[Senate Hearing 112-755]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 112-755
 
   OVERSIGHT OF THE FEDERAL HOUSING ADMINISTRATION: EXAMINING HUD'S 
                     RESPONSE TO FISCAL CHALLENGES 

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

                                HEARING

                               before the

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

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

             EXAMINING HUD'S RESPONSE TO FISCAL CHALLENGES

                               __________

                            DECEMBER 6, 2012

                               __________

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

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            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

                     Laura Swanson, Policy Director

              Erin Barry Fuhrer, Professional Staff Member

                 William Fields, Legislative Assistant

                 Beth Cooper, Professional Staff Member

                 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, DECEMBER 6, 2012

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Vitter...............................................     4
    Senator Menendez.............................................     4

                                WITNESS

Shaun Donovan, Secretary, Department of Housing and Urban 
  Development....................................................     5
    Prepared statement...........................................    27

                                 (iii)


   OVERSIGHT OF THE FEDERAL HOUSING ADMINISTRATION: EXAMINING HUD'S 
                     RESPONSE TO FISCAL CHALLENGES

                              ----------                              


                       THURSDAY, DECEMBER 6, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:06 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. Thank you 
for joining us, Mr. Secretary.
    I asked you to testify today because I am deeply concerned 
about the recent report that the FHA could potentially need 
taxpayer support for the first time in its 78-year history. I 
would like you to help the Committee gain greater insight into 
the fiscal challenges at the FHA and what HUD has done and can 
do to mitigate losses and address the shortfall in the capital 
reserve ratio.
    FHA has been helping stabilize the mortgage market by 
ensuring that qualified low- to moderate-income and first time 
home buyers have access to mortgage credit since 1934. Since 
the beginning of the financial crisis, the FHA has increased 
its market share from below 5 percent in 2006 to about 30 
percent at its peak volume in 2009 in pursuit of that mission. 
This countercyclical expansion was essential to the mortgage 
market, especially for first-time home buyers who comprised 78 
percent of single-family purchase loans insured by FHA in 2011.
    FHA's multifamily and health care insurance programs have 
also played an important countercyclical role since the 
financial crisis, with a fourfold increase in volume from 2008 
to 2011. According to Mark Zandi, chief economist at Moody's 
Analytics, without the FHA's countercyclical support, and I 
quote, ``the housing market would have cratered, taking the 
economy with it.''
    However, providing a backstop for mortgage credit when 
private sources flee from the market has a cost. The losses at 
the FHA stem from the now prohibited seller-funded downpayment 
program, heavy losses in the reverse mortgage program, and 
loans made at the height of the crisis to prevent a cratering 
of the housing market. While HUD has already taken some actions 
to prevent the Mutual Mortgage Insurance Fund for single-family 
loans from seeking Federal funds, the Fiscal Year 2012 
Actuarial Report suggests that much more needs to be done to 
prevent such a draw.
    I want to hear more today about the administration's 
actions and proposals to manage the risks to taxpayers stemming 
from the older books of business and what safeguards are in 
place to ensure the quality and sustainability of the new books 
going forward.
    If the administration's actions and proposals will not be 
sufficient to restore FHA's fiscal health, then I plan to work 
with my colleagues on both sides of the aisle on the Banking 
Committee to find a bipartisan way to make that happen.
    Before I turn to Ranking Member Shelby, I want to recognize 
his work as Ranking Member on this Committee over the past 6 
years. This may be our last hearing together this year, and we 
will have a new Ranking Member next year. I am proud of our 
bipartisan record over the last 2 years. We continued the 
tradition of bipartisanship that this Committee has been known 
for by passing four significant bills together this Congress, 
and I thank Senator Shelby for his service.
    With that, I turn to Ranking Member Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    First of all, I appreciate your remarks. I have been on 
this Committee 26 years, ending it, but I am not ending being 
on. I will just have to move down a notch as I go over 
hopefully to be the Ranking on Appropriations. I will not be 
far away, and I will not be far from the Secretary on HUD stuff 
either over there.
    [Laughter.]
    Senator Shelby. But I enjoy working with this Committee. I 
have enjoyed being Chairman of this Committee in two 
Congresses. The people on this Committee are superb. The staff 
is superb. And this is a very important Committee not only for 
the Senate but for the American people and perhaps the world, 
as most people know, people who are active on this Committee, 
because banking and housing and everything that goes with it 
goes right to the heart of what ticks in America: job creation, 
availability of money, the regulation of our banks, the 
Securities and Exchange Commission, money laundering, sanctions 
on Iran. You name it. Most of it, this is the active Committee. 
So I will be around right near here, but I will be yielding, 
moving down one notch next to Senator Crapo, and he will do 
well.
    Having said that, welcome again, Mr. Secretary. Just days 
after the President's reelection, the FHA released its 2012 
Actuarial Report which revealed that the economic value of the 
FHA Fund has fallen to negative $16 billion. A lot of money. 
That means the fund's capital reserve ratio, as I understand 
it, now stands at a negative 1.44 percent.
    This news is obviously very disturbing to us and to the 
Secretary, for those of us who have long been concerned about 
the health of the FHA. For years, the problems of the Federal 
Housing Administration have been well known. During the housing 
boom, the FHA, unwisely I thought, guaranteed millions of risky 
mortgages with low downpayments to borrowers with poor credit 
scores. We are reaping that now. These mortgages have resulted 
in billions of losses to the FHA.
    The Federal Housing Administration has made matters worse, 
I think, by failing to come to grips with the magnitude, Mr. 
Secretary, of the problems. Back in 2007, as the Federal 
Housing Administration's poor financial position was becoming 
clear to all, including right here in this Committee, I urged 
the FHA to devise a credible plan to improve its finances. I 
stated then, and I will quote, that ``before the taxpayers are 
faced with greater losses, I believe we must determine how the 
FHA got into this position, Mr. Secretary, and how it intends 
to get out.''
    Unfortunately, for the past 5 years, the FHA's leadership 
has understated their problems and sought to kick the can down 
the road. This is now the fourth year in a row that the FHA 
Fund has been below its statutory minimum capital levels. Yet 
each year we are told that this is a temporary dip and that 
within a few years everything will be fine.
    In fact, in 2009, Mr. Secretary, you told this Committee 
that the drop in the capital ratio was expected to be 
``temporary,'' and that it would ``return above 2 percent 
within the next 2 or 3 years, even if FHA were to make no 
policy changes at all.''
    We now know this forecast was way off the mark. The 
administration, however, continued to be optimistic. In 2011, 
for example, HUD still had its projections showing the FHA's 
capital ratio reaching 2 percent in 2014. Now, despite all 
these reassurances, the Actuarial Report projects that the FHA 
Fund has a capital reserve, as I mentioned earlier, of a 
negative 1.44 percent. And what is the response of the FHA's 
leadership here?
    Just this year, after further declines in the FHA Fund, 
both Secretary Donovan and Acting FHA Commissioner Carol 
Galante testified to two different Senate Committees that the 
fund would ``return to the congressionally mandated capital 
reserve ratio of 2 percent by 2015.''
    Needless to say, I am not nearly as optimistic about the 
future of the FHA. I hope it works. I hope it does.
    The inability of FHA's leadership to clearly recognize and 
address its problems is raising doubts, Mr. Secretary, about 
their credibility and their willingness to properly manage 
FHA's financing. I think it is time for FHA to face facts. We 
have to.
    First, the capital reserve ratio, the Federal Housing 
Administration Fund, is dangerously low. You know that. And it 
has shrunk nearly every year since 2006.
    Second, the fund's capital ratios have been below FHA's 
statutory obligations every year since 2008.
    Third, every year since then, future growth in the capital 
ratio has underperformed in relation to FHA's predictions. 
Hopefully, the shock produced by these latest projections will 
finally be a wake-up call for everyone. Hard choices lie ahead 
for this program. We have talked about this.
    FHA leadership, I believe, must fully realize its existing 
authority to shore up the value of this fund. Additionally, 
Congress must consider reductions in permissible risk layering 
and further underwriting reforms and a reexamination of premium 
structures. It is time, I believe, to get serious reform of FHA 
before it needs a taxpayer bailout, if it is not too late 
already.
    I wish you well, Mr. Secretary, but you have a real 
challenge here. We do with you.
    Thank you.
    Chairman Johnson. Thank you, Senator Shelby.
    Are there any other Members who wish to make a brief 
opening statement? Senator Vitter.

               STATEMENT OF SENATOR DAVID VITTER

    Senator Vitter. Thanks, Mr. Chairman. Just briefly, I want 
to agree with the comments of our Ranking Member, Mr. Shelby. 
And our general concern is that we have seen this coming for a 
while. We have been talking about it, and the response from the 
administration has been very modest. Unfortunately, our worst 
fears are coming true, and even today I am very concerned that 
the response even given this news is just way too modest.
    In discussing last year's Actuarial Report, the Acting 
Commissioner, Carol Galante, said there is no evidence or 
widespread prediction that home prices are going to decline to 
the kind of levels that would require a bailout. Yet right now 
the question is quickly becoming not if but when. And, still, 
even in the Secretary's testimony today, we are only talking 
about things like waiting until the second quarter of next year 
to raise premiums and then buy ten basis points.
    So I would really urge the Secretary and others to consider 
other more aggressive, more proactive measures. Even the 
Washington Post, which is not exactly a right-wing think tank, 
said recently, ``Right now the critics are starting to look 
pretty prescient. Affordable possession of one's own home is 
the American dream. Government support for excessive borrowing 
has turned into a national nightmare.'' And the focus of that 
editorial was we still have not fundamentally reformed that, 
including at FHA. So I hope we start getting on that track 
starting today.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Menendez.

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Mr. Chairman, thank you very much, and I 
will be brief. I look forward to hearing the Secretary's 
response on how FHA balances the goals of remaining self-
sufficient without taxpayer funds, but also helping what is 
still a fragile housing market and ensuring that first-time 
home buyers can get credit.
    There is a clear case to be made, in my mind, that but for 
FHA in the midst of this housing crisis we would have a far 
greater crisis on our hands. And so reconciling the fiduciary 
responsibilities here to the taxpayers as well as the mission 
to people of America is incredibly important, and I look 
forward to hearing that.
    And with your indulgence, Mr. Chairman, when it comes to my 
time to question, while I certainly care about FHA, I have an 
even more pressing issue in the State of New Jersey after 
thousands of homes were lost, lives were lost, and we are 
facing the greatest devastation the State has ever had. The 
Secretary has been charged by the President in that regard to 
be the--I call it ``czar,'' but whatever the appropriate title 
is, and I will have some questions in that regard on behalf of 
my State.
    Thank you.
    Chairman Johnson. Thank you all.
    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 witness. The 
Honorable Shaun Donovan is the 15th Secretary of Housing and 
Urban Development. This is his ninth time before the full 
Committee.
    Secretary Donovan, you may proceed with your testimony.

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

    Mr. Donovan. Mr. Chairman, thank you, Ranking Member 
Shelby, and Members of the Committee. Thank you for the 
opportunity to testify today regarding the status of the 
Federal Housing Administration's mortgage insurance programs. 
I, too, want to add my thanks to Ranking Member Shelby for his 
leadership and partnership on so many issues these last few 
years.
    This is an important moment for our housing market and our 
Nation's economic recovery. As 2012 draws to a close, there are 
encouraging signs: housing construction growing faster than at 
any time since 2008, the strongest year of home sales since the 
economic crisis began, and rising home values lifting 1.3 
million families above water in the first half of the year 
alone.
    FHA's programs have been a critical component of this 
economic recovery. That should come as no surprise given the 
programs' goals and history. With the dual mission of providing 
access to home ownership for underserved, low-wealth 
populations and critical financing for multifamily 
developments, nursing homes, assisted living properties, and 
hospitals, the FHA is designed to fill gaps in the market, meet 
important community needs, and act as a stabilizing force 
during economic distress.
    It is clear that FHA has done just that. By ensuring much 
needed liquidity in the Nation's mortgage finance markets, FHA 
was a vital, stabilizing force as we experienced the worst 
economic decline since the Great Depression.
    In the last 4 years, the FHA has made home ownership 
possible for over 3.5 million families, including 2.8 million 
first-time buyers and for 50 percent of all African American 
and Latino home buyers last year. While FHA has acted as a 
critical support, it has not been immune to the stresses of 
falling home values and rising unemployment of the recession. 
According to the independent actuary's annual report on the MMI 
Fund, this fiscal year the capital reserve ratio fellow below 
zero to negative 1.44 percent, representing a value of negative 
$16.3 billion.
    We take and I take these findings extremely seriously. As 
stewards of taxpayer dollars, we have, since the start of this 
administration, made it a priority to strengthen the fund, and 
we are continuing to take aggressive action to return the fund 
to fiscal health, including those measures just announced in 
our annual report to Congress.
    It is important for me to start by highlighting several key 
points that put the actuary's report in perspective. Fully $70 
billion in claims are attributable just to the 2007-09 books of 
business. These 3 years are the major source of stress to the 
fund. In fact, in its report, the actuary attests to the high 
quality and significant profitability of the books insured 
since 2010, the strongest in the agency's history.
    It is important to understand this report does not in and 
of itself mean that it will be necessary for the FHA to use its 
authority to draw from the Treasury to cover projected losses. 
While this possibility obviously exists, it is dependent on 
several factors.
    First, that determination would be made using the 
assumptions in the President's budget to be released in 
February, not the assumptions used in the actuary's report.
    Second, we expect that the new books of business generated 
after 2012 will create approximately $11 billion in economic 
value, further strengthening the MMI Fund.
    Third, since the Actuarial Report is a point-in-time 
snapshot, it does not take into account changes FHA recently 
has announced to address the health of the fund. The final 
accounting of any shortfall would be done at the end of fiscal 
year 2013 in order to determine whether funds from the Treasury 
are necessary.
    I would also like to address the primary drivers of the 
decline in the capital reserve ratio as compared to last year's 
projections.
    First, the house price appreciation estimates used by the 
actuary for this review were significantly lower than those 
used last year. That may seem counterintuitive given the 
economic progress we have seen, but the actual turnaround in 
the market occurred later than was projected in last year's 
forecast. In addition, for technical reasons, the forecast is 
also somewhat artificially dampened by the significant increase 
in refinancing activity in the market this year.
    Second, the continued decline in interest rates, while good 
for the overall economy, impacts the actuary's model by 
indicating marginally higher defaults as well as lost revenue 
to FHA as its borrowers pay off their mortgages to refinance at 
lower rates.
    Third, based on recommendations made by the GAO and HUD's 
IG and at the direction of FHA, in this year's report the 
actuary changed the way it reflects losses from defaulted loans 
and reverse mortgages in the economic value of the MMI Fund.
    Let me be clear. These are all important factors to 
consider when explaining the current status of the fund, but 
they do not minimize the seriousness of this report in any way. 
As I said at the outset, we have already taken significant 
actions to protect and strengthen the fund, including premium 
increases and changes to credit policy, such as increasing 
downpayments for lower credit score borrowers and ending 
seller-financed downpayment assistance. With your help, our 
efforts have added well over $32 billion to the fund.
    The measures I will outline today further address the 
primary source of the problem: losses stemming from legacy 
books of business, particularly those insured during the 2007-
09 period, and are designed to reduce our loss severities by at 
least 5 percent, generating approximately $3 billion in 
economic value over the next 2 years.
    First, we have announced changes to our Loss Mitigation 
Program that targets deeper levels of relief for struggling 
borrowers to more effectively assist families in meeting their 
obligations and avoid costly foreclosures for FHA. Similarly, 
we are streamlining the use of short sales and aligning our 
practices with those recently announced by the GSEs to provide 
more families the opportunity to avoid foreclosure while 
reducing costs for the FHA. And we have dramatically increased 
the use of alternative dispositions for defaulted loans, 
including our new Distressed Asset Stabilization Program. The 
improvement in recoveries to FHA from this program is estimated 
at over $1 billion this year alone.
    We are also taking proactive measures on new loans. In 
particular, we are reversing a policy change made over a decade 
ago that allowed borrowers to stop paying premiums after their 
loans reached a certain loan-to-value ratio. This change left 
the FHA without premiums to cover the losses on loans held 
beyond the period for which those premiums were collected, 
reversing the policies expected to improve the value of the 
fund by $2.6 billion in this fiscal year alone.
    In addition, we will raise our annual mortgage insurance 
premiums by 10 basis points. We estimate this will increase 
costs to new borrowers by about $13 per month, but it will also 
further reduce our footprint in the market while adding an 
estimated $1 billion of additional economic value to the fund 
this year.
    As private capital returns, FHA must continue to balance 
pricing to ensure that it occupies a smaller, healthier share 
of the market. In fact, FHA's market share has been declining 
since 2009, and 2012 represents our lowest-volume year since 
the start of the economic crisis.
    While I focused today on FHA's single-family programs, I 
wanted to take the opportunity to reassure the Committee that 
our efforts to protect our insurance funds span the range of 
our programs. We have already raised our mortgage insurance 
premiums on multifamily and health care loans and instituted 
other risk management reforms, such as special reviews for 
large loans, post-commitment reviews by credit risk officers, 
and an active loan committee process.
    Even as we use our existing authority to take these 
aggressive measures to protect the fund, other actions require 
your partnership. In addition to the increased indemnification 
authority and broader geographical enforcement powers recently 
passed by the House, we have a number of proposals designed to 
place FHA in a stronger fiscal position over the next 12 months 
and beyond, including new loss mitigation authority, additional 
enforcement authority, and greater administrative flexibility 
in managing the reverse mortgage program.
    The house has recently passed important bipartisan FHA 
reform legislation, and we look forward to continuing to work 
with both chambers to create the tools we need to strengthen 
the program, meet its mission, and place the MMI Fund back on 
firm footing. I encourage the Senate to engage in discussions 
that build on this progress in the House in order to achieve a 
consensus that will give FHA these tools as quickly as 
possible.
    There are no guarantees that the actions I have described 
will prevent FHA from tapping into the Treasury next September. 
However, swift action from Congress, coupled with the $11 
billion in additional value from the new fiscal year 2013 
business, will reduce the likelihood that a Treasury draw will 
be necessary.
    Furthermore, these changes, as well as those we have made 
over the past 4 years, have laid the foundation for a stronger 
FHA and a healthier MMI Fund that supports the recovery of the 
housing market and economy while actively reducing FHA's market 
share.
    As we work together to adapt and reform the FHA program, we 
must proceed with a balanced approach that recognizes both the 
challenges to FHA and its contributions to our economy. We are 
eager to work with you to achieve these shared goals.
    Thank you again for the opportunity to testify today, and I 
look forward to taking your questions.
    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, I am very concerned about the FHA's 
fiscal condition, as detailed by fiscal year 2012 report, 
particularly the negative capital reserve ratio. What action 
have you taken to restore FHA's capital reserve and prevent FHA 
from requesting taxpayer support?
    Mr. Donovan. Mr. Chairman, the most important actions that 
we have taken have been in partnership with this Committee, and 
I would particularly recognize the fact that you passed a ban 
on seller-funded downpayments, which went into effect and we 
implemented in 2009. That action alone we believe has saved the 
FHA fund about $12 billion.
    There are additional actions that we have taken. We have 
raised premiums four times, made underwriting changes that 
include raising downpayments for the riskiest borrowers. That 
series of changes has added, we estimate, an additional $20 
billion to the value of the fund. Quite simply, if we had not 
taken those actions in partnership with you, we would find 
ourselves in a vastly worse position today for the FHA fund.
    Chairman Johnson. Mr. Secretary, you have detailed several 
steps that would help stabilize FHA's finances. Given the 
condition of the FHA's old books of business, why weren't these 
changes made earlier? Will these changes allow the FHA to 
outperform projections again this year and avoid drawing funds 
from the Treasury?
    Mr. Donovan. As I said in my testimony, I cannot guarantee 
that we will not need to draw at the end of the fiscal year. 
What I can say is that I believe we are taking all appropriate 
steps to try to avoid that, balancing both the health of the 
fund but also the fragile recovery that we have in the market.
    For example, we have already moved to increase premiums for 
the fifth time. We believe that that is an appropriate step and 
that it leaves FHA appropriately priced. We would be concerned, 
however, about going significantly further in raising premiums 
both because it would have potential negative impacts on the 
housing market--we are seeing a recovery, but it is still 
fragile, and we do not want to hurt the market and in turn hurt 
the FHA fund by going too far to stop that recovery.
    But I would also suggest, as you see in the chart on the 
right, we are currently--and the independent actuary confirms 
this, that the new books of business are highly profitable. And 
so I think there is, beyond the market question, a question of 
how far do we go in visiting the sins of the past on new 
borrowers. The premiums that are being paid by new borrowers 
more than cover the expected losses. We think that is 
appropriately priced and will help to shrink our market share. 
But what we need to do is continue to focus on these older 
books of business, and that is why I have focused, in the 
changes that we have made, we announced in our report to 
Congress, on steps that will increase our collections from 
these older books of business.
    Just from the asset sales that we have instituted, and we 
are going to ramp up going forward, we have increased the 
returns on these distressed loans by more than 10 percent 
simply with those steps.
    So we need to continue to focus on things, and we have 
asked for authority from you to take steps that would help 
increase our returns on the older books of business. We think 
those are the most appropriate measures that we can take.
    Chairman Johnson. Secretary Donovan, one of these steps is 
better loss mitigation by transferring sourcing from servicers 
who are underperforming. What is preventing FHA from doing that 
under its existing servicing contracts?
    Mr. Donovan. Quite simply, we need legislative authority to 
be able to force those transfers to happen, and that is a 
critical step. It is something that we have seen in the private 
market start to increasingly happen. It is something we believe 
would be very helpful to send a very strong message to those 
servicers that are underperforming. But it is one of a number 
of steps that we would ask that you give us legislative 
attorney for as quickly as possible.
    Chairman Johnson. One more question. Secretary Donovan, the 
Actuarial Report's finding of a negative economic value in the 
MMI Fund is mainly a reflection of problem legacy loans 
guaranteed during the housing bubble. What steps has FHA taken 
to improve its underwriting criteria and risk assessments for 
the new loans?
    Mr. Donovan. As I mentioned earlier, clearly the steps that 
you took to ban seller-funded downpayment loans were a critical 
piece of that. We also looked at the performance of our loans 
very carefully, and so in addition the premium increases, we 
did require a 10-percent downpayment for our riskiest 
borrowers. That we believe was a very important step in 
changing our underwriting.
    We also have taken many other steps on other aspects of 
underwriting that have to do with what costs can be rolled into 
the loan, and other steps that reduce the effective risk of 
those loans that are quite important. Part of that has been 
able to be done because, quite frankly, we did not have a 
strong enough risk focus at FHA in the midst of the crisis. We 
have created a very strong risk management focus through the 
creation of a chief risk officer for FHA--that has never 
existed before--as well as building a team of analysts that are 
really providing data on an ongoing basis on early payment 
defaults and a whole range of other information that we simply 
did not have before in real time.
    So it is not only the underwriting changes themselves, it 
is also the focus on risk and the way that we are measuring it 
on a real-time basis that has given us new tools.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Secretary Donovan, lead me through this and tell me if I 
wrong on this, or right, or what. It is my understanding that 
under the statutes now prevailing, the Federal Housing 
Administration could, if necessary or you deemed it necessary, 
tap the Treasury for an endless supply of money. A lot of us 
would call that a bailout. Do you anticipate that? Can you 
assure us and the American people today, as the Secretary of 
HUD, that FHA will not do that? Or you do not know yet?
    Mr. Donovan. Senator, I wish I had a crystal ball and I 
could tell you that we will not at the end of the year. Given 
the Actuarial Report this year, obviously I am highly concerned 
about that possibility.
    Senator Shelby. Are you getting close?
    Mr. Donovan. Certainly we are closer than we have been in 
the past.
    Senator Shelby. And how close are you, honestly?
    Mr. Donovan. What I will tell you is, again, an independent 
actuarial report is the best I can give you in terms of that 
view.
    Senator Shelby. And that is not good, is it?
    Mr. Donovan. What it says----
    Senator Shelby. The Actuarial Report is not good.
    Mr. Donovan. It is not. But one important piece of this is 
that what is required for the actuarial is a review as if we 
stopped doing business on the date of the actuarial. The 
important thing that we can do and that we have done to try to 
avoid taking funds from the Treasury at the end of the year is 
to look at the revenue we expect this year--that is about $11 
billion--and to make changes to underwriting and other steps 
that would help avoid that.
    Senator Shelby. Does that include upping the premium a 
little?
    Mr. Donovan. We have already moved to increase the premium 
an additional 10 basis points, an average of about $13 a month 
that we expect from borrowers.
    Senator Shelby. And how much money would that be 
projecting?
    Mr. Donovan. That would add about $1 billion just this year 
alone and much more into the future.
    Senator Shelby. What is the size of your portfolio today, 
roughly?
    Mr. Donovan. It is over $1 trillion when you combine----
    Senator Shelby. $1 trillion worth of loans, right?
    Mr. Donovan. When you combine all of the various programs.
    Senator Shelby. And how close are you as far as working 
capital, so to speak?
    Mr. Donovan. It is an important question. Today, even 
though the Actuarial Report shows a negative balance, we have a 
cash balance of over $30 billion today, $30.5 billion. And, in 
fact, one of the things the actuary looks at, assume that we 
continue to do business, assume that we continue to operate, 
what is the likelihood--which obviously we plan to continue to 
operate.
    Senator Shelby. Sure.
    Mr. Donovan. What is the likelihood that we actually--the 
cash balance goes negative? And the actuarial, despite the 
worse condition this year, still has a less than 5-percent 
chance that we actually run through all of those cash reserves 
going forward.
    Senator Shelby. Give us the worst-case scenario. It is the 
first week of December now. Say 3 weeks from now, what is your 
worst-case scenario getting up to the 1st of the year where you 
might be or not be? What would cause you to have a lot of 
heartburn say around the 1st of the year?
    Mr. Donovan. The single greatest issue of concern is where 
the housing market will go from here. If the housing market 
continues to recover, as it has this year, that is the most 
important thing that we can see to restore the fund to health. 
House price appreciation is the single most important variable 
in the health of the fund going forward, and that is also why I 
will say we are so concerned about balancing the steps that we 
are taking to make sure we are not doing anything that would 
impede the recovery and come back and harm the FHA in the long 
run by decreasing the improvement that we see in housing 
markets.
    Senator Shelby. We all realize that FHA serves a good 
purpose, but it is just not sound financially. As the Secretary 
of HUD, shouldn't the fiscal well-being of FHA be one of your 
highest priorities?
    Mr. Donovan. Absolutely. Absolutely.
    Senator Shelby. And are you just going to deal with what 
comes up like you outlined today?
    Mr. Donovan. I would welcome additional ideas and 
suggestions that you may have. I certainly feel that there--we 
will take steps within our power. We would like to work with 
you, as I have said, as quickly as possible to move additional 
authorities that would help us do this. But I am also open 
today or at any time to additional suggestions about what 
further steps we could take.
    Senator Shelby. If you do tap the Treasury--in other words, 
there is a bailout, so to speak, if it is a sizable one--how 
would you pay that money back? Premiums or efficiency or the 
housing recovery, or all of the above?
    Mr. Donovan. We certainly believe that we need to keep FHA 
in a position where our new books of business are producing 
substantial revenue for the taxpayer. This year alone, we 
expect our new loans to return a $10 billion profit, if I can 
use that term, to the taxpayer. That is the way that we need to 
continue to restore the health of the fund and, should we need 
to draw on the Treasury, to restore that money to the taxpayer.
    Senator Shelby. Thank you.
    Thanks, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and thank 
you, Mr. Secretary.
    I would repeat what my colleagues have said. It is very 
disturbing to have a report that shows 1.4 percent negative 
equity in a critical fund, and this is an issue that has not 
suddenly emerged. It has been growing over several years.
    You have indicated that you are taking steps to fix these 
problems, and many people have said that in the past, too, and, 
again, can you sort of give us some assurance that this time is 
different?
    Mr. Donovan. What I can say, Senator, is that I believe we 
are taking every responsible measure that we can to improve the 
health of the fund, while at the same time not hurting the 
fragile recovery that we have. I do not have a crystal ball, 
and I believe that we need to continue to take input and 
guidance on getting a better picture of the fund.
    One of the reasons why the fund looks significantly worse 
this year than it did last year, we got criticism last year 
from outside experts, from the GAO, from our IG, of the way 
that we model claims in our actuarial. We went back and 
directed our actuary to change the way we model, and that 
change alone subtracted $13 billion from the value of the fund.
    So I am not going to sit here and say we have been perfect 
in the way that we have looked at the fund or that we have 
modeled it. And one of my responsibilities is to continue to 
make changes to get as accurate a picture as we possibly can 
and to take steps based on that.
    Senator Reed. Let me ask perhaps a related question. As you 
look forward in terms of the health of the fund, one fact, it 
would seem to me--and I would assume it would be explicitly in 
the model--would be an assumption about unemployment rates 
going forward. What unemployment rate are you assuming over the 
next year or so? Because it directly affects payment.
    Mr. Donovan. Absolutely. One of the important changes we 
made to the model this year, not to get too wonky here, is to 
go to something that is called ``stochastic modeling.'' One of 
the criticisms we had is that we--the way the model worked is 
we chose one path and modeled based on that. State-of-the-art 
modeling assigns probabilities to a whole different range of 
paths that the economy might go through. So we have actually 
modeled a vast range of scenarios.
    One of the things we looked at last year, that we directed 
our actuaries to look at, was to say: What if interest rates go 
low? What is going to happen to the fund? We ran that last 
year. That scenario predicted that the fund would go negative. 
In fact, we have had what is effectively the low interest rate 
scenario happen this year with QE3, and that has clearly had a 
substantial impact, roughly a $10 billion negative impact on 
the fund, just from those interest rates alone. So those are 
clearly steps that we are taking. We would be happy to share 
with you the various unemployment rate scenarios that we are 
looking at and home price paths that we are looking at. But, 
again, we look at a range of those to get to the best possible 
prediction.
    Senator Reed. You got close to watching this with 
stochastic modeling, but you avoided Bayes' theorem, so you are 
fine.
    One of the problems that you face is this series of years 
of terribly mispriced loans in 2007 to 2009, and it would seem 
to me one of the things that you are trying to do is to clear 
these as quickly as possible. But as you have indicated to us, 
you need help with servicing, that you have to do much more 
aggressive modification sales, and also for the real estate 
that effectively you own, you have to dispose of it.
    Can you comment on how much you think you can achieve in 
relieving pressure on the fund by doing that, looking back and 
taking care of that period?
    Mr. Donovan. We think with a set of changes that we are 
already taking, that we announced in our report to Congress 
with the actuarial, that include the loan sales that we have 
taken, changes to short sales, changes to what we call our loss 
mitigation waterfall, how we work with borrowers that are in 
trouble, those alone could add about $3 billion to the fund 
over the next couple years.
    What we need help on is that many of our enforcement 
authorities--and, again, if you think about how we collect on 
the bad loans, enforcement is an important piece of that, to 
say to lenders, you made a bad loan, there was fraud or there 
was something else involved, we need to hold you accountable 
for that and bring funding back to the taxpayer. There are a 
number of provisions that would help us.
    One is giving us broader geographic authority. We have some 
perverse restrictions right now in legislation in terms of the 
way that we can hold lenders accountable on a narrow geographic 
basis, what we can do to require indemnification of loans, the 
standard for fraud. Those are all pieces of what we would want 
to work with you to get passed very quickly to be able to 
enhance our enforcement authority. Those as well would likely 
add billions of dollars to the fund.
    As you know, we have been able to recover well over $1 
billion just this year in settlements around servicing and 
originations with many of our biggest lenders.
    Senator Reed. Thank you very much, Mr. Secretary, and thank 
you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. And, Mr. 
Secretary, thank you for your testimony today. You asked for 
some suggestions, and I would like to make just a few.
    It is my understanding that on the private side right now, 
FICO scores really at 620 is where the market is. And FHA is at 
580, and basically it is creating a situation where the private 
lenders are being made out to be bad guys because even though 
your FICO scores are 580, they are not doing anything below 
620.
    As one of the steps that you might take, would it make 
sense for you to go ahead and get on up to 620? Right now there 
is huge demand out there, and at some point that is going to 
diminish, and then we will drive back down as people try to get 
market share again. Would it not make sense to go ahead and 
implement what the market is telling you to do?
    Mr. Donovan. That is something that we are actually looking 
at. I think it is likely that we take additional steps as we 
are working toward the President's budget and understanding in 
more detail the results of the actuarial. That is clearly 
something we are looking at.
    We are concerned that some of the overlays that lenders are 
putting on go farther than are necessary. In other words, we do 
believe that there has been an overcorrection, if you will, in 
some parts of the market where we have what are very safe 
borrowers that are having a hard time accessing credit. But I 
also agree that we need to be looking at and perhaps adjusting 
on the FICO side as well.
    Senator Corker. And, generally, for what it is worth--I 
appreciate your testimony today. I know we have had discussions 
about that sometimes in the past, and I do realize you had a 
lot of bad loans on the books that you inherited. I do think 
there are things you can do now to really cause the fund to be 
far more sound, and I do think you all are being a little slow 
in moving that way.
    And so a second one I would move to is reverse mortgages. I 
mean, you are losing your shirt on reverse mortgages. Losing 
your shirt. It is a small part of what you are doing, and yet 
you have got mortgage brokers out there that are making an 
absolute fortune right now--a fortune. Some of them are good 
operators. A lot of them are schlocky operators. And I do not 
understand why you do not shut the program down for 24 months, 
as I know has been suggested to you. Why don't you do that?
    Mr. Donovan. Once again, Senator, you have hit on an issue 
that is an important one and that we do believe we need to make 
changes on.
    Senator Corker. But why don't you just do it?
    Mr. Donovan. Well, frankly, we did make changes. We 
introduced a much safer--better, we thought--alternative 
through our SAVER program. We could effectively do what you 
said, which is to just create a moratorium on the other 
program. What we are concerned about is, particularly given the 
economic crisis that seniors are going to--have gone through, 
that we would be eliminating an option that works for some 
seniors if it is done safely in order to eliminate also the bad 
loans that are being made.
    Our preference, if we could get the authority from you to 
change the structure of the program to make it much more 
effective and safe, that would be a better way to go. If we 
cannot get that authority quickly, we will have to look at----
    Senator Corker. I mean, I would think--why can't we do a 
unanimous consent? It seems to me that most people would be 
willing to do that.
    Mr. Donovan. Let us talk about that today. I would love 
to----
    Senator Corker. I know you have got a partial situation 
that has been very healthy, and it seems to me if you are 
worried about seniors, you could keep the ability to draw down 
a partial amount, which is very safe, and you would eliminate--
and you could do that all by yourself, and we could worry about 
the legislation whenever it is time. I am willing to look at it 
now, but just for what it is worth, it does feel like there is 
a lot you could do to make FHA healthy today that is not being 
done. But let us talk further, OK?
    Loan limits. It seems like right now--I mean, Fannie and 
Freddie are down at, I think, 625. You are still up at 729. 
Wouldn't it make sense to go ahead now and make some changes 
that need to be made? I mean, you can do that yourself. Why 
don't we do that?
    Mr. Donovan. We, as I think you know, supported our loan 
limits coming down, and they were supposed to expire last year. 
Congress made the decision to lower the GSEs' loan limits, but 
kept FHA's----
    Senator Corker. Can you self-implement that, though? You 
cannot do that without----
    Mr. Donovan. I do not believe, given that Congress 
explicitly extended those higher limits, that we can take that 
step and----
    Senator Corker. Would you like for us to help you do that?
    Mr. Donovan. We have supported before and I will state 
again today that going back to the pre-HERA limits makes real 
sense, and I will go further than that, that we should lay out 
a path to go back to even lower limits that existed before the 
crisis in a way that is done consistent with how we do housing 
finance reform. That is a larger question, but the immediate 
step of going back to the pre-HERA limits is one that we would 
support.
    Senator Corker. Well, you are developing a fan, and I hope 
that we can look at some of those things.
    Home mortgage insurance. The way I understand that it works 
is private mortgage insurers, when you get down to a certain 
loan-to-value ratio, the premium is dropped, but also the 
insurance is dropped. And yet you have a $1 trillion in loans 
on your books where the loan-to-value has dropped, they are no 
longer paying premiums, but you are keeping the guarantee in 
place. That does not make any sense to me. Why don't you 
continue to make the homeowner who has that guarantee continue 
to make the premium payments? That would be something that, it 
seems to me, would be extremely helpful to you during this 
difficult time.
    Mr. Donovan. Once again, an excellent suggestion. We 
announced with our report to Congress that we are doing that 
for new loans. Unfortunately----
    Senator Corker. But why not the trillion that are on the 
books?
    Mr. Donovan. Unfortunately, we cannot go back and modify a 
contract. When that homeowner took that loan, they signed a 
deal with FHA that said this is the way the premium structure 
would work. We looked at this. We fully analyzed it. We cannot 
break those contracts, unfortunately. And so it is something 
that we're going to need to implement.
    I will say, however, that the value of doing it now in a 
low interest rate environment is substantially larger on these 
new loans, for two reasons: the lower the interest rate, the 
faster the amortization of the principal, and, therefore, this 
will be a more valuable change; second, because these loans are 
so low interest rate, they will be on our books far larger. So, 
frankly, not many loans in the past have hit that limit. So 
even though it is a $1 trillion portfolio, the value of that 
change is quite small for the old loans. It is really going to 
be quite valuable for these newer very low interest rate loans.
    Senator Corker. Mr. Chairman, I made no opening statement. 
Briefly, two more questions.
    I see that FHA is now making loans to people who 3 years 
ago were foreclosed upon, and that is a very different standard 
than even exists at Fannie and Freddie. I do not understand. 
Why are you doing that?
    Mr. Donovan. This is another area where we are working on 
changes, and here is the issue: We have a significant number of 
homeowners that were responsible homeowners, had good credit 
scores, that lost their jobs in the biggest economic crisis 
this country has faced since the Depression. And we believe if 
somebody can show that they are back at work and are a 
responsible borrower again, that is somebody that we ought to 
work with.
    I would agree that our standards are not clear enough in 
dividing those, so what we believe we need to do is clarify 
those standards, but not necessarily eliminate the possibility 
that somebody who has done the right thing and through no fault 
of their own lost a job but can now be a responsible homeowner 
again has the chance.
    So my view would be it is not just the 3-year limit that is 
important. It is: What are the criteria that we set for how 
somebody reestablishes their credit and being a responsible 
homeowner? That is where I would propose we work together.
    Senator Corker. OK. My last question, and thank you for 
your patience. First of all, it sounds like there are a lot of 
things that could be done right now to solve a lot of problems, 
and I hope that we as a Committee will figure out a way to work 
with you on those things we need to work with you on, but that 
you will do the things you can do on your own now.
    You and I had a pretty long conversation several months ago 
when Carol Galante had the opportunity, candidly, to assume her 
post on a permanent basis, and we could not get the 
Administration to agree to not air-drop something and bypass 
the Committee. It was an unfortunate circumstance. But I guess, 
as I look at it, I would just ask you the question: Did we 
dodge a bullet in appointing her full-time with all the issues 
that we have at FHA? And does she really have the ability to 
press the Administration to overcome political issues to 
actually cause the fund itself to be actuarially sound? Because 
it appears to me that we are still not quite doing the things 
we ought to do to make the fund operate. And it seems to me 
that maybe there is a little political pressure, and maybe she 
is not strong enough to make that happen.
    Mr. Donovan. Senator, here are the facts as I see them: We 
have taken the most aggressive steps I think in the history of 
the agency to make sure the new business that we are doing is 
strong. If you look at that chart right there, what you will 
see is huge profitability relative to the history for the new 
loans that we are making. We have only so much that we can do 
to fix the problems of those older loans.
    So I agree with you on many of the steps that you describe 
today. What we should not imagine is that somehow taking those 
steps can take us from the difficult financial condition that 
we find the FHA in today, somehow eliminating what has been an 
enormous trauma in the housing market.
    I have enormous confidence that Carol can and will lead us 
on the path that we need to take. And, in fact, you do not have 
to take my word for it. I think the evidence of the changes 
that we have made, the steps that we took--you remember last 
year the President's budget thought that we might need a draw 
at the end of last year. Carol took aggressive steps on 
enforcement, on changes to underwriting that meant instead of 
close to a negative $1 billion balance, we ended the year with 
a more than $3 billion positive balance.
    Those were aggressive steps that she took. I listened to 
her, but she took those. And I believe that that is the kind of 
leadership that can help us continue down this path.
    Senator Corker. Thank you.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman. And, Mr. Secretary, 
thanks for your testimony today.
    I know that Senator Corker asked about reverse mortgages, 
and I am concerned about that issue. And I am particularly 
concerned that $2.8 billion of the $16 billion economic 
shortfall are related to that program.
    Can you talk a little bit more about why these losses under 
the reverse mortgage program are so severe?
    Mr. Donovan. Here is the fundamental problem, without 
getting into too much of the history. At one point when Fannie 
Mae was issuing these loans, they were generally variable rate, 
and they allowed a borrower to basically draw on, you know, 
over time the amount of money that they needed.
    As that program has switched to being a Ginnie Mae program, 
there is basically no option for those borrowers to do anything 
but draw the full amount.
    Senator Hagan. And why?
    Mr. Donovan. Because we do not have the statutory authority 
to be able to make the changes to the program that would allow 
us to limit the draw up front. That is the change that we are 
asking that be made.
    Our alternative--and I was just discussing it with Senator 
Corker--we could basically eliminate or put a moratorium on our 
regular program and just go to what we call our SAVER program, 
which is somewhat safer. But the problem is we still do not 
have the authority even under that program to avoid this full-
draw feature of it.
    So the right answer, in our view, is: Give us the authority 
to make the changes we need so that we end up with what is a 
safer product for FHA and, frankly, a safer and better product 
for seniors. What we are finding is with this full-draw 
product, too many seniors end up in situations where they 
cannot cover their insurance and their taxes, and too often we 
lead to a situation where they have more leverage, more debt 
than their home is worth by the time they are ready to sell 
that home.
    Senator Hagan. And so you are saying because of that 
change, there is what resulted in the $2.9 billion?
    Mr. Donovan. That is for many of these--for most of the new 
loans that we are making, they are at this full draw, and the 
actuary predicts there are going to be enormous losses on those 
going forward because of this full-draw feature.
    Senator Hagan. OK. And, also, the last time you testified 
before the Committee, we discussed the National Mortgage 
Settlement. Can you talk briefly about the MMI Fund, how it has 
benefited from the settlement?
    Mr. Donovan. In the most direct way, it has benefited by 
well over $1 billion that came directly to the fund from that 
settlement or that series of settlements. Also important, 
though, is we put in place, not just for FHA loans but for 
every kind of loan serviced by the five banks that were part of 
it that control 60 percent of all servicing, new standards for 
how they foreclose on loans, how they work with troubled 
borrowers, and in the long run those changes will have very 
important effects not just for homeowners and communities but 
also benefits to the FHA fund, because we will have fewer 
foreclosures and better recoveries on the loans, whether it is 
through short sales or keeping homeowners in their homes.
    Senator Hagan. The settlement also includes billions of 
dollars in debt forgiveness for the borrowers, and generally 
the discharge of indebtedness is taxable to borrowers, but 
certain exceptions exist for indebtedness related to principal 
residences. This exception is set to the expire at the end of 
this year.
    What is the interplay of the expiring tax provision and 
principal reduced from borrowers? And how would the expiration 
of that provision impact participation in the settlement and 
the relief that borrowers see now?
    Mr. Donovan. Well, it would be a cruel irony if homeowners 
have the ability to stay in their homes because of a principal 
reduction that is both good for them and their lender because 
it is going to lower the losses on that loan in the long term, 
only to get, come tax time, a giant tax bill for that principal 
reduction, which drives them back into delinquency and 
potentially foreclosure.
    And so the President has made it a real priority to try to 
get that provision into whatever tax extenders we may do at the 
end of this year, and it is a very high priority for us among 
the many things that will be at issue in that tax extender.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman. Thank you, Mr. 
Secretary.
    Again, as I said at the beginning, I have the real concern 
that I think is shared by a lot of Committee Members that the 
changes in reforms FHA has made and you are talking about today 
are not significant enough given the looming threat. And you 
say they are unprecedented. Both of those things could still be 
true. They could be more than ever before, and still not enough 
given the magnitude of what we are talking about. And that is 
the concern.
    First of all, let us talk about the clear potential now for 
a taxpayer bailout. Is it not right that under the Federal 
Credit Reform Act it would allow the Treasury to make necessary 
cash or credit transfers to FHA in order for them to continue 
making payments sort of automatically?
    Mr. Donovan. That is absolutely correct. That is the way 
not only FHA but other similar programs are designed.
    Senator Vitter. That is obviously significant for the 
taxpayer. We all care about that. Can you commit to us that you 
will keep us and the Congress fully apprised of your moving 
projections with regard to that, and certainly fully apprised 
when that happens?
    Mr. Donovan. I am absolutely committed to make sure that if 
we are going to take that step, you would be fully notified.
    Senator Vitter. Well, my question was a little more than 
that. It was to keep us fully apprised of your current and 
updated projections toward that issue. Can you commit to us to 
give us that information, your best projections today and 
whenever that changes, and certainly if that is going to 
happen?
    Mr. Donovan. I do. And, Senator, what I would suggest--we 
do provide a monthly report to Congress on the status of the 
fund. If there is additional information or somewhat different 
information that would be useful to you in that, we are very 
happy to work with you on that.
    Senator Vitter. OK. Well, what I am talking about is, as of 
today, when do you project there is going to have to be a 
taxpayer-funded bailout? What is your best projection?
    Mr. Donovan. What I would say is our best projection will 
be contained in the President's budget. We are still working on 
the underlying economic assumptions that go into that. And so I 
do not have anything beyond what the actuary did that would be 
a different prediction today.
    Senator Vitter. So today, within all of HUD and all of FHA, 
you have no best guess about that?
    Mr. Donovan. I am not sure what you would suggest is a best 
guess other than to say the Actuarial Report has a value of the 
fund as of the date it was performed. In addition to that, we 
expect about $11 billion of new revenue, and the changes that 
we have implemented we believe will bring billions of dollars 
of additional revenue to the----
    Senator Vitter. Based on all of that, do you expect a 
taxpayer bailout, as we sit here today? If so, when?
    Mr. Donovan. Based on those steps, I believe we have 
significantly decreased the chance of having a bailout at the 
end of 2013 or having to draw on the Treasury. I am not going 
to assign a probability at this point because we are still 
working on the assumptions and other steps in the budget, and I 
will be able to give you a number when we have completed the 
budget projections.
    Senator Vitter. OK. Well, again, I want to re-ask for your 
best information about that as it develops, and, unfortunately, 
we do not have that today. I think you all have some idea, some 
best guess. You are not giving it to us. We would really like 
that as soon as you can give it to us and from then on, on an 
updated basis.
    With regard to changes that are being made, you just said 
they are unprecedented and the proof is in the pudding and the 
changes that Ms. Galante made in the last year stepped us back 
from that possibility. I just want to add for the record, there 
was another big factor. The $1 billion in the AG settlement--
that was just found money--was a huge factor that had nothing 
to do with reforms or changes.
    But I also want to associate myself with Senator Corker's 
suggestions about a whole menu of things that we believe exist 
that you all are not doing that I believe is warranted. There 
are several ways--and Senator Corker touched on this--that FHA 
has much laxer standards than Fannie and Freddie. And as a 
result, you are creating a huge magnet to draw the worst 
problem loans to FHA because of that. One of those is maximum 
loan limit, and another is the issue he brought up of allowing 
a borrower to reborrow 3 years after a foreclosure. Fannie and 
Freddie, that is 4 to 7 years.
    On those two things and anything else like that, why 
wouldn't you align FHA with Fannie and Freddie to stop this 
negative selection that is occurring toward FHA?
    Mr. Donovan. Senator, two things I would just say.
    One is it is not accurate to say that the reason the fund 
remained positive last year was because of the settlement. The 
value at the end of the year was over $3 billion. If the 
settlement had not happened, we still would have been positive.
    And the second thing I would say is I do not see the 
settlement as unrelated to policy changes. Strong enforcement 
is part of what we need to do to make sure that we hold lenders 
accountable and that we minimize losses from those older books 
of business which are causing the stress to the fund.
    And so I believe very strongly it was the right policy 
decision. It is related to steps that we have taken. And even 
if it had not happened, we would have remained positive last 
year.
    So on loan limits, as I said before, we do not have the 
authority without Congress acting. The administration advocated 
that loan limits come down. I thought it was, frankly, perverse 
to bring Fannie and Freddie's loan limits down and not to lower 
FHA's at the same time, exactly for the reasons that you have 
said. We are concerned that it would drive business to FHA that 
should go back to the private market.
    So I would urge you and others--I know you are supportive, 
but to work with your colleagues to try to do that as quickly 
as possible. And I do agree that we need to look at--and we are 
doing that, looking at the standards for how we allow borrowers 
who may have defaulted in the past to borrow. Again, I would 
say, though, we should not hold a responsible homeowner who has 
demonstrated their ability to pay back their debts and to be a 
homeowner, a successful homeowner, simply because they may have 
lost a job due to what is an unprecedented economic crisis that 
we have been through.
    So this is not just about timelines. It is about what the 
standards are for when we allow folks to borrow.
    Senator Vitter. Well, my broader point is this and several 
other factors should also be about doing it in a way that you 
are aware of what competing opportunities' rules are, like 
Fannie and Freddie. And if FHA has laxer standards, I mean, 
clearly you are going to encourage the accumulation of weaker 
loans. I think that is obvious.
    Mr. Donovan. Yes, I agree with you. One of the things that 
we announced just a few weeks ago with the Actuarial Report is 
that we are implementing standards on short sales that are 
aligned with what Fannie and Freddie are doing. So we are 
looking for opportunities wherever we can to try to align those 
standards. That does not mean on everything that we should be 
identical to them, but aligning where appropriate makes great 
sense.
    Senator Vitter. And as I understand it, another significant 
factor in terms of potential loss is the whole reverse mortgage 
program, which is projected to be a drain on the system even in 
the best economic circumstances. And as I understand it, FHA 
has the authority to suspend that program. It is a huge profit 
center for folks who participate in the private sector. It is 
costing the taxpayer money essentially, or threatening exposure 
in the best of times. Why wouldn't we suspend that tomorrow?
    Mr. Donovan. That is an option that we are clearly looking 
at. We believe there is a better option, which would be to get 
legislative reform to allow us to implement a better product. 
That is something, as I talked about with Senator Corker, we 
would love to work with you on the next few weeks. The House 
has passed an FHA reform bill. We would love to be able to do 
something even in this session of Congress before the Ranking 
Member leaves. That is area----
    Senator Vitter. Well, let me----
    Chairman Johnson. Senator Vitter, please begin to wrap it 
up.
    Senator Vitter. Sure. I will wrap it up very quickly.
    Let me suggest melding those two ideas together. I think if 
you suspend that program tomorrow, you will start saving the 
taxpayer money and create more pressure for the reform you are 
describing.
    Thank you.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Secretary, while I clearly have questions about Sandy, 
let me just create some balance here from my perspective.
    First of all, am I wrong to say that the HUD report says 
that FHA continues to be impacted by losses from mortgages 
originated prior to 2009?
    Mr. Donovan. That is exactly right, and, Senator, if you 
look at the chart, on the right here, what you see is that 
through 2007 and 2008 in particular are huge costs to the fund 
that in 2009 we saw still negative impact but real improvement, 
and then in 2010 through 2012, those loans are expected to 
contribute substantial revenues to the fund and to the 
taxpayer.
    Senator Menendez. So a good part of the portfolio that we 
have been suffering with here certainly took place prior to 
this administration.
    Mr. Donovan. That is correct. But I would also give you all 
credit for acting to end seller-funded downpayment at the end 
of 2008, which we implemented in 2009.
    Senator Menendez. Now, I know there is some talk about the 
higher loan limits and your own view, but let me just say, 
Doesn't the audit also say that ``larger loans tend to perform 
better compared with smaller loans in the same geographical 
area, all else being equal''?
    Mr. Donovan. Our early data is that these larger loans are 
performing somewhat better. We do believe, however, it is too 
early to make any final conclusions about it simply because 
these loans have not had much time to season at this point.
    Senator Menendez. Well, it seems to me that so far they 
have probably strengthened FHA's balance sheet by allowing 
larger, better performing loans. And there is a problem here. 
There are parts of the country in which those lower loan limits 
would make FHA virtually non as valuable to its core mission as 
it would in other parts of the country, which is why on a 
bipartisan basis we passed preserving the higher loan limits. 
So I am looking forward to seeing the continuing performance of 
them because I think it would make another case. And I am 
waiting for the private sector to come in. I mean, I keep 
hearing about the private sector ready to come in, but it just 
does not seem to be happening.
    Now, there are some who would suggest that Ms. Galante has 
not been performing well. Maybe my eyesight is not good, but I 
look at that second chart, and it seems to me in the time 
period that she has become the acting head, in fact, the 
performance of the portfolio under her watch has gone from the 
negative performance that existed before her watch to a 
positive performance, significantly positive performance during 
her watch. Is that a fair statement?
    Mr. Donovan. That is absolutely fair. I would add that the 
chart just to the left of it also shows that we have done that 
while reducing FHA's market share. So we have taken steps to 
try to bring private capital back to shrink our market share, 
but still to have the performance improve substantially.
    Senator Menendez. Do you have a different view than Moody's 
data that shows that the FHA's presence in the market prevented 
housing prices from dropping another 25 percent?
    Mr. Donovan. I think that is as good an analysis, as 
thorough an analysis as we have seen of the important impact 
that FHA had on the market and, frankly, what would have 
happened if we had not been there as you see--Congress intended 
FHA to be here when the country went through a crisis, either a 
regional crisis where there was not lending available or a 
national crisis. And that is exactly the role that FHA played 
with that increase in market share. We agree it is time, as the 
market is improving, to shrink that share, but not to do it in 
so precipitous a way to raise premiums or to take other steps 
that would hurt what is still a fragile recovery.
    Senator Menendez. And I would simply say that in a time in 
which the housing market, although we see some indicators 
moving upward and prices, values moving upward, it is still a 
very significant challenge. And just like a doctor, I mean, I 
think the principle starts off with you do no harm, especially 
when you are in the midst of a challenging recovery.
    So I look forward to seeing how we move in this dual track 
of making sure the taxpayers are held whole, but at the same 
time preserving some of the core missions of FHA.
    I want to turn to hurricane recovery. This hurricane, Mr. 
Chairman, we are not used to hurricanes in the Northeast. We 
have been blessed not to have them. But when you have a 
superstorm that comes with a full moon, high tides, and a 
drawing-in of what was the hurricane because of a front that 
came from the west, you have a perfect storm in all of its 
iterations.
    I have lived in the State of New Jersey my whole life. I 
have never seen the type of devastation that exists in the 
State. The pictures that some of my colleagues have seen on 
television and whatnot do not do justice to the death and scope 
of devastation. We have thousands of people who do not have a 
home to go back to. I know that when people talk about the New 
Jersey shore because of some of these shows, they think of a 
certain thing. These are people's homes. I am not talking about 
second homes. I am talking about their lifetime homes, year-
round communities that do not have a home to go back to. I am 
talking about a $35 billion tourism industry that is largely 
devastated. I am talking about the megaport of the east cost, 
the port of New York and New Jersey that suffered huge damages, 
250,000 jobs, $30 billion of economic activity for the Nation, 
national security because we closed the only port in the 
Northeast in Bayonne, New Jersey, that was a military port, and 
now we use the commercial port for forward deployment when we 
need to in the case of emergencies. And I could go on and on.
    So, Mr. Secretary, in your other role here, I want to get a 
sense from you as to the commitment of this administration and 
the Federal Government to helping New Jersey, and certainly New 
York as well and the region, recover. Because, you know, when 
we had Hurricane Katrina on the gulf coast in Mississippi and 
Alabama and Louisiana, I was there; when we had tornadoes in 
Joplin, Missouri, I was there; when we had flooding along the 
Mississippi, I was there; when we had crop destructions in the 
Midwest, I have been there--because I believe this is the 
``United'' States of America. And so I fully expect that now 
that for the first time we have the type of devastation that 
others have suffered and should understand, that we are going 
to have the type of response that others have received.
    And so I would like to get a sense of--I know we are 
working toward this goal, but I would like to get a sense from 
you as to the type of commitment that this administration has 
toward those goals.
    Mr. Donovan. Senator, thank you for the eloquent remarks 
about this. As you know, this is a region I, too, have deep 
roots in. I think, to use your term, I ``married up,'' married 
a Jersey girl, and have worked in New Jersey, grew up in New 
York. And besides the personal commitment I feel, I have also 
seen a President who was on the ground in New Jersey almost 
immediately, has done everything he can to help the short term, 
and has given me the responsibility to help make sure that this 
recovery is a full, complete recovery, not just to build back 
what was there but to build back smarter and stronger.
    So you have my commitment that we will do that. We will 
propose a supplemental this week that I hope you will see 
demonstrates that commitment. But we will also be committed to 
making sure that we get that supplemental passed in the next 
few weeks because, frankly, there are too many homeowners, too 
many small businesses, too many renters that have lives that 
are simply on hold until they know what resources will be 
available to them to rebuild.
    FEMA cannot by statute provide for a full recovery. They 
are a response organization. And we need to take further steps 
through a supplemental this month to be able to move toward a 
fuller recovery and give those families and those businesses 
some hope that there is a future for them in New Jersey and 
around the region.
    Senator Menendez. Well, Mr. Chairman, let me close, if I 
may, with your indulgence, because of the nature of this issue, 
by saying, number one, we await what the supplemental looks 
like, and we will reserve judgment until them.
    Number two, regardless of the size of the supplemental, we 
need flexibility in being able to seek the recovery that we all 
want.
    Number three, in addition to a perfect storm, there is 
another perfect storm here. We get this storm in the midst of 
the beginning of winter. Most of the hurricanes are in gulf 
seasons, in summer seasons, totally different in terms of the 
consequence to people--huge in terms of the impact, but still 
time to recover without the ravishing of the winter months.
    If we have a northeaster, our defenses are so far down that 
it would be like a person's immune system being susceptible to 
any type of illness. And, third, we come with less than 30 days 
to the end of a Congress in which this has to be done. I feel 
like I have to be Houdini to accomplish this, so--but we are 
going to do this. We are going to do this. And so, Mr. 
Secretary, I look forward to your work and your help as we get 
there, and to our colleagues as well.
    Thank you, Mr. Chairman, for your indulgence.
    Chairman Johnson. I would note that Senator Menendez will 
chair our Subcommittee field hearing in New Jersey next Monday, 
December 10, on Superstorm Sandy.
    Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman, and thank you, Mr. 
Secretary, for joining us.
    I would like to understand better an aspect of the 
actuarial review, and the question that I have arises from the 
interest rate assumptions and the interest rate environment 
that is used to determine the prevailing view about the value 
of the Mutual Mortgage Insurance Fund, the single-family fund.
    More specifically, you observe on page 8 of your testimony 
the fact that the lower the interest rate environment, the 
worse shape the fund is, to simplify things. You walk through 
the mechanisms by which lower interest rates, while good for 
the economy overall, tend to have an adverse impact on the 
value of the fund.
    My understanding is that the actuarial review contemplates 
a low interest rate environment, and in the low interest rate 
environment, the value of the fund is negative $31 billion.
    Aren't we in a low interest rate environment today? And 
aren't we by virtue of what the Fed has said, which is to say, 
maintaining current policy at least through mid-2015--so 3 
years or so, at least--isn't it very likely that we are going 
to stay in a low interest rate environment? And shouldn't that 
be the prevailing environment assumption?
    Mr. Donovan. You make a very important point in terms of 
the fact that the actuarial review was done not today but at a 
point with economic projections that are primarily in July, 
over the summer.
    Senator Toomey. Right.
    Mr. Donovan. And so it is accurate that interest rates have 
dropped further than were built into the primary actuarial 
view. There are two offsetting factors to that, though.
    One is that home prices have performed better than were 
used in the actuarial, and based on what we know today, even 
for this year, the actuarial would be significantly better if 
it were performed today just on that one variable.
    And then the second point is that the actuarial review is a 
point in time that assumes that we do no further FHA business, 
and one of the things that is artificial about it, if I can use 
that term, is that when interest rates go lower, it assumes 
people pay off faster. That is accurate. What it does not take 
into account is that typically about half of those folks 
refinance into an FHA loan. So by the nature of the actuarial, 
taking a snapshot in time, assuming that you are closing down 
the fund, there are revenues that will come to the fund that 
are not built in.
    Senator Toomey. Right.
    Mr. Donovan. All that being said, we will in the 
President's budget include the lower interest rates that you 
describe; we will also include an updated projection of house 
prices; and at that point, we will have a clearer picture of 
how these offsetting factors play. But it would not be accurate 
to say that the right number is today the $30 or $31 billion 
because of that.
    Senator Toomey. Do you believe that the difference in home 
prices that prevail today versus at the time that this was done 
and the difference in the volume that you referred to would be 
enough to offset the lower value that is caused by the fact 
that we are in a lower interest rate environment?
    Mr. Donovan. The truth is, just to be honest, we have not 
finished those calculations. We are in the midst of doing that 
for the budget. What I will tell you is they are both large 
effects, and it is certainly conceivable that they could be 
offsetting or in the range of offsetting, but we simply do not 
have an answer to that.
    Senator Toomey. It is a pretty large effect that comes from 
the difference in the interest rate. Do you know what the low 
interest rate environment scenario assumes for the 10-year 
Treasury yield, by any chance?
    Mr. Donovan. Let me ask my crack team behind me to get 
that. We will have that for you in a moment.
    Senator Toomey. All right. My guess is--I am not sure even 
that assumption is as low as the rate is today. With an 
interest rate, 10-year Treasury, of about 1.6 percent, it is 
shockingly low, and we have a Fed insisting that it is going to 
keep it this way for a long time. So I will be very interested 
in seeing what the net effect of these changes are because we 
know that the interest rate component will reflect a 
significant adverse valuation here.
    Mr. Donovan. Yes. But, again, I would just point out that 
there is an artificiality of the point in time because it 
presumes every one of the payoffs, we have no more revenue to 
FHA; whereas, in fact, we know a large number of those 
refinance----
    Senator Toomey. So you are saying there is a flaw in the 
model.
    Mr. Donovan. No, no. Congress requires that the actuarial 
review be done in a way that is what we call a ``runoff 
scenario.''
    Senator Toomey. OK.
    Mr. Donovan. We also in the actuarial look at what if we 
keep doing business, so we have those projections in the 
actuarial. That is not the 2-percent calculation, but it is 
something that we could sort of give you more detail on from 
the actuarial of what the net effect would be with the 
refinances.
    Senator Toomey. The other question is: Does the modeling 
assume any recession between now and 2017?
    Mr. Donovan. The modeling does include a range of runs from 
a mild recession to a very severe recession, and through the 
kind of stochastic nature of the modeling, we do look at 
probabilities for those recessions----
    Senator Toomey. But the model that comes up with a 
valuation of negative $13.5 billion, does that assume a 
recession?
    Mr. Donovan. It assigns probabilities to the potential for 
different types of recessions and builds those in. I am not 
sure if I am being clear, but it is not----
    Senator Toomey. All right. Let me put it this way: What is 
the average economic growth rate that is implicit in or 
explicit in that valuation?
    Mr. Donovan. Again, I can get that for you momentarily.
    Senator Toomey. OK.
    And my last point, the Senator from New Jersey made a very 
important and impassioned argument about the effects of 
Hurricane Sandy. In Pennsylvania, we had very significant 
damage, but it was exclusively from wind, almost entirely from 
wind damage. Millions lost power. But the damage was not 
comparable to the damage that was compounded by the water 
damage, of course, that was done along the shore. I am looking 
forward to seeing a supplemental that is well crafted and, I 
hope, properly offset, because we also have a fiscal crisis of 
enormous magnitude. So the necessary spending to address 
emergencies is very real, but it is really important that that 
be offset.
    Thank you, Mr. Chairman.
    Chairman Johnson. I would like to thank Secretary Donovan 
for his testimony and for being here with us today.
    The financial stability of the FHA is an issue that the 
Committee does not take lightly, and we will continue this 
dialog and take action where necessary to protect taxpayers.
    We appreciate your testimony, Mr. Secretary. This hearing 
is adjourned.
    Mr. Donovan. Thank you, Mr. Chairman.
    [Whereupon, at 11:36 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                  PREPARED STATEMENT OF SHAUN DONOVAN
         Secretary, Department of Housing and Urban Development
                            December 6, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify today regarding the 
status of the Federal Housing Administration's mortgage insurance 
programs. The testimony will cover the single family programs, for 
which we recently submitted a report on the Mutual Mortgage Insurance 
Fund (MMIF), as well as the multifamily and health care programs.
    I appear before you today at an important point in the recovery of 
the Nation's housing markets. As 2012 draws to a close, a number of 
promising signs indicate that our economy is improving and that the 
recovery of the housing market is underway. The number of families 
falling into foreclosure is half what it was in the early days of 2009. 
Housing construction is growing faster than at any time since 2008, and 
this has been the strongest year of home sales since the crisis began. 
Finally, rising home values have lifted 1.3 million families above 
water in the first half of 2012. All of these indicators point to a 
housing sector on the mend--a sector vital to the broader recovery of 
our economy.
    However, while there is cause for optimism, we must remain mindful 
that the recovery remains fragile, and that a broad array of factors 
could limit the progress we are now seeing. Therefore, we must remain 
diligent in our efforts to restore our housing markets, help families 
get back on their feet, and enter into a new era of housing finance in 
this country.
I. Overview of Findings of the Independent Actuary With Regard to FHA's 
        Single Family Programs
    It is with this context in mind that I now want to turn to a 
discussion of FHA's single family programs. Much of the progress that 
we are seeing in the housing sector has been possible because of the 
FHA, which has provided access to home ownership for millions of 
American families and without which the crisis would have been much 
deeper. In fact, Moody's analytics estimates that were it not for FHA's 
presence during the crisis, house prices would have fallen 25 percent 
further than they did already.
    FHA's contribution has not been without stress, however. On 
November 16, 2012, HUD delivered its fiscal year (FY) 2012 Report to 
Congress on the Financial Status of the FHA Mutual Mortgage Insurance 
Fund, which is used for FHA's single family programs. That report 
summarizes the results of the independent actuarial review conducted by 
Integrated Financial Engineering (IFE) and provides a status report on 
the fiscal health of the MMI Fund. Via its review, the actuary measures 
the economic net worth of FHA's portfolio--essentially, the total value 
of the portfolio after FHA pays all expected claims for the next 30 
years in a run off scenario where no new loans are insured. This 
economic value is then divided by the total value of the MMI Fund's 
insurance in force to derive an estimated capital reserve ratio for the 
Fund. According to the latest findings of the independent actuary, in 
fiscal year 2012 the capital reserve ratio of the Fund fell below zero 
to negative 1.44 percent, and the Fund's economic value stands at 
negative $16.3 billion. Earlier books of business continue to be the 
prime source of stress to the Fund, with fully $70 billion in claims 
attributable to the 2007-2009 books of business alone. In contrast, the 
actuary attests once again to the high quality and profitability of 
books insured since 2010. Thus, this year's report shows that even 
though our books of business insured since 2010 are the strongest in 
agency history, there is still work to be done in mitigating the 
impacts to the Fund of losses stemming from older books of business 
which were most severely impacted by the recession and other risk 
factors, such as seller-funded downpayment policies. Toward this end, a 
series of aggressive measures FHA will take in this fiscal year is 
discussed later in this testimony.
    While the actuary's finding regarding the economic net worth of 
FHA's portfolio is obviously of very serious concern, it is not the 
determining factor for whether FHA will need to draw on permanent and 
indefinite budget authority from the Treasury. Any determination that 
such a draw is necessary will not be made until the end of FY2013, and 
in any event, does not affect the full faith and credit of the Federal 
Government to pay any claims. In the intervening period, the 
President's budget will outline the Administration's expectation of 
whether or not FHA will need assistance by the end of the fiscal year. 
However, the ultimate need will be borne out in the actual performance 
of the FHA single family program over the course of the fiscal year, 
and will be impacted by the steps FHA takes over the course of the year 
to increase revenue or reduce losses.
    While the magnitude of the figures involved in this year's budget 
reestimate are large, as an example, the President's FY2013 budget 
submission, issued in February of this year, anticipated that FHA would 
need to draw nearly $700 million in assistance from the U.S. Treasury 
in order to satisfy the required transfer of funds from the Capital 
Reserve Account to the Financing Account to meet expected claim 
obligations. Instead, at the end of FY2012 the Capital Reserve Account 
held $3.3 billion--even after the transfer for these expected costs. 
The fact that the MMI Fund ended the year with this balance is due 
primarily to policy changes made during the fiscal year that 
substantially improved the value of the Fund. Likewise, the series of 
additional changes FHA has announced and which are described below are 
designed to reduce the likelihood that FHA will need to draw on 
Treasury assistance at the end of FY2013.
    We will continue, as we have throughout this Administration, to be 
diligent in taking every action appropriate to protect taxpayers while 
continuing to ensure that FHA supports the stabilization of the housing 
market, and that families have access to sustainable mortgage credit 
options.
II. The Role of FHA's Programs in the Nation's Housing Finance System
    As we discuss the current status of FHA's programs and finances, it 
is important to frame this discussion within the context of the role 
FHA has played historically in the Nation's housing finance system. 
Throughout its history, FHA has supported access to affordable, 
sustainable mortgage financing to persons and entities underserved by 
the conventional market. Through its single family, multifamily and 
health care loan guarantee programs, FHA has acted as a stabilizing 
force in the housing market during times of economic distress. At no 
time has this countercyclical influence been more pronounced than 
during the recent housing crisis. In the face of ongoing challenges in 
these sectors, FHA has continued to provide access to mortgage finance 
opportunities during a period of severe constriction in conventional 
markets. As a result, FHA has played a central role in bringing the 
housing market from the brink of collapse to a place where the outlook 
is positive and improving.
    Since its inception in 1934, FHA has provided access to home 
ownership through its single family programs for credit-worthy lower 
wealth or otherwise underserved borrowers, enabling more than 40 
million families who might otherwise have been prevented from doing so 
to realize the American dream of home ownership. In addition to 
providing access to financing for credit-worthy borrowers by insuring 
mortgage lenders against losses on defaulted loans, FHA's single family 
programs have also offered crucial liquidity in the mortgage finance 
system during periods of market stress. Whether providing ongoing 
credit availability in areas experiencing regional recessions, or 
ensuring nationwide liquidity during broader economic crises such as we 
have recently experienced, FHA has repeatedly acted as a vital 
stabilizing force in the single family mortgage market when 
constriction in conventional lending threatens effective functioning of 
the market.
    Likewise, FHA's multifamily and health care programs have been very 
important to facilitating credit availability in their respective 
sectors. These programs provide critical mortgage financing 
opportunities that strengthen communities by addressing specialized 
financing needs including insurance for loans to develop, rehabilitate, 
and refinance multifamily rental housing, nursing home facilities, and 
hospitals. These sectors faced a severe contraction in the availability 
of conventional financing, as well as a near collapse of the tax exempt 
bond market, making FHA's programs essential. FHA multifamily and 
health care mortgage insurance programs operate under FHA's General 
Insurance-Special Risk Insurance (GI-SRI) Fund, which is separate and 
distinct from the MMI Fund used for single family programs.
III. FHA Single Family Programs
    Created in the aftermath of the Great Depression and designed to 
expand access to home ownership that would in turn stimulate the ailing 
residential housing markets, FHA played a central role in developing 
today's mortgage finance system. It redefined mortgage underwriting 
practices so that qualified borrowers could obtain mortgage financing, 
and it standardized construction and appraisal requirements so that 
mortgage contracts could be tradable across the country. Even more 
important than FHA's contribution to developing modern mortgage 
standards and practices, however, has been its role as a 
countercyclical force that ensured continued liquidity throughout the 
mortgage finance system during periods of economic stress. This has 
been true on a number of occasions at the regional level as FHA has 
offered support for mortgage financing in specific geographies 
experiencing localized recessions, and much more so as FHA has played a 
prominent role in stabilizing the market and averting a total collapse 
of the housing market during the recent crisis. By design, FHA's 
programs are meant to complement, not supplant, private capital. It is 
there to combat a lack of available mortgage credit when private 
capital retreats or underserves markets, and to step back when private 
capital returns or expands to serve previously underserved populations. 
And because of this unique role, its business cannot and should not be 
evaluated on the same terms as a private firm, as such a requirement 
would force FHA to act as a private firm and therefore eliminate its 
value in providing countercyclical liquidity and credit to underserved 
markets.
A. FHA Single Family Activity in FY2012
    In 2012, FHA continued to play an important part in the ongoing 
recovery of the Nation's housing market and broader economy. FHA 
insured nearly 1.2 million single-family forward mortgage loans during 
the year, with a total dollar value of approximately $213 billion. Of 
the over 700,000 homepurchase mortgages endorsed during the year, 78 
percent were for first-time homebuyers, reaffirming FHA's role in 
providing access to new entrants to the home ownership market. Indeed, 
over the past four fiscal years, FHA has insured mortgages for over 2.8 
million first-time buyers.
    FHA has also continued to be a vital source of home financing for 
minority borrowers. While FHA insurance was used for approximately 27 
percent of all home purchase mortgages in 2011, FHA accounted for 50 
percent of home purchase mortgages for African American borrowers and 
49 percent for Latino borrowers.
    Clearly, FHA has played a very crucial role in facilitating 
continued liquidity in the single family mortgage finance market, 
preventing even more severe economic circumstances during the 
recession. As Moody's Analytics Chief Economist Mark Zandi said in a 
Washington Post article, ``If FHA lending had not expanded after 
private mortgage lending collapsed, the housing market would have 
cratered, taking the economy with it.'' Moody's estimates that were it 
not for FHA's presence during the recent crisis, house prices would 
have fallen an additional 25 percent, resulting in 3 million more job 
losses and a reduction of economic output of $500 billion.
    Although FHA continues to be an important source of access to 
credit for American families, its market share continues to decrease as 
the economy recovers and private capital begins to return to the 
market. New insurance endorsement activity in FY2012 fell once again 
from that of the prior year, continuing its decline from the peak 
levels seen in FY2009. In terms of dollars of single-family loans 
insured, 2012 is the lowest volume since the start of the crisis. Home 
Equity Conversion Mortgage (HECM) insurance endorsements in FY2012 were 
also down by 25 percent from FY2011 levels, to 54,591 loans. FY2012 
marks the third consecutive year in which HECM volume declined, as the 
combined effects of policy revisions to the product and changes within 
the industry have reduced participation in the program.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    FHA has served an important and necessary role in the Nation's 
housing finance system throughout the past year. Because of the 
agency's importance to the overall health of the housing market and its 
responsibility to American taxpayers, FHA constantly seeks to balance 
efforts to provide access to credit for underserved borrowers and 
ensure continued liquidity in the system with its responsibility to 
prudently protect the health of the MMI Fund. Throughout the current 
Administration, we have continually sought such balance in establishing 
policies and practices for FHA.
B. The Mutual Mortgage Insurance Fund
    The important services FHA single family programs provide to the 
Nation's housing sector are made possible through FHA's Mutual Mortgage 
Insurance Fund. The MMI Fund operates with two primary sets of 
financial accounts: \1\ a Financing Account, which reflects the 
business transactions related to insurance operations, and a Capital 
Reserve Account, which reflects secondary reserves for unexpected claim 
expenses. Both of these accounts are held at the U.S. Treasury. The 
Capital Reserve Account is unique to MMI Fund operations. It was 
established to assist in managing to the 2-percent capital ratio 
requirement enacted by Congress in 1990. FHA's MMI Fund programs, 
however, are backed by the full faith and credit of the U.S. 
Government, and like all Federal Government direct-loan and loan-
guarantee programs, its financing account operates with what is called 
``permanent and indefinite budget authority.'' This authority provides 
access to the U.S. Treasury for any funds needed to pay claim 
obligations, and provides assurance to lenders and investors that FHA 
programs are never in jeopardy of lacking sufficient funds to pay 
insurance claims. That would be true even in the absence of a Capital 
Reserve Account.
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     \1\ There are two additional sets of accounts that are independent 
of the insurance operations, and for which funds are directly 
appropriated by the Congress each year. The first is the set of Program 
Accounts which cover all personnel and administrative expenses for FHA 
operations. The other is the Liquidating Account, which represents 
remaining cash flows each year on pre-1992 insurance endorsements. The 
year 1992 marks implementation of the Federal Credit Reform Act of 1990 
and introduction of the Financing Accounts.
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    The Fund is subject to two distinct portfolio valuations each year. 
Both project all future revenues and expenses based upon a forecast of 
loan performance under defined economic conditions. One is performed by 
an independent actuary in accordance with requirements of the National 
Housing Act, and the other is the annual subsidy reestimate performed 
by the Administration under the terms of the Federal Credit Reform Act 
and published in the President's Budget.
    The independent actuarial study uses statistical models to develop 
30-year projections of default, claim, loss-on-claim, and prepayment 
rates on current and future books of business. Those models are 
estimated using historical patterns of FHA-insured loan performance 
under a wide variety of economic conditions. They are applied to active 
loans, and they use commercially available forecasts of home prices and 
interest rates to predict loan performance in the future. The resulting 
projections determine business-operation cash flows needed to estimate 
the economic value of the Fund.
    This year, the actuarial study applied a stochastic method to 
estimate the net present value (NPV) of future cash flows. The move to 
a stochastic method represents one of the advancements that have been 
made to the actuarial modeling process this year and is implementing 
recommendations by the GAO and the HUD OIG. In previous studies, the 
net present value of cash flows was computed along a single path of 
house prices and interest rates. This year, 100 equally likely paths 
were generated to develop a wide variety of possible economic 
conditions, creating what is known in mathematical terms as a Monte 
Carlo simulation. The discounted, net present value (NPV) of cash flows 
was computed for each path. They were then averaged to obtain an 
overall estimate of the expected NPV that provides the base-case 
estimate.
    The outcome of the complete actuarial study modeling effort is the 
estimated ``economic net worth'' of the MMI Fund, which is defined by 
the National Housing Act as capital resources plus the present value of 
future cash flows of the MMI Fund. The calculation of economic net 
worth is repeated for each of the next 7 years by adding projected 
endorsements each year, forecasting their cash flows and adding them to 
those of the current portfolio, and then reassessing economic net worth 
on the updated portfolio at the end of each fiscal year.
    Economic net worth represents additional resources directly 
available to FHA for absorbing claim expenses above-and-beyond those 
already anticipated in the present-value-of-future-cash-flow 
calculations. Those calculations are for the remaining life of all 
outstanding loan guarantees and can extend for more than 30 years on 
HECM loans. Economic net worth is the numerator of the statutory 
capital ratio measure. The denominator is the outstanding dollar volume 
of active insurance contracts.
    The credit subsidy reestimate is performed each year as part of the 
Federal budget process in accordance with the budget valuation of all 
Federal direct loan and guarantee programs. For FHA single-family 
programs, this evaluation uses a modified version of the actuarial 
study forecasting model, applying the economic assumptions common to 
the President's Budget. The estimate is used to determine any necessary 
transfers between the MMI Fund Financing and Capital Reserve accounts, 
based on projections of expected claims and premium revenue on 
outstanding loan cohorts over their remaining lifetimes (up to 30 
years). It is this estimate that establishes any expected need to draw 
on support from the Treasury to ensure possession of sufficient capital 
resources to meet all future expected claim costs. Permanent and 
indefinite authority from Treasury is only necessary if FHA is unable 
to satisfy the budget reestimate requirements from the funds in the 
Capital Reserve at the end of the fiscal year.
C. The FY2012 Actuarial Review
    This fiscal year, as noted above, the MMI Fund capital reserve 
ratio fell below zero to negative 1.44 percent. The actuarial 
assessments estimate that the economic value of the Fund as of the end 
of FY2012 is negative $16.3 billion against an active portfolio of 
$1.13 trillion. The economic value of the forward portfolio was 
estimated at negative $13.5 billion, the HECM portfolio at negative 
$2.8 billion. These economic values represent capital reserve ratios of 
negative 1.28 percent and negative 3.58 percent respectively. The 
actuary projects that the MMI Fund capital reserve ratio will be 
positive by FY2014 and reach 2.0 percent during FY2017 under its base-
case estimate. These forecasts assume no changes in policy or other 
actions by FHA, including those that were announced when the actuarial 
report was released last month that might accelerate the time to 
recovery.
    The low capital ratio today reflects an expectation that FHA's 
current pool of insured loans still has significant foreclosure and 
claim activity yet to occur. Projected losses are particularly large 
for the fiscal year 2007-2009 loans. Those loan cohorts were impacted 
by the severe recession and accompanying increases in unemployment, and 
by large volumes of seller-funded downpayment loans. Indeed, loans 
insured from 2007-2009 are projected to yield more than $70 billion in 
claims for FHA.
    Loans using seller-funded downpayment assistance have proven to 
place substantial stress on the Fund. Those loans are projected to cost 
the Fund $15 billion as they continue to experience elevated rates of 
insurance claim. In fact, the Actuary estimates that, if FHA had not 
insured any seller-funded-downpayment loans, the net economic value of 
the MMI Fund would be positive $1.77 billion today. Thus, we are very 
grateful for the action by Congress in 2008 to eliminate seller-funded 
downpayment loans from the FHA program, avoiding substantial additional 
losses from these loans.
    In contrast to the drain caused by those older loans, the actuary 
expects endorsements in fiscal years 2010 through 2012 to produce 
significant net revenues that can be used to partially offset losses 
from earlier books of business. The contrast in quality between these 
two vintage eras--pre- and post-2009--is demonstrated by the following 
table.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    While the general trends revealed in this year's actuarial report 
are consistent with those reported in the reports of the past few 
years--books of business insured through 2009 are placing a great 
amount of stress on the MMI Fund while those insured since 2010 are 
adding substantial value to the Fund--the overall results in this 
year's actuarial report differ substantially from last year's 
projections on the status of the Fund at the end of this fiscal year. 
There are three factors driving the change in the estimated economic 
value of the MMI Fund compared to what was projected last year:
    First, the Moody's July 2012 house price appreciation forecast, 
which was used in this year's actuarial study, predicted significantly 
lower levels of appreciation in the near term than the forecast used in 
last year's actuarial study. This results in a cumulative difference in 
projected house price appreciation of 8 percentage points over the 
first 5 years. Thus, this downward revision in house price forecasts 
from last year to this year accounted for an estimated $10.5 billion in 
reduced economic value compared to the actuary's 2011 projection of 
what the Fund's economic value would be as of the end of FY2012. 
Further, near-term house-price movements in the index used by the 
actuaries were depressed by high levels of refinance activity in 2012, 
and therefore, they do not reflect improvements seen this year to home 
prices in other measures of housing market strength. Additionally, 
because the forecast utilized only covers the period through June 2012, 
it does not include substantial improvements to home prices seen since 
that time. Second, the continued decline in interest rates since last 
year, while good for the overall economy, causes a substantial loss of 
revenue. The reasons for this are two-fold. First, because of the 
higher interest rates being paid by borrowers on loans made before 
2009, the actuary projects that these borrowers will default at 
marginally higher rates than would otherwise be expected. Second, the 
actuary projects that FHA loans would be paid off earlier than expected 
through refinances that take advantage of the lower rates, and because 
the methodology required by statute that the actuary utilizes assumes 
that none of these loans will refinance back into FHA. The effect of 
these two assumptions by the actuaries resulting from a prolonged 
period of low interest rates is a reduction of $8 billion in estimated 
economic value for the Fund from what was anticipated in last year's 
report.
    Third, based on recommendations made by the GAO, HUD's Inspector 
General, at FHA's direction, the actuary employed a refined methodology 
this year to adjust the way losses from defaulted loans and reverse 
mortgages are reflected in the economic value of the MMI Fund, 
resulting in an estimated $13 billion in reduced economic value 
compared to last year's projections. Specifically, shares of Pre-
foreclosure sale (PFS or short sales) and REO in claim predictions are 
now explicitly modeled, and each has its own loss rate forecast. PFS 
share of claims is now less than half of what was implied in past 
models. Also, model structure changes removed an artificial cap on the 
effect of declining home prices on REO loss rates.
    It should be noted that while the shift in value from what was 
projected last year to what was calculated in this year's review is 
substantial, last year's actuarial report did indicate that should 
house price appreciation or interest rates deviate from the base case 
scenario used for the actuary's projections, such deviations would 
impact the Fund's value in FY2012. Furthermore, last year's report 
stated explicitly that there was an approximately 50 percent chance 
that if economic forecasts differed from those used in the FY2011 
report the Fund would have a negative value. These findings were the 
result of stress testing requested by HUD. While stress tests are not 
required by statute, FHA directs the actuary to perform them annually 
to provide greater insight into what may be expected if conditions 
deviate from those envisioned in the base case scenario. This year, FHA 
asked the Actuary to estimate the value of the Fund based upon those 
economic paths that yield the 10th best, 25th best, 25th worst, 10th 
worst, and the singular worst projected economic values. Additionally, 
the Actuary was also asked to evaluate two additional scenarios which 
represent singular, deterministic economic paths with no random 
fluctuations. First was the Moody's Protracted Slump Scenario, the most 
stressful alternative scenario forecasted by Moody's Analytics in July 
2012. Second was a Low Interest Rate Scenario, representing a 
continuation of the historically low interest rate environment 
prevailing at the end of FY2012.
    The significant shift in dollar value this year from what was 
expected in last year's report highlights the volatility associated 
with 30 year projections of economic conditions. Additionally, they are 
indicative of what occurs when underlying factors change for a 
portfolio the size of FHA's. The $23 billion difference between the 
estimated value of the Fund in this year's actuarial review versus that 
projected in last year's represents only a 2 percent shift in value.
D. Actions Taken to Date To Protect the Fund
    Throughout the tenure of this Administration, FHA has taken 
aggressive and decisive actions to improve the health and trajectory of 
the MMI Fund, while ensuring continued access to mortgage credit for 
American families. The changes made to FHA policy since 2009 are 
projected to have improved the economic value of the Fund by at least 
$20 billion. That FHA's capital ratio has remained positive until this 
year is primarily due to the reforms to risk management, credit policy, 
lender enforcement, and consumer protections made over the past 4 
years--the most sweeping changes to policy in FHA's nearly 80 year 
history. Our efforts to date to strengthen FHA have been focused on 
eliminating unnecessary risks and ensuring sufficient revenue 
generation from new endorsements while continuing to learn from what is 
working in our efforts to improve FHA's asset management and loss 
mitigation approaches.
            1. Counterparty Risk Management and Lender Enforcement
    Toward these ends, one of the first things this Administration did 
upon taking office was to take strong actions to improve FHA's 
monitoring and oversight of lenders. This has included substantial 
improvements to risk analysis systems and procedures, and policy 
changes to focus resources on the areas of FHA's business which pose 
the greatest potential risk to the MMI Fund. These efforts have 
resulted in record numbers of lenders being withdrawn from FHA 
programs, substantial improvements in lender compliance with FHA 
requirements, and a number of settlements with lenders and servicers 
for violations of FHA origination or servicing requirements.
            2. Credit Policy
    We have also worked to strengthen our credit policies for FHA 
borrowers. First and foremost, FHA implemented Congress's elimination 
of seller-funded downpayment assistance programs which cost the MMI 
Fund more than $15 billion in economic value. Further, we enacted 
increased downpayment requirements for borrowers with credit scores 
below 580. The long-term positive impact of these two credit policy 
changes cannot be overstated. The 2005--2008 vintages, accounting for 
less than 15 percent of total originations over the last 30 years, are 
projected by the Actuary to contribute more than one-third of total 
credit losses of the Fund. Loans with credit scores below 580 and/or 
seller-funded downpayment assistance will have accounted for 44 percent 
of those losses. Additionally, we have worked to reduce the amount of 
allowable seller concessions that increase risks to FHA arising from 
inflated appraisals. Together, these measures will better ensure that 
home buyers using FHA-insured financing are capable of meeting their 
mortgage obligations and won't put undue stress on the Fund.
            3. Increased Revenue
    In addition to the improvements made to the quality of new 
endorsements, we have also made the difficult choice to increase 
mortgage insurance premiums for FHA-insured loans multiple times in the 
past 4 years. Since 2009, FHA has increased premiums four times--the 
most recent increase coming in response to the FY2011 actuarial review. 
Combined, the premium increases made since 2009 have yielded more than 
$10 billion in additional economic value for the Fund. These increases 
have not been undertaken lightly, and FHA has been careful to balance 
changes to pricing to improve the outlook of the Fund with its 
countercyclical role of providing liquidity and access to credit in the 
midst of the recent crisis and ongoing recovery.
            4. Loss Mitigation and Asset Management
    FHA has not just addressed issues associated with the origination 
of new loans, but has also taken decisive steps to control costs and 
limit losses on the back end of its business through improvements to 
its REO disposition processes and loss mitigation strategies. First, we 
changed our strategy and approach with regard to the REO management and 
marketing contracts through which FHA's REO property inventory is 
managed and sold. Enhancements to the oversight of contractors and 
better monitoring of their compliance with FHA guidelines, as well as 
measures which promote competition and continuity within specific 
markets, have resulted in notable improvements to FHA's REO processes. 
As a result of the changes HUD has made, the gap between appraised 
values of REO properties and their sales prices has decreased by 62 
percent and the time in inventory for FHA properties has reduced by 45 
percent, decreasing losses on the REO portfolio and improving 
recoveries for the Fund.
    Finally, in FY2012, FHA implemented a significant expansion of its 
note sales program whereby nonperforming loans are sold in pools at a 
market-determined price via auction to investors, who are then able to 
explore options for homeowners to either remain in their homes or 
obtain a viable nonretention solution. This initiative, known as the 
Distressed Asset Stabilization Program (DASP), exponentially expands 
the number of loans sold in each sale while introducing innovations 
designed to promote stability in hard hit geographies. In addition to 
the sale of pools comprised of properties located throughout the 
Nation, FHA also created Neighborhood Stabilization Pools of loans 
concentrated in specific Metropolitan Statistical Areas (MSAs). For the 
first sale in this expanded program, the MSAs of Newark, Tampa, 
Chicago, and Phoenix were selected for inclusion in the program. These 
pools included additional requirements targeted at reducing the 
inventory of vacant foreclosed properties in these communities and 
providing enhanced options for homeowners and community members to 
benefit from these properties that would otherwise end up in FHA's REO 
inventory. The initial results from the first DASP sale were positive, 
resulting in the Actuary's estimate of improved economic value for the 
Fund from this initiative of more than $1 billion over the next 2 
years.
    The effectiveness of these changes can be seen in the stark 
contrast between books of business insured prior to 2010 and those 
insured since that time, which is clear in the graph below.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

E. Actions To Be Taken in FY2013
    While FHA has enacted substantial reforms under the current 
Administration, this year's actuarial review makes clear that loans 
made prior to and at the outset of the recent crisis continue to weigh 
heavily on the health of the MMI Fund. Therefore, building upon the 
significant efforts already undertaken to protect and preserve the MMI 
Fund, FHA is implementing a series of additional actions to continue 
improving the Fund's trajectory over both the short and long term. 
Using the Actuary's model, collectively, these changes are projected to 
provide billions of economic value for the MMI Fund in FY2013.
            1. Reduce Losses From Legacy Books of Business
    The changes made since 2009 to FHA's lender oversight, credit 
policies, and premium pricing have yielded substantial improvements in 
the quality of new loans endorsed by FHA. But significant opportunity 
remains to reduce the impact on the Fund of poorly performing legacy 
loans severely impacted by the recession, and to provide greater 
assistance for distressed borrowers as they seek to recover and find 
meaningful assistance in dealing with their delinquent loans. With a 
majority of FHA's projected losses attributable to loans insured from 
2007-2009, FHA will take several additional steps to maximize recovery 
in the areas of loss mitigation and asset management.
    The Actuary projects nearly $60 billion in claims costs for FHA 
from seriously delinquent loans that will go to claim by the end of 
FY2014, largely arising from loans insured between 2007 and 2009. As a 
result, reducing the severity of losses derived from these loans will 
exert a demonstrable positive impact to Fund performance over the next 
few years. Throughout the past fiscal year, FHA has been executing on 
an overall asset management strategy aimed at ramping up REO 
alternatives. REO alternatives (primarily short sales) comprised about 
15 percent-20 percent of total dispositions since 2010, yielding 
average loss severities about 20 percent lower than REO. In recent 
months, as noted, FHA also unveiled its Distressed Asset Stabilization 
Program (DASP), another REO alternative that improves Fund performance. 
These and other actions have had a measurable effect, as loss 
severities have already fallen by 9 percent in the last year A further 
reduction in loss severities will further improve fund performance.

    Redesign of FHA Modification Treatments to Better Assist 
        Delinquent Homeowners

    FHA issued a Mortgagee Letter on November 16, 2012, that 
established revised standards for repayment plans, standard 
modifications, and FHA-HAMP loss mitigation products, which are 
expected better assist distressed borrowers and reduce losses to the 
Fund from foreclosures. FHA loss mitigation policies will be geared 
towards greater payment relief for borrowers, targeting payment 
reductions of at least 20 percent for FHA-HAMP modifications, which 
will result in more sustainable payment outcomes for borrowers over the 
long term. This approach will yield lower claim costs for FHA while 
also reducing prepayment speeds for insured loans, both of which will 
positively impact the MMI Fund.

    Streamlining of the FHA Short-sale Policy

    Although FHA is deeply committed to providing loss mitigation 
alternatives to borrowers which permit them to retain their homes, home 
retention is simply not an option for some borrowers. For these 
borrowers, preforeclosure sales (short-sales) offer an opportunity to 
transition out of their homes. This enables both FHA and the borrowers 
to avoid the costs and damages of the foreclosure process. FHA will 
introduce a streamlined preforeclosure sale policy which removes 
certain barriers for borrowers in obtaining a short sale on their FHA-
insured mortgage. This change is expected to increase the number of 
defaulted loans that end in short sales rather than foreclosures. 
Because losses from short-sales are substantially lower than from the 
traditional FHA REO process, the shift of greater numbers of distressed 
homeowners to short-sale dispositions rather than foreclosures will 
yield better results for the MMI Fund while allowing distressed 
borrowers to start anew without having to go through the difficult and 
costly foreclosure process.

    Claim Without Conveyance Pilot Program

    FHA is conducting a pilot whereby properties secured by 
nonperforming FHA-insured loans are offered for sale by the lender who 
has completed the foreclosure process. At a reserve price slightly 
below the outstanding unpaid principal balance of the loan, the 
properties are sold to third party purchasers without ever being 
conveyed to FHA. This method of disposing of these properties may yield 
lower losses for the MMI Fund than selling them through FHA's normal 
REO disposition process, as carrying costs associated with preserving, 
managing, and marketing an REO property were eliminated.
    Proactive Strategies to Further Improve Recoveries
    In addition to the policy and programmatic changes outlined above, 
FHA will also take several innovative and proactive steps to increase 
utilization of loss mitigation options and reduce unnecessary asset 
disposition losses. First, beginning in 2013, FHA will launch a large-
scale proactive marketing campaign to promote modification and short-
sale strategies for delinquent borrowers. This effort is expected to 
increase utilization of these programs, which will permit more 
borrowers to become aware of and take advantage of these opportunities, 
while reducing foreclosures and decreasing associated losses for FHA. 
In addition, FHA will also pursue more creative strategies to dispose 
of REO properties in geographies where traditional asset disposition 
methods yield net negative recoveries for FHA. This approach will both 
save money for FHA on unnecessary losses as well as contribute to 
community stabilization initiatives in cities hit hard by the 
recession.
            2. Further Strengthen the Quality and Impact of New 
                    Endorsements
    While much has been done under the current Administration to 
improve the performance and revenue of new FHA endorsements, we believe 
it is vital to take additional steps to strengthen new books to ensure 
the long term health of the MMI Fund. Accordingly, in the second 
quarter of FY2013, FHA will implement the following policies for new 
originations.

    Revised Premium Cancellation Policy

    Under a policy change made in 2001, FHA has been canceling required 
mortgage insurance premiums (MIPs) on loans for which the outstanding 
principal balance reaches less than 78 percent of the original 
principal balance. However, FHA remains responsible for insuring 100 
percent of the unpaid principal balance of a loan for the entire life 
of the loan, such loan life often extending far beyond the cessation of 
MIP payments. As written, the timing of MIP cancellation is directly 
tied to the contract mortgage rate, not to the actual loan LTV. The 
current policy was put in place at a time when it was assumed that home 
price values would not decline, but today we know that LTV measured by 
appraised value in a declining market can mean that actual LTVs are far 
lower than amortized mortgage LTV, resulting in higher losses for FHA 
on defaulted loans. Analyses conducted by FHA's Office of Risk 
Management projects lost revenue of approximately $10 billion in the 
2010-2012 vintages as a result of the current cancellation policy. The 
same analyses also suggest that 10 percent-12 percent of all claims 
losses will occur after MIP cancellation. Therefore, beginning with new 
loans endorsed after the policy change becomes effective later in 
FY2013, FHA plans to once again collect premiums based upon the unpaid 
principal balance of FHA loans for the entire period during which they 
are insured, permitting FHA to retain significant revenue that is 
currently being forfeited prematurely.

    MIP Increase

    We are very grateful for the flexibility Congress granted us in 
2010 to adjust FHA's premium pricing. And we have utilized that 
flexibility three times already. This fiscal year, we plan to use it 
once again as, consistent with FHA's continued efforts to balance its 
countercyclical role in the Nation's mortgage market with its 
responsibility to manage the Fund, FHA plans to increase annual 
mortgage insurance premiums by an additional 10 basis points. While the 
new loans being made today are profitable to FHA and we do not want to 
over-burden or constrict access to credit as the housing market 
continues to mend, we also must ensure that we are (1) rebuilding 
adequate reserves for the future and (2) phasing out of our 
countercyclical role by reducing FHA's footprint in the marketplace and 
helping to facilitate the return of private capital. FHA has played a 
vital part in ensuring access to credit for borrowers and liquidity in 
the market, yet its current outsized role should and will decrease. 
Indeed, its market share has declined yearly since a peak in 2009. This 
premium increase--$13 per month for the average FHA borrower--which FHA 
plans to implement in 2013 will add significant revenue to the Fund and 
ensure that FHA does not take on additional market share, while at the 
same time being modest enough that it doesn't impact borrower access to 
credit or threaten our emerging housing recovery.

    Future Credit Policy and Pricing Changes

    While much has already been done to improve the quality of new FHA 
endorsements, the effectiveness of which are clear in the performance 
and projected value of loan cohorts insured since 2010, FHA is 
continually evaluating its portfolio to identify and mitigate risks, 
and to provide enhancements that benefit both consumers and the Fund. 
Based upon these evaluations, FHA is also developing additional 
proposals which will further assist in strengthening the MMI Fund.

    Housing Counseling Incentive Policy

    Significant evidence has shown that housing counseling improves the 
success of home buyers--particularly first time homebuyers. \2\ FHA 
intends to develop new policies which incentivize, or in some cases 
require, borrowers to complete a prepurchase housing counseling program 
prior to the purchase of a home using FHA-insured financing. We will 
work during this fiscal year to craft and receive feedback on the 
precise contours of this initiative. This endeavor is expected to 
ultimately improve outcomes for both borrowers and FHA, reducing losses 
to the Fund as higher numbers of new borrowers attain successful home 
purchases.
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     \2\ HUD conducted a review of prepurchase counseling that was 
published in 2012, which also found that the program was serving its 
intended population. The study tracked 573 participants at 12 to 18 
months after receiving prepurchase counseling services. Only one of the 
purchasers had fallen at least 30 days behind on his or her mortgage 
payments and none had a major derogatory event on a mortgage account. A 
report on the study's findings can be found at: http://www.huduser.org/
portal/publications/hsgfin/pre_purchase_counseling.html.
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            3. Stabilize and Strengthen the HECM Program
    Changes in borrower utilization of the HECM program and the 
modeling changes employed by the actuary this year show substantial 
stress in the HECM program. In order to mitigate the negative impact of 
the 2013 and future HECM books on the MMI Fund, FHA is taking 
aggressive actions in both the near and long terms to ensure that 
consumers are better protected and able to sustain their reverse 
mortgage, while also protecting the Fund.

    Immediate Steps to Reduce Losses in the Near Term

    Given current regulatory authority, FHA has limited ability to 
address root cause issues and will, therefore, be forced to make blunt 
changes to the program on an interim basis. FHA will take immediate 
action to better align the program with its objective of enabling 
seniors to age-in-place. These changes will protect FHA from losses and 
reduce the likelihood of borrower defaults due to nonpayment of 
property taxes and insurance.
    In addition, FHA will consolidate the Fixed Rate Standard program 
with the Fixed Rate HECM Saver product, resulting in a reduction of the 
maximum amount of funds available to a HECM borrower. Further, the 
principal limit factors that are used to determine the maximum amount a 
homeowner may borrow using the remaining HECM products will be reduced 
across the board (i.e., Fixed/ARM Saver, ARM Standard).
    Additionally, in an effort to reduce losses associated with the 
conveyance and disposition of properties mortgaged with a HECM, FHA 
will issue new incentives for estate executors of HECM borrowers to 
dispose of properties themselves rather than conveying them to HUD. 
Executors are permitted to either sell such properties or convey them 
to HUD. Reversing the historical trend, over the past few years, larger 
numbers of executors have been choosing to convey these properties to 
FHA rather than sell them, adding costs and reducing recoveries for 
FHA. By incentivizing the sale of properties by executors, FHA is able 
to avoid property management, maintenance, and marketing costs 
associated with the REO disposition process, thereby reducing losses to 
the Fund on these properties.

    Longer-term Changes to Permanently Strengthen the Program

    Over a longer term, either through the granting of the legislative 
authority described below or via the much longer rule making process, 
FHA will also pursue other material changes to ensure the long-term 
viability of the HECM program. These measures include:

      Limiting the draw at origination to mandatory obligations 
        (i.e., closing costs, mortgage liens, and Federal debt), 
        providing greater flexibility in addressing the individual 
        needs of borrowers than the across-the-board reductions to 
        principal limit factors described above, while still protecting 
        the Fund from losses on loans where the maximum loan amount is 
        drawn up-front;

      Performing a financial assessment of borrowers as a basis 
        for loan approval and determining the suitability of various 
        HECM products to protect consumers from acquiring loans not fit 
        for their situation; and

      Establishing a tax and insurance set-aside to ensure 
        sufficient equity or an annuity is available to pay taxes and 
        insurance on the mortgaged property so that defaults resulting 
        from nonpayment of taxes and insurance can be avoided.
F. Legislative Requests to Further Strengthen the Fund
    Throughout the past 4 years, Congress has moved in important ways 
to strengthen and protect FHA, and for that we are very grateful. 
Indeed, were it not for the flexibility granted by Congress to FHA in 
2010 in setting premium pricing, the current economic value of the MMI 
Fund would be more than $10 billion lower than it is today. And the 
work this body has done to establish FHA's first ever Office of Risk 
Management has been instrumental to our improved ability to identify 
risks in FHA programs and take action to mitigate them. So thank you 
for your commitment to making FHA stronger and more secure over the 
long term.
    But today, we are asking for your help once again so that FHA is 
better able to protect the Fund while continuing to execute its 
mission. The proposals outlined below will enhance FHA's ability to 
hold lenders accountable for noncompliance with FHA policy and provide 
greater flexibility for FHA to make changes to policies and procedures 
as emerging needs and trends are identified. As a result, FHA will 
better be able to avoid unnecessary losses before they occur.

  1.  Indemnification Authority for Direct Endorsement Lenders: This 
        provision, which FHA has been seeking since 2010, would allow 
        FHA to seek indemnification from Direct Endorsement lenders, 
        which represent 70 percent of all FHA approved lenders. 
        Currently FHA only has authority to require indemnification for 
        lenders with Lender Insurance (LI) approval. In granting this 
        authority, FHA will be able to obtain indemnification from all 
        of its approved lenders for loans that do not comply with its 
        guidelines.

  2.  Revised Indemnification Authority: This change would eliminate 
        the ``knew or should have known'' standard with regard to fraud 
        or misrepresentation. While the Government-Sponsored 
        Enterprises require lenders to retain all fraud related risk, 
        FHA only holds lenders accountable for fraudulent activity if 
        they ``knew or should have known'' of its occurrence. Providing 
        proof to meet this standard limits FHA's ability to require 
        lenders to be accountable for fraud in FHA-insured loans, and 
        its removal would significantly improve FHA's ability to avoid 
        unnecessary losses arising from fraudulent activity.

  3.  Authority to Terminate Origination and Underwriting Approval: 
        This legislation would give FHA enhanced ability to review 
        lender performance and, if a lender is found to have an 
        excessive rate of early defaults or claims, would provide 
        greater flexibility in terminating the approval of the lender 
        to originate or underwrite single family mortgages for FHA 
        insurance. FHA has been seeking this authority since 2010.

  4.  Revised Compare Ratio Requirement: This provision would revise 
        the statute governing the Credit Watch Termination Initiative 
        to provide greater flexibility in establishing the metric by 
        which FHA compares lender performance so that it more 
        effectively captures the true performance of a lender during 
        all market conditions, minimizing further poor performance by 
        FHA lenders while reducing uncertainty for them. Specifically, 
        this legislation would allow the Secretary to compare the rate 
        of early defaults and claims for insured single family mortgage 
        loans originated or underwritten by a lender with those same 
        rates for other lenders on any basis the Secretary determines 
        appropriate, such as geographic area, varying underwriting 
        standards, or populations served. Further, the provision would 
        permit the Secretary to implement such comparisons via 
        regulations, notice, or Mortgagee Letter. This will allow FHA 
        to tailor the compare ratio such that it provides meaningful 
        comparisons of lenders in varying market conditions, providing 
        greater clarity for lenders and a more refined understanding of 
        their performance for FHA.

  5.  Authority to Transfer Servicing: In order to facilitate more 
        effective loss mitigation, this change would give FHA the 
        authority to require any of the following actions when a 
        servicer is at or below a servicer tier ranking score (TRS) of 
        III, or when the Secretary deems the action necessary to 
        protect the interests of the MMI Fund: (1) transfer servicing 
        from the current servicer to a specialty servicer designated by 
        FHA; (2) require a servicer to enter into a subservicing 
        arrangement with an entity identified by FHA; and/or (3) 
        require a servicer to engage a third-party contractor to assist 
        in some aspect of loss mitigation (e.g., borrower outreach). 
        Such authority would permit FHA to better avoid losses arising 
        from poor servicing of FHA-insured loans, yielding better 
        results for both borrowers and FHA.

  6.  Authority to Manage the HECM Program by Mortgagee Letter: This 
        provision would allow FHA to take specific actions via 
        Mortgagee Letter to more effectively manage the HECM program. 
        In light of the HECM portfolio's sensitivity to changing market 
        conditions, this change would provide FHA with the flexibility 
        to make necessary changes as soon as trends or issues are 
        identified within the HECM program.
IV. FHA Multifamily Programs
    The use of FHA MF programs increased exponentially during the 
crisis, providing needed liquidity in the market for MF residential and 
affordable mixed use buildings despite general constriction in credit 
markets. FHA has steadily provided liquidity in the market over the 
past several years in which conventional financing has not been readily 
available. With historically low interest rates, FHA has seen 
exponential growth in this area.

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    Today, as the market recovers, we are beginning to see private 
capital return to the market and expect to see a reduction in our share 
of new market rate units. FHA will continue to play a vital role in the 
creation and preservation of affordable housing and will continue to 
implement policies that balance risk and improve processes.
A. Risk Management for FHA Multifamily Programs
            1. MIP Increase
    As part of the broader efforts in the Office of Housing since the 
start of this Administration, FHA has taken a number of comprehensive 
steps to improve its risk management capabilities and processes. These 
actions were carefully crafted to balance the mission of FHA and its 
role in the broader credit marketplace. FHA Multifamily provided 
critical liquidity to the marketplace during the recession and during 
that time (from 2008 to 2011) FHA volume increased five-fold. The GI/
SRI funds provide financing for the FHA multifamily and health care 
loan guarantee programs, as well as several very small specialized loan 
products. These accounts also continue to hold a sizable portfolio of 
single family loan guarantees (HECM, condominium, and rehabilitation 
loans) insured prior to FY2009 when responsibility for new lending 
under these programs was transferred to the Mutual Mortgage Insurance 
Fund. Given the unprecedented increase in the number and dollar volume 
of loans insured under the GI/SRI, particularly with respect to market 
rate loans, the Department implemented premium increases for programs 
in the GI/SRI. This was the first premium increase in 10 years for 
these programs. Also, private capital is returning to the multifamily 
lending marketplace. We want to encourage this private capital to 
continue to return. In order to do this we need to be sure that our FHA 
products are not underpriced relative to what is available in the 
private market.
    The MIP increases range from 5 basis points for 223(a)(7) 
refinancing to 20 basis points for 221(d)(4) new construction or 
rehabilitation activity. The increase premiums will have no impact on 
either development costs or rents. And, as the Department monitors the 
programs, the impact of implementing the proposal, and the interest 
rate environment, the Department will consider adjusting the premiums 
as appropriate. Also worth noting is that premiums for affordable 
housing projects (such as those with HUD rental subsidies and low 
income housing tax credits, as well as those insured under FHA risk-
sharing programs) were not increased.

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    It is important to note that the elevated role FHA is currently 
playing in the market is temporary. The new premium structure in these 
programs brings FHA's pricing more in-line with the private mortgage 
insurance industry and enables more robust private competition while 
continuing to ensure sufficient levels of available capital in these 
sectors. The increase in premiums also reflect new realities--the 
Multifamily annual book of business is five times greater than it was 
just 3 years ago, and the risk profile has changed dramatically. FHA's 
multifamily apartment portfolio is now more than 50 percent market rate 
by unit count and 70 percent by unpaid principal balance (UPB), which 
adds a new component of risk, and a need to take steps to ensure the 
future viability of the portfolio. These risks are not yet fully 
captured by historical claim and default trends because they are too 
new to have matured as risks to the portfolio. Further, because of 
historically low rates, it is likely that we will own these risks for 
an extended period of time given the unlikelihood that borrowers will 
refinance out of historically low rates and may have difficulty 
refinancing when interest rates rise over time.
            2. Loan Committees
    FHA Multifamily has also implemented a new loan committee approval 
process, aligning Hub and Program Center commitment authority and 
practice to ensure consistency in underwriting throughout the regional 
offices, as well as to provide a platform to share best practices. Loan 
committees at the Hub and National levels provide oversight for high 
risk transactions in the multifamily insurance program, based on loan 
size and a project's number of units. Loan committee approval processes 
are standard practice in the lending community and are an important 
tool to prudently manage credit risks and ensure the integrity and 
stability of the GI/SRI insurance fund. The Loan Committee has also 
proven to be an effective tool for increasing communication and a more 
consistent FHA platform.
            3. Large Loan Policy
    The Department has implemented more stringent underwriting and 
owner experience requirements for large loans, generally over $40 
million for new construction and $50 million for existing refinances. 
This policy addresses the risk of ``single point failure'' by more 
conservative loan ratios for large market rate loans and a higher 
threshold of owner experience and financial strength. The Department's 
Large Loan Policy mirrors other industry best practices but still 
provides attractive leverage and terms. Our volume after implementation 
of this policy has seen a modest decline in the number of market rate 
new construction loan requests, and an overall safer book of business 
for loans underwritten to its requirements.
            4. Revisions to Loan Documents: Increasing Accountability 
                    For Borrowers and Lenders
    The Multifamily documents have been revised for the first time in 
decades to reflect modern day lending practices and to provide more 
accountability for both Borrowers and Lenders participating in 
Multifamily FHA programs. The documents now more clearly set forth 
contractual responsibilities and obligations of all parties and will 
enhance the Departments ability to enforce against parties in violation 
of business agreements. This will improve the ability of the Department 
to intervene more effectively to execute workouts for projects in 
contractual or financial violation, thereby mitigating the potential 
risk of claim and further protecting FHA exposure to loss.
            5. Project Capital Needs Assessments (PCNA) Enhanced 
                    Guidance
    The Department has published guidance incorporating industry 
feedback on how owners should conduct capital needs assessments for 
projects insured under FHA programs. The guidance aligns physical 
inspection standards for various programs and offices within HUD; 
ensures sufficient funding for replacement of building components, 
particularly for older properties; and addresses FHEO Accessibility 
issues.
            6. Breaking Ground: Complete in all Multifamily Office and 
                    Delivering Results
    Breaking Ground created extensive tools to monitor and access 
credit for Multifamily insured loans. Tools include a stronger credit 
review of borrowers; an early warning system that targets loans early 
in the process that do not meet FHA underwriting criteria; and a 
dashboard monitoring tool that monitors accountability of field 
offices; and establishment of a queue in order to more efficiently 
manage workload and provide greater transparency to lenders. Breaking 
Ground has produced results. Survey results demonstrate that staff 
morale has improved in the majority of field offices, with over 83 
percent of HUD multifamily staff believing that the program helped 
their office become more effective and efficient. Almost 90 percent of 
staff now feel encouraged to come up with new and better ways of doing 
things. In terms of processing efficiency improvements, offices that 
had large application backlogs prior to Breaking Ground have begun to 
methodically clear out older applications, evidenced by the number of 
applications in process for over 90 days dropping from 191 to 50 in 
just seven months. In addition, offices that began Breaking Ground 
without a large backlog have begun to meet aggressive application 
processing time cycles established by the Office of Multifamily 
Housing. The Department will continue to track these metrics and look 
forward to reporting on these results.
            7. Sustaining Our Investments: A Multifamily Asset 
                    Management Sister Initiative to Breaking Ground
    The Department has launched Sustaining Our Investments, an 
initiative that focuses on Risk Based Management of the portfolio 
allowing project managers at both the Headquarters and field level to 
focus day to day operations on managing at-risk loans in the portfolio. 
Risk based reports keyed on financial and physical risk triggers direct 
project managers to act early on potential problems with particular 
assets. The first step in this initiative is completing a full ranking 
of FHA's entire multifamily market rate portfolio.
            8. Low Income Housing Tax Credit Pilot
    The Department launched a new program to facilitate the 
underwriting of FHA insured loans on transactions that include Low 
Income Housing Tax Credit equity. The pilot provides a more efficient 
delivery system for affordable housing by focusing on training Senior 
Underwriters to process loans that meet specific qualifying criteria 
and risk characteristics. The Tax Credit Pilot program will enable HUD 
to better meet our goals to finance affordable rental housing. Focusing 
on refinance and repair of existing properties, the Tax Credit Pilot 
offers a streamlined process and a staffing structure that meets 
industry best practices and allows HUD to focus on critical risk-based 
underwriting. In September, the program was expanded from a limited 
pilot geography to nationwide. I am pleased to report that we will 
endorse the first two loans under the program within the next month. 
These two loans were completed in less than half the processing time of 
our conventional program structure. With nearly two dozen loans in the 
pipeline under the Pilot program, we expect to see similar outstanding 
results using this new tool for financing and preserving affordable 
housing.
B. Legislative Requests
    As part of the Fiscal Year 2013 Budget, HUD is seeking legislation 
to facilitate lending to small multifamily properties which are an 
important provider of affordable, but unsubsidized, housing for low and 
moderate-income families. According to the 2010 American Community 
Survey, nearly one-third of renters live in 5 to 49 unit buildings. 
These buildings also tend to have lower median rents than do larger 
properties: $400 per month for 5 to 49 unit properties as compared to 
$549 per month for properties with 50 or more units. Because they are 
expensive to finance, particularly in this environment, these 
properties are at risk of divestment.
    HUD is proposing two legislative changes: first, changes to the 
Section 542(b) Risk Share program that would allow the Department to 
explore flexibility with the 542(b) Risk Share program to work with 
experienced affordable housing lenders to make Risk Share loans to 
small properties; and second, changes that would allow Ginnie Mae to 
securitize risk share loans under Section 542(b).These changes would 
allow HUD to enter into Risk Share agreements with qualified lenders--
such as well-capitalized Housing Finance Agencies or Community 
Development Financial Institutions--that have demonstrated experience 
making loans to support affordable housing and neighborhood 
stabilization. Under these Risk Share agreements, qualified lenders 
could make refinance, acquisition or rehab loans available to small (5 
to 49 unit) properties. Lenders approved by Ginnie Mae could then 
securitize those loans on the secondary market, increasing the 
availability of capital for more multifamily lending. HUD's proposal to 
improve the resources available to small building owners is part of the 
Department's broader commitment to rebalance the Nation's housing 
policy to support rental housing and neighborhood revitalization. These 
changes will provide small property owners with the same access to our 
Risk Share program as other multifamily property owners currently have. 
As Federal and State budgets shrink and the need for quality, 
affordable rental housing is on the rise, it's critical that we support 
small businesses who are finding solutions that work for families and 
for local economies. We look forward to working with Congress to ensure 
the availability of these unsubsidized, affordable housing units.
    HUD is also pursuing legislative authority to allow Ginnie Mae 
securitization for 542(c) Risk Share loans. The 542(c) program 
currently serves State and local housing financing agencies whereby FHA 
``shares the risk'' but allows the HFA to set the underwriting 
standards and monitor the loan. This proposal is strongly supported by 
the HFAs because of the long-term structural collapse of the municipal 
bond market that has severely constrained HFAs' access to capital and 
substantially increased HFAs' cost of capital.
V. FHA Health Care Programs
    FHA has steadily provided liquidity in the market during times of 
economic constriction. Combined with historically low interest rates, 
FHA has seen exponential growth in this area. FHA issued a record 
number of $6.5 billion in commitments in Fiscal Year 2012. FHA's health 
care programs for hospitals and residential care facilities (nursing 
homes, assisted living facilities, and board and care homes) have 
helped private lenders fill the gap left with the shrinkage of the 
conventional finance resources. And while this market seems to be 
rebounding, we continue to expect high levels of mortgage insurance 
activity for Fiscal Year 2013. As of September 2012, the FHA's 
portfolio of health care loan guarantees had an unpaid principal 
balance of $29.0 billion on 2,957 loans and counting.
A. Evolution of FHA HC Programs--Balancing Risk and Improving Processes
    The increased activity within FHA's health care programs have 
brought in positive risk management changes to both balance risk and 
improve processes. Given the unprecedented increase in the number and 
dollar volume of loans insured under GI-SRI, in Fiscal Year 2013, 
premium increases for FHA's General Insurance and Special Risk 
Insurance health care programs were instituted to protect capital 
reserves and increase the stability of the insurance fund. With the 
premium increases, FHA Health Care loans are priced more appropriately 
to encourage the return of private capital while, at the same time, 
continuing to ensure sufficient levels of available capital in these 
sectors.
    In FHA's Office of Health Care Programs, weekly loan committees are 
held to review and approve loan submissions and to monitor health care 
industry trends and risks. By implementing proactive asset management 
using early intervention monitoring tools, the Office of Health Care 
Programs succeeded in maintaining very low claim rates in both health 
care facility mortgage insurance programs in Fiscal Year 2012.
    LEAN Business Process Reengineering has also played an integral 
part in streamlining business operations within FHA's health care 
programs. Despite volume increases, LEAN Processing improvements 
reduced loan processing times while increasing risk management efforts. 
Revised program requirements and documents were established to enhance 
accountability for borrowers, operators, and lenders. To further manage 
risk in the health care portfolio, in areas of large risk 
concentrations, such as insuring portfolios of multiple health care 
facilities, reviews are conducted at both the corporate and individual 
loan levels. In the residential care facility mortgage insurance 
program, implementation of a Master Lease Structure to cross-
collateralize properties not only works to improve the overall risk 
profile of FHA's health care portfolio, but ultimately reduces claims.
    The Office of Health Care Programs is in ongoing collaboration with 
HHS, CMS, and State public health departments to support efforts to 
ensure quality of care for the most vulnerable populations. Also, by 
incorporating State survey inspection results, cost reports, and data 
from other Federal and State agencies into FHA's underwriting and asset 
management procedures, the shared utilization of data and cross-
collaboration has been instrumental in keeping health care claim rates 
low within FHA.
B. Legislative Request
    As part of the efforts of FHA's Health Care programs to strengthen 
communities by addressing specialized financing needs, HUD is seeking 
passage of the language in the THUD Appropriations Bill to permit rural 
Critical Access Hospitals to be eligible for FHA insurance.
    We are appreciative of the Congress' long standing support for 
Critical Access Hospitals by amending Section 242 to permit these 
important facilities to be eligible for FHA insurance, and hope that 
this language will be approved to allow Critical Access Hospitals to 
continue to be eligible for FHA insurance.
    The efforts of FHA's Health Care programs are essential in 
achieving the Department's mission of strong, sustainable, inclusive 
communities and quality, affordable housing and services for all 
Americans.
VI. Conclusion
    Mr. Chairman, there are real signs of recovery in the Nation's 
housing market. Given the progress we've seen--and FHA's central role 
in that progress--it's clear that FHA has fulfilled its intended role 
in the Nation's housing finance system. It has allowed millions of 
American families to benefit from home ownership and affordable rental 
options. It has ensured much needed liquidity in the Nation's mortgage 
finance markets. And it has acted as a vital stabilizing force when an 
economic crisis precipitated by the housing market could have resulted 
in this country's second Great Depression. Our job now is to be good 
stewards of taxpayer dollars and ensure FHA can continue be a source of 
opportunity and access to home ownership for future generations. We are 
committed to that goal, and we look forward to working with you to 
achieve it.
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