thus displace private sector risk-
taking and private capital.

Q.3. Given that the FHA is severely undercapitalized and 
teetering on the edge of a massive bailout, shouldn't the FHA 
be focused on managing and containing its significant risk 
exposure, and not on increasing its market share and financial 
exposure?

A.3. As documented by Joseph Gyourko and Edward Pinto in 
research released by the American Enterprise Institute (AEI), 
FHA is in severe financial difficulty. As Pinto notes, the 
agency is on track to end 2012 with only $3 billion in 
reserves, considerably worse than the $11.5 billion in reserves 
projected in November 2011 (http://www.aei.org/files/2012/08/
20/-fha-watch-no-8-august-2012_142920761624.pdf). The agency is 
likely insolvent if measured by private sector standards rather 
than governmental accounting methods. The FHA should focus on 
managing and containing its risk, since FHA losses ultimately 
would require a costly bailout by taxpayers.

Q.4. What actions should Congress take to mitigate these risks 
and level the playing field?

A.4. Congress should refocus FHA on a core mission of assisting 
homebuyers with low- and moderate-incomes. This could be done 
by reducing the limit for mortgages to qualify for an FHA 
guarantee and by imposing income tests on borrowers receiving 
FHA assistance. These steps would help reduce the FHA market 
presence back to the roughly 10-15 percent historical market 
share. It would be useful as well to require FHA to provide 
more realistic measures of its financial condition so that 
Congress and the public have a full understanding of the 
agency's financial condition and the risks borne by taxpayers.
              Additional Material Supplied for the Record
     STATEMENT OF THE NATIONAL ASSOCIATION OF REALTORS'
Introduction
    On behalf of more than 1.1 million REALTORS' who are 
involved in residential and commercial real estate as brokers, sales 
people, property managers, appraisers, counselors, and others engaged 
in all aspects of the real estate industry, thank you for giving us an 
opportunity to share our thoughts on improving the housing sector, and 
thus spurring an economic recovery.
    It's no secret our Nation's housing markets remain depressed and 
continue to suffer. While no one thought the crisis would carry on so 
long, markets are slowly recovering, but remain in need of immediate 
policy solutions to address the myriad challenges in order to stabilize 
housing and support an economic recovery. REALTORS' have 
long maintained that the key to the Nation's economic strength is a 
robust housing industry. And, we remain steadfast in our belief that 
swift action is needed to directly stimulate a housing recovery.
REALTORS' Plan To Improve Housing
    REALTORS' are eager to work with Congress and the 
Administration to put a plan into action that helps significantly 
reduce monthly mortgage payments by reducing the barriers to low-cost, 
streamlined refinancing for millions of homeowners as an alternative to 
defaulting on their mortgage loans. Moreover, improving access to 
simple, low-cost refinancing and streamlining the process will help 
hardworking families who have also stayed current on their mortgage 
payments, which also goes a long way to helping keep more families in 
their homes.
    With the mantra of helping the Nation's homeowners maintain their 
homes, in late 2011, NAR worked with two well-respected policy think 
tanks--the Progressive Policy Institute (PPI) and the Economic Policies 
for the 21st Century (e21)--to organize and conduct a housing solutions 
policy. ``New Solutions for America's Housing Crisis'' brought together 
policy leaders, industry representatives, Members of Congress, thought 
leaders and the media to present ideas and make actionable 
recommendations intended to stimulate the growth necessary for a 
sustained recovery in housing and extend an ensuing positive effect on 
job creation and the broader economy.
    Crafted from the conference's discussions are recommendations that 
REALTORS' respectfully submit as examples of relatively easy 
solutions that can help the housing sector recover. In recent weeks, 
some of these ideas have been suggested as solutions by the 
Administration and Federal Reserve. REALTORS' appreciate 
their thoughtfulness in identifying a plethora of fixes that we believe 
will make an immediate, positive impact.
Do Not Risk Weakening Our Nation's Housing Markets Any Further
    There are a number of proposed rules and recent congressional 
actions that actively thwart the housing recovery. Rectifying these 
issues will offer confidence and reassurance to investors and 
consumers, and bring them back into the marketplace.

  1.  Re-craft the Qualified Residential Mortgage rule mandated by the 
        Dodd-Frank Act to include a wide variety of traditionally safe, 
        well documented and properly underwritten products. Requiring a 
        20 percent down payment coupled with stringent debt-to-income 
        ratios and rigid credit standards--as defined under the 
        proposed rule by six Federal regulators--would be detrimental 
        to prospective home buyers, especially first-time and middle-
        income buyers.

  2.  Restore higher loan limits supported by the GSEs to provide 
        additional liquidity in housing markets and to assure mortgage 
        financing options while stabilizing local housing markets.

  3.  Resist proposals that call for changing the tax rules that apply 
        to home ownership now or in the future. Without a doubt, now is 
        not the time to change the mortgage interest deduction or any 
        other housing incentives. Making gradual or targeted changes 
        would send the wrong signal further undermining confidence and 
        further depressing home values.

  4.  Reject further g-fee increases as a means to offset the costs of 
        a payroll tax extension. Additionally, we urge you to reject 
        measures that would increase Ginnie Mae's g-fees or FHA 
        mortgage premiums (both single- and multi-family) that will 
        disproportionately harm low- and moderate-income borrowers, 
        first-time homebuyers, renters with modest incomes, and others 
        when those funds are diverted to the Treasury and used as an 
        offset to pay for a 10-month extension of the current law. 
        Diverting these fees away from their intended purpose is a de 
        facto tax increase on homebuyers and raises costs on the very 
        same Americans the underlying bill sought to help.
Restore Vitality to Our Communities and Neighborhoods by Reducing the 
        Foreclosure Inventory
    REALTORS' are more than business owners within local 
communities--we are residents. As foreclosures mount, 
REALTORS' are not just impacted by reduced sales, we are 
also impacted by depressed home values that reduce Government services 
and further deteriorate communities. Therefore, efforts to mitigate 
foreclosures and restore communities are paramount to our members.

  1.  Support S.170, The Helping Responsible Homeowners Act, sponsored 
        by Senators Barbara Boxer (D-CA) and Johnny Isakson (R-GA). 
        Their bill would remove refinancing limits on underwater 
        properties for borrowers that have been paying on time, and 
        would eliminate risk-based refinancing fees charged by Fannie 
        Mae and Freddie Mac.

  2.  Support bipartisan Senate efforts calling for improvements to the 
        Home Affordable Refinance Program (HARP). Led by Senators 
        Barbara Boxer (D-CA), Johnny Isakson (R-GA) and Robert Menendez 
        (D-NJ), the time is appropriate to enhance HARP and provide 
        refinancing opportunities to at-risk borrowers as an 
        alternative to defaulting on their mortgage loans.

  3.  Direct Fannie Mae, Freddie Mac and servicers to prioritize short 
        sales above foreclosures.

  4.  Support all necessary foreclosure/loss mitigation efforts to keep 
        American families in their homes. Realogy Corporation's 
        President and CEO, Richard Smith, has proposed a debt for 
        equity approach to help underwater borrowers in trouble keep 
        their homes and lower their monthly payments while lenders take 
        a smaller hit than they would have with a default and 
        foreclosure. Realogy Corporation is a leading provider of real 
        estate and relocation services representing world-renowned 
        brands and business units that include Better Homes and 
        Gardens' Real Estate, CENTURY 21' , 
        Coldwell Banker' , Coldwell Banker 
        Commercial' , The Corcoran Group' , 
        ERA' , Sotheby's International Realty' , 
        NRT LLC, Cartus and Title Resource Group.

  5.  Ensure that any plans by Government agencies to sell foreclosed 
        properties in bulk are done on a limited scale, are carefully 
        tailored and appropriate for the markets in which they occur, 
        and provide flexibility should market conditions not ultimately 
        favor rental conversion of properties.
Open Opportunities for Private Capital To Return to the Mortgage 
        Marketplace To Foster New Demand Among Responsible Homebuyers
    Reforming the secondary mortgage market is essential to ensuring a 
reliable source of mortgage lending for consumers in all types of 
markets and is integral to the Nation's economic and housing recovery. 
NAR supports efforts to increase private capital in the housing finance 
market and reduce the size of the Government's involvement. Below are 
two quick fixes that we believe will immediately encourage the return 
of private capital.

  1.  Open up the FHA Section 203(k) rehabilitation loan program to 
        investors to encourage purchasing of foreclosed property. This 
        will facilitate the rehabilitation of the existing housing 
        stock and help reduce the inventory of foreclosed homes.

  2.  Require the GSEs to temporarily suspend investor financing 
        limitations, especially the limit on the number of mortgage 
        loans allowed for any one investor/borrower (currently 4 for 
        Freddie Mac and 10 for Fannie Mae). This will give small, 
        private investors the opportunity to absorb some of the excess 
        inventory, resulting in the stabilization of prices for 
        existing real estate-owned (REO) properties.
Support a Secondary Mortgage Market Model That Includes Some Level of 
        Government Participation
    Though REALTORS' agree that a properly functioning 
housing finance market requires reducing the Government's participation 
and increasing private capital, full privatization is not an effective 
option.
    REALTORS' oppose proposals that call for full 
privatization of Fannie Mae and Freddie Mac. This is not an effective 
option because private firm's business strategies will focus on 
optimizing their revenue/profit generation. This model would foster 
mortgage products that are more aligned with the businesses goals than 
in the best interest of the Nation's housing policy or the consumer.
Conclusion
    Home ownership matters. It represents the single largest 
expenditure for most American families and the single largest source of 
wealth for most homeowners. The development of home ownership has a 
major impact on the national economy and the economic growth and health 
of regions and communities. Home ownership is inextricably linked to 
job access and healthy communities and the social behavior of the 
families who occupy it. We recognize the serious public debate as to 
which tax and spending policies will best support the sound fiscal 
management that our Nation requires. However, we urge caution against 
dismantling or eliminating vital resources for housing that provide 
important economic, social, and societal benefits.
    The National Association of REALTORS' sees a bright 
future for the housing market and the overall economy. However, our 
members are well aware that the future we see rests on the industry's 
and the economy's ability to successfully navigate some significant 
obstacles. Congress and the housing industry must maintain a positive, 
aggressive, forward looking partnership if we are to ensure that 
housing and national economic recoveries are sustained.
    I thank you for this opportunity to present our view on improving 
the housing market. As always, The National Association of 
REALTORS' is at the call of Congress, our industry partners, 
and other housing stakeholders to help facilitate a sustainable housing 
and national economic recovery.
                                 ______
                                 
STATEMENT SUBMITTED BY TIM C. FLYNN, CEO, NATIONAL VALUE ASSURANCE, LLC
A Unique Strategy for Addressing the Enterprise REO Inventory Imbalance
A solution designed to be immediately deployable and without cost to 
        taxpayers!
    The purpose of this submission is to present a new and compelling 
strategy that will significantly reduce, or even eliminate the excess 
REO inventory that is owned by the Enterprises. This strategy is best 
described as the ability to provide qualified homebuyers, who intend to 
be owner occupants, with the contractual assurance that their home 
purchase will not be subject to the value degradation that has been 
experienced by almost all homebuyers in America over the past 6 years. 
In a phrase, we are referring to the strategy as ``homebuyer's price 
(value) protection.''
    Over the past 2 years, the inability of the American housing 
economy to absorb it's excess housing inventory and install a solid 
bottom to the downward spiral in home prices has been a great 
disappointment. This is especially true in the case of the Federal 
Reserve, which through various policy initiatives, has facilitated the 
lowest costs for mortgage financing in the Nation's history. Most 
regulators and policy makers believed that home affordability was the 
key to resolving the Nation's housing problem. This strategy proved 
ineffective, and the need to find a solution continued with increasing 
intensity. Policy makers and the Fed are now defaulting to one of the 
only remaining options: a bulk sales strategy discussed in the January 
4 white paper.
    The principal contention of this document is that the Enterprises, 
neighborhoods, and taxpayers would be better served by occupying these 
REO's with qualified buyers rather than ``bulk purchase owners.'' We 
contend that this can be accomplished quickly and efficiently with a 
``homebuyer's price (value) protection'' program. We disagree with the 
conclusion that if the most favorable home affordability metrics in 
history couldn't attract buyers, then individual qualified buyers were 
not present in sufficient numbers to significantly impact REO 
inventory. In our opinion, the major barrier to attracting qualified 
home buyers in this market is crowd psychology. It's about fear--the 
fear of losing principle value on the largest investment most families 
will ever make.
    Our strategy represents a substantial departure from traditional 
thinking. The January 4, 2012, Fed white paper, entitled ``The U.S. 
Housing Market: Current Conditions and Policy Considerations'', did not 
include the concept of homebuyer's price protection in its analysis and 
subsequent recommendation to Congress. It is our contention that the 
implementation of this strategy into the Enterprises REO marketing plan 
will result in a dramatic reduction of inventory and an optimum return 
of capital to the taxpayer. It will also foster a rapid, if not 
immediate, perceived bottom to the downward spiral in home prices.
    We have created a model utilizing homebuyer's price protection that 
projects a present value benefit in excess of $42 billion dollars, or 
in our estimate, 36 percent in excess of the reasonable financial 
returns from any ``bulk sales'' tactic that is being considered and 
seems to be gaining momentum.
    Certainly the financial implications are an important 
consideration, but as suggested in both the August 15th RFI issued by 
the Enterprises and the Fed white paper, another critical consideration 
is to protect the value and integrity of affected neighborhoods. On 
this point, there is universal agreement that the most desirable 
occupants for the REO inventory are qualified owner occupants.
    Our model that generated the above result assumed a 100 percent 
utilization of one strategy versus another. We clearly understand that 
the characteristics of the Enterprise REO inventory require multiple 
approaches to attain a satisfactory result for taxpayers. However, it 
is clear and financially irrefutable that the most beneficial solution 
for all related parties is to install owner occupants into as many REOs 
as possible and the only way to accomplish this is to use a form of 
homebuyer's price protection.
    Thank you.


 STATE OF THE HOUSING MARKET: REMOVING BARRIERS TO ECONOMIC RECOVERY--
                                PART II

                              ----------                              


                       TUESDAY, FEBRUARY 28, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:07 a.m., in room SD-38, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I will call this hearing to order.
    I thank our witnesses for joining us. Today's hearing is 
part two of our examination of the state of the housing market 
and steps that can be taken in the near term to remove housing 
market barriers to economic recovery.
    This Committee has undertaken a bipartisan, in-depth look 
at long-term housing finance reform. I hope to continue this 
effort with additional hearings and by working with Ranking 
Member Shelby and Committee Members to seek bipartisan 
consensus. In today's hearing, we will focus on the immediate 
problems confronting the housing market and the larger economy, 
which is a critical first step in finding a long-term solution.
    In January, the Federal Reserve released a white paper 
entitled, ``The U.S. Housing Market: Current Conditions and 
Policy Considerations.'' In this paper, the Fed stated that 
continued weakness in the housing market poses a significant 
barrier to a more vigorous economic recovery.
    As I stated during our February 9 hearing on this topic, I 
share the concern that ongoing challenges in the housing market 
are acting as a drag on the economic recovery. I want to find 
practical solutions to help overcome them.
    Today's hearing provides a good opportunity to discuss the 
current housing market environment with regulators and the 
Administration's top housing official. I would like to hear 
from our witnesses about potential solutions, both legislative 
and administrative.
    In addition to the Federal Reserve's recent white paper, 
other analysts, regulators, and the Administration have offered 
up options and proposals to address barriers to housing and 
economic recovery. Earlier this month, the Administration 
outlined a new housing plan to give more families the 
opportunity to refinance at today's low rates. Just yesterday, 
the Federal Housing Finance Agency announced its first pilot 
sale in an initiative to address the large volume of real 
estate-owned properties held by the Government Sponsored 
Enterprises.
    At our February 9 hearing, the witnesses and a number of 
Committee Members on both side of the aisle cited helping 
families refinance at today's low interest rates as a powerful 
example of an action that would help bolster the housing market 
and stabilize housing prices. This is particularly true for 
mortgages held by the GSEs. I would like to see the FHFA take 
additional steps to facilitate refinancing for families 
currently stuck in higher-interest mortgages held by Fannie and 
Freddie. I look forward to hearing more from Acting Director 
DeMarco on steps that FHFA is planning to take to speed up 
these refinancings.
    Without a robust housing market recovery, our economy will 
continue to drag and millions of Americans will continue to 
struggle to make ends meet. I look forward to continuing to 
work with our witnesses and Members of the Committee to find 
workable solutions to improve the housing market and lead us 
further down the road to prosperity.
    With that, I turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Welcome, again, Mr. Secretary.
    Mr. Donovan. Good morning.
    Senator Shelby. This is the second hearing this Committee 
has held this year to examine the Nation's weak housing market. 
Each witness before us today has a proposal to revive the 
housing market and help struggling homeowners. Some of these 
proposals would require Congressional action.
    As I stated during our last hearing, I believe that this 
Committee should come together and craft common sense 
legislation to address the serious problems weighing on the 
housing market today. Hopefully, today's witnesses will 
identify some potential solutions to these problems and give 
the Committee some options for its consideration.
    Our first panel will be HUD Secretary Shaun Donovan, who 
will discuss the President's most recent housing proposal. The 
centerpiece of that plan, as I understand it, would allow 
underwater borrowers with loans held in the private sector to 
refinance with an FHA loan. To subsidize the additional risk 
placed on the FHA fund, the President has proposed using money 
from a bank tax. As we have not yet received many of the 
details or any analysis of this plan, I look forward to hearing 
more from the Secretary as to who this plan may help and the 
Administration's estimate of its impact on the housing market 
as a whole.
    Because the President has proposed a new use for the FHA, I 
would like Secretary Donovan to update us on the status of the 
FHA fund. The President's budget predicted that FHA would 
require a taxpayer bailout this year were it not for the funds 
it would receive from the recent mortgage settlement. And given 
the repeated assurances from the Secretary and multiple FHA 
Commissioners as to the strength of the fund, this revelation 
is troubling, although not unexpected for those of us here who 
have predicted insolvency for the FHA for quite some time. 
Hence, today's discussion should also include what changes 
should be made, Mr. Secretary, I hope, to FHA to ensure that 
the taxpayer is not on the hook for FHA losses.
    We also, I believe, we need to learn more about the 
settlement that is providing these funds to the FHA. To date, 
Congress and the public have been given only broad outlines of 
the terms of the settlement, and as a result, there are many 
unanswered questions about how the settlement was reached and 
how it will operate. The most important question, I believe, is 
how will this money be distributed, Mr. Secretary. In 
particular, is there a connection between how much harm a 
homeowner suffered and the amount of compensation a homeowner 
receives?
    Although having the settlement compensate as many people as 
possible may make sense politically, settlement funds, I 
believe, should compensate homeowners who suffered actual harm 
and deter future violations of the law. The settlement, 
however, appears to come up short on both counts, but we will 
wait and see.
    For example, the Administration's press release indicates 
that homeowners who were improperly foreclosed upon will 
receive only about $2,000, and as a result, homeowners who were 
wrongfully foreclosed upon will still likely have to pursue the 
remainder of their claims in court or through financial 
regulators. In contrast, many homeowners who suffered no legal 
harm appear to be eligible for compensation under the 
settlement, as well. I hope Secretary Donovan today can provide 
more clarity on how the Administration will determine who will 
be compensated under the settlement and for what.
    Our second panel today, Mr. Chairman, as you pointed out, 
will discuss two recent papers by the Federal regulators on 
reforming the housing market. Federal Reserve Governor Duke 
will be discussing the white paper that was recently sent to 
Congress by Chairman Bernanke. This paper reviewed numerous 
proposals but concentrated on measures to convert bank-owned 
real estate to rental property.
    FHFA Director DeMarco will be discussing the new strategic 
plan he recently released outlining the future of the 
conservatorships of Fannie Mae and Freddie Mac. The 
conservatorship has already lasted over 3 years. The longer it 
continues, the greater the risk is, I believe, that taxpayers 
will suffer additional losses as Fannie and Freddie's uncertain 
future erodes their ability to retain high-quality personnel 
and make essential infrastructure investments.
    But given the FHFA's limited legal authority as 
conservator, only Congress, I believe, can determine the future 
of Fannie and Freddie. I regret that Congress did not take 
action with regard to these companies years ago. I look forward 
to learning more about what FHFA intends to do until Congress 
does act and what additional steps Congress should take to end 
the conservatorships of Fannie and Freddie.
    I believe the testimony of all three of today's witnesses 
reveals that there is a great deal to be done to both revive 
the housing market and reform the GSEs. It is always my hope 
that this Committee does not delay any further in moving 
bipartisan legislation to help struggling homeowners and to 
reform our housing market.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Shelby.
    Are there any other Members who wish to make a brief 
opening statement? Senator Menendez.

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you, Mr. Chairman. I appreciate you 
holding this hearing. I think it is incredibly important. It 
has long been our top priority in the Housing Subcommittee that 
I am privileged to chair to restore the housing market to full 
health so that we can get the broader economy moving more 
quickly. And we have made some progress in knocking down 
barriers that are slowing the housing market rebound, but there 
is a lot more to do.
    So I welcome the Secretary. I am looking forward to hearing 
more about the Administration's plan. Many of those items are 
items that the Subcommittee has proposed. That includes helping 
homeowners refinance more easily, which I am currently working 
on a bill to implement. It also creates national servicing 
standards so that banks are held accountable for following 
foreclosure laws and fixing the vacant homes that are blighting 
our neighborhoods and turning some of them into affordable 
rentals in those places that make sense.
    But last, I am really concerned, and I look forward to Mr. 
DeMarco's appearance, Mr. Chairman. The FHFA has shown a dismal 
lack of initiative in the housing crisis and needs to be far 
more aggressive in taking steps that could both help homeowners 
and taxpayers, particularly on the question of refinancing and 
principal reduction. We can either achieve that through 
foreclosure or we can achieve it through refinancing and 
principal reduction. It seems to me that there are greater 
benefits for both the housing market and American families 
through that--via that process than what we have seen today, 
and I think that we can do that without sacrificing taxpayers' 
interest, because Fannie and Freddie's financial health is 
directly tied to how quickly the housing market recovers. So I 
look forward to the opportunity to hear from Mr. DeMarco as 
well as the Secretary.
    Chairman Johnson. Any other Members?
    [No response.]
    Chairman Johnson. Thank you.
    I want to remind my colleagues that the record will be open 
for the next 7 days for opening statements and any other 
materials you would like to submit.
    Now, I would like to briefly introduce our first panel 
witness. Secretary Shaun Donovan is the 15th Secretary of the 
Department of Housing and Urban Development. Secretary Donovan 
has served in this capacity since January 2009. Secretary 
Donovan, you may proceed with your testimony.

 STATEMENT OF SHAUN DONOVAN, SECRETARY, DEPARTMENT OF HOUSING 
                     AND URBAN DEVELOPMENT

    Mr. Donovan. Thank you, Chairman Johnson, Ranking Member 
Shelby, Members of the Committee. Thank you for this 
opportunity to testify about how the Administration's housing 
initiatives are helping remove barriers to economic recovery.
    Thanks in part to the partnership of this Committee, this 
is a very different environment than the one we faced when 
President Obama took office. Back in January 2009, America lost 
818,000 jobs. Housing prices had fallen for 30 straight months 
and foreclosures were surging to record levels month after 
month.
    Today, more than 13 million homeowners have refinanced 
their mortgages since April 2009, putting nearly $22 billion a 
year in real savings into the hands of families and into our 
economy. Because we provided responsible families opportunities 
to stay in their homes, more than 5.6 million mortgage 
modifications have been started in the last 3 years and 
foreclosure notices are down about 50 percent since early 2009. 
Because we helped communities struggling with concentrated 
foreclosures, today, vacancy rates are down and property values 
are up in areas where we focused Neighborhood Stabilization 
dollars. Most important of all, our economy has added private 
sector jobs for 23 straight months, totaling 3.7 million jobs.
    Mr. Chairman, this represents important progress, but there 
is more to be done. Three key barriers hold back the recovery 
of our housing market, which is key to our broader economic 
recovery. The first is keeping more families in their homes. 
While the number of homeowners at risk of losing their home is 
down significantly, there are still too many families that face 
hardships and are underwater, and their unaffordable monthly 
payments put them at an increased risk of default, dragging 
down markets, reducing labor mobility and consumer spending.
    Indeed, as economist Mark Zandi said, there is no better 
way to quickly buoy hard-pressed homeowners than helping them 
take advantage of the currently record low fixed mortgage rates 
and significantly reduce their monthly mortgage payments. That 
is why last fall, the President announced critical changes that 
would help more families with loans backed by Fannie Mae and 
Freddie Mac to refinance. Thanks to this work, another 300,000 
families have already filed applications for refinancing and 
stand to save an average of $2,500 per year, the equivalent of 
a good-sized tax cut.
    Similarly, we have also been taking steps to make FHFA 
streamlined refinance available to more borrowers with loans 
insured by the FHA, allowing them to refinance into a new FHA 
insured loan at today's low interest rates without any 
additional underwriting. This not only reduces homeowners' 
monthly mortgage payments, but also risk to FHA.
    Still, there is no reason why families with FHA loans or 
loans backed by the GSEs should be the only ones who get help. 
Millions of homeowners who have done the right thing and paid 
their bills cannot refinance because they are underwater and 
owe more than their homes are worth, leaving them stuck paying 
higher interest rates that cost them thousands of dollars more 
a year and putting them unnecessarily at risk.
    That is why in his State of the Union Address President 
Obama announced a plan that will give every responsible 
homeowner in America the chance to take advantage of today's 
record low interest rates. Any borrower with a loan that is not 
currently guaranteed by the GSEs or insured by FHA can qualify 
if they are current on their mortgage, meet a minimum credit 
score, have a loan that is within FHA's conforming loan limits, 
and are currently employed. While this program would be run by 
FHA, it would be financed from a completely separate account 
from FHA's MMI Fund. Indeed, by financing this proposal through 
a dedicated funding source, it will have no impact on FHA's MMI 
Fund. We look forward to working with Members of this Committee 
to craft legislation to accomplish these goals and establish a 
broad-based refinancing program.
    At the same time we provide relief to responsible 
homeowners and keep families in their homes, we also need to 
attack the second barrier to our housing recovery, the overhang 
of properties that are at risk of or already in foreclosure. 
While targeted support to markets struggling with foreclosures, 
blight, and abandonment has reduced vacancy rates, increased 
home prices, and shrunk the inventory of homes for sale, an 
overhang of properties at risk of or in foreclosure continues 
to drag down property values and harm the hardest-hit 
communities. With the rental market recovering faster, we need 
to think creatively about ways we can dispose of this shadow 
inventory.
    With about a quarter-of-a-million foreclosed properties 
owned by HUD and the GSEs, this August, HUD joined with FHFA 
and Treasury to seek new and innovative ideas for absorbing 
excess inventory and stabilizing prices. Yesterday, the FHFA in 
conjunction with Treasury and HUD announced the first major 
pilot sale of foreclosed properties to be repurposed into 
rental housing. This marks the first of a series of steps that 
the FHFA and the Administration will take to develop a smart 
national program to help manage REO properties and ease the 
pressure of these distressed properties on communities and the 
housing market.
    While expanding REO to rental is a critical tool, in the 
hardest-hit markets where prices have dropped the most and the 
most vacant and abandoned buildings are found, more needs to be 
done to jump-start construction and reduce vacancy rates. That 
is why President Obama has proposed Project Rebuild. Building 
on the Neighborhood Stabilization Program, Project Rebuild 
would allow commercial redevelopment essential to neighborhood 
revitalization to be funded directly and expand the ability of 
the private sector to participate with localities, ensuring 
there is the expertise and capacity to bring these 
neighborhoods back in a targeted way. Most important of all, it 
would create 200,000 jobs in the places that need the most.
    The third barrier to recovery, Mr. Chairman, is access to 
credit. While we stabilize the market and put an end to the 
worst abuses that caused this crisis, uncertainty over making 
loans has made it too difficult to get a mortgage today. 
Reducing this uncertainty is why we recently published our 
indemnification rule to clarify standards in FHA's Lender 
Insurance Program and continue to work with Congress to ensure 
FHA direct endorsement lenders are subject to the same rules 
and regulations. And it is why we believe it is important for 
the Federal Housing Finance Agency to make clear the rules of 
the road for GSE lenders with well defined, straightforward 
reps and warranties that will further reduce uncertainty around 
repurchase risk.
    And, Mr. Chairman, a clear example of our efforts to clear 
away all of these barriers to recovery is the historic $25 
billion mortgage servicing settlement reached by the Obama 
administration and an unprecedented coalition of 49 State 
Attorneys General that spanned partisan and geographic lines. 
The product of 16 months of intensive negotiations, the 
settlement addresses the harm mortgage servicing abuses have 
done to homeowners and the housing market more broadly. It 
keeps more families in their homes by providing tens of 
billions of dollars in relief for struggling homeowners, much 
of which will come in the form of principal reduction for 
distressed homeowners.
    Keeping these families in their homes not only improves 
their prospects, but also those of their neighborhoods who have 
watched their own property values plummet by $5,000 to $10,000 
each time a foreclosure sign goes up on their block. Indeed, 
that is why we recently tripled the incentives for cost 
effective mortgage modifications through the HAMP program that 
include a write-down of the borrower's principal balance and, 
for the first time, made these incentives available to Fannie 
Mae and Freddie Mac. We believe this is good for taxpayers and 
families alike.
    The settlement attacks the shadow inventory by reducing the 
number of homes that will need to go to foreclosure and by 
establishing a clear foreclosure process, helping families who 
are waiting to buy vacant homes and lifting neighborhood home 
prices as a result. And it reduces uncertainty that impedes 
access to credit by providing clear and fair servicing 
standards that build upon the new protections in our Homeowner 
Bill of Rights.
    That means at the same time the new Consumer Financial 
Protection Bureau is putting in place a single, straightforward 
set of common sense rules that families can count on when they 
are buying a home, the standards in this settlement will give 
people the confidence that lenders and servicers are adhering 
to a specific set of rights should they ever lose a job or have 
a medical emergency that puts their home at risk. No more lost 
paperwork. No more runaround. No more excuses. And by forcing 
banks that service a majority of all mortgages in the country 
to fix the types of problems we uncovered during our 
investigations, these new protections set the stage for 
servicing standards reform more broadly.
    And so, Mr. Chairman, as you can see, we have made very 
important progress in recent months to get our housing market 
back on track, putting in place the most significant principal 
reduction effort in history and establishing critical consumer 
protections that hold powerful institutions accountable for 
their actions, helping our housing market recover and giving 
every homeowner the dignity, respect, and fair treatment they 
deserve.
    But for all this progress, we still need Congress to act to 
ensure that every responsible family in America, regardless of 
who owns their loan, has the opportunity to refinance. We still 
need to continue our work together to create a robust private 
housing system of housing finance and protect the FHA fund for 
the future. And we still need a balanced National Housing 
Policy that ensures Americans have choices in housing that make 
sense for them and their families. That is the goal of all of 
this work and it is fundamental to creating an economy that is 
built to last. I look forward to working with Congress to make 
it possible.
    And with that, I look forward to taking your questions. 
Thank you.
    Chairman Johnson. Thank you for your testimony.
    As we begin questions, I will ask the Clerk to put 5 
minutes on the clock for each Member.
    Secretary Donovan, some have stated concern about the 
potential risk to taxpayers from the President's proposal to 
refinance non- Government-backed loans through a new FHA 
program. What policy do you believe FHA can adopt to ensure 
that any risk to the FHA and taxpayers is paid for?
    Mr. Donovan. Mr. Chairman, a very important question. First 
and foremost, I think the focus of this program, this proposal, 
is on borrowers who are paying, who have come through this 
entire crisis even though they are underwater and continue to 
be responsible and make their payments. Those are already low-
risk loans, and by lowering their payments further, on average, 
about $3,000 a year, we would make them even less risky. So 
that is the first important focus.
    Second, as I mentioned in my testimony, we would set up an 
entirely separate fund to--that would not affect FHA's finances 
in its MMI or other funds and would identify a dedicated source 
of funding to offset risk in those loans.
    Third, we would also impose and look forward to discussing 
with Congress a set of standards around what loans could 
refinance. For example, we have proposed a cap of 140 percent 
loan-to-value so that whoever owns the loans currently is 
required to do principal reduction and reduce the risk on those 
loans even further as they are refinanced.
    But the last thing I would say, and this is perhaps the 
most important, is the single most important thing we can do to 
protect the taxpayer is to ensure that existing investments of 
FHA, Fannie Mae, Freddie Mac, any Government-backed entity, 
that those investments improve in value. And by stabilizing the 
housing market more broadly, by putting billions of dollars 
into the pockets of homeowners that can help to boost the 
economy more broadly, we believe that these steps on 
refinancing can lift the overall housing market and, therefore, 
lower losses on legacy books of loans in the FHA and at the 
GSEs.
    Chairman Johnson. Mr. Secretary, a key component of the 
multi-State Federal servicer settlement is that a uniform set 
of servicer standards will be put in place for the five largest 
banks. In your opinion, how will this part of the settlement 
affect the foreclosure and loss mitigation process that 
servicers engage in, and what benefits will be provided to the 
housing finance sector as a whole? What is the time line for 
implementation of these standards?
    Mr. Donovan. A very important piece of the settlement, as 
you recognize, is establishing these standards, and one of the 
things I would point out, we worked very closely with the FHFA, 
and I want to compliment them on their work on that, to make 
sure that these standards did not just cover FHA and non-GSE 
loans, but also would cover GSE loans. So it is comprehensive 
in terms of the types of loans that it covers. And just the 
five servicers that have signed on at this point--there are 
others that we continue to negotiate with--but just the five 
represent a majority of all loans serviced in the country. So 
it is very important just to have those five signed on.
    The three key benefits that I would identify in terms of 
the servicing standards, one is that homeowners will be able to 
depend on getting real help to stay in their homes, as required 
by FHA standards and, frankly, in a way that will benefit the 
investors in those loans, as well. We found in our 
investigations significant noncompliance with our requirements 
for FHA in terms of loss mitigation and other standards, and so 
protections like, for example, not being foreclosed on while 
your application for assistance is being evaluated by the bank 
is one of the standards. Having a single point of contact at 
the banks so that you are not shuffled from person to person, 
your paperwork lost, et cetera. So those are important 
consistent standards that are there that will help homeowners.
    Second of all, by establishing these standards, we expect 
to speed up not just the process of getting help to homeowners, 
having fewer families falling into foreclosure, but right now, 
the foreclosure process itself is dragging on across many, many 
States and is hurting neighbors where homes are sitting vacant 
in those communities. And so clarifying and having a single 
foreclosure process across the country is a very important step 
in terms of getting relief to housing markets, as well.
    And then, finally, I would point out that investors in 
these loans will also now have a more consistent set of what 
they can expect in the way that loans are serviced and the 
kinds of steps that will be taken to protect their investment, 
just as they will the taxpayers' interest in the FHA.
    Chairman Johnson. Secretary Donovan, can you provide 
additional detail on how the elements of the servicing 
settlement coordinate with the Administration's housing plan.
    Mr. Donovan. I would be very happy to do that. I think two 
specific points that I would make beyond the servicing 
standards that we just spoke about. These servicing standards, 
I think, are a good starting point for the broader work that we 
are doing across all the regulatory agencies to create uniform 
servicing standards by regulation, and so that is a first 
important step. But two other points are very critical here. 
One is that the settlement would make available to non-GSE, 
non-FHA borrowers some amount of refinancing for current 
borrowers. So it is, if you will, a downpayment, so to speak, 
on the broader proposal that the President laid out in the 
State of the Union Address. So that refinancing piece is 
important.
    Second, it is, as I said in my testimony, the most 
important step that we have taken thus far of the crisis, to 
get real significant principal reduction started. But by 
combining that with increasing our incentives for principal 
reduction through the HAMP program, making those incentives 
available to Fannie Mae and Freddie Mac, we think that the 
settlement could have a catalytic effect in really showing, 
demonstrating that principal reduction is positive, not just 
for homeowners and communities, but is also positive for 
investors. When it is done in a net present value positive way, 
in a way that increases returns to investors, we think it could 
set a new standard along with these other steps that we have 
taken to make principal reduction more widespread as a solution 
to our housing challenges.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you.
    Secretary Donovan, in 2009, right here, you told this 
Committee, and I will quote, ``Based on current projections and 
absent any catastrophic home price decline, FHA will not need 
to ask Congress and the American taxpayer for extraordinary 
assistance. There is no need for any bailout.'' Those are your 
words.
    Despite this reassurance, OMB predicted that were it not 
for the funds that FHA is to receive in the mortgage 
settlement, FHA likely would have required a taxpayer bailout 
this year. As Secretary of HUD, you are ultimately responsible 
for ensuring the solvency of FHA regardless of unexpected 
events or erroneous projections. Without any caveats or 
qualifiers, can you assure this Committee that the American 
taxpayer will not need to bail out the FHA fund?
    Mr. Donovan. Senator, I wish I had a crystal ball----
    Senator Shelby. I know that.
    Mr. Donovan. ----of exactly how the housing market would 
perform the rest of this year and beyond. The fact is that I am 
confident, and I remain confident, that we are taking 
responsible steps to protect the FHA fund and, at the same 
time, to ensure that our housing market continues to recover.
    And specifically to your question about the numbers in our 
budget, as OMB made clear, those numbers were outdated at the 
time that they were published. We did not include in our budget 
additional premium increases that were announced yesterday 
because we were waiting to see the outcome of the servicing 
settlement and the recoveries that we would make there from our 
increased enforcement activities.
    Senator Shelby. What will the additional fees do for you? 
How much money will it bring in, roughly?
    Mr. Donovan. If you include both the--actually, not 
including the premium increases that were included in our 
budget, the additional changes that we announced yesterday will 
net us over a billion dollars more between fiscal year 2012 and 
2013.
    Senator Shelby. OK. Secretary Donovan, there has been very 
little information provided to the public regarding how the 
Administration determined that the settlement compensates 
fairly homeowners who have legal claims. In your review, how 
many borrowers did you find that had been improperly foreclosed 
upon?
    Mr. Donovan. Senator, I think this is a very important 
point about the investigations that we did. One piece of it was 
on improper foreclosures.
    Senator Shelby. OK.
    Mr. Donovan. But we also--we began our investigation at FHA 
in the summer of 2010 looking at, more broadly, at servicing 
problems, not just in the foreclosure process but more broadly 
in the servicing problems. And before even the word ``robo-
signing'' became a publicly used term, we were more than a year 
into those investigations.
    Senator Shelby. OK.
    Mr. Donovan. And so, to be clear, what we found in the case 
of some institutions, as high as 60 percent error rates in 
servicing FHA loans, a whole range of different types of 
errors. And then equally high rates of problems in foreclosures 
with certain institutions.
    We will be actually making public a number of those 
investigations, redacting sensitive information that may be 
there, but we will be making those available publicly this 
week----
    Senator Shelby. Would you furnish that----
    Mr. Donovan. ----and that we would be happy to share more 
detail on the----
    Senator Shelby. With the Committee.
    Mr. Donovan. ----specifics of those reports with the 
Committee.
    Senator Shelby. With this Committee.
    Mr. Donovan. Yes.
    Senator Shelby. Does a borrower under the settlement need 
to have suffered any legal harm to be eligible for a refinanced 
mortgage or principal reduction under the settlement?
    Mr. Donovan. There are different pieces of assistance that 
come from the settlement. There is direct compensation that is 
available that really coordinates with assistance that is made 
available by the OCC and the Fed through their process which 
came out of the very same investigations. So there is direct 
assistance there.
    But one of the things that we found, Senator, as we went 
through and investigated this is that there were many, many 
harms to those who had FHA loans, for example, who, because 
their paperwork was lost, did not get help or did not get help 
as quickly. And in that case, it is very difficult to say 
precisely what would have happened had they gotten help on 
time. And so without the ability to say exactly what the amount 
of harm is in each of those cases, we had to set some standards 
for those who were harmed to help those homeowners. So, 
honestly, there is no precise way to measure exact harm in all 
of these processes that we had.
    The other thing, frankly, that we found, as I said in my 
testimony, is that if you live next door to a foreclosure, if 
there was somebody wrongly foreclosed on, that harms your 
neighbor who has done absolutely nothing wrong. And so we felt 
having a settlement that provided broader help to those housing 
markets that have been hardest hit through, for example, 
refinancing for borrowers who are current, was a--had a real 
connection to the type of harm that we saw as we went through 
these investigations.
    Senator Shelby. But should not compensation as a principle 
be based on harm, in other words, somebody suffering harm?
    Mr. Donovan. I could not agree more----
    Senator Shelby. OK.
    Mr. Donovan. and again, the number of families that I have 
seen who have done everything right, who have paid their 
mortgages, and because there was a wrongful foreclosure next 
door, because somebody lost their home that should not next 
door, their own house prices have been harmed as a result.
    Senator Shelby. Mr. Secretary, shifting around a little 
bit, about a month ago, President Obama told the American 
people that he was sending this Congress a plan to address the 
troubled housing market. Subsequently, he has given speeches 
urging Congress to, quote, ``pass his plan.'' Today, it is my 
knowledge, as of this morning, Congress has not received that 
plan. We have not received it here. It has not been supplied to 
the Committee. When will the Administration's housing plan be 
sent up for us to consider?
    Mr. Donovan. Senator, I think it is fair to say that we 
have shared a plan of the program that we would like to see 
enacted. We have had a series of meetings with your team, with 
others on the Committee----
    Senator Shelby. ----no more than----
    Mr. Donovan. We do not at this point have specific 
legislative language----
    Senator Shelby. OK.
    Mr. Donovan. ----but we want to make sure that we get the 
input of Members of this Committee and others in Congress 
before we settle on a final legislative proposal.
    Senator Shelby. Thank you. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Tester.
    Senator Tester. Yes. Thank you, Mr. Chairman, and I want to 
thank you for bringing the folks together at this hearing to 
determine what is happening in our housing market. I think we 
heard some good news, recent data, and I think you have 
presented some good news, Secretary Donovan, on the housing 
market, but I think we all realize we have got a ways to go.
    One important step toward a healthy market is resolving and 
addressing the missed contact, which you addressed, that hurt 
homeowners, that pushed them into foreclosure. And while I 
appreciate the efforts of the State Attorney Generals and HUD 
and the Department of Justice to hold mortgage servicers 
accountable through this settlement, I still have questions how 
this settlement is going to help Montana or rural America 
specifically.
    I understand that Montana is going to receive a portion of 
the funds, and I know that Attorney General Bullock will put 
those to good use with that flat payment, but it is not going 
to be nearly enough to compensate, but it is a step. The bulk 
of the settlement is targeted toward struggling homeowners 
through refinancing as well as a menu of options, including 
principal reduction, forbearance, and short sales. Each of the 
parties of the settlement were required to meet dollar targets 
through these options and receive varying amounts of credit 
based on what sort of assistance is provided to original 
homeowners. I am getting there.
    As I understand it, the servicers the servicers are the 
party which will have complete discretion in determining which 
loans are modified, provided that they meet dollar obligations. 
So the question is, is what guarantee--since the servicers are 
making the call, what guarantee is there that any of the 
troubled homeowners in Montana will see a benefit from this 
settlement?
    Mr. Donovan. Senator, we would be happy to share with you 
specifics on what our estimates are of that help to Montana 
homeowners. But I think you asked a very important question, 
particularly given the experience we have had with past 
settlements where what was promised was not delivered. And 
there are three specific ways that we have built into this 
settlement to make sure that what has been promised will 
actually be delivered.
    First of all, there are substantial financial penalties for 
not reaching those specific numeric goals. Again, this is not, 
like in some past settlements, a promise to knock on a door, to 
send a solicitation to offer something to a homeowner. There 
are very specific targets of what they actually have to deliver 
in each of these categories, and if they do not, any amount 
that they do not provide is converted to a cash penalty with a 
25 percent or a 40 percent penalty on top of that amount.
    Senator Tester. OK.
    Mr. Donovan. Second of all, there is a very strong 
monitoring system that has been put into place that will 
include a State Monitoring Committee. They have the ability to 
go into court, and both the monitor can levy fines up to $5 
million for any violations and, beyond that, can go back into 
court for other remedies.
    Finally, and I think this is one of the most important 
aspects, we have built into the settlement a requirement that 
any principal reduction or any other help to homeowners has to 
be successfully working for 90 days to be able to count. In 
other words, it is not just that you have reduced principal, 
but that you have done it in such a way that we can assure that 
that homeowner has actually benefited and will continue to be 
able to stay in the home, and that, I think, is very important 
in terms of creating sustainable modifications for these 
families.
    Senator Tester. OK. And just correct me if I am wrong. Is 
there--I mean, there are bigger incentives where there are a 
lot of foreclosures, especially compared to rural areas of this 
country, Montana being one of them, where we have had our share 
of foreclosures, too, but not nearly as many from a numeric 
standpoint. Is there anything that will require the servicers 
to go into rural areas, or will they just focus on--or could 
they just focus on the urban areas?
    Mr. Donovan. So this was a--this is an important question 
as we went through the settlement negotiations. Had we 
established individual targets for every State around the 
country----
    Senator Tester. Right.
    Mr. Donovan. ----we could have ended up--if you multiply 15 
States by 14 servicers, we could have ended up with 700 
different targets----
    Senator Tester. Understand----
    Mr. Donovan. ----which was not practical. What we did put 
in, though, is a specific requirement that there can be no 
actions that any of the servicers take that harm any particular 
geography. So the monitor does have the ability to go and say, 
wait a second. You are not reaching out to rural borrowers. You 
are not treating rural borrowers in the same way that gives 
them access to the same benefits. And we think that that 
protection will be strong enough to make sure that, whether it 
is Montana borrowers or other rural borrowers, do not get 
treated in a different way than anyone else around----
    Senator Tester. OK, and that monitoring system is the State 
Monitoring Committee that you had talked about in a previous 
question?
    Mr. Donovan. There is a full-time monitor who has been 
appointed who has very broad authorities to oversee. There is a 
Monitoring Committee, including Federal and State officials, 
that will have an ability to oversee the monitor. And then 
there is the Federal District Court in D.C. that will oversee 
the settlement. Should there be any disputes with the monitor, 
they can be resolved in the Federal District Court.
    Senator Tester. And so--not to put words in your mouth, and 
my time has run out--but you feel confident that there are 
protections in place--and it can go either way, by the way. 
They could all focus on rural America. That has not 
traditionally been the way it has been. So you feel confident 
that there are entities in place that can force the settlement 
to go into rural America.
    Mr. Donovan. I do feel strongly that that is true. But I 
would also say, Senator, do not take my word for it. Forty-nine 
different State AGs, including yours, signed on----
    Senator Tester. Yes.
    Mr. Donovan. ----and many, many other rural States felt 
confident that this would benefit their States.
    Senator Tester. And there is no doubt that the payment that 
those AGs are going to get is going to go to those States. I am 
talking about----
    Mr. Donovan. Absolutely.
    Senator Tester. OK. Thank you, Mr. Chairman.
    Mr. Donovan. Thank you.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. Thank you, Mr. 
Secretary, for being here.
    With the AG settlement, what is the differentiation that is 
being made between second lien holders and first lien holders? 
It is my understanding that it appears that first lien holders 
are going to be taking hits while second lien holders are not, 
which is incredibly perverse. I would like for you to enlighten 
us----
    Mr. Donovan. Yes.
    Senator Corker. ----if that is the case.
    Mr. Donovan. A very important question, and there have been 
some mistaken reports about this, so I am glad you asked the 
question. There are two different ways that we are making sure 
that lien priority is respected.
    First of all, the credit for the write-offs of second liens 
is different from the write-off for first liens. We are 
recognizing----
    Senator Corker. Let me just ask it a different way.
    Mr. Donovan. Yes.
    Senator Corker. I do not want this to take that long. You 
are going to make sure that second liens are totally 
extinguished first, is that correct, before first liens are 
taking any heat, which is the way law works.
    Mr. Donovan. The minimum--we are basically using the 
standards for the HAMP program. The minimum is that it is at 
least pari passu, and any seriously----
    Senator Corker. So equal----
    Mr. Donovan. If I could just finish, any seriously 
delinquent second has to be completely written off in the----
    Senator Corker. So you are going to do pari passu, equal-
equal----
    Mr. Donovan. Equal----
    Senator Corker. ----and even though contract law would say 
that first lien holders have priority, you are going to pari 
passu. You are going to let the second lien holder have equal 
rights to the first lien holder, is that what you are saying?
    Mr. Donovan. Senator, it is actually not correct that law 
requires--if a second lien is current, for example, there is no 
requirement that says it has to be totally written off. These 
are standards that are in place for the HAMP program and that 
work. I think they absolutely respect lien priority. It is at 
least pari passu, but if it is significantly delinquent, it has 
to be written off entirely in any of these transactions.
    Senator Corker. How many of the homes--you all are really 
interesting when you use the word ``improperly'' foreclosed. 
What percentage would be your guess of loans that were 
improperly foreclosed on over a technicality and over those 
that actually were not making payments or behind, or maybe they 
were making payments and were not behind but were foreclosed 
upon?
    Mr. Donovan. I think this is a very important point, 
because I think the perception is somehow that the settlement 
was all about folks who lost their homes that should not have, 
and the percentage, as I think you imply, rightly, there are a 
very few folks who actually lost their home that should not 
have because of some error in the--still----
    Senator Corker. It would be very good if you all would 
actually say that instead of continuing down this rhetorical 
path that you----
    Mr. Donovan. Senator, I----
    Senator Corker. ----and in your testimony alluded to on the 
front end.
    Mr. Donovan. I am not sure--I would be interested in your 
point on the testimony, but what we did find was very 
significant and very pervasive errors in the servicing process 
more broadly that have real impacts on families. And we have 
taken criticism, why is it only $1,500 or $2,000, the 
compensation, because most of the errors did not cause somebody 
to lose their home wrongly. Most of the errors were smaller 
errors that might have delayed help for a month or fees that 
should not have been charged, and that is why the predominant 
help that we are providing is a smaller number.
    Senator Corker. Yes.
    Mr. Donovan. But if somebody did lose their home wrongly, 
they should obviously be compensated, and we have set up a 
system that can do that, as well.
    Senator Corker. Do you think it is a good idea for someone 
with a credit score of 580, just out in the private sector, to 
come on the FHA's balance sheet? Do you think that is good 
public policy?
    Mr. Donovan. What I will tell you is the large majority of 
the homeowners with 580 credit scores that we are making loans 
to are successful homeowners----
    Senator Corker. Yes.
    Mr. Donovan. ----and I do not believe we should take away 
the ability for somebody who can be a successful homeowner to 
be one. We obviously have to make sure that we are implementing 
risk controls. That is why when we first came in we raised the 
downpayment requirement for low credit score borrowers, and we 
have taken a series of other steps to protect that. But I think 
if you look at the performance of our new books of loans, what 
you see is the best credit quality in the history of FHA and I 
think we are--you know, given that we have to find a balance 
between protecting the fund and helping homeowners get access 
to a home, and, frankly, making sure that the housing recovery 
continues.
    Senator Corker. You know, every now and then, a guy comes 
along, or a person comes along in public service that you 
really are excited to be here and you think that they are going 
to be here really putting forth their honest opinions about 
things and really be here about good public service. You are 
one of those people.
    Mr. Donovan. Thank you.
    Senator Corker. You and I have talked often. I am really 
disappointed in the overly political approach that you have 
taken, and you and I talked about a GSE proposal and you put 
forth a white paper a long, long time ago that had a multiple 
choice.
    I just want to tell you that I hope at some point you will 
recover from the mode that you are in right now and that you 
will actually bring forth solutions to our housing programs, 
including a real GSE reform bill. I just want to tell you, I am 
personally disappointed and I hope we will begin addressing the 
real issues that we have here in our country in housing in a 
way that is fair to all Americans, and I hope to talk to you 
soon.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
Mr. Secretary, I want to thank you for your leadership.
    Mr. Donovan. Thank you.
    Senator Reed. I think most people acknowledge that this 
Attorney General's settlement, although ably led by Attorney 
General Miller of Iowa, would probably not have come together 
without your personal involvement, and that is an extraordinary 
achievement.
    Mr. Donovan. Thank you.
    Senator Reed. I think the paralysis that we have seen 
around here, maybe it has been broken, because now, at least, 
we have taken a step forward. There is tangible relief to 
homeowners. It is not perfect. Seldom do we do perfect things 
here. But it is progress and we have not seen a lot of progress 
over the last few years.
    Not only that, you have led the way with proposals to 
expand the effectiveness of the HAMP program to make it more 
useful, to apply it to a broader spectrum of Americans. All of 
those have been practical solutions to this gnawing problem of 
a housing market that was collapsed, frankly, not on your watch 
but on your predecessor's watch, and you have been trying to 
rehabilitate it. We have seen some modest progress, but not 
enough.
    Now, one of the things I think is interesting, and I think 
you have sensed it, too, is that if you look at the people who 
are the commercial banks that hold loans in their portfolio 
that are--and bound by fiduciary obligations to make money for 
their shareholders, they are actually writing down principal as 
a way to keep people in their homes. In fact, yesterday, the 
American Banker reported 80 percent of homeowners who received 
a modification from these commercial banks saw their principal 
cut, and yet we have not seen that by the GSEs and by others, 
although I think you have made progress in the HAMP program by 
giving further financial incentives. Could you talk about this 
issue of principal reduction as the way to keep people in their 
homes?
    Mr. Donovan. Senator, thank you for asking about this 
because I think it is--if I look at the sort of range of tools 
that we have tried to use through the last few years in the 
housing crisis, principal reduction is the one tool that we 
have made perhaps the least progress on until recently. And 
there is growing evidence that, particularly where someone is 
deeply underwater, if they are looking at, you know, 10, 15 
years of paying their mortgage without being able to start 
building equity again, that at some point, that will have a 
real impact on their ability to keep going and keep paying 
their mortgage.
    So the ability to begin to sort of break the logjam, if you 
will--there are so many frictions that we see in this system 
that we have to principal reduction, to be able to break 
through some of those frictions to get interests aligned among 
all the trustees and the owners of the loans and others is one 
of the things that we have been focused on, particularly over 
the last few months. And I think between the settlement itself 
as well as these other incentives that we are providing, that 
those are very important steps that we hope can jump-start more 
principal reduction happening, which, again, we do think is 
good both for homeowners and communities, but also for 
investors in those loans where it can allow people to pay, stay 
in their homes, and increase the value of those mortgages.
    Senator Reed. As a follow-on point, one of the perceptions, 
and I think this is borne by people throughout this country, is 
that we have gone to extraordinary lengths to provide support 
for financial institutions, mainly through Federal Reserve 
policy of lowering interest rates very close to zero. And yet 
many homeowners cannot take advantage of that because their 
property values have deteriorated so much.
    But if, in fact, through these principal reductions they 
can refinance, that would be a tremendous boom to them. And as 
I think it is reflected by the commercial banking experience, 
it is a lot smarter for a bank to keep someone in their home 
paying rent and maybe even have a principal kicker at the end 
than to foreclose, maintain the property, pay property taxes on 
the property, and in many cases watch the property deteriorate 
despite all of that. That logic seems to be compelling to most 
people back home, but it is having a--you are having a hard 
time persuading lots of people here, is that fair?
    Mr. Donovan. Well, look, I do think that given the scale of 
the housing declines that we saw across the country, we are in 
a little bit uncharted territory in terms of what this means. 
It is one of the reasons why the settlement, we think, is 
important, because it can establish a track record for 
principal reduction. But there is increasing data available, we 
believe, that shows that this principal reduction can be good 
not only for homeowners and communities but for investors, as 
well.
    The other thing I would just say is we have a very big 
opportunity with interest rates where they are today. 
Typically, any homeowner who is less than about 130 percent 
loan-to-value by refinancing to today's low interest rates can 
get back above water in 5 years or less just through plowing 
their savings from refinancing into rebuilding their equity. 
And that is something we want to encourage with our plan. It is 
why we have proposed eliminating closing costs and providing 
other incentives to folks to choose to take their savings from 
refinancing and plow it back into rebuilding their equity.
    Senator Reed. Thank you.
    Chairman Johnson. Senator Johanns.
    Senator Johanns. Thank you, Mr. Chairman.
    Mr. Secretary, it is good to see you again. I was looking 
at your written testimony, and let me quote something that you 
wrote. You did not say this in your oral testimony, but it is 
here in front of me. You say on page one, near the bottom, 
``Today, because the Obama administration moved to keep 
interest rates low and restore confidence in Fannie Mae, 
Freddie Mac, and the Federal Housing Administration,'' then you 
go on to talk about homeowners refinancing.
    Mr. Secretary, on both points, you do not seriously believe 
that it was the Obama administration that kept interest rates 
low, do you? I always thought that was the Federal Reserve 
function.
    Mr. Donovan. What I would say--I think it is perfectly fair 
to point out the Federal Reserve had taken very significant 
steps. There were additional steps that the Administration 
took, particularly through Treasury, early on in the 
Administration to keep interest rates low, as well. So if you 
read as us taking full credit for that, it is certainly not 
accurate. There are steps that we took, however, that 
contributed to keeping interest rates low.
    Senator Johanns. Now, on your second point, I have not run 
into a single person since I joined the Senate 3-plus years ago 
that came up to me and said, ``You know, Mike, thanks for your 
efforts back in Washington. I now have confidence in Fannie and 
Freddie.'' Do you really believe that, that confidence has been 
restored in these gigantic operations that have been nothing 
but a liability for taxpayers?
    Mr. Donovan. Senator, there is no question that there are 
additional steps that need to be taken and we continue to take, 
and certainly as we laid out our plan for what should be done 
with Fannie and Freddie, we said very clearly that it is 
structurally a model that we should discontinue. It is not the 
right model for the future.
    On the other hand, in the midst of the crisis, we were very 
dependent on ensuring that a new homeowner trying to buy a 
home, because private capital was not available in the midst of 
the crisis, that we needed to ensure at least that new loans 
were available. And so when we talk about confidence that those 
loans will stand the test of time, we took very difficult steps 
to stand behind, to back those loans, to make sure that 
interest rates continue to be at a level that folks could buy 
homes.
    So when we talk about confidence, what we really meant is 
confidence that the backing of Fannie and Freddie would be good 
for homeowners that were looking to buy homes or refinance.
    Senator Johanns. Well, let me ask you about that, because I 
think you are making my point. How much today would the 
taxpayers be on the hook for when it comes to Fannie and 
Freddie? Everything, right?
    Mr. Donovan. There is no question that taxpayers are at 
risk for those loans being made. What I would also say, though, 
is all the evidence that we have is that the new loans being 
made are safe, good loans. The exposure that taxpayers have is 
to the legacy loans that were made before they went into 
conservatorship, and this is----
    Senator Johanns. And how much----
    Mr. Donovan. and I think this is where the confidence issue 
is important. The single most important thing we can do to 
protect taxpayers is ensure that those old loans, which we 
cannot make go away, perform in a way that improves their value 
rather than has their value decline. And in that sense, 
improving the housing market more broadly, keeping confidence 
in the securities that are issued by Fannie and Freddie is 
critical going forward.
    Senator Johanns. How much are those legacy loans? If you 
are the average taxpayer out there and you are tuned into this 
hearing and you want to know how much you are on the hook for, 
how much is that?
    Mr. Donovan. I am sorry, Senator, I do not have a number in 
front of me. Perhaps--I know that FHFA will be testifying on 
the next panel. I am sure that they would have more specific 
details. But it is obviously substantial, in the over a 
trillion dollar range.
    Senator Johanns. To me, that is not a confidence builder. 
The average taxpayer is out there saying, are you kidding me? I 
am on the hook for that, too, in addition to the massive 
national debt?
    Let me, if I might, ask you a quick question about the 
investigations. When you talk about servicing errors, could 
that be something like the failure of Mike Johanns to sign one 
of the pieces of paper that you get at a closing?
    Mr. Donovan. We did not look at closing specifically, but 
there are clearly failures to properly review and sign 
documents in the servicing and in the foreclosure process.
    Senator Johanns. What percentage of all of that would you 
say was due to just outright fraud? I want to take advantage of 
this poor innocent person sitting in front of me.
    Mr. Donovan. I would say the minority of those errors that 
we found, I would say, could be linked directly to outright 
fraud. On the other hand, the extent of the errors, as I said, 
up to 60 percent error rates, serious error rates, in the worst 
of the companies that we reviewed, did real damage to families 
and to communities. So what I want to make sure people 
understand about these investigations, what we found were not 
just trivial errors that had no impact on families. These were 
significant errors that had real impacts, cost families real 
money, caused some families to lose their homes that should not 
have. And, frankly, we felt they needed to be held accountable. 
They were violations of FHA's rules, among other things, and 
that is why we took them so seriously.
    Senator Johanns. Mr. Chairman, thank you.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman, and Mr. 
Secretary, thank you for your service. I think you have done an 
extraordinary job.
    Mr. Donovan. Thank you.
    Senator Menendez. I want to follow my colleague, Senator 
Johanns, line of question. What is the time frame in which this 
explosion at Fannie and Freddie took place, of the challenges 
we are facing now in terms of taxpayer exposure? What is the 
time frame in which that took place?
    Mr. Donovan. Well, their market share really took off sort 
of in the middle of the 2000 decade, in the 2005 range, and 
they were obviously taken into conservatorship before the 
Administration came into office in 2009.
    Senator Menendez. So----
    Mr. Donovan. And so it is really those legacy loans in that 
period that are at issue.
    Senator Menendez. So everything you just described with 
Senator Johanns was largely--that explosion took place 
somewhere in the time frame of 2005 leading up to 
conservatorship prior to 2009?
    Mr. Donovan. That is correct.
    Senator Menendez. So largely during the Bush years is when 
this explosion took place. So I find it ironic at times that we 
hear about these concerns, which are legitimate--they are 
legitimate concerns, I share them--but there was no one putting 
the brakes on during that period of time to make sure that 
these institutions did not follow the marketplace in excesses.
    Let me ask you about principal reduction. I know that my 
colleague, Senator Reed, began on this. When you look at loans 
that are in the banks' own private portfolios, the banks are 
finding it profitable to give principal reductions to about 20 
percent of their own loans, while, ironically, the Government 
is not allowing principal reductions on any loans. Do you 
think, or do you believe that it should be completely taken off 
the table as an option in literally all cases, as the FHFA has 
done with Fannie and Freddie?
    Mr. Donovan. Clearly, given our focus in the servicing 
settlement and the work we are doing elsewhere in HAMP that I 
described, we believe principal reduction is an important tool 
in the tool kit, if you will, that should be available where it 
can be the most help to homeowners.
    Senator Menendez. So, clearly, if the private sector is 
looking at 20 percent and saying, this makes sense for us, and 
we always hear about how the private sector can lead us in a 
way, it seems to me that they are leading in a way in which 20 
percent has already been principally reduced. So it is an 
indicator, at least.
    In that context, I have introduced a bill that basically 
promotes shared appreciation mortgages at the FHFA and FHA as a 
creative solution to the housing crisis, in part, and principal 
reduction problems. In essence, a shared appreciation mortgage 
or debt for equity is basically when lenders reduce principal 
now in exchange for getting a percentage of future increases in 
home prices. It seems to me that a lot of things are resolved 
in that process. The homeowner can be kept in their home, be a 
responsible--continuing to be a responsible borrower. The 
question of moral hazard is largely resolved because the 
appreciation value to the lender is there. And so, therefore, 
they have opportunity to recoup equity. Do you believe that we 
could see such a pilot program at FHA?
    Mr. Donovan. First of all, I want to compliment you on the 
work on this legislation. It is a creative solution, I think, 
that you have come up with to what can be a very complex 
problem of misaligned incentives between homeowners and 
lenders. We have done a lot of work with your team and look 
forward to continuing to do that. I do think that it is 
something that could be valuable as a tool going forward.
    I also would just say, on your earlier point, I do think 
the fact that where--and this is what is increasingly being 
found--where principal reduction is happening, it is happening 
more frequently in the portfolios of banks with their own 
loans, and I think that does show that where the barriers to 
principal reduction are removed, which is exactly what we are 
trying to do through HAMP, through the servicing settlement, 
that more principal reduction will make sense because it is 
better for those investors. If banks are doing that with their 
own portfolios, I think it shows they have clearly made the 
decision. It protects their own investments. So your point is a 
very important one. I want to make sure it does not get lost.
    Senator Menendez. And my final question is, how do you 
anticipate that the settlement that was entered into with all 
the AGs will interact with the appeals of foreclosures that are 
being implemented by the consent orders between the OCC and the 
Federal Reserve and the major servicers? It seems that there 
are two parallel tracks going on. I want to clarify what that 
means for homeowners.
    Mr. Donovan. Yes. This is a great question because there 
has been a lot of misunderstanding when you think about this--
--
    Senator Menendez. I only ask great questions.
    [Laughter.]
    Senator Menendez. I am kidding, of course.
    Mr. Donovan. And this relates to some of the earlier 
discussion with Senator Corker and otherwise. What we have to 
recognize is that many of the sort of harms that were done here 
did not lead to somebody losing their home, but it might have 
been a fee that was imposed that should not have or a month 
delay in getting help which cost a homeowner a month's payment. 
And we wanted to make sure that homeowners did not have to go 
through a lengthy process of putting together documentation, 
maybe even getting a lawyer that might cost more than the help 
they would actually get. So we created through the settlement 
almost like a class action process, where somebody can come in 
very simply, in a very efficient, streamlined process, and get 
help that averaged sort of $1,500 to $2,000.
    For someone who was harmed much more significantly, the OCC 
and the Fed have set up a separate process where they can come 
in, demonstrate exactly what that harm is, and get full 
restitution. If they lost their home and it was a cost of 
$100,000 to them, they can get that restitution.
    Those two processes work in concert, if you will, to make 
sure that there are options available. Somebody taking $1,000 
or $1,500 or $2,000 from the settlement does not stop them from 
pursuing the longer, more detailed process. And, frankly, 
neither of them stops a homeowner from going into court if they 
feel like they have been wronged and their harm has not been 
adequately addressed.
    Senator Menendez. Thank you very much, Mr. Chairman.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you, Mr. Secretary----
    Mr. Donovan. Thank you.
    Senator Merkley. ----for the hard work you are doing to try 
to figure out the strategies in a very, very complex mortgage 
world.
    One thing I wanted to draw attention to was your commentary 
over the Mutual Mortgage Insurance Fund, where you note that 
there is a series of basis point insurance premium increases 
and then some additional changes announced yesterday, and you 
conclude that with these additional revenues, the capital 
reserve is estimated to have sufficient balances to cover all 
future projected losses without triggering a mandatory 
appropriation under the Federal Credit Reform Act.
    Essentially, since 2009, as you observe, we have been under 
the 2 percent reserve ratio and kind of hanging by the seat of 
our pants, but as I read this, I get the feeling that the 
adjustments that have been made, that there is a little bit of 
a sigh of relief that we are not going to have a major solvency 
problem in MMI, that it is looking fairly decent minus a major 
unexpected downturn in the economy.
    Mr. Donovan. Yes. I would not say it is a sigh of relief at 
this point from my perspective. I think we have to remain very 
vigilant, because, frankly, the single most important thing 
that drives the reserves of the fund and whether they are 
adequate is what the performance of the housing market is going 
to be more broadly. And given the expected direction of the 
market, given what we have seen lately in terms of the most 
recent numbers, we have taken steps between the settlement and 
the additional premium increases that should protect us this 
year. But, obviously, we are going to continue to watch very 
closely, and if there are other unexpected changes in the 
market, we will react accordingly.
    Senator Merkley. In any event, it is good news and I 
appreciate the vigilance going forward.
    Mr. Donovan. Thank you.
    Senator Merkley. Turning to HARP 2.0, I appreciate the 
Administration really working hard to have the FHFA have this 
program. How many actual HARP 2.0 loans have they actually 
closed, if you will?
    Mr. Donovan. So the estimates that we have at this point 
are that about 50,000 loans have actually closed and that there 
are about 300,000 applications that have been filed. Recognize 
that the improvements--the HARP 2.0 improvements really started 
to go into effect only in mid- to late-December and that the 
most important change, perhaps, particularly for the hardest-
hit communities is the ability to refinance above 125 percent 
loan-to-value. That was completely unavailable before HARP 2.0. 
That only started to go into effect really this month.
    So what I will tell you is we are encouraged thus far in 
terms of the response. There are higher than we expected 
response rates coming in terms of homeowners saying, yes, I 
want to participate, and particularly in that above 125 percent 
loan-to-value. So we are encouraged by those numbers so far.
    Senator Merkley. So that is good, because I had not heard 
that 50,000 had closed, so I think that is great news, and that 
there is a whole pipeline coming into effect.
    When folks come into my casework team with housing 
challenges, there is always a bit of a lottery as to whether or 
not their loan is owned by Fannie or Freddie and, therefore, 
whether they are eligible for HARP 2.0. So the work the 
Administration is doing to try to find a strategy to address 
the non-GSE is important and very difficult.
    I did want to ask you about one feature that you mentioned, 
which is if a family does a 20-year loan, keeping their 
payments higher and essentially gaining equity faster, they are 
incentivized by having their closing costs covered. And the 
reason I found this interesting is at first glance, it felt 
counterintuitive to me in this sense, that one of our goals is 
to reduce strategic defaults. So if your monthly payments are 
lower, you therefore have less incentive, if you will, to walk 
away and go to a rental. And second is to decrease financial 
defaults, and if your monthly payment is lower, you therefore 
are much less likely to financially default if your income 
changes, you lose a part-time job or new job that pays less.
    And so in some ways, I would have thought that maybe the 
incentive would work the other way, encourage people to have 
the lower monthly payment and, therefore, more robust or more 
resilient finances. So I just thought I would have you share 
just a little bit more of the thinking that went into that 
strategy.
    Mr. Donovan. Clearly, that is an option that is up to the 
homeowner. They can make that choice, and they could even take 
a portion of the savings and plow it into rebuilding equity. It 
is not an all or nothing proposition.
    We simply felt that given the substantial challenges that 
negative equity provides, that--and the likely natural sort of 
short-term focus that many homeowners would have on reducing 
those payments, that we wanted to ensure that those homeowners 
took seriously the option of rebuilding equity, as well. Again, 
the numbers do show that it is not just payment reduction that 
matters, but also how deeply underwater a family is to be able 
to do that.
    Senator Merkley. Thank you, and just a very short closing 
question, which is it is my understanding that the AGs still do 
not have all of the details in writing for the settlement, and 
it is a little surprising that they have been asked to sign on 
before having all the details in writing because, like every 
contract, the details make a difference. When are the AGs going 
to have all the details, and is it possible that when folks 
look at those details, some that have said, ``Yes, I am in,'' 
might say, ``Hmm, I am going to rethink that''?
    Mr. Donovan. The documents were finalized in terms of all 
the significant aspects of the agreement when they signed on, 
and so they had those documents. What is being finalized, and, 
in fact, we expect the documents to be registered in court this 
week and then they would become public--but what was being 
finalized, for example, each State has the option to decide how 
to direct their own funding through the AGs. There are a series 
of individual qui tam actions that were being finalized in 
particular States. Those had to be reflected in the documents.
    So I would put it more in the dotting ``I''s and crossing 
``T''s rather than in any significant terms of the settlement 
that are being finalized in terms of the documents. And again, 
they have been finalized. We expect them to be registered in 
court this week and become available publicly.
    Senator Merkley. Thank you.
    Mr. Donovan. Thank you.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman.
    Secretary Donovan, thank you for being here today.
    Mr. Donovan. My pleasure. Thank you.
    Senator Hagan. The premium changes announced by FHA this 
week are expected to increase receipts to the FHA by $1 billion 
and, obviously, improve the fund's capital position. Can you 
discuss how and when we will know what this move--whether this 
move has proven to be sufficient to restore the fund's capital 
position?
    Mr. Donovan. To be honest, Senator, we really will not know 
until the end of the fiscal year. We will be watching it very 
carefully and we will have early signs of that. But the--it 
really will depend on the volume of business that comes in and 
the trajectory of home prices over the remaining year, and we 
will have a new actuarial report available to Congress in the 
fall that will redo those projections based on these new 
premiums as well as where we expect the fund to go.
    Senator Hagan. The FHA is limited in statute from taking 
certain emergency actions that could restore the fund's capital 
position if an appropriation from the Treasury Department 
became more likely. Can you discuss some of those limitations 
and what additional authorities might benefit the FHA in its 
efforts to avoid a draw on the Treasury?
    Mr. Donovan. Well, first of all, I would just say this 
Committee has been very helpful, has given us in the past few 
years greater statutory authority to raise our premiums. We are 
using that authority here.
    But what I would also say is while we are focused on 
premiums for new loans, it is very, very important that we 
continue to take steps to make sure that prior loans that were 
made that did not meet our standards can be held to account and 
that we are enforcing effectively. We have dramatically 
increased our enforcement. In fact, the settlement is the 
single biggest recovery the FHA Fund has ever made from our 
enforcement.
    But there are additional steps. For example, we have 
limited authority to go after lenders on a national basis. We 
are required to go after them on a sort of region by region 
basis, which we do not think is as efficient. We have 
legislation that is, in fact, reflected in the House bill right 
now that we would like to continue to work with the Committee 
to get done this year that would increase our enforcement 
authorities on that issue and on a number of others, as well.
    Senator Hagan. Thank you. Last year, the FHA was seeing 
improvements in mortgage delinquency rates in early period 
delinquencies. What is the FHA seeing in delinquency rates 
today and are those rates improving?
    Mr. Donovan. Yes. So what we are seeing on the sort of 
early delinquencies, 30-day, 60-day, continues to improve and 
really tracks what is happening, probably most of all, in the 
jobs market and the improvement we have seen there.
    We have seen our serious delinquencies and in foreclosure 
tick up somewhat and that is really due to two factors. One is 
that because of the problems that we found in servicing our 
loans with a number of the institutions, some of them have held 
off on foreclosing and presenting claims to us, and so that has 
kept those loans in the foreclosure process longer. And so 
instead of having--it has also made our claims go down, which 
is a good thing, but it has increased the number that are in 
the foreclosure process and seriously delinquent. And so that 
has sort of had them tick up.
    The other thing, frankly, is just simply that we have had 
very large books of business in the last couple years. There is 
a natural sort of seasoning process that happens with loans and 
you do not generally see them start to have delinquencies or 
defaults until they are typically kind of 2 years old. And so 
these very large books are--the delinquencies are increasing 
for those. But, frankly, we looked very carefully at how those 
loans are performing relative to past years. We are still very 
confident that those new loans are performing extremely well. 
But as an average, it has kind of driven the delinquency rates 
up somewhat because they are just so much larger, those books, 
than the prior years, which were much worse loans.
    Senator Hagan. The FHA announced the discretionary up front 
premium increases and changes to annual premiums that were 
mandated by law in December. Can you discuss how these changes 
will impact the borrowers who will be refinancing under FHA?
    Mr. Donovan. So in the budget was reflected a ten basis 
point increase across the board for these loans, for all FHA 
single-family loans. What we also did, though, which I think is 
important, we implemented or are implementing a higher premium 
increase for larger loans. We want to make sure that the higher 
loan limits that FHA has are seen as temporary and that we are 
encouraging private capital to come back into the market more 
broadly, but particularly in those larger loans, so that as we 
transition back to our lower loan limits, private capital is 
already filling that space.
    Yesterday, we announced an additional 75 basis point 
increase on the up front premium that complements the other 
changes that were in the budget. In total, if you combine the 
ten basis point annual premium and the 75, for our typical 
loan, you are going to see an increase that is about $15 a 
month for the average homeowner. So that is when you combine 
them. The annual premium is close to $10 a month. The up-front 
will add about $5 a month. So that is the impact. And we think 
given where interest rates are, we have tried to balance the 
health of the fund with making sure that we do not impede the 
recovery of the housing market.
    Senator Hagan. Thank you.
    Mr. Chairman, I did want to state that North Carolina's 
Commissioner of Banks, Joe Smith, I am pleased to see that he 
has been named--I cannot remember his exact title----
    Mr. Donovan. He is the monitor for this----
    Senator Hagan. ----the monitor for the fund, so----
    Mr. Donovan. He will do a terrific job.
    Senator Hagan. ----we have an excellent individual in that 
position. Thank you.
    Mr. Donovan. Thank you.
    Chairman Johnson. I would like to thank Secretary Donovan 
for his testimony and for being here with us today. We 
appreciate your testimony, Mr. Secretary.
    With that, I would like to call forward the second panel 
for this hearing.
    [Pause.]
    Chairman Johnson. The second panel of witnesses that we 
have here today are no strangers before this Committee and need 
very little introduction.
    Governor Elizabeth Duke is a member of the Board of 
Governors of the Federal Reserve System. She has served in this 
position since June of 2008.
    Mr. Edward DeMarco is the Acting Director of the Federal 
Housing Finance Agency. He has held this position since 
September of 2009.
    Governor Duke, you may proceed with your testimony.

STATEMENT OF ELIZABETH A. DUKE, GOVERNOR, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Ms. Duke. Thank you. Chairman Johnson, Ranking Member 
Shelby, Members of the Committee, thank you for inviting me to 
talk about the current situation in housing markets.
    The Federal Reserve has a keen interest in the state of 
housing and has been actively engaged in analyzing issues in 
the housing and mortgage markets. Issues related to the housing 
market and housing finance are important factors in the Federal 
Reserve's various roles in formulating monetary policy, 
regulating banks, and protecting consumers of financial 
services.
    In particular, the failure of the housing market to respond 
to lower interest rates as vigorously as it has in the past 
indicates that factors other than financial conditions may be 
restraining improvement in mortgage, credit, and housing market 
conditions and, thus, impeding the economic recovery.
    Federal Reserve staff have been actively working to 
understand the reasons behind the impairment in housing and 
mortgage markets and the tradeoffs involved in designing 
policies that would remove obstacles to normal market 
functioning.
    On January 4, 2012, the Federal Reserve released a staff 
paper titled, ``The U.S. Housing Market: Current Conditions and 
Policy Considerations,'' which is attached at the end of my 
written statement. The paper provides information on current 
conditions in the housing market and analytic background on 
some housing market issues. Although the paper does not include 
recommendations for any specific policy actions, it does lay 
out a framework for discussion, outlining some options and 
tradeoffs for policy makers to consider. My testimony today 
will be drawn from this paper.
    Six years after aggregate house prices first began to 
decline and more than 2 years after the start of the economic 
recovery, the housing market remains a significant drag on the 
U.S. economy. In a typical economic cycle, as the economy turns 
down, households postpone purchases of durable goods such as 
housing. Once the cycle bottoms out, improving economic 
prospects and diminishing uncertainty usually help unleash this 
pent-up demand. This upward demand pressure is often augmented 
by lower interest rates, to which housing demand is typically 
quite responsive.
    The current economic recovery has not followed this script, 
in part because the problems in the housing market are a cause 
of the downturn as well as a consequence of it. The 
extraordinary fall in national house prices has resulted in $7 
trillion in lost home equity, more than half the amount that 
prevailed in early 2006. The substantial blow to household 
wealth has significantly weakened household spending and 
consumer confidence.
    Another result of the fall in house prices is that around 
12 billion households are now underwater on their mortgages. 
That is, they owe more on their mortgages than their homes are 
worth. Without equity in their homes, many households who have 
experienced hardships, such as unemployment and unexpected 
illness, have been unable to resolve mortgage payment problems 
through refinancing their mortgages or selling their homes. The 
resulting mortgage delinquencies have ended in all too many 
cases in foreclosure, dislocation, and personal adversity. 
Neighborhoods and communities have also suffered profoundly 
from the onslaught of foreclosures as the neglect and 
deterioration that may accompany vacant properties makes 
neighborhoods less desirable places to live and may put further 
downward pressure on home prices.
    An ongoing imbalance between supply and demand exacerbates 
these problems in the housing market. For the past few years, 
the actual and potential supply of single-family homes for 
purchase has greatly exceeded the effective demand, in part 
because of the large number of homes that have come back onto 
the market after moving through the foreclosure process. The 
elevated pace of foreclosures, unfortunately, is likely to be 
sustained for quite a while and, therefore, will continue to 
put downward pressure on home prices.
    At the same time, a host of factors have been weighing on 
housing demand. Many households have been reluctant or unable 
to purchase homes because of concerns about their income, 
employment prospects, or the future path of home prices. Tight 
mortgage credit conditions have also prevented many households 
from purchasing homes. Although some retrenchment in lending 
standards was necessary and appropriate given the lax standards 
that prevailed before the crisis, current lending practices 
appear to be limiting or preventing lending even to 
creditworthy households.
    In the paper, we discuss the benefits and costs of a 
variety of policy options that have been proposed to respond to 
difficult housing issues, including increasing credit 
availability for households seeking to purchase a home or to 
refinance an existing mortgage; exploring the scope for further 
mortgage modifications, including encouraging short sales and 
deeds in lieu of foreclosure in cases where foreclosure cannot 
be avoided; and expanding the options available for holders of 
foreclosed property to dispose of their inventory responsibly. 
Any policy proposals, though, will require wrestling with 
difficult choices and tradeoffs as initiatives to benefit the 
housing market will likely involve shifting some of the burden 
of adjustment from some parties to others.
    I greatly appreciate the leadership that the Senate Banking 
Committee has shown on the profound challenges facing the 
housing market. For its part, the Federal Reserve will continue 
to use its policy tools to support the economic recovery and 
carry out its dual mandate to foster maximum employment in the 
context of price stability. In its supervisory capacity, the 
Federal Reserve will continue to encourage lenders to find ways 
to maintain prudent lending standards while serving 
creditworthy borrowers.
    Thank you again for inviting me to appear before you today. 
I would be happy to answer any questions you may have.
    Chairman Johnson. Thank you, Governor Duke.
    Mr. DeMarco, you may proceed with your testimony.

   STATEMENT OF EDWARD J. DeMARCO, ACTING DIRECTOR, FEDERAL 
                     HOUSING FINANCE AGENCY

    Mr. DeMarco. Thank you, Mr. Chairman. Chairman Johnson, 
Ranking Member Shelby, Members of the Committee, I am pleased 
to be invited here today to discuss the actions FHFA is taking 
in our role as conservator for Fannie Mae and Freddie Mac to 
aid recovery of the U.S. housing market.
    My written statement responds to the Committee's request 
for a description of FHFA's work as conservator of Fannie and 
Freddie, or the Enterprises, as I will refer to them, to 
address barriers to housing recovery, including preventing 
foreclosures through loss mitigation, facilitating refinancing 
at today's low interest rates, and initiating an REO sales 
program. My written statement also summarizes the recent 
strategic plan for conservatorship that I submitted to you last 
week.
    In contrast to how they are sometimes portrayed, the 
Enterprises are playing a leading role in providing assistance 
to homeowners seeking to avoid foreclosures. On a nationwide 
basis, Fannie Mae and Freddie Mac own or guarantee 60 percent 
of the mortgages outstanding, but they account for a much lower 
proportion, 29 percent, of seriously delinquent loans. And let 
me add here, there was a little discussion in the prior panel 
regarding market share. During the period 2005 to 2007, the 
Enterprises' market share was actually generally declining. 
More of this was--more mortgage activity was being financed 
through the private label market, which is, of course, where a 
good bit of our difficulties today are and where a lot of 
troubled loans reside.
    Even though the Enterprises have a smaller share of 
seriously delinquent loans than other market participants, they 
account for about half of all HAMP modifications. Between HAMP 
modifications and their own proprietary loan modifications, 
Fannie and Freddie have completed over one million loan 
modifications since the fourth quarter of 2008.
    We have also made great strides in improving mortgage 
servicing standards. The Servicing Alignment Initiative, which 
FHFA announced last year, focuses servicers' resources and 
attention on moving all borrowers in trouble into alternatives 
to foreclosure and to do so quickly, efficiently, and 
aggressively. The Servicing Alignment Initiative aligned the 
requirements of the Enterprises to remove inconsistencies that 
could cause servicer confusion and delay.
    Fannie and Freddie are also at the forefront of refinance 
activity for current borrowers. Since April 1 of 2009, the 
Enterprises have completed more than ten million mortgage 
refinances. The Home Affordable Refinance Program, or HARP, 
provides refinancing opportunities to borrowers that might 
otherwise be unable to refinance due to house price declines. 
Changes to this program that we announced last October are 
still being implemented, but early indications are promising.
    Just yesterday, we announced the first transaction in our 
Real Estate Owned, or REO, Initiative Pilot Program. This 
transaction includes approximately 2,500 properties divided 
into eight subpools by geographic area. We also want to enhance 
the opportunity for smaller-scale investors to bid on 
properties and obtain financing should initial efforts to 
market these properties to owner-occupants fail.
    Now, at FHFA, we are faced with a fundamental task of 
directing the operations of two companies that account for 
roughly three-quarters of current mortgage originations and 
have approximately $5 trillion in outstanding obligations and 
credit guarantees. To the question from the earlier panel, that 
is the answer. Five trillion dollars is what the American 
taxpayer is standing behind through the Treasury Department's 
Senior Preferred Stock Purchase Agreement. Our task in 
overseeing this is complicated by the very uncertain future of 
the Enterprises.
    Now, last week, I submitted to Congress a strategic plan 
for the next chapter of conservatorship. The plan sets forth 
three strategic goals. Build--build a new infrastructure for 
the secondary mortgage market. Contract--gradually contract the 
Enterprises' dominant presence in the marketplace while 
simplifying and shrinking their operations. And maintain--
maintain foreclosure prevention activities and credit 
availability for both new and refinanced mortgages.
    Achieving these strategic goals will fulfill the statutory 
responsibilities Congress assigned to FHFA as conservator and 
also prepare the foundation for a new, stronger housing finance 
system. Although that future may not include Fannie and 
Freddie, at least as they are known today, this important work 
in conservatorship can be a lasting positive legacy for the 
country and its housing system. Properly implemented, we 
believe this strategic plan should benefit homeowners by 
ensuring continued emphasis on foreclosure prevention and 
credit availability, taxpayers by furthering efforts to limit 
losses from past activities while simplifying risk management 
and reducing future risk exposure, market participants by 
creating a path by which the Enterprises' role in the mortgage 
market is gradually reduced while maintaining market stability 
and liquidity, and finally for lawmakers by building a 
foundation on which you may develop new legal frameworks and 
institutional arrangements for a sound and resilient secondary 
mortgage market of the future.
    Thank you again for the opportunity to be here and I would 
be happy to answer any questions you may have about my 
testimony or about our strategic plan.
    Chairman Johnson. Thank you, Mr. DeMarco.
    Governor Duke, we have heard arguments that the market 
should be left to hit bottom. The Fed's white paper seems to 
indicate that there are barriers or frictions to the market 
healing itself. Governor Duke, can you discuss some of the 
barriers your staff has identified. Are there any risks to 
permitting housing prices to fall further?
    Ms. Duke. Thank you. Yes. The bulk of our work was on 
trying to identify barriers for the market to seek its own 
level. One of the most obvious signals is the difference in the 
rental market and the owner occupied market. Right now, you 
have prices falling and vacancies falling in the owner occupied 
market, and then you have lower vacancies and higher prices in 
the rental market, which indicates that the market wants to 
move housing from owner occupied to rental.
    Some of the frictions that are involved in this are 
difficulties in aggregating the properties together in getting 
the properties for rental, financing for these properties, and 
in some cases, regulatory barriers to facilitating a movement 
to rental in these properties. So that is why there is a strong 
discussion of REO to rental.
    Other barriers that we identified were barriers to 
refinancing, primarily loans that were underwater, high loan-
to-value loans, and so we discuss some of the changes that 
might be made in order to facilitate refinancing of those 
loans.
    Chairman Johnson. Mr. DeMarco, at our last housing hearing, 
Democrats, Republicans, and experts stated that there is more 
FHFA can do and should be doing to expand refinancing 
opportunities. Yes or no, will you act without delay to take 
additional steps to provide more Americans with the opportunity 
to refinance at historically low market rates? If so, what 
steps will you take?
    Mr. DeMarco. Mr. Chairman, I believe we have already taken 
those steps through the changes we announced to the HARP 
program in October. The program actually became effective in 
December and we are seeing just the first fruits of that. So if 
there are additional changes to the HARP program that anyone 
would like to suggest to us, I would be quite pleased to 
immediately take a look at it and see if we can implement them, 
if that is going to help further this process along. But I 
believe the steps we took in creating the HARP 2.0 program, if 
you will, was a very responsive and responsible set of actions 
and I am very encouraged by the early indications from the 
marketplace regarding this program.
    Chairman Johnson. Mr. DeMarco, your plan is currently a 
high-level document without much detail. You have indicated 
that you will be conducting additional analysis to implement 
the plan to contract the role of the GSEs. What is your time 
line for doing so? In this analysis, how will you account for 
factors that are important to the operations of a healthy 
secondary market?
    Mr. DeMarco. So, Mr. Chairman, you are right. What we sent 
up here was a strategic plan. It is meant to set the broad 
goals, the things that we want to achieve in this next period 
of conservatorship. Now that we have established those goals, 
the next step is to develop specific operating plans, to 
examine particular options for how we go about achieving those 
goals, and it is in that process that we will develop specific 
time lines with regard to particular actions.
    But I will say this, Mr. Chairman. You asked with regard to 
the second goal, the contracting. There are several things 
there that I would fully expect that during this calendar year, 
you are going to see activity from Fannie and Freddie in that 
regard. We have already begun with one, and that is raising 
guarantee fees. We have already had our first announcement of 
that, actually, the end of December, based upon the legislation 
Congress enacted. But we are also proceeding with both loss 
sharing as well as additional guarantee fee increases and 
looking to see if we cannot get some additional transactions in 
which private mortgage insurance companies start undertaking 
additional credit risks to the extent they have got the 
capacity to do so. I would like to see all of that begin this 
year.
    Chairman Johnson. Mr. DeMarco and Governor Duke--Mr. 
DeMarco, you have stated in your testimony that the secondary 
market for mortgages would not exist if not for the 
Enterprises. Could you state what might happen if the 
Enterprises' activities were to be terminated immediately? 
Governor Duke, could you also comment on this?
    Mr. DeMarco. Well, Secretary Donovan would certainly be a 
busy man.
    Chairman Johnson. Yes.
    Mr. DeMarco. In the absence of Fannie and Freddie, if we 
literally, Mr. Chairman, to your question, simply turned off 
the lights tonight and did not startup again, there is no 
immediate infrastructure for secondary market transactions 
outside of FHA and Ginnie Mae securitization. So it would take 
market participants a while to be able to step in and redo 
this. Certainly, some lending would go on. Banks would book 
some of this in portfolio. But I think the near-term impact 
would clearly be to constrain mortgage credit.
    Chairman Johnson. Governor Duke, could you also comment on 
this scenario?
    Ms. Duke. Well, first of all, I would agree with Mr. 
DeMarco. There would be much, much less lending going on. But I 
think for the private market to come in and take up that slack, 
to begin to do that lending, it is going to take a couple of 
things. It is going to take some certainty, some visibility as 
to what is going to happen to the mortgage market in the 
future, so some idea of what is going to happen ultimately to 
the GSEs because the investments in the infrastructure to do 
securitization, to do servicing, to do all the parts of the 
mortgage market are so large that it takes an understanding of 
what the future is going to be before anybody is going to be 
able to make those kinds of investments.
    Mr. DeMarco. If I might add, Mr. Chairman, I would strongly 
endorse that. I think that while--if I may go back to the 
previous question you asked me about contracting--these are 
things we can do at the margin to shift some amount of mortgage 
credit risk off of the balance sheet of Fannie and Freddie and, 
hence, away from the taxpayer. But fundamentally, Governor Duke 
is quite right. Market participants, if they are going to make 
a permanent and lasting investment in bearing mortgage credit 
risk, they are going to need much more long-term certainty 
about the role of the Government and what the institutional and 
legal arrangements are going to be. I very much agree with 
that.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Director DeMarco, your strategic plan, as I understand it, 
would shrink Fannie and Freddie's footprints in the marketplace 
and seek to establish a unified securitization platform. And it 
is my understanding that the actions would be designed to set 
the stage for broader housing finance reform.
    Mr. DeMarco. That is correct, Senator.
    Senator Shelby. Are there legal limits on how much the 
Federal Housing Finance Administration can reform the GSEs 
without further Congressional action? In other words, Congress 
has got to step in here, have they not?
    Mr. DeMarco. Yes, Senator Shelby, that is quite correct. We 
have no authority to alter the charters of Fannie Mae and 
Freddie Mac, nor do we actually have the authority to abolish 
those charters.
    Senator Shelby. Could you describe the legal limitations in 
this regard that Congress placed on the Director of the Federal 
Housing Finance Administration, which is you, relating to the 
approval of any business activity, such as principal write-
downs, so long as these institutions remain in conservatorship.
    Mr. DeMarco. So the way we interpret this is that Congress 
has given us a responsibility as conservator to preserve and 
conserve the assets of the company for the benefit of the 
company owners----
    Senator Shelby. To protect the taxpayer, right?
    Mr. DeMarco. Protect the taxpayers, yes, Senator, and that 
is what we are trying to do.
    Senator Shelby. If Congress enacts housing finance reform, 
which we desperately need, could such an action perhaps help 
the housing market recover by providing the legal certainty 
needed to attract private capital, which they are going to 
need? And if Congress continues to delay the needed reform, 
could this not continue to undermine the recovery of our 
housing market? How do you see that?
    Mr. DeMarco. I would concur with that view.
    Senator Shelby. That the sooner we do a comprehensive 
reform of Freddie and Fannie, the better off the taxpayer is 
going to be and the better off the housing market is going to 
be, is that----
    Mr. DeMarco. Yes, Senator.
    Senator Shelby. Thank you. In your running the Federal 
Housing Finance Administration, describe the risk and what it 
could ultimately mean to the taxpayers regarding human capital. 
In other words, how do you keep the human capital, the 
executives, the knowledgeable people that know these markets 
that help you preserve these entities and the taxpayers' risk 
here.
    Mr. DeMarco. Yes, Senator. This is actually, I believe, one 
of the key risks that FHFA faces as conservator, because what 
we have here is we have got two large, complex financial 
institutions, but they are operating with a great deal of 
uncertainty regarding their future. The Administration has made 
clear they want----
    Senator Shelby. What does that mean to personnel?
    Mr. DeMarco. It means that these folks do not know if the--
--
    Senator Shelby. I mean, you are in the market for high-
quality personnel, are you not?
    Mr. DeMarco. Yes, Senator, we certainly are, and the people 
working at these companies today do not know if that company is 
going to be there 2 years from now, 3 years from now, and so 
what is it that induces them to stay given that uncertainty? 
Certainly, as financial markets more generally recover, we are 
seeing pick-up in the labor market for this kind of talent, and 
so their opportunity to go work elsewhere continues to get 
better.
    Senator Shelby. Governor Duke, in your written testimony, 
you refer to the Fed's white paper on housing, quote, as a 
``staff paper,'' end quote. You also state that the paper, and 
I will quote you again, ``does not include recommendations for 
any specific policy actions.'' To be clear here in the 
Committee, it seems that the Fed is not making policy 
recommendations to Congress in its housing white paper, is that 
correct?
    Ms. Duke. That is correct.
    Senator Shelby. Did all the members of the Board of 
Governors, on which you serve as a Governor, approve the white 
paper, and if not, who did and who did not? Is that an internal 
matter or is that something you can supply to the Committee?
    Ms. Duke. I want to make sure I am correct, but I think 
that the members of the Board of Governors saw the white paper 
but did not vote on the white paper.
    Senator Shelby. OK. The Fed's white paper, among other 
things, discusses several ways to address the inventory of Real 
Estate Owned properties, REOs, and lays out options for the REO 
to rental program. Governor Duke, if the REO rental, Real 
Estate Owned, policies outlined in the white paper were to be 
adopted, how much faster will housing markets recover, in your 
judgment, and how long will it take them to recover in the 
absence of such policies? In other words, it seems like you 
have got to do something to move the market.
    Ms. Duke. I wish I could estimate the exact amount of time 
that it would take or how much difference this would make. We 
are beginning to see multifamily housing construction pick up 
in response to these market requests, so----
    Senator Shelby. Excuse me a moment. Now, we do not have 
many foreclosures, do we, with multifamily housing?
    Ms. Duke. I do not know how many foreclosures there are----
    Senator Shelby. We have had testimony here before this 
Committee that it was less than one-half of 1 percent. I do not 
know if that is correct. Mr. DeMarco might want to comment on 
it.
    Mr. DeMarco. That may be, Senator. Yes. It is certainly not 
anywhere near the proportion we are having with single family.
    Senator Shelby. But in multifamily housing, as a rule, 
people have to put more skin in the game, do they not, Mr. 
DeMarco? They have to pay down----
    Mr. DeMarco. Yes, Senator.
    Senator Shelby. ----with your loans. They have to put some 
money into the game, is that correct?
    Mr. DeMarco. Yes, Senator.
    Ms. Duke. But Senator, if I could----
    Senator Shelby. Governor Duke.
    Ms. Duke. My point was that an alternative to multifamily 
housing are portfolios of single-family housing that are 
offered for rental. But the difficulty there is that there has 
not historically been large-scale rental of single-family 
houses. So you do not have an infrastructure that is developed 
to manage them. You do not have the infrastructure for 
financing----
    Senator Shelby. Explain what you mean. Give us some 
examples here.
    Ms. Duke. Let us say you had a 100-unit apartment building 
or you had 100 single-family units that you were going to rent 
in a market area.
    Senator Shelby. You have got two different games there.
    Ms. Duke. Two different games. There is financing 
experience with the multifamily. There is not financing 
experience with the large number of single-family houses.
    Senator Shelby. So just to put foreclosed properties or 
inventoried properties out there, single houses, is a lot more 
difficult than it would be with somebody experienced in 
multifamily housing----
    Ms. Duke. Right. If somebody wanted to build a 100-unit 
apartment building, they could build it----
    Senator Shelby. Right----
    Ms. Duke. ----but if somebody wanted to acquire 100 
properties, one at a time, it gets very difficult. Now, the 
unfortunate truth is that there are a number of properties that 
exist that have been acquired within the GSEs, FHA, on bank 
books, with servicers, so those properties are already on the 
books of various entities, and so a mechanism where those 
properties can be acquired by investors would seem to be an 
alternative to multifamily housing.
    Senator Shelby. Has the Fed done an inventory on their 
portfolio, their securities and how many houses there are at 
risk?
    Ms. Duke. The Fed does not have a----
    Senator Shelby. And if not, why not?
    Ms. Duke. The Fed certainly does not have a large portfolio 
because we do not foreclose on houses. The securities that we 
own are agency securities, and so the houses that would be 
foreclosed on in those loans would be on the books of the GSEs, 
not on our books.
    Senator Shelby. They would have to handle it.
    Ms. Duke. Right.
    Senator Shelby. OK. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, Governor Duke and Director DeMarco.
    Director DeMarco, in response to a question I posed to your 
IG, he indicated that FHFA, in his words, quote, ``has too few 
examiners to ensure the efficiency and the effectiveness of its 
GSE oversight programs.'' You have repeatedly told us that your 
responsibility is to minimize losses to taxpayers, but if, 
according to your IG, you cannot ensure the effectiveness of 
your oversight program, how can you assure us that you are 
carrying out this duty to minimize taxpayer losses?
    Mr. DeMarco. The IG's report also points out that we have 
been undertaking a number of steps regarding both restructuring 
our organization regarding safety and soundness oversight and 
reallocating resources toward it and his report also commends 
us for those actions.
    I would point out that we recently hired a new head of 
Enterprise Regulation. It is actually a statutorily stipulated 
position at the agency. It is an individual that actually spent 
most of his career at the Federal Reserve System as a Senior 
Examiner and one of the most senior executives in supervision 
at the Fed. And we are continuing in the process of not just 
increasing our staffing levels with regard to supervision, but 
under this new Deputy Director's leadership, we are 
restructuring, reorganizing the deployment of those resources 
to be more effective in our supervisory oversight.
    Senator Reed. And how long has it taken to hire the 
individual and to begin to bulk up your resources?
    Mr. DeMarco. It took a fair amount of time to find the 
right person for this position, Senator, but he is on board now 
and we have hired--since the IG's report came out, we have 
hired over a dozen new examiners and that hiring process 
continues.
    Senator Reed. The IG also pointed out, in response to my 
question, that the FHFA, quote, ``trend of deference to the 
Enterprises, including a reliance on the determination of the 
Enterprises without independently testing and validating them. 
This largely hands-off approach to the conservatorships 
exacerbates FHFA's challenges in anticipating problems.'' Given 
your deferential approach, it appears from the IG, is it just 
business as usual back at Fannie and Freddie? And given the 
fact that until very recently you have not had a significant 
number of staff at a significantly high level to overtake your 
responsibilities, that you have not been able fully to 
guarantee that the taxpayer loss is being minimized?
    Mr. DeMarco. I do not believe that to be the case, Senator. 
We have over 500 very hard working people at the Federal 
Housing Finance Agency. I believe the IG and I have a somewhat 
different perspective on the degree of involvement FHFA shall 
have in the day-to-day business operations of Fannie Mae and 
Freddie Mac. Long before I became Acting Director, at the time 
the conservatorships were established, FHFA made clear that it 
was delegating day-to-day business operation decision making 
back to the companies with a set of stipulated goals and things 
that the Enterprises were supposed to accomplish in 
conservatorship. We have reconstituted new Boards of Directors 
in order to assist FHFA in ensuring that these companies 
operated with proper internal controls and governance 
processes. That, to me, is part of conserving the value in 
these entities for lawmakers to ultimately dispose of.
    But I believe that in all critical matters where there is a 
question about the appropriateness of an action or a decision 
for the conservatorships, I am in close communication and 
discussions with the companies regarding such matters.
    Senator Reed. Have you directed Fannie or Freddie or both 
to independently conduct an evaluation of the pros and cons of 
principal reduction as a way to, hopefully, in the long run, 
enhance the value of their franchises?
    Mr. DeMarco. Both companies have been reviewing principal 
forgiveness alternatives. Both have advised me that they do not 
believe it is in the best interest of the companies to do so. 
But as you know, Senator, FHFA has done a great deal of 
independent review itself of this important matter because I 
believe that assuring that we are taking appropriate steps to 
provide assistance to troubled borrowers is very much at the 
heart of what we are trying to do, but we need to do so in a 
way in which we are meeting our mandate to protect the 
taxpayers.
    Senator Reed. Have you personally reviewed the independent 
analysis that Fannie and Freddie have done?
    Mr. DeMarco. I have met with and been briefed by both 
companies on this and I have certainly reviewed all the work 
that my staff has done on multiple occasions, which I have 
shared with the Congress.
    Senator Reed. Do you review the SEC filings that Fannie and 
Freddie make?
    Mr. DeMarco. Senator, I have drafts of them before they go 
up, so I have an opportunity to see them, yes. But those 
filings are the responsibility of the companies.
    Senator Reed. But you are the conservator. You are 
representing the Federal Government in everything that they do 
or fail to do. And again, you simply allow deference to what 
they decide? You review the drafts and--have you ever made any 
comments or changes in their SEC filings?
    Mr. DeMarco. We have made some observations to them about 
their SEC filings. But even in conservatorship, Senator, these 
companies remain private companies with responsibilities under 
the securities laws for the filings that are submitted, and the 
individual executives at those companies that have to sign 
those filings are subject to all of the legal responsibilities 
and potential penalties that other private firms are when they 
do securities filings, Senator.
    Senator Reed. But----
    Mr. DeMarco. That is part of being in conservatorship.
    Senator Reed. As conservator, you feel no responsibility 
similarly?
    Mr. DeMarco. Senator, I do not share the responsibility 
under the Sarbanes-Oxley Act for the filing of those documents. 
The executives of the companies do.
    Senator Reed. Can you assure us that you believe there are 
no material misstatements or material omissions in those 
statements?
    Mr. DeMarco. We would certainly be concerned about such 
things, Senator, and we would have responsibilities both as 
conservator and as regulator for that and would execute that 
appropriately both in terms of our oversight of the companies 
and in terms of our interactions with the Securities and 
Exchange Commission.
    Senator Reed. So the answer is you have no concerns.
    Mr. DeMarco. That is correct, Senator. I have not raised 
any concern with the filings that have been done while they 
have been in conservatorship.
    Senator Reed. Thank you.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman.
    Governor Duke, I appreciate your testimony, talking about 
the fact that the lack of knowledge about what is going to 
happen, whether GSEs continue to keep the private market off 
balance and not knowing what to do. Let me ask you, the $25 
billion settlement that just occurred where--I think a lot of 
people think this is coming out of the hides of the servicers, 
but actually, they can cram down mortgage investors and get 
credit for that, which is pretty unique and I do not think most 
Americans understand that is what is really happening, but let 
me just ask you this. Would that also potentially create some 
lack of consistency and concern about the private sector being 
involved in buying mortgages when these types of things can 
happen and the mortgage investor had nothing whatsoever to do 
with what happened but was just trying to play a role in 
financing housing with no underwriting themselves?
    Ms. Duke. I think mortgage investors are certainly going to 
be interested in all the ways that they can recover the money 
that they have loaned and ways that they would not recover that 
money. One thing, though, that the settlement does do is remove 
an uncertainty, and it is these various uncertainties that are 
out there about what is going to happen in the mortgage 
servicing settlement and what is happening with mortgage 
servicing standards. And so with that information, then various 
market participants will decide either to invest in mortgages, 
to invest in servicing and origination platforms, and what they 
are going to do in that market.
    Senator Corker. But it just continues the lack of knowledge 
of knowing that settlements can occur that affect them that 
they had nothing to do with. We just continue down this path of 
Government getting involved in areas, breaking rationality and 
creating issues. I appreciate you saying what you just said.
    I would ask--and I am going to move on to Mr. DeMarco--I 
know you wrote a white paper on housing and I know it met with 
a degree of criticism. But I would appreciate if you guys would 
write a white paper on financial reform as it is taking place 
and share with us the pros and negatives that you are seeing 
there. I would ask for you to commit to that and maybe send 
something up to us, giving some editorial comments about 
something that is actually in your central core area. That 
would be great to hear.
    Ms. Duke. I think as financial reform gets implemented, one 
of the things we will be following very closely is what are the 
effects of that financial reform, and as we get that 
information, yes, we would be happy to share it with you.
    Senator Corker. So you do not have input now?
    Ms. Duke. We have input now, but we are still developing 
the regulations, and so we are trying--as we develop the 
regulations, we are absolutely looking at ways that they will 
impact the market and ways that they will impact the financial 
system. But I think, further, after all of the regulations are 
implemented, it is going to be important to then test the 
assumptions of what you expected to happen and----
    Senator Corker. If you could do those on an interim basis 
before this is all done over the next 3 years, it would be 
helpful. But again, I appreciate your testimony about the lack 
of consistency out there in the private side.
    Mr. DeMarco, I just want to tell you, you guys have to go 
back and just laugh. Here you have tried to lay something out 
to begin the process of doing something with GSEs, lay out a 
strategic paper that I think has been met widely as a good 
step, and here Congress up here has not done a single thing, is 
totally feckless--feckless--as it relates to these issues. The 
Administration has done nothing except sending a multiple 
choice plan up here that, you know, you can choose, each of 
which is very different than the other.
    What is it like to be out there, a person who basically is 
there to serve the taxpayers, has done a good job at doing 
that, is trying to move things ahead, and to have people up 
here criticize you when they themselves do not have the 
courage, the will, the desire to address these issues?
    Mr. DeMarco. There is a lot of conflict in this job and a 
lot of balancing, and you are quite right, Senator. There 
appears to be a lot of criticism.
    Senator Corker. So what do you think it is? I mean, I think 
most Americans would love to see us deal with the GSEs. I think 
if you did a poll nationally, people would really love to see 
us move back to the private sector being more involved. What is 
it about Congress, do you think, that likes to instead have an 
entity like this that they can play with and have principal 
reductions and serve the social purposes that they would like 
to see that are really outside the norms of the housing 
industry? What is it about a body like ours, do you think, that 
causes us to want to do that?
    Mr. DeMarco. Well, there is something about the structure 
of Congress chartering companies like this, giving it certain 
benefits unavailable to other market participants, that 
certainly Congress is then going to want something in return 
for all those favors. And that goes back well before 
conservatorship, Senator. For many, many years, Fannie Mae and 
Freddie Mac operated in a very unique place in our financial 
system and were viewed very uniquely by Congress and it 
affected in an adverse way the ability to have appropriate 
oversight of them, and it certainly has politicized housing and 
housing finance to a very troubling degree.
    Senator Corker. I know that you have to be diplomatic in 
your approach, and I appreciate the way you handle yourself and 
I certainly appreciate you taking the first steps, but I will 
tell you, if I were in your position and I had any criticism 
whatsoever from Congress about what you were doing, I would ask 
them to lay out their plan. And obviously, we have no plan. We 
like to criticize. I thank you for your leadership. I hope at 
some point Congress will do its job and reform these entities 
that I think every American--most every American, except for 
those who serve in Congress--would like to see reformed. I 
thank you for your service.
    Mr. DeMarco. Thank you, Senator. When the Congress is 
ready, we are sure ready to work with them.
    Senator Corker. Thank you.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Well, let us see if we can get some things that Congress 
and you can agree on. For starters, would you agree that if we 
have a foreclosure, on average--I know there is a Freddie Mac 
study, but maybe you have a different study--that says the loss 
in foreclosure is, on average, about $60,000?
    Mr. DeMarco. That sounds ballpark.
    Senator Menendez. OK. So if we can either conserve the--as 
I look at the law and think about how do we preserve and 
conserve FHFA to minimize losses on behalf of taxpayers, we can 
either preserve that loss either by proceeding to foreclosure, 
which has a $60,000 loss, or we might very well be able to look 
at principal reduction at the end of the day if it is somewhere 
at least in that ballpark.
    And so it seems to me that what we get, however, in 
principal reduction is a homeowner who continues to stay in 
that home instead of become a vacant property, a homeowner who 
can under that guise be a responsible borrower, a homeowner who 
is paying taxes on a ratable base and not creating a ripple 
effect on the community in which multiple foreclosed homes 
create depressed values for the community in general, and the 
savings that takes place in not having to take that property 
and go through our present challenges on the REO to move it so 
that we can get this housing market to move.
    If that is the case, then why is it that you have taken the 
view that principal reduction is not within the domain of the 
possibility of what you can do under the law, because it would 
preserve and conserve just as well, certainly in that universe, 
as a foreclosure, and it would also meet under the Emergency 
Economic Stabilization Act the other goal that you have, which 
is a responsibility to implement a plan that seeks to maximize 
assistance for homeowners.
    Mr. DeMarco. So, Senator, I have not said that we do not 
have the legal authority to reduce principal. And in the spirit 
of your question, which is let us find things we can agree on, 
there is much that we do agree on here, Senator. We agree that 
foreclosure----
    Senator Menendez. Well, I was listening to Senator Corker 
and you and I thought there was nothing we agreed on, so that 
is why I wanted to----
    Mr. DeMarco. Well, I will be happy to clear that up----
    Senator Menendez. OK.
    Mr. DeMarco. ----because, Senator, there is much that we 
agree on, specifically in the context of your question. 
Foreclosure is the worst possible outcome in almost all 
instances. It is the most costly. It is the most devastating to 
the family. It is most devastating to the neighborhood and 
surrounding community. And we have a responsibility to make all 
prudent actions to find a remedy to a troubled borrower short 
of foreclosure because of these costs. So we agree there.
    We also agree that if a borrower is committed to their home 
and perhaps has had a change in circumstances where they have 
more limited ability to make their mortgage payment, that as 
one of the approaches to trying to avoid foreclosure, this 
borrower should be offered an opportunity to have their loan 
restructured in a way that is affordable to them. And we have 
taken a great leadership role at FHFA and through Fannie and 
Freddie to ensure that borrowers get this opportunity.
    And I would like to expand on this, because this is very 
important for everybody to understand. What we did in the 
Servicing Alignment Initiative is we made clear in terms of 
aligning Fannie and Freddie's instructions to mortgage 
servicers that as soon as a borrower goes delinquent, that is 
the time to get a hold of the borrower, find out what the 
problem is, and develop quickly an appropriate response to that 
borrower's condition. If it is just a very limited short-term 
thing, then it is a pretty simple thing to handle. If it has 
been a permanent decline in the financial circumstances of the 
family, then it might require something different, like a loan 
modification.
    But we are doing that, Senator, and we are doing that 
aggressively. We are outpacing the market, as my testimony 
shows, with regard to the amount of that activity that we are 
doing----
    Senator Menendez. I do not want to cut you short, but my 
time is going to expire----
    Mr. DeMarco. You have asked about----
    Senator Menendez. Can you get to the point about principal 
reduction for me----
    Mr. DeMarco. Yes----
    Senator Menendez. ----and then I have one other quick 
question.
    Mr. DeMarco. Yes, I will, Senator. So to understand 
principal reduction, here is how this works, because there has 
certainly been a lot of attention focused on us on this issue. 
Principal reduction alternative in the HAMP modification 
program is the fourth tool for how to provide assistance to a 
troubled borrower to make good on their mortgage. HAMP gets--in 
all of these HAMP modifications, the objective is to get 
something to--get the borrower to an affordable payment, and it 
defines affordable payment as 31 percent of their monthly 
income would go to their mortgage. That is the target when you 
are doing a loan modification in HAMP, is to get to a 31 
percent payment. That can be done by reducing the interest 
rate. It can be done by extending the term of the loan. It can 
be done by forbearing on the underwater portion of principal. 
Or it can be done by principal forgiveness. So these are four 
tools, using Secretary Donovan's description, in the tool kit 
for loan modifications.
    What FHFA has consistently found in its analysis is that 
the first three of those tools work better than the fourth one 
with regard to our fundamental mandate of preserving and 
conserving, and I think it would be helpful to understand 
principal forbearance and why that is the case, because it 
actually----
    Senator Menendez. No, I understand what principal 
forbearance is----
    Mr. DeMarco. But, Senator----
    Senator Menendez. You put it at the back end of the loans--
--
    Mr. DeMarco. Well, but it works very much in accord with 
the spirit of your proposal, Senator, about shared 
appreciation, because it takes that underwater--it takes the 
underwater portion of the principal, sets it aside and says, we 
are not going to focus on that. We are going to focus on 
getting you, the borrower, into an affordable payment. You pay 
that and this underwater portion is going to sit over here to 
the side, and if you are successful, then we are all going to 
share in your success.
    Senator Menendez. Well, let me ask you this question and 
then I will yield. We have a disagreement, obviously, in that 
respect.
    Mr. DeMarco. Mm-hmm.
    Senator Menendez. I think there is a fundamental difference 
that when the marketplace on the private sector is looking at 
20 percent of its portfolios and saying it makes sense for us 
in the marketplace to do so, and they certainly want to 
preserve their assets as much as possible as you do as a 
conservator, but I get concerned about this issues on principal 
reduction, looking at these other issues, because I look at the 
stories that came out about Freddie making investments that 
paid off in the event that homeowners are kept in higher-cost 
loans. And I would assume that they would not make those bets 
if at the end of the day they were not hopeful that the bet 
would pay off.
    And so it seems to me, is that leading--do you believe that 
that has influenced Freddie's policies that discourage 
refinancing for homeowners, because if your bet is that you are 
going to keep homeowners in the higher rate, then, in fact, why 
would you make that bet when you can--you would hope to win 
that bet, and when you can influence that bet at the end of the 
day by not permitting refinancing, principal reduction, and 
other elements to take place.
    Mr. DeMarco. Senator, there is no betting going on here. 
When someone makes a mortgage to a borrower, right, let us say 
that mortgage is made at 6 percent. If the mortgage rates then 
subsequently go down to 4 percent, then the holder of that 
mortgage knows that they have got the risk the borrower is 
going to exercise their right to refinance that mortgage and, 
hence, they are going to get their money back faster than they 
expected and then they are going to have to reinvest it, if 
they are going to stay in mortgages, they are going to have to 
reinvest it at lower mortgage rates. If interest rates go from 
6 percent to 8 percent, right, then the borrower--the investors 
holding this 6 percent----
    Senator Menendez. Are you telling me Freddie did not make 
investments----
    Mr. DeMarco. I am saying----
    Senator Menendez. ----I called them bets, but they made 
investments in saying that the consumers would--that it would 
pay off in the event that homeowners were kept in higher-cost 
loans. Why would they do that?
    Mr. DeMarco. I am saying, Senator, anybody that is holding 
a premium mortgage in this mortgage environment has an 
investment----
    Senator Menendez. Your staff is shaking their head behind 
you. Maybe you can explain what she is shaking her head about.
    Mr. DeMarco. Do I need to consult--all right. So anyone 
that is holding a 6-percent mortgage in a 4-percent mortgage 
environment, Senator, is holding an investment by which if the 
borrower refinances, they are going to get their money back and 
have to reinvest at a lower rate. This is not a bet against the 
homeowner.
    Senator Menendez. I do not think Freddie would take its 
money and make investment decisions and say, let me invest to 
ensure that at the end of the day, I am going to have a 
positive result in my investment, and the only way I have a 
positive result in my investment is if the mortgage borrower is 
kept in a higher rate. I just find that ethically troubling, to 
say the least.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thanks, Mr. Chairman. I would like to thank 
our witnesses for joining us today.
    I just want to briefly follow up on a comment or line of 
questioning that Senator Corker raised, which, I guess from my 
point of view, had to do with the impact on the private 
market's ability to provide mortgage financing, especially 
after this settlement has demonstrated the fact that the 
Government can come along and change the value of a contract 
that you have pretty much as it sees fit. Frankly, I worry 
about how much more it is going to cost homeowners to be able 
to finance their mortgages in light of that. But that is not 
what I actually wanted to talk to you about, and I would like 
to direct my questions to Mr. DeMarco.
    First, I have a copy here of a cover letter that you sent 
to Representative Elijah Cummings, and it is dated January 20. 
And in it, you stated that the FHFA has essentially three 
principal mandates, the first of which is a statutory 
responsibility as conservator to preserve and conserve the 
assets and property of the regulated entities. Is this not a 
way of saying to protect taxpayers? Is that not----
    Mr. DeMarco. Yes, Senator.
    Senator Toomey. You go on--now, you mentioned the other two 
mandates, and then you have a discussion in the next paragraph 
that--and you state right here, you did not conclude that 
principal reduction never serves the long-term interests of the 
taxpayer when compared to forbearance. But you did compare, as 
I understand it from your letter, the relative cost to 
taxpayers, and your conclusion, as I read it here, is that by 
avoiding the principal forgiveness, the net effect is a smaller 
loss to taxpayers. Is that a fair way to characterize this?
    Mr. DeMarco. Yes, Senator.
    Senator Toomey. You go on to then quantify what it would 
cost in this letter if the FHA set out to actually provide the 
principal forgiveness that would be enough to diminish the 
value of mortgages to make them equivalent to the value of 
homes, and you estimate that that would cost almost $100 
billion and that that would and this is your language--you say, 
this would be in addition to the credit losses both Enterprises 
are currently experiencing. So that is a lot of additional cost 
to taxpayers, right?
    Mr. DeMarco. Yes, Senator.
    Senator Toomey. And then, last, you have a discussion about 
this fact that I do not think has been discussed as much as it 
ought to be, namely that nearly 80 percent of Enterprise 
underwater borrowers are current on their mortgage. And, in 
fact, those who have a loan-to-value ratio above 115 percent 
are 74 percent current, which seems to me to present a real 
dilemma of how you would go about doing this.
    For instance, if you provided principal forgiveness for 
everybody who was underwater, you would be asking taxpayers to 
pick up the tab for people who are actually clearly 
demonstrating that they are capable of making the payments for 
the loan that they chose to take. If you did not and you said, 
no, it is only the people who are not making payments, why, 
then how fair would that be to the people who are making 
payments, and would that not create an incentive for people who 
are currently making payments to stop? Is that not a pretty 
tough dilemma?
    Mr. DeMarco. I think that says it quite well, Senator. I 
think that one of the under-reported things here is that while 
this country has many borrowers with mortgages that are 
underwater, the vast majority of them are making their payment 
every month, and they must wonder about some of these 
discussions we are having.
    Senator Toomey. And then I will conclude on this, Mr. 
Chairman. In the next paragraph, you say, ``given that any 
money spent on this endeavor,'' and by that you are referring 
to principal reductions, ``would ultimately come from 
taxpayers, and given that our analysis does not indicate a 
preservation of assets for Fannie and Freddie substantial 
enough to offset the costs, an expenditure of this nature would 
at this time, in my judgment''--that is you talking--``require 
Congressional action.''
    I just want to say I share that view. I commend you for 
taking that view and I want to recognize that you have been 
under a lot of pressure to change that view and I hope you will 
not change it. I hope you will stick to that view because I 
think that is the correct view.
    Mr. DeMarco. Thank you, Senator.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you to the 
panel for your testimony.
    One of the things that I found very interesting recently 
was the article in American Banker, ``Why FHFA is Wrong On 
Principal Forgiveness,'' and I am sure you have had a chance to 
read that article as it has been widely discussed. And 
essentially, the author, Kevin Wack, says that in the third 
quarter of 2011, I believe it was 18 percent of bank 
modifications involved principal reduction and he raises the 
question why it is that for-profit institutions are doing 
nearly a fifth of their loans with principal reduction and 
finding that that is the most cost effective way to their 
profits but you have not found any similar results. And I do 
want you to give brief responses so that we can actually have a 
bit of a dialog over several issues.
    Mr. DeMarco. A number of these institutions have purchased 
these mortgages at a discount. They have bought them at a price 
at which doing the principal forgiveness was not something 
where they were taking a loss by doing so.
    Senator Merkley. Well, fair enough, but no matter what you 
paid for it, the alternative of the strategies that you use 
with the individual would still be the same range of options 
that you have if you had paid a lot more for the loan. So in 
that context, your logic does not hold, and do you want to 
further try some other argument?
    Mr. DeMarco. No. I am comfortable with where I have left 
it.
    Senator Merkley. OK. You provided the six-page report to 
the House, and I believe Representative Cummings has said, 
really, on such a major issue, you ought to provide the full 
analysis and they have asked you to do so by February 29. Do 
you intend to make public the full analysis?
    Mr. DeMarco. I provided Representative Cummings and others 
with the full three different analyses that we had done on this 
issue and he has come back with some follow-up questions and 
asked for yet additional information and we are working on 
that.
    Senator Merkley. So does that meet his request for the 
February 29, or----
    Mr. DeMarco. I will not have additional information 
tomorrow for him.
    Senator Merkley. One of the notes has been that your 
analysis did not make one of the most fundamental distinctions, 
that is, between folks who have mortgage insurance and people 
who do not have mortgage insurance. Obviously, that has a huge 
bearing on the net present value impact. Why was such a 
fundamental distinction not analyzed or not laid out, at least 
in what you presented to Congress?
    Mr. DeMarco. Because we were able to reach the conclusion 
about principal forgiveness without going to that point. But if 
we want to go there, that is quite right. Another issue with 
principal forgiveness is that I am then putting the taxpayer, 
jumping them ahead of the mortgage insurance company who is in 
the first loss position on this mortgage. I would say the same 
thing holds for any second liens that might exist on this 
mortgage. So this is reorienting the priority of loss 
absorption that is part of the structure that is in place 
today. But we have not had to go to that issue with regard to 
the analysis that we have done.
    Senator Merkley. Other observers have noted that in your 
analysis, you did not look at the shared appreciation model, 
which actually is forgiveness plus funds that come back to the 
originator which changes the net present value calculation. So 
you gain the advantages of people having lower monthly 
payments, therefore, less likely to strategically default, less 
likely to financially default, and yet there is a back-end 
funds that return. Do you intend to--you actually mentioned 
shared appreciation earlier. Do you intend to do an analysis of 
that, and if you have not already done it, why not?
    Mr. DeMarco. Shared appreciation mortgages are complex 
instruments that are not widely articulated in the marketplace. 
What I was trying to convey to Senator Menendez is that 
principal forbearance modifications, which we are doing and we 
are doing a lot of them, are effectively principal forgiveness 
with a shared appreciation on the mortgage attached to it. It 
is economically approximately the same thing. So we are, in 
fact, doing that now, Senator.
    Senator Merkley. OK. I did not see that in the analysis you 
presented to Congress. Do you intend to provide that analysis 
to us?
    Mr. DeMarco. I believe I will try to articulate this more 
clearly in our next round of discussions regarding principal 
forgiveness.
    Senator Merkley. OK. One of the things that was disturbing 
to folks across the country is when you said in October you had 
not met any homeowner who has suffered a foreclosure. Have you 
had a chance to actually talk to homeowners in the real 
marketplace since October?
    Mr. DeMarco. You know, Senator, I do know families that 
have suffered foreclosures and I believe that my--people I know 
personally, things in my personal life really are not relevant 
to the realm of this because I believe my responsibility goes 
to analyzing the law, analyzing the options that are available 
to us, and proceeding.
    I will say something I have done since that time, Senator, 
that you may find meaningful in this regard. In December, I 
went up to the city of Baltimore and I met with people from the 
Baltimore City Housing, the Maryland State Housing Finance 
Agency, and a local community bank there as well as some 
community activists and had a lengthy discussion about the 
impact of the housing crisis in Baltimore. We took a tour of 
several neighborhoods, some of which one might call--for which 
this housing crisis has been very damaging. And we have talked 
about what happened. We have talked about demographic issues. 
We talked about alternatives for trying to generate recovery in 
those neighborhoods.
    I take this seriously, Senator, that we have communities 
and families across the country that have been greatly harmed 
by this, and FHFA is trying very hard to be part of bringing 
some solutions and stability back to this. But I will do so in 
a disciplined way following the mandate that I believe Congress 
has given us.
    Senator Merkley. I believe what you just said is that you 
are correcting the record from your October statement, or were 
you misquoted in October?
    Mr. DeMarco. I was not misquoted. That is what I had told 
the Congresswoman. I thought she meant it in the form of as 
part of my work effort, had I been going out and meeting with 
foreclosed homeowners.
    Senator Merkley. Well, I applaud what you did in Baltimore 
because I think actually seeing communities on the ground gives 
one an understanding that analysis and ivory towers do not 
gain. I think you would be hard pressed to find a street in a 
working class community like the one I live in that does not 
have one or two families on it that are foreclosed on. I mean, 
the impact is very real, very evident, the destruction of 
families' dreams, the destruction of their finances. I applaud 
you for going to Baltimore and doing what you can to kind of 
see the real impact on the ground. Thank you.
    Chairman Johnson. I would like to thank Governor Duke and 
Mr. DeMarco as well as Secretary Donovan for being here with us 
today.
    This hearing has provided this Committee important insight 
toward achieving realistic solutions to many of the problems 
confronting the housing market. Stabilizing this market remains 
a top priority of this Committee and I will continue to work to 
find bipartisan consensus to achieve it.
    This hearing is adjourned.
    [Whereupon, at 12:34 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
    I thank our witnesses for joining us. Today's hearing is part two 
of our examination of the state of the housing market and steps that 
can be taken in the near term to remove housing market barriers to 
economic recovery.
    This Committee has undertaken a bipartisan, in-depth look at long-
term housing finance reform. I hope to continue this effort with 
additional hearings and by working with Ranking Member Shelby and 
Committee Members to seek bipartisan consensus. In today's hearing, we 
will focus on the immediate problems confronting the housing market and 
the larger economy, which is a critical first step in finding a long-
term solution.
    In January, the Federal Reserve released a white paper entitled 
``The U.S. Housing Market: Current Conditions and Policy 
Considerations.'' In this paper, the Fed stated that ``continued 
weakness in the housing market poses a significant barrier to a more 
vigorous economic recovery.''
    As I stated during our February 9th hearing on this topic, I share 
the concern that ongoing challenges in the housing market are acting as 
a drag on economic recovery. I want to find practical solutions to help 
overcome them.
    Today's hearing provides a good opportunity to discuss the current 
housing market environment with regulators and the Administration's top 
housing official. I would like to hear from our witnesses about 
potential solutions, both legislative and administrative.
    In addition to the Federal Reserve's recent white paper, other 
analysts, regulators, and the Administration have offered up options 
and proposals to address barriers to housing and economic recovery. 
Earlier this month, the Administration outlined a new Housing Plan to 
give more families the opportunity to refinance at today's low rates. 
Just yesterday, the Federal Housing Finance Agency announced its first 
pilot sale in an Initiative to address the large volume of Real Estate 
Owned properties held by the Government-Sponsored Enterprises.
    At our February 9th hearing, the witnesses and a number of 
Committee Members on both sides of the aisle cited helping families 
refinance at today's low interest rates as a powerful example of an 
action that would help bolster the housing market and stabilize housing 
prices. This is particularly true for mortgages held by the GSEs. I 
would like to see the FHFA take additional steps to facilitate 
refinancing for families currently stuck in higher-interest mortgages 
held by Fannie and Freddie. I look forward to hearing more from Acting 
Director DeMarco on steps that FHFA is planning to take to speed these 
refinancings.
    Without a robust housing market recovery, our economy will continue 
to drag and millions of Americans will continue to struggle to make 
ends meet. I look forward to continuing to work with our witnesses and 
Members of the Committee to find workable solutions to improve the 
housing market and lead us further down the road to prosperity.
                                 ______
                                 
                  PREPARED STATEMENT OF SHAUN DONOVAN
         Secretary, Department of Housing and Urban Development
                           February 28, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for this opportunity to testify about how the 
Administration's housing initiatives are helping remove barriers to 
economic recovery. This hearing comes at an important moment--a moment 
President Obama described in his State of the Union as ``a make or 
break moment for the middle class and those trying to reach it.'' In 
that address, he said that what's at stake is the survival of the basic 
American promise--the idea that if you work hard, you can do well 
enough to raise a family, own a home, and put a little away for 
retirement.
    Mr. Chairman, I couldn't agree more. As the President said, the 
defining issue of our time is how to keep that promise alive--to build 
a Nation where everyone gets a fair shot, everyone does their fair 
share, and everyone plays by the same rules. And nowhere is that 
challenge clearer than in the homes where we live--from when we buy a 
home--and make the biggest financial decision of our lifetimes--to our 
ability to refinance that loan, to the way banks treat us as customers 
should we ever lose a job or experience a medical crisis that puts our 
homes at risk.
    Indeed, as this Committee knows well, too often in the years 
leading up to the crisis, mortgages were sold to people who couldn't 
afford or understand them. Banks made huge bets and bonuses with other 
people's money. The resulting recession cost more than 8 million jobs 
and our economy and the world plunged into a crisis from which we are 
still recovering.
    Thanks in part to the partnership of this Committee, today we face 
a very different environment than the one we faced when President Obama 
took office. Back in January 2009, America's economy was shed 818,000 
jobs alone. Housing prices had fallen for thirty straight months. And 
foreclosures were surging to record levels month after month after 
month.
    Today, because the Obama administration moved to keep interest 
rates low and restore confidence in Fannie Mae, Freddie Mac, and the 
Federal Housing Administration, more than 13 million homeowners have 
refinanced their mortgages since April 2009--putting nearly $22 billion 
a year in real savings into the hands of American families and into our 
economy.
    Today, because we provided a range of solutions to responsible 
families fighting to hold on to their homes, more than 5.6 million 
families have been able to reduce their payments and modify their loans 
to more sustainable terms and foreclosure notices are down nearly 50 
percent since early 2009. Because we provided resources for communities 
struggling with concentrated foreclosures, today we are on track to 
help them fund better uses for almost 100,000 vacant and abandoned 
properties through our Neighborhood Stabilization Program. Most 
important of all, because of our commitment to economic growth and 
recover, our economy has added private sector jobs for 23 straight 
months, totaling 3.7 million jobs.
    Mr. Chairman, this represents important progress. But we know there 
is much more to be done. Three key barriers prevent our housing 
market--and our economy--from fully recovering.
    While the number of homeowners at risk of losing their home is down 
significantly, there are still too many families that face hardships 
and are underwater--and their unaffordable monthly payments put them at 
an increased risk of default, dragging down markets, reducing labor 
mobility and consumer spending alike.
    While targeted support to markets struggling with foreclosures, 
blight and abandonment has reduced vacancy rates, increased home prices 
and shrunk the inventory of homes for sale, an overhang of properties 
at risk of or in foreclosure continues to drag down property values and 
harm the hardest-hit communities.
    While we put an end to the worst abuses that caused this crisis and 
stabilized the market, it is too difficult to get a mortgage today--
largely because of uncertainty over making loans attributable to lack 
of clarity around mortgage servicing, and continued market volatility.
    And so today, I want to talk about the new tools we are providing 
to overcome these three key barriers--keeping people in their homes, 
the shadow inventory and access to credit--and the steps we still need 
to take to move forward.
Relief for Responsible Homeowners, Keeping People in Their Homes
    First and foremost, we needed to ramp up our efforts to keep people 
in their homes and provide relief for homeowners who've done the 
responsible thing time every month when that mortgage bill arrives in 
their mailbox.
    Mr. Chairman, millions of responsible homeowners who are current on 
their mortgages and could benefit from today's low interest rates face 
substantial barriers to refinancing through no fault of their own. 
Sometimes homeowners with good credit and clean payment histories are 
rejected because their mortgages are underwater. In the end, these 
responsible homeowners are stuck paying higher interest rates, costing 
them thousands of dollars a year.
    Indeed, as economist Mark Zandi said, ``There is no better way to 
quickly buoy hard-pressed homeowners than helping them take advantage 
of the currently record low fixed mortgage rates and significantly 
reduce their monthly mortgage payments.''
    That's why, on February 1st, President Obama announced a package of 
administrative actions and legislative proposals to help responsible 
homeowners save thousands of dollars through refinancing. Under his 
proposal, borrowers with loans insured by Fannie Mae or Freddie Mac 
(GSE-insured loans) would have access to streamlined refinancing 
through the GSEs. Borrowers with FHA insured loans will be able to take 
advantage of an enhanced FHA streamline refinance program. And 
borrowers whose loans are held by private banks or are securitized in 
private label securities would have access to refinancing through a 
new, low-cost, streamlined refinance program that would be facilitated 
by the FHA.
    Allow me to explain each of these efforts in detail.
Refinance Assistance for Borrowers With GSE Loans--HARP 2.0
    In his jobs speech to Congress last September, President Obama 
charged HUD and Treasury to work with the Federal Housing Finance 
Agency to lower barriers to refinancing. Following weeks of intensive 
discussions with lenders, mortgage insurers, regulators, and investors, 
FHFA announced changes to help borrowers whose loans were purchased or 
guaranteed by Fannie Mae or Freddie Mac and who are located in areas 
suffering from house price declines.
    With the Administration's Home Affordable Refinancing Program 
previously limiting refinancing to borrowers with high loan-to-value 
ratios (LTVs) of 125 percent and responsible for less than a million 
refinances, the need to pick up the pace was clear. Announced in 
October 2011, HARP 2.0 eliminates the LTV ceiling, reduces certain 
risk-based loan-level guarantee fees (also referred to as loan level 
pricing adjustments, or LLPAs), extends the program's end date to 
December 2013, streamlines automated valuation model (AVM) coverage and 
foregoes appraisal requirement when AVM is available, and provides 
representations and warranties relief.
    Eliminating the LTV cap will allow those GSE borrowers who have 
been responsible in paying their mortgage, but happen to be deeply 
underwater, the opportunity to take advantage of unprecedented mortgage 
interest rates. The extension of the program for 2 years will allow 
lenders to hire staff and upgrade systems to assure all eligible 
borrowers will have the opportunity to take advantage of the HARP 
program. It will minimize the amount of funds borrowers would be 
required to obtain for a refinance because the GSEs reduce the fees 
that borrowers have to pay on 30-year fixed rate loans with an LTV over 
80 percent from 2 percent to .75 percent of the loan amount. And by 
ensuring that the GSEs do not require the HARP originator to take 
responsibility for the quality of the loan that is being refinanced, it 
will expand the universe of responsible borrowers to whom they offer 
the refinancing option.
    In addition to these changes, the Administration continues to work 
with FHFA on ways to increase uptake. Specifically, the Administration 
is evaluating automated valuation models as approval alternatives to 
manual appraisals, removing operational barriers that preclude or 
hinder cross-servicer refinances, and seeking to extend HARP 2.0 to 
those borrowers with LTVs under 80 percent so that more responsible, 
current homeowners have the opportunity to refinance.
    We expect most lenders will have their HARP 2.0 operations fully up 
and running by the end of March. These changes have met with a very 
positive response from homeowners. Already, according to an informal 
survey almost 300,000 families have filed applications for refinancing 
and stand to save on average $2,500 per year--the equivalent of a 
pretty good-sized tax cut--speeding our efforts to help responsible 
families stay in their homes and start to rebuild the wealth they lost 
in the economic crisis.
    We look forward to working with Congress to further reduce the 
barriers to refinancing under HARP 2.0, including easing costs 
associated with mortgages that have greater equity than 80 percent, 
easing underwriting standards, and easing appraisal requirements.
Refinance Assistance for FHA Borrowers--FHA Streamlined Refinance
    FHA Streamline Refinances allow borrowers with loans insured by the 
Federal Housing Administration who are current on their mortgage to 
refinance into a new FHA-insured loan at today's low interest rates 
without requiring additional underwriting, allowing these borrowers to 
reduce their mortgage payments in a low-cost, simple manner. This 
program benefits current FHA borrowers--particularly those whose loan 
to value may exceed the current value of their home. This both lower's 
a borrower's payment and reduces risk to FHA. As part of our efforts to 
help responsible homeowners who are current on their mortgages and 
because we see potential for more widespread use of this product, FHA 
will make changes to the way in which streamline refinance loans are 
displayed in the Neighborhood Watch Early Warning System (Neighborhood 
Watch), so that these lenders are not on the hook for loans they did 
not originate and thus will be more willing to provide the refinancing.
    In addition to taking steps to make these refinance loans more 
widely available, FHA is working on adjusting the premium structure for 
all Streamline Refinance transactions that are refinancing FHA loans 
endorsed on or before May 31, 2009, to further incentivize refinance 
activity. These changes will ensure that borrowers benefit from a net 
reduction in their overall mortgage payment while still ensuring FHA 
has the resources to pay any necessary claims.
Broad Based Refinancing for Non-GSE, Non-FHA Borrowers
    Lastly, the President has called on Congress to open up 
opportunities to refinancing for responsible borrowers who are current 
on their bills and paying their mortgage but whose loans aren't GSE or 
FHA-insured. Under the proposal, borrowers with standard non-GSE, non-
FHA loans will have access to refinancing through a new program run 
through the FHA. For these responsible borrowers, there will be no more 
barriers and no more excuses.
    Key components of this plan include:
    Providing Non-GSE, Non-FHA Borrowers Access to Simple, Low-Cost 
Refinancing: The program will be simple and straightforward. Any 
borrower with a loan that is not currently guaranteed by the GSEs or 
insured by FHA can qualify if they meet the following criteria--each of 
which is designed to help reduce risk to the taxpayer:

    They are current on their mortgage: Borrowers will need to 
        have been current on their loan for the past 6 months and have 
        missed no more than one payment in the 6 months prior.

    They meet a minimum credit score. Borrowers must have a 
        current FICO score of 580 to be eligible. Approximately 9 in 10 
        borrowers have a credit score adequate to meet that 
        requirement.

    They have a loan that is no larger than the current FHA 
        loan limits in their area: Currently, FHA limits vary 
        geographically with the median area home price--set at $271,050 
        in the lowest cost areas and as high as $729,750 in the highest 
        cost areas.

    The loan they are refinancing is for a single family, 
        owner-occupied principal residence. This will ensure that the 
        program is focused on responsible homeowners trying to stay in 
        their homes.

    They are currently employed. To determine a borrower's 
        eligibility, a lender need only confirm that the borrower is 
        employed.

    Borrowers will apply through a streamlined process designed to make 
it simpler and less expensive for both the borrower and the lender. The 
President's plan includes additional steps to reduce program costs, 
including:

    Establishing loan-to-value limits for these loans. The 
        Administration will work with Congress to establish risk-
        mitigation measures which could include requiring lenders 
        interested in refinancing deeply underwater loans (e.g., 
        greater than 140 LTV) to write down the balance of these loans 
        before they qualify. This would reduce the risk associated with 
        the program and relieve the strain of negative equity on the 
        borrower.

    Creating a separate fund for new streamlined refinancing 
        program. This will help the FHA better track and manage the 
        risk involved and ensure that it has no effect on the operation 
        of the existing Mutual Mortgage Insurance (MMI) Fund, which is 
        FHA's already established insurance fund.

    Cost-Savings to the Borrowers who Participate in This New Program: 
Given today's record low interest rates, we estimate that on average, 
borrowers who participate in this program would reduce their monthly 
payments by between $400 and $500 a month.
    Option To Rebuild Equity in Their Homes Through This Program: All 
underwater borrowers who decide to participate in this refinancing 
program through the FHA outlined above will have a choice: they can 
take the benefit of the reduced interest rate in the form of lower 
monthly payments, or they can apply that savings to rebuilding equity 
in their homes. The latter course, when combined with a shorter loan 
term of 20 years, will give the majority of underwater borrowers the 
chance to get back above water within 5 years, or less.
    To encourage borrowers to make the decision to rebuild equity in 
their homes, we are proposing that the legislation provide for the 
closing costs of borrowers who chose this option--a value averaging 
about $3,000. To be eligible, a participant in this option must agree 
to refinance into a loan with a term of no more than 20 years and with 
monthly payments roughly equal to those they make under their current 
loan. For those who agree to these terms, their lender will receive 
payment for all closing costs directly from the FHA or another entity 
involved.
    A Separate FHA Fund: The broad based refinance program will have a 
separate fund that is funded through premiums established and direct 
funding provided under this program with its net cost offset by the 
financial crisis fee. The program's premium structure will be designed 
in a way to ensure that homeowners have the incentive for lower monthly 
payments through the program. By maintaining a separate fund and 
funding source for this program the broad-based refinance will not be 
contingent on appropriations action and will have no impact on FHA's 
MMI Fund which, as the Committee knows, has been strained in recent 
years.
    We look forward to working with Members of this Committee to craft 
legislation to accomplish these goals and offset the costs associated 
with establishing a broad-based refinance program.
    Further easing refinancing through HARP 2.0, the FHA streamlined 
refinance, and expanding refinance options for homeowners with non-GSE 
and non FHA loans finally ties together a critical patchwork of 
refinance programs. By working together with Congress, we can ensure 
that every family can have the opportunity to take advantage of today's 
historically low interest rates. This will save homeowners thousands of 
dollars a year, and as a result provide much needed payment relief and 
further strengthen the economy.
HAMP Changes and Extension
    In February 2009, the Obama administration introduced the Making 
Home Affordable Program and the Home Affordable Modification Program 
(HAMP) to stabilize the housing market and to help struggling 
homeowners get relief and avoid foreclosure.
    As I noted at the beginning of my testimony, since that time more 
than 5.6 million families have received mortgage modifications with 
affordable monthly payments--which include more than 1.7 million HAMP 
trial modification starts. HAMP is managed primarily by Treasury.
    There is no question that HAMP has had a positive impact on the 
private market. Before President Obama took office, as many of you 
know, many mortgage modifications actually increased costs for 
borrowers. HAMP has not only helped keep families in their homes--it's 
also helped set a standard for affordability in the private market, 
where families today save an average of $333 per month.
    And we've made changes to respond to evolving challenges. For 
instance, when foreclosures began to migrate from the subprime to the 
prime market because of unemployment, we expanded our focus to offer 
more help for unemployed homeowners--requiring servicers participating 
HAMP to give borrowers a minimum of 12 months to catch up on payments 
while they are looking for work.
    In addition, last month, the Administration took a series of steps 
to expand the eligibility for HAMP and maximize its impact.
    Expanded Eligibility: To ensure HAMP reaches a broader pool of 
distressed homeowners, we opened the program up to those who struggle 
with secondary debt, such as second liens, medical bills, and credit 
cards.
    In particular, the Administration has created a second tier that 
would provide modification relief to borrowers not currently eligible. 
This tier would include:

    Mortgages secured by properties that are currently tenant 
        occupied or properties that are vacant but which the borrower 
        certifies intention to rent.

    Borrowers failing to satisfy the 31 percent debt-to-income 
        (DTI) test, unable to achieve the target monthly mortgage 
        payment ratio without excessive forbearance or who have 
        received a negative net present value (NPV) test due to other 
        factors.

    These changes will not only not only help homeowners, but also 
stabilize neighborhoods struggling with foreclosures by helping 
hundreds of thousands of owners who rent their properties avoid 
foreclosure--in turn, keeping more families in their homes.
    Principal Reduction: Still, it's not enough to lower the barriers 
to participation in HAMP--we also need to increase its impact. HAMP has 
made a real difference for the families who have received a 
modification--saving an average of more than $500 per month. But to 
rebuild the equity these families have lost, lowering payments isn't 
enough.
    That's why we are also increasing incentives for cost-effective 
mortgage modifications that include a write-down of the borrower's 
principal balance through HAMP.
    With these changes to the Principal Reduction Alternative (PRA), 
whereby investors are eligible for financial compensation incentives 
whenever the servicer provides a borrower with a permanent modification 
that reduces mortgage principal, we are tripling the incentives 
provided to encourage modifications that rebuild equity.
    Specifically, with respect to loans which were less than or equal 
to 6 months past due at all times during the 12-month period prior to 
the NPV evaluation date, investors will be entitled to receive, 
effective in May 2012:

    $0.63 per dollar of principal reduction equal to or greater 
        than 105 percent and less than 115 percent mark-to-market LTV 
        (MTM) ratio;

    $0.45 per dollar of principal reduction equal to or greater 
        than 115 percent and less than or equal to 140 percent MTMLTV 
        ratio; and

    $0.30 per dollar of principal reduction in excess of 140 
        percent MTMLTV ratio

    With respect to loans which were more than 6 months past due at any 
time during the 12-month period prior to the NPV evaluation date, 
irrespective of MTMLTV (mark-to-market loan-to-value) ratio range, 
investors will be paid $0.18 per dollar of principal reduction and will 
not be eligible for incentives in the above extinguishment schedule. 
These improvements to HAMP augment incentives in a meaningful way for 
investors to allow for a greater degree of principal reduction of loans 
underlying the securities they own, thus keeping more people in their 
homes with mortgages they can afford.
    To further increase the amount of principal reduction provided to 
borrowers, we are also working to expand it to those with loans 
guaranteed by the GSEs. Borrowers with GSE loans have been unable to 
benefit from the PRA modification due to FHFA restrictions on the use 
of principal reduction in modifications. So homeowners couldn't benefit 
solely because they had a GSE loan. In order to ensure consistency 
throughout the HAMP program, and to ensure that homeowners can be 
considered for rebuilding equity modifications, we have notified FHFA 
that Treasury will pay these incentives to the GSEs if they participate 
in the program.
    Sunset Extension: Lastly, we have extended HAMP's sunset deadline. 
Originally slated to sunset at the end of 2012, HAMP has been extended 
to December 31, 2013, which conforms to the recently extended deadline 
for HARP and provides an expanded window of time for homeowners to gain 
relief which investors provide while preserving their investments.
Strengthening FHA's Mutual Mortgage Insurance Fund
    The books of business in the few years before 2009 have largely 
driven the high number of claims to the MMI Fund. This was driven by 
overall economic and unemployment trends as well as by the combined 
effects of poor underwriting, unscrupulous and noncompliant practices 
on the part of lenders, and a seller-funded downpayment assistance 
program that allowed many borrowers to obtain mortgages that they 
shouldn't have or without a meaningful down payment. As a result, the 
books of business FHA insured prior to the start of this Administration 
have severely impacted the health of FHA's MMI Fund. But thanks to our 
efforts, I can say confidently that FHA is moving in another direction, 
and that the long term outlook for FHA and the Fund are now much better 
than they were in 2009. Through systematic tightening of risk controls, 
increased premiums to stabilize near-term finances and expanded usage 
of loss mitigation workout assistance to avoid unnecessary claims, the 
efforts of this Administration have led to the highest quality of loans 
FHA has seen in its history.
    And still, we continue to take steps to further strengthen the 
Fund. In the FY2013 Budget submission we included 10 bps annual premium 
increase passed late last year by Congress on all FHA insured loans 
mandated by law in December, as well as an additional 25 bps annual 
premium increase on ``jumbo'' loans making the total increase for these 
larger loans 35 bps. And, just last yesterday, we announced a series of 
premium changes that will further increase receipts to FHA by $1 
billion in fiscal years 2012 and 2013, beyond the receipts already 
included in the President's budget submission. In addition, we have 
also taken significant additional steps to increase accountability for 
FHA lenders discussed in more detail below.
    Yet, despite the unprecedented efforts of the Administration to 
alter the trajectory of FHA, considerable risks remain. The FHA Mutual 
Mortgage Insurance (MMI) Fund has two components: the Financing 
Account, which holds enough money to accommodate expected 30-year 
losses on FHA's insured portfolio as of the end of the current fiscal 
year; and the Capital Reserve Account, which is required to hold an 
additional amount equal to 2 percent of the insurance in force. Since 
2009, the Fund's capital reserve ratio has been below that 2 percent 
level.
    Annually, the President's Budget includes estimates regarding the 
status of the capital reserve at the end of the current fiscal year. 
This prediction is based on estimates and projections of future 
economic conditions, including house prices and other economic factors. 
The 2013 Budget estimate for the FHA Capital Reserve account in fiscal 
year 2012 did not include the added revenue from the further increased 
premiums and the proceeds from the recently announced settlements with 
FHA-approved lenders. With these additional revenues accounted for, the 
Capital Reserve is estimated to have sufficient balances to cover all 
future projected losses without triggering a mandatory appropriation 
under the Federal Credit Reform Act. What's more, the Budget estimates, 
FHA will add an additional $8 billion to the Capital Reserve Account in 
2013, and will return to the congressionally mandated capital reserve 
ratio of 2 percent by 2015.
    As we undertake efforts to strengthen FHA and lay the foundations 
for the return of private capital, it is important to recognize the 
critical role that FHA has and continues to play in times of stress on 
the housing market. One of the critical purposes of the FHA is to stand 
as a bulwark of liquidity in a time when capital has fled the market, 
and in such times the FHA will inevitably grow beyond the size that we 
would be comfortable with, taking on more risk that we would normally 
be comfortable with. We are in such a time now. So while we will 
continue to take the steps needed to ensure an FHA that is as strong as 
we can make it, and we will gradually take the steps needed to pull the 
FHA back from the market to crowd in more private capital, we must not 
forget that it is playing an absolutely critical role today, ensuring 
access to capital in an environment when capital is extremely difficult 
to come by. As we discuss and consider ways to strengthen FHA and to 
create an environment for the return of private capital, we must be 
mindful of its continued critical role inherent in its mission--
providing home ownership opportunities to families that do not have 
access to traditional financing, and to serve as vital source of 
credit, when the broader market undergoes stress.
Reducing the Overhang and Shadow Inventory
    At the same time we provide relief to responsible homeowners and 
keep families in their homes, we also need to attack the second barrier 
to our housing recovery: the shadow inventory--the overhang of 
properties that are at risk of or already in foreclosure.
REO to Rental
    With the rental market recovering faster, we need to think 
creatively about ways we can dispose of this shadow inventory.
    With the purchase market continuing to be dragged down by the glut 
of vacant foreclosed properties and rental rates rising as those who 
lose their homes to foreclosure seek rental housing, there is an 
unprecedented imbalance of supply and demand between the purchase and 
rental markets.
    When there are vacant and foreclosed homes in neighborhoods, it 
undermines home prices and stalls the housing recovery. As part of the 
Administration's effort to help lay the foundation for a stronger 
housing recovery, the Department of Treasury and HUD have been working 
with the FHFA on a strategy to transition REO properties into rental 
housing. Repurposing foreclosed and vacant homes will reduce the 
inventory of unsold homes, help stabilize housing prices, support 
neighborhoods, and provide sustainable rental housing for American 
families.
    With about a quarter-of-a-million foreclosed properties owned by 
HUD and the GSEs, this August, HUD joined with FHFA and Treasury to 
issue a ``Request for Information'' to generate new ideas for absorbing 
excess inventory and stabilizing prices. In all, about 4,000 
submissions were received.
    Over the past several months, the interagency task force has been 
reviewing the submissions and formulating strategies based on the best 
practices gathered from the RFI. Throughout this process, the task 
force has continuously met with industry members, community groups and 
other key stakeholders to make sure they are heard in the strategy 
development process.
    We expect a range of strategies to emerge; however the most 
commonly discussed centers around selling REO properties to buyers who 
will convert and market them as rental units.
    Recently, the FHFA, in conjunction with Treasury and HUD, announced 
that investors may prequalify for the first major pilot sale of 
foreclosed properties repurposed into rental housing. This marks the 
first of a series of steps that the FHFA and the Administration are 
taking to develop a smart national program to help manage REO 
properties, and ease the pressure of these distressed properties on 
communities and the housing market.
    We plan to learn and leverage all we can from this initial pilot as 
we work towards conducting a series of additional pilots throughout the 
rest of the year.
Project Rebuild
    While expanding REO-to-Rental is a critical tool, in the hardest-
hit markets, where prices have dropped most and the most vacant and 
abandoned buildings are found, more needs to be done to jumpstart 
construction and reduce vacancy rates.
    As I mentioned earlier, the Neighborhood Stabilization Program 
(NSP) has helped improved sale prices and vacancy rates in areas with 
concentrated investments. In fact, three-quarters of communities across 
the country with targeted neighborhood stabilization investments have 
seen vacancy rates go down--and two-thirds have seen home prices go up 
compared to surrounding communities. Further, the $7 billion that has 
been allocated under the three phases of NSP will support an estimated 
88,000 jobs by the time the funding is fully spent. These jobs are 
created in a variety of fields including housing construction, 
infrastructure construction, maintenance and repair, management, 
technical consulting services, real estate, State and local Government.
    In Hernando County, Florida, our NSP investments have helped 
families move in to once-foreclosed homes in hard-hit places. Just as 
importantly, they've helped keep construction workers on the job and 
given real estate agents the opportunity to show and sell homes once 
again. Indeed, in the La Puente community, a predominately Hispanic 
suburb outside Los Angeles, these efforts have helped increase home 
prices by nearly 15 percent.
    However, even in these NSP investment clusters, NSP has been able 
to reach only 46 percent of the census tracts in the United States that 
are hardest hit by the foreclosure and unemployment crisis. That is why 
President Obama has proposed Project Rebuild to further stabilize 
neighborhoods and communities, an initiative which would create 200,000 
jobs in the places that need them most.
    Nearly two thirds of the $15 billion Project Rebuild funding will 
be provided to States and local governments by formula as specified in 
the American Jobs Act. The remaining third will be allocated by 
competition--which is open to State and local governments, nonprofits, 
and for profit entities and consortia of these parties. Project Rebuild 
proposes important modifications to the NSP model to extend the 
benefits of the program beyond affordable housing, enabling greater job 
creation, and a broader positive impact on neighborhoods.
    Recognizing that it's not just abandoned homes that can drag down 
an entire neighborhood, but also vacant commercial properties, Project 
Rebuild broadens eligible uses to allow commercial projects and other 
direct job creating activities, capped at 30 percent of funds. Up to 10 
percent of formula grants may be used for establishing and operating 
jobs programs to maintain eligible neighborhood properties. Formula 
funding will go directly to States and entitlement communities across 
the country. Competitive funds will be available to States, local 
governments, for-profit entities, nonprofit entities and consortia of 
these entities.
    Each State will receive a minimum of $20 million of the $10 billion 
in formula funds. Funds will be targeted to areas with home 
foreclosures, homes in default or delinquency, and other factors, such 
as unemployment, commercial foreclosures, and other economic 
conditions. Project Rebuild also will expand the ability of the private 
sector to participate with localities--ensuring there is the expertise 
and capacity to bring these neighborhoods back in a targeted way. I 
urge the Committee to join with the Administration in working toward 
the enactment of this proposal.
Reducing Uncertainty, Improving Access to Credit
    Of course, underlying many of the issues in our housing market is a 
lack of certainty--of a clear understanding of the rules of the road 
lenders need to do business and our housing market needs to recover. 
And one way to reduce uncertainty is to clear away barriers to 
recovery--to resolve these matters in a way that holds those 
responsible accountable, but moves us forward by creating conditions 
more conducive for lending.
Lender Indemnification
    As part of FHA's continued efforts to protect and strengthen the 
MMI Fund, facilitate access to mortgage credit for qualified borrowers 
and provide clarity to our lending partners, last month FHA issued 
final rule governing the process for receiving and maintaining approval 
to participate in the Lender Insurance (LI) process. These new 
regulations will provide greater clarity regarding our expectations for 
our LI lending partners, as well as the actions we will take to prevent 
losses when those standards are not met.
    The regulations reiterate FHA's commitment to ongoing quality 
assurance reviews of lenders with LI authority. In addition, the rule 
sets a standard for what constitutes a ``serious and material 
violation'' of FHA origination requirements. Serious and material 
violations, as well as instances of fraud or misrepresentation, will 
require indemnification by LI mortgagees. In providing a standard for 
these violations, along with a clear process by which FHA will require 
indemnifications for loans that do not meet these standards, FHA is 
providing a level of certainty to our partners with regard to the types 
of violations which are actionable under HUD policy.
    It is significant, however, that FHA currently has the ability to 
exercise this indemnification authority with respect to only one of our 
two classes of FHA approved lenders. FHA Direct Endorsement (DE) 
Lenders are currently not subject to the same regulations with regard 
to indemnification. In order to protect the MMI Fund and ensure the 
term viability of the FHA, the Administration continues to pursue 
legislation to allow FHA to pursue indemnifications from these DE 
lenders.
    In addition, we believe it is important for the Federal Housing 
Finance Agency to work with Fannie Mae and Freddie Mac to make clear 
the rules of the road for GSE lenders with straightforward and well 
defined representations and warranties that will further reduce 
uncertainty around repurchase risk. Equipping banks with a better 
understanding of what mortgages they can be held responsible for can 
yield positive externalities with respect to REO inventory overhang and 
the damaging impact of foreclosures on house prices.
Homeowner Bill of Rights
    Consumers need certainty and clarity most of all. The Homeowners 
Bill of Rights recently announced by President Obama would guarantee 
consumers access to a simple mortgage disclosure form, so borrowers 
understand the loans they are taking out; full disclosure of fees and 
penalties; guidelines to prevent conflicts of interest that end up 
hurting homeowners; support to keep responsible families in their homes 
and out of foreclosure; and, protection for families against 
inappropriate foreclosure, including right of appeal.
Tackling All Three Barriers: Mortgage Servicing Settlement
    All three of the barriers I have described--keeping people in their 
homes, the shadow inventory, and uncertainty--are addressed by the 
historic mortgage servicing settlement the Obama administration and a 
bipartisan coalition of attorneys general from 49 States reached 
providing at least $25 billion on behalf of American homeowners.
    The product of 16 months of intensive negotiations between the five 
banks and an unprecedented coalition of State attorneys general and 
Federal agencies, including the Departments of Justice, Treasury, and 
HUD, that spanned partisan lines, the settlement helps families keep 
their homes and reduces the shadow inventory by providing relief to 
homeowners, in part by forcing banks to reduce the principal balance on 
many loans, refinancing loans for ``underwater'' borrowers. In addition 
the settlement will pay billions of dollars to States to stabilize 
communities and cover the costs associated with the foreclosure crisis 
and consumers who have been foreclosed upon.
    And it reduces uncertainty by providing clear servicing standards 
going forward for these five institutions which currently service over 
70 percent of all mortgages--standards that can set the stage for 
servicing standards going forward.
Background
    In the summer of 2010, HUD initiated a large-scale review of the 
FHA's largest servicers, devoting thousands of hours to reviewing 
servicing files for thousands of FHA-insured loans. While we began with 
a focus on failure to engage in loss mitigation, the scope of this 
review encompassed a long list of mortgage servicing issues, such as 
lost paperwork, long delays and missed deadlines. As HUD's Office of 
the Inspector General found, the country's five largest loan servicers 
routinely signed foreclosure related documents without really knowing 
whether the facts they contained were even correct.
    In effect, many of the very same financial institutions responsible 
for selling loans to people who couldn't afford them and then packaging 
those mortgages to make profits, effectively fueling the housing 
crisis, were actually making it worse--harming families, neighborhoods 
and our economy.
    Following revelations of widespread use of ``robo-signed'' 
affidavits in foreclosure proceedings across the country, the Federal-
State working group launched an investigation into the problem and 
confronted the 5 largest servicers, representing more than 80 percent 
of the loans serviced, about these problems. These banks soon 
acknowledged that individuals had been signing thousands of foreclosure 
affidavits without reviewing the validity or accuracy of the sworn 
statements. Several national banks then agreed to stop their 
foreclosure filings and sales until corrective action could be taken.
    Other servicer-related problems were identified as well, including 
deceptive practices in the offering of loan modifications (for example, 
telling consumers that a loan modification was imminent while 
simultaneously foreclosing). These performance failures resulted in 
more than just poor customer service. Unnecessary foreclosures occurred 
due to failure to process homeowners' requests for modified payment 
plans. And where foreclosures should have been concluded, shoddy 
documentation led to protracted delays. This misconduct not only harmed 
homeowners--but communities, our housing market and economy.
Relief for Homeowners
    The settlement imposes monetary sanctions on the banks while 
providing immediate and continuing relief to homeowners. The single 
largest Federal-State civil settlement ever agreed to--and the largest 
financial recovery from the banks during this crisis--the accord will 
enable hundreds of thousands of distressed homeowners to stay in their 
homes through enhanced loan modifications. It will also fund payments 
to victims of unfair foreclosure practices and provide support for 
housing counseling and State-level foreclosure prevention programs.
    One of the most important features of the settlement is the $17 
billion in consumer relief options that will offer homeowners a variety 
of home retention and home disposition alternatives. Because the banks 
will receive credit for employing these options at specified credit 
rates (e.g., a deficiency waiver carries a 10 percent credit, so for 
every dollar supplied by the bank, it would only count 10 cents), this 
$17 billion has the potential to provide as much as $32 billion in 
relief.
    Much of this relief will come in the form of principal reduction 
for distressed homeowners. Enabling these families to restructure their 
debt and start building equity again not only improves their 
prospects--but also those of their neighbors who have watched property 
values plummet by $5,000-10,000 simply because there are foreclosures 
on their block.
    In addition, it provides:

    $3 billion for refinances for current homeowners who, 
        because their home values are underwater, would not be able to 
        refinance their mortgages into lower interest rate loans.

    Approximately $2.6 billion to States which can choose to 
        apply funds to repay public funds lost as a result of servicer 
        misconduct, fund housing counselors, legal aid, and other 
        similar purposes determined by State attorneys generals.

    A $1.5 billion Borrower Payment Fund for borrowers who were 
        foreclosed upon on or after January 1, 2008. Banks must notify 
        those borrowers of their right to file a claim. Payout is 
        anticipated to be approximately $2,000 per person, depending 
        upon levels of claim and whether they meet some relatively 
        basic criteria. Borrowers receiving claims will not have to 
        waive any legal rights or claims against the banks, and can 
        seek additional relief.

    With specific regard to the Borrower Payment Fund, as I noted 
earlier, when HUD initiated a large-scale review of the FHA's largest 
servicers in the summer of 2010, we found that families who should not 
have gotten into trouble--and who should have been able to get some 
help early on that was both good for them and good for the lender--
didn't get that help--help that in many cases banks were legally 
obligated to provide.
    These $2,000 payments will be made to families who suffered from 
these kinds of errors--where borrowers were charged fees that they 
shouldn't have been or had dropped calls or lost paperwork when they 
sought help with their mortgages.
    For families who suffered much deeper harm--who may have been 
improperly foreclosed on and lost their homes and could therefore be 
owed hundreds of thousands of dollars in damages--the settlement 
preserves their ability to get justice in two key ways:
    First, if a borrower can document that they were improperly 
foreclosed on, they can receive every cent of the compensation they are 
entitled to through a process established by Federal banking 
regulators. The agreement also preserves the right of homeowners to 
take their servicer to court. Indeed, if banks or other financial 
institutions broke the law or treated the families they served 
unfairly, they should pay the price--and with this settlement they 
will.
    I would note that these funds are paid entirely by the banks. The 
taxpayer doesn't pay a dime.
    And homeowners aren't the only ones who will see the benefits of 
this settlement. So, too, will the taxpayer who has paid a steep price 
for financial institutions' failure to follow the law when it came to 
families who had FHA-insured loans. In addition to the steps I 
mentioned earlier that FHA is taking to protect its MMI fund, 
approximately $900 million from this settlement will help shore up the 
FHA's finances, preserving this critical resource for the future and 
protecting taxpayers' investment.
Residential Mortgage Backed Security Group
    While this historic settlement will offer significant help to those 
who suffered the most harm and provide a path toward stability for our 
housing market and our broader economy, it isn't designed to address 
all the issues of the housing crisis. While it resolves certain 
violations of civil law based on the banks' mortgage loan servicing 
activities, the United States and the State attorneys general preserved 
the right to pursue claims in a number of important areas, including 
criminal authorities, securities claims, and loan origination claims.
    Indeed, in some ways, just as important as what this settlement 
accomplishes is what it does not do. It will not prevent State 
attorneys general or regulators from pursuing criminal cases or 
conducting investigations that get to the bottom of the crisis. Last 
month, Attorney General Holder and I joined New York Attorney General 
Schneiderman and several other State attorneys general in announcing a 
working group comprised of representatives from DOJ, HUD, SEC, and the 
State AGs focused on investigating the conduct of financial servicers 
that broke the law and contributed to the crash of the housing market, 
including securities- and origination-related cases.
New Customer Service Standards
    That's why this agreement forces the banks that service nearly 2 
out of every 3 mortgages to take action to address the problems 
uncovered during our investigations.
    In particular, these standards prohibit robo-signing, improper 
documentation and lost paperwork; clarify what servicers have to do on 
foreclosures and modifications, including requiring strict oversight of 
foreclosure processing, including of third-party vendors; make 
foreclosures a last resort by requiring servicers to evaluate 
homeowners for other loan mitigation options first; restrict banks from 
foreclosing while the homeowner is being considered for a loan 
modification; and establish procedures and timelines for reviewing loan 
modification applications, and give homeowners the right to appeal 
denials. Having to satisfy these requirements, banks are also more 
certain of the costs associated with them.
    These standards will set the stage for clear, national servicing 
rules for all servicers which the new Consumer Financial Protection 
Bureau, under the leadership of Director Richard Cordray, and along 
with an interagency team comprised of independent regulators as well as 
Treasury and HUD, are working to craft These national standards are an 
aggressive and critical first step in a broader Administration effort 
to provide a single, straightforward set of commonsense rules that are 
in keeping with Homeowner Bill of Rights that families can count on 
when they're buying a home and paying their mortgage. The standards in 
this settlement will serve as benchmark for the development of these 
uniform rules, giving people the confidence that lenders and servicers 
are following a long list of rights should they ever lose a job or have 
a medical emergency that puts their home at risk.
    Lastly, the settlement's release of limited origination claims with 
both Bank of America and Citibank which, coupled with the Lender 
Insurance indemnification rule discussed earlier, provides clarity for 
lenders on when the FHA will take action, reducing concerns over 
lawsuits and additional reputational risk. In the same way, clarifying 
representations and warranties at the GSE level will help to achieve a 
well-defined and well understood buyback policy that fosters a degree 
of uniformity and certainty across the Government-backed space.
An Economy Built to Last
    And so, Mr. Chairman, as you can see, we have made very important, 
significant progress in recent months to get our housing market back on 
track--helping tens of thousands of additional families refinance, 
putting in place the most significant principal reduction effort in 
history and establishing critical consumer protections that hold 
powerful institutions accountable for their actions, help our housing 
market recover and give every homeowner the dignity, respect and fair 
treatment they deserve.
    But for all this progress, we can't declare victory and go home. We 
still need Congress to act to ensure that every responsible family in 
America, regardless of who services their loan, has the opportunity to 
refinance.
    We still need to continue our work together to create a robust 
private system of housing finance and protect the FHA fund for the 
future.
    And we still need a balanced national housing policy that ensures 
Americans have access to credit for those in a position for sustainable 
home ownership, assistance for those who feel the strain of high 
housing costs, rental options near good schools and good jobs, and 
above all--choices in housing that make sense for them and for their 
families.
    That is the goal of all this work--and it is fundamental to 
creating an economy built to last. And I look forward to working with 
Congress to make it possible. Thank you.
                                 ______
                                 
                PREPARED STATEMENT OF ELIZABETH A. DUKE
       Governor, Board of Governors of the Federal Reserve System
                           February 28, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for inviting me to talk about the current 
situation in housing markets.
    The Federal Reserve has a keen interest in the state of housing and 
has been actively engaged in analyzing issues in the housing and 
mortgage markets. Issues related to the housing market and housing 
finance are important factors in the Federal Reserve's various roles in 
formulating monetary policy, regulating banks, and protecting consumers 
of financial services. In particular, the failure of the housing market 
to respond to lower interest rates as vigorously as it has in the past 
indicates that factors other than financial conditions may be 
restraining improvement in mortgage credit and housing market 
conditions and thus impeding the economic recovery. Federal Reserve 
staff have been actively working to understand the reasons behind the 
impairment in housing and mortgage markets and the tradeoffs involved 
in designing policies that would remove obstacles to normal market 
functioning.
    On January 4, 2012, the Federal Reserve released a staff paper 
titled ``The U.S. Housing Market: Current Conditions and Policy 
Considerations'', which is attached at the end of my written statement. 
The paper provides information on current conditions in the housing 
market and analytic background on some housing market issues. Although 
the paper does not include recommendations for any specific policy 
actions, it does lay out a framework for discussion by outlining some 
options and tradeoffs for policy makers to consider. My testimony today 
will be drawn from this paper.
    Six years after aggregate house prices first began to decline, and 
more than 2 years after the start of the economic recovery, the housing 
market remains a significant drag on the U.S. economy. In a typical 
economic cycle, as the economy turns down households postpone purchases 
of durable goods such as housing. Once the cycle bottoms out, improving 
economic prospects and diminishing uncertainty usually help unleash 
this pent-up demand. This upward demand pressure is often augmented by 
lower interest rates, to which housing demand is typically quite 
responsive.
    The current economic recovery has not followed this script, in part 
because the problems in the housing market are a cause of the downturn 
as well as a consequence of it. The extraordinary fall in national 
house prices has resulted in $7 trillion in lost home equity, more than 
half the amount that prevailed in early 2006. This substantial blow to 
household wealth has significantly weakened household spending and 
consumer confidence. Another result of the fall in house prices is that 
around 12 million households are now underwater on their mortgages--
that is, they owe more on their mortgages than their homes are worth. 
Without equity in their homes, many households who have experienced 
hardships, such as unemployment or unexpected illness, have been unable 
to resolve mortgage payment problems through refinancing their 
mortgages or selling their homes. The resulting mortgage delinquencies 
have ended in all too many cases in foreclosure, dislocation, and 
personal adversity. Neighborhoods and communities have also suffered 
profoundly from the onslaught of foreclosures, as the neglect and 
deterioration that may accompany vacant properties makes neighborhoods 
less desirable places to live and may put further downward pressure on 
house prices.
    An ongoing imbalance between supply and demand exacerbates these 
problems in the housing market. For the past few years, the actual and 
potential supply of single-family homes for purchase has greatly 
exceeded the effective demand, in part because of the large number of 
homes that have come back onto the market after moving through the 
foreclosure process. The elevated pace of foreclosures, unfortunately, 
is likely to be sustained for quite a while and therefore will continue 
to put downward pressure on home prices.
    At the same time, a host of factors have been weighing on housing 
demand. Many households have been reluctant or unable to purchase homes 
because of concerns about their income, employment prospects, and the 
future path of home prices. Tight mortgage credit conditions have also 
prevented many households from purchasing homes. Although some 
retrenchment in lending standards was necessary and appropriate given 
the lax standards that prevailed before the crisis, current lending 
practices appear to be limiting or preventing lending even to 
creditworthy households.
    In the paper, we discussed the benefits and costs of a variety of 
policy options that have been proposed to respond to these difficult 
housing issues, including increasing credit availability for households 
seeking to purchase a home or to refinance an existing mortgage; 
exploring the scope for further mortgage modifications, including 
encouraging short sales and deeds-in-lieu of foreclosure in cases where 
foreclosure cannot be avoided; and expanding the options available for 
holders of foreclosed properties to dispose of their inventory 
responsibly. Any policy proposals, though, will require wrestling with 
difficult choices and tradeoffs, as initiatives to benefit the housing 
market will likely involve shifting some of the burden of adjustment 
from some parties to others.
    I greatly appreciate the leadership that the Senate Banking 
Committee has shown on the profound challenges facing the housing 
market. For its part, the Federal Reserve will continue to use its 
policy tools to support the economic recovery and carry out its dual 
mandate to foster maximum employment in the context of price stability. 
In its supervisory capacity, the Federal Reserve will continue to 
encourage lenders to find ways to maintain prudent lending standards 
while serving creditworthy borrowers.
    Thank you again for inviting me to appear before you today. I would 
be happy to answer any questions you may have.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                PREPARED STATEMENT OF EDWARD J. DeMARCO
            Acting Director, Federal Housing Finance Agency
                           February 28, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, I am pleased to be invited here today to discuss the actions 
the Federal Housing Finance Agency (FHFA) has taken or will take in our 
role as Conservator for Fannie Mae and Freddie Mac (the Enterprises) to 
aid recovery of the U.S. housing market.
    In my testimony, I will respond to the Committee's request for a 
description of FHFA's work as Conservator of the Enterprises to address 
barriers to housing recovery, including our leadership role in 
preventing foreclosures through loss mitigation, facilitating 
refinancing at today's low interest rates, and initiating a real estate 
owned (REO) program to address the supply of foreclosed homes.
Current Activities
    Let me start by describing some of the key activities that FHFA and 
the Enterprises have undertaken to address problems in the mortgage 
market. In contrast to how they are sometimes portrayed, the 
Enterprises are playing a leading role in providing assistance to 
homeowners and seeking to avoid foreclosures. As I have stated before, 
these activities are based on FHFA's statutory responsibilities as 
Conservator, and the Enterprises' historic statutory missions.
Enterprise Loss Mitigation Activities
    The Enterprises have been leading the effort on foreclosure 
prevention since they entered conservatorship. On a nationwide basis, 
Fannie Mae and Freddie Mac own or guarantee 60 percent of the mortgages 
outstanding, but they account for a much lower proportion, 29 percent 
of seriously delinquent loans. These are loans that have been 
delinquent for 3 or more months or are in the process of foreclosure. 
However, the housing crisis is concentrated in a handful of States. Ten 
States account for approximately half of loans serviced and 60 percent 
of the country's seriously delinquent loans. Similar to the nationwide 
proportions, the Enterprises hold approximately 59 percent of the loans 
in those States but account for 29 percent of seriously delinquent 
loans in those States. As such, while the Enterprises are taking a 
leadership role in solving the crisis, similar actions from the holders 
of the other 70 percent of seriously delinquent loans are crucial to a 
successful outcome.
    Even though the Enterprises have a smaller share of seriously 
delinquent loans than other market participants, they account for about 
half of all Home Affordable Modification Program (HAMP) permanent 
modifications. Similarly, data from the Office of the Comptroller of 
the Currency (OCC) show that in the 2 years ending in the third quarter 
of 2011, modifications on Fannie Mae and Freddie Mac loans accounted 
for 40 percent of all loan modifications. Between HAMP modifications 
and their own proprietary loan modifications, Fannie Mae and Freddie 
Mac have completed over one million loan modifications since the fourth 
quarter of 2008. These modifications typically lowered borrowers' 
payments by substantial amounts and have yielded positive results.
    The performance of Enterprise modified loans has improved relative 
to Enterprise loan modifications from before HAMP was fully 
implemented, and it is better relative to contemporaneous modifications 
on Federal Housing Administration (FHA) or Veterans' Administration 
(VA) loans and loans held by private investors. For Enterprise loans 
modified throughout 2010, fewer than 20 percent of the loans had missed 
two or more payments after 9 months. Comparable redefault rates are 
down from the 40 percent range for their loans modified in 2008 and 
most of 2009.
    Some observers have cited declines in the number of loan 
modifications completed by Fannie Mae and Freddie Mac over the past 
year or so as evidence of a lack of support for foreclosure prevention. 
In fact, this trend is applicable to all investors in mortgages as 
illustrated by the OCC's report. The quarterly number of loan 
modifications peaked in the second and third quarters of 2010 for all 
investors in mortgages (i.e., the GSEs, FHA, VA, portfolio investors, 
and private investors). A contributing factor to this trend may be that 
the initial backlog of eligible borrowers in 2009 has been addressed to 
some extent.
    The continued leadership and improvements in the Enterprises' 
foreclosure prevention efforts is based on continued program 
evaluations and efforts to make these programs work better. In 
particular, the Servicing Alignment Initiative (SAI) established new 
borrower communication requirements for servicers to ensure that 
borrower outreach occurs at the earliest stage of delinquency, when 
foreclosure prevention measures are most effective. Furthermore, under 
SAI, Fannie Mae and Freddie Mac made clear that servicers are expected 
to evaluate borrowers for the full range of loss mitigation options 
simultaneously. This allows the borrower and servicer to pursue and 
lock in an alternative to foreclosure as quickly as possible. Servicers 
are obligated to collect information from borrowers and assess their 
eligibility for a modification well before a loan is referred for 
foreclosure and such referrals may only occur after an independent 
review of the case to ensure that the borrower was, in fact, considered 
for an alternative to foreclosure.
    To encourage loan modifications, the Enterprises offer substantial 
incentive payments to servicers to motivate them to meet the aggressive 
timelines for offering loan modifications, be they HAMP or Enterprise 
standard modifications. The payments should cover the servicers' costs 
for engaging in more borrower outreach, such as ``door-knocking'' and 
other face-to-face techniques.
    The SAI improvements represent a highly targeted approach, the goal 
of which is to refocus the servicers' resources and attention on moving 
all borrowers into alternatives to foreclosure, quickly, efficiently, 
and aggressively. The SAI aligned the requirements of the Enterprises 
to remove inconsistencies that could cause servicers confusion and 
delay.
    Furthermore, under the SAI the Fannie Mae standard modification 
program was adopted by Freddie Mac, again, to ensure that borrowers had 
easy access to a simple and straightforward modification option. I am 
pleased to see that the Treasury Department has acknowledged the 
benefit of this program, creating a Tier 2 program under the HAMP that 
is modeled on the Enterprise program. As the data show, more borrowers 
have benefited from the Enterprise modification programs than from 
HAMP, so I think that this program change will help more households 
access a modification.
The Home Affordable Refinance Program
    Fannie Mae and Freddie Mac are at the forefront of refinance 
activity for current borrowers. Since April 1, 2009, the Enterprises 
have completed more than 10 million refinances, accounting for 63 
percent of refinance originations over that period. With respect to 
underwater borrowers, Fannie Mae and Freddie Mac account for less than 
half of underwater borrowers compared to their 60 percent share of 
total mortgages serviced. However, Fannie Mae and Freddie Mac are the 
only institutions that currently operate a large-scale refinancing 
program for underwater borrowers. Since the inception of the Home 
Affordable Refinance Program (HARP), the Enterprises have completed 
over one million HARP refinances. Furthermore, since the inception of 
HARP, Fannie Mae and Freddie Mac have completed 1.9 million streamlined 
refinances that expedited the refinance process for borrowers.
    HARP was designed in 2009 to allow borrowers with loans backed by 
Fannie Mae and Freddie Mac, whose loan-to-value (LTV) ratios had 
increased as a result of declining home values, a refinancing option 
that did not require new or additional mortgage insurance coverage. In 
October 2011, FHFA announced a set of changes to HARP meant to enhance 
access to the program.
    The program allows lenders to qualify borrowers using a very 
streamlined underwriting process, relying on the borrower's payment 
history as an indication of capacity and willingness to repay the new 
loan. While this streamlined underwriting approach is available for 
most borrowers with loans backed by Fannie Mae and Freddie Mac, those 
with the highest LTV ratios stand to benefit most because they have 
fewer or no other refinance options available to them. HARP is intended 
to serve these borrowers, whose LTV ratios are greater than 80 percent.
    FHFA and the Enterprises have been closely tracking program 
participation and performance since the program's inception in 2009. 
The eligible population for the program is fairly limited, but the 
data, reported monthly in the FHFA Foreclosure Prevention and Refinance 
Report, suggested that some borrowers were not being reached or were 
not taking advantage of the program.
    To better understand why eligible borrowers were not accessing the 
program, FHFA and the Enterprises established a task force to work with 
the industry to assess and streamline program operations. The research 
showed that increasing access to the program would not be driven by 
addressing any single or obviously restrictive program feature. Rather, 
a variety of operational constraints and risk mitigation measures put 
in place by program participants, to control for and limit a transfer 
of risk from one party to another required revision. By working through 
the broad set of issues with a cross-section of market participants, 
FHFA and the Enterprises were able to create an environment where all 
parties were willing to accept some degree of risk and to streamline 
program requirements and operations in a way that was mutually 
beneficial.
    In the end, the set of policy changes announced by FHFA were fairly 
simple--(a) extend the program sunset date to December 31, 2013, to 
provide lenders with more time to execute against the more liberal 
program terms; (b) provide lenders with additional relief from 
representations and warranties, to provide comfort that the Enterprises 
would not pursue repurchases for defects in original loan files; (c) 
transmit property value data to lenders to use when originating the new 
loans, limiting the need for appraisals; (d) reduce the loan-level 
pricing adjustments for all borrowers and eliminate them altogether for 
borrowers who choose mortgage terms of 20 years or less, a product 
option that reduces risk to the Enterprises and helps a borrower build 
equity faster; and (e) remove the loan-to-value cap, previously set at 
125 percent. The program modifications took effect on December 1, 2011, 
for those lenders who were able to update and implement quickly; for 
most in the industry, including the Enterprises, implementation will 
continue through the next few months.
    In exchange for these program changes, lenders and mortgage 
insurance companies agreed to remove their own restrictions and 
overlays, to offer the program in a manner that is consistent with the 
parameters set out by the Enterprises. This agreement across the 
industry was unprecedented and the participation and support of the 
industry is to be commended. Already many of the largest lenders are 
seeing tremendous borrower interest and we expect to see an increase in 
HARP volume in the upcoming reports.
    Some have suggested that the program changes made to HARP ought to 
be carried over to the rest of the book of business at Fannie Mae and 
Freddie Mac. In fact, both companies do have streamlined refinance 
programs available today. The data suggests that borrowers are not 
having any excessive difficulty accessing these and other refinance 
programs as over 10 million households have refinanced with Enterprise-
backed loans over the last 3 years.
Real Estate Owned Initiative
    The Enterprises are also in the process of evaluating alternative 
methods for selling Real Estate Owned (REO) in ways that produce value 
for taxpayers and contribute to improved housing market stability. 
Yesterday we announced the first transaction in our REO Initiative 
pilot program. This transaction includes approximately 2,500 
properties, divided into 8 subpools by geographic area. Information on 
the number of properties in each location is available on FHFA's Web 
site, but let me say here that the targeted Metropolitan Statistical 
Areas are likely no surprise to you because they represent hard-hit 
parts of the country: Las Vegas, Nevada; Phoenix, Arizona; various 
communities in Florida; Chicago, Illinois; Riverside and Los Angeles, 
California; and Atlanta, Georgia.
    With this next step, prequalified investors will be able to submit 
applications to demonstrate their financial capacity, relevant market 
experience, and specific plans for purchasing pools of foreclosed 
properties with the requirement to rent the purchased properties for a 
specified number of years.
    Future transactions will also be targeted to these types of 
markets, where the supply of homes for sale is greater than the demand 
from homebuyers and where demand for rental housing is strong. The 
pilot is not intended to be a national bulk sale program, where the 
entire existing inventory is pooled for sale to investors; we are 
engaged in a targeted effort that is focused on markets with a large 
number of foreclosed properties and where local market conditions 
suggest a possible benefit from this approach.
    The number of properties available for sale by Fannie Mae and 
Freddie Mac represents only a fraction of the total supply that is 
depressing home values in certain affected markets. The existing retail 
sales strategy at both companies works well for moving properties into 
the hands of new owner-occupants at close to market values. However, 
through FHFA's REO Initiative, we are testing to see if FHFA can help 
address the broader set of market conditions with pilot programs that 
could serve as models to be replicated by other market players and in 
differing market situations.
    In addition to this pilot work, which is focused on moving 
properties in bulk, both companies are looking for ways to enhance 
their existing retail sales strategies, reexamining the programs 
available for homebuyers and for small investors. The Enterprises' 
retail execution has been very successful to date. Our primary goal 
will continue to be selling properties first to homebuyers who will use 
them as their primary residences or nonprofits that include homes in 
mission-oriented activities. We also want to enhance the opportunity 
for smaller-scale investors to bid on properties, and obtain financing, 
should initial efforts to market the properties to owner-occupants 
fail.
Strategic Plan
    At FHFA we are faced with a fundamental task of directing the 
operations of two companies that account for roughly three-quarters of 
current mortgage originations and have approximately $5 trillion in 
outstanding obligations and credit guarantees. FHFA's task is 
complicated by the uncertain future of the Enterprises and increasing 
dissatisfaction with various aspects of their business operations. 
Conflicting opinions abound about what our responsibilities should be. 
Some think FHFA should be doing more to help housing recover, others 
think that FHFA should be winding down the Enterprises' operations more 
quickly, others think that FHFA should be making all the business 
decisions at the Enterprises, and others think that the Enterprises are 
part of the Federal Government.
    To address these issues, what FHFA has done since conservatorship 
is to be clear about how we view our legal responsibilities as 
Conservator, and what actions we are going to take to fulfill those 
responsibilities.
    Two years ago, FHFA sent a letter to Congress that set forth the 
agency's understanding of its conservatorship obligations and what 
actions we intended to take to fulfill those obligations. In that 
letter, we focused on four main areas, including: Enterprise focus on 
loan modifications and mitigating credit losses; reduction in the 
Enterprises' retained portfolios; no new product deployments by the 
Enterprises; and meeting the Enterprises' affordable housing goals.
    It is time to update and extend that plan in view of where the 
Enterprises and the country's housing system are today. In particular, 
with the conservatorships operating for over 3 years and no near-term 
resolution in sight, it is time to assess the goals and directions of 
conservatorship.
    The strategic plan FHFA released last week, which is attached to 
this testimony, outlines the steps FHFA has taken and will be taking to 
address these challenges. The plan sets forth three strategic goals for 
the next phase of conservatorship:

  1.  Build. Build a new infrastructure for the secondary mortgage 
        market.

  2.  Contract. Gradually contract the Enterprises' dominant presence 
        in the marketplace while simplifying and shrinking their 
        operations.

  3.  Maintain. Maintain foreclosure prevention activities and credit 
        availability for new and refinanced mortgages.

    The first goal--building a new infrastructure--recognizes that the 
country would be without a secondary market for non- Government-insured 
mortgages without the Enterprises. No private sector infrastructure 
exists today that is capable of securitizing the $100 billion per month 
in new mortgages being originated. This goal establishes the steps FHFA 
and the Enterprises will take to create that necessary infrastructure 
and upon which Congress and market participants may use to develop the 
mortgage market of the future.
    The ``Build'' component includes the following activities, some 
that FHFA has already been working on over the last year:

    New securitization platform

    Standardized pooling and servicing agreements, including 
        transparent servicing requirements

    Servicing compensation structure that promotes competition

    Enhanced loan-level data for investors

    An efficient system for document custody and record keeping

    The second goal--contracting Enterprise operations--describes steps 
that FHFA plans to take to gradually shift mortgage credit risk from 
the Enterprises to private investors and eliminate the direct funding 
of mortgages by the Enterprises. This goal is consistent with the 
fundamental goals of the conservatorship, of the Enterprises operating 
in a sound and solvent condition, and of limiting future risk exposure 
in the face of uncertainty.
    The ``Contract'' component includes the following activities:

    Single-Family Credit Guarantees

    Increase guarantee fee pricing

    Develop loss-sharing arrangements

    Expand ways of using mortgage insurance

    Multifamily Credit Guarantees

    Market analysis of the viability of the Enterprises' 
        multifamily operations

    Capital Markets

    Portfolio already on a steady path of reduction

    The third goal--maintaining foreclosure prevention efforts and 
credit availability--recognizes that the work begun 3 years ago is not 
finished. Programs and strategies to ensure ongoing mortgage credit 
availability, assist troubled homeowners, and minimize taxpayer losses 
while restoring stability to housing markets continue to require 
energy, focus, and resources.
    The ``Maintain'' component includes the following activities:

    Implementation of recent HARP changes

    Continued implementation of SAI and loss mitigation 
        activities

    Further implementation of REO disposition initiative

    Renewed focus on short sales, deeds-in-lieu, and deeds-for-
        lease foreclosure prevention options

    Alignment and greater transparency on Enterprise 
        representation and warranty policies

    Achieving these strategic goals will fulfill the statutory 
responsibilities Congress assigned FHFA as Conservator and also prepare 
the foundation for a new, stronger housing finance system in the 
future. Although that future may not include Fannie Mae and Freddie 
Mac, at least as they are known today, this important work in 
conservatorship can be a lasting, positive legacy for the country and 
its housing system.
    Properly implemented, this strategic plan should benefit:

    Homeowners, by ensuring continued emphasis on foreclosure 
        prevention and credit availability;

    Taxpayers, by furthering efforts to limit losses from past 
        activities while simplifying risk management and reducing 
        future risk exposure;

    Market participants, by creating a path by which the 
        Enterprises' role in the mortgage market is gradually reduced 
        while maintaining market stability and liquidity; and

    Lawmakers, by building a foundation on which they may 
        develop new legal frameworks and institutional arrangements for 
        a sound and resilient secondary mortgage market of the future.

    The public interest is best served by ensuring that Fannie Mae and 
Freddie Mac have the best available corporate leaders and business 
professionals to carry out the work necessary to meet the critical 
goals set forth here. The managers and staff at each company also have 
critical roles to play since the numerous activities and changes 
necessary to accomplish the strategic goals will require substantial 
effort by many people at Fannie Mae and Freddie Mac.
Conclusion
    The strategic plan provides an outline for the next chapter of 
conservatorship, one that focuses in earnest on building a secondary 
mortgage market infrastructure that will live beyond the Enterprises. 
The steps envisioned in the strategic plan are consistent with various 
approaches to housing finance reform.
    The final chapter, though, remains the province of lawmakers. 
Fannie Mae and Freddie Mac were chartered by Congress and by law, only 
Congress can abolish or modify those charters and set forth a vision 
for a new secondary market structure. This plan envisions actions by 
the Enterprises that will help establish a new secondary mortgage 
market, while leaving open all options for Congress and the 
Administration regarding the resolution of the conservatorships and the 
degree of Government involvement in supporting the secondary mortgage 
market in the future.
    I would be happy to answer any questions you may have about my 
testimony or FHFA's new strategic plan.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                       FROM SHAUN DONOVAN

Q.1. Secretary Donovan, in your testimony before the Committee, 
you stated that the non-GSE loans that would be eligible for 
refinancing through the Federal Housing Administration as part 
of the President's recently announced housing plan are 
``already low-risk loans.'' The President's plan, however, 
appears to include loans that do not fall into this category. 
For example, it specifies that the refinancing program would be 
open to borrowers with a low FICO score of 580 as well as 
borrowers with ``deeply underwater loans.''
    How do you define ``low-risk loans?''

A.1. Although the plan calls for loans with FICOs as low as 
580, the plan explicitly states that the loan must be current 
at the time of the refinancing. Furthermore, the borrower must 
have exhibited a strong track record of on-time payments, with 
no late payments in the 6 months prior to the refinancing and 
no more than one 30 day late in the 6 months prior to that. The 
borrower may have suffered one or more hardships in the past 
which may be the reason the credit score is low, however, the 
borrower has reestablished the ability to pay and has proven 
responsibility with the strong 12-month payment history.

Q.2. Specifically, what are the expected default rates for 
borrowers eligible for this program? What is the expected 
participation rate, and how many foreclosures do you expect 
this program would prevent? What is the projected subsidy for 
this program, and how would it be offset?

A.2. We expect that that with homeowners experiencing lower 
interest rates, the likelihood of default would be decreased. 
However, at this time we do not have official estimates of 
default rates, participation rates, or other performance 
parameters.
    It is estimated, based on the current program guidelines 
that roughly three million borrowers would be eligible to 
participate. We cannot estimate exactly how many homeowners 
will participate in this program, as the decision to refinance 
is contingent on many personal factors, such as expected time 
in a residence, employment, etc.
    This is not an explicitly targeted foreclosure prevention 
program like HAMP, but we do expect that home ownership 
sustainability will improve when homeowners can refinance to 
lower rates. This in turn improves neighborhood stability and 
reduces the likelihood of default in the long run.
    We are working with members of the Senate to develop 
program parameters and identifying sources of funding to serve 
as a backstop to the premiums that would be collected through 
the program to absorb unexpected large losses.
