[Senate Hearing 110-978]
[From the U.S. Government Publishing Office]
S. Hrg. 110-978
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING PROPOSALS TO MITIGATE
FORECLOSURES
AND RESTORE LIQUIDITY TO THE
MORTGAGE MARKETS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
THE HOPE FOR HOMEOWNERS ACT AND OTHER PROPOSALS TO ADDRESS THE ONGOING
TURMOIL IN THE CREDIT AND MORTGAGE MARKETS WITH FOCUS ON THE
IMPLEMENTATION OF VARIOUS PROPOSALS TO ADDRESS THE FORECLOSURE CRISIS
__________
WEDNESDAY, APRIL 16, 2008
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania MEL MARTINEZ, Florida
JON TESTER, Montana BOB CORKER, Tennessee
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Amy S. Friend, Chief Counsel
Jonathan Miller, Professional Staff
Aaron D. Klein, Economist
Julie Y. Chon, International Economic Policy Adviser
Didem Nisanci, Professional Staff Member
Chuck Jones, Professional Staff Member
Megan Bartley, Legislative Assistant
Mark Osterle, Republican Counsel
Jim Johnson, Republican Counsel
Mark A. Calabria, Republican Senior Professional Staff Member
Tewana Wilkerson, Republican Professional Staff Member
Gregg A. Richard, Republican Professional Staff Member
Courtney Geduldig, Republican Legislative Assistant
Dawn Ratliff, Chief Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
C O N T E N T S
----------
WEDNESDAY, APRIL 16, 2008
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Reed................................................. 6
Senator Allard............................................... 7
Senator Carper............................................... 7
Senator Menendez............................................. 8
Senator Corker............................................... 9
Senator Tester............................................... 10
WITNESSES
Brian D. Montgomery, Assistant Secretary for Housing, and Federal
Housing Commissioner, Department of Housing and Urban
Development.................................................... 11
Prepared statement........................................... 45
Response to written questions of:
Chairman Dodd............................................ 88
Arthur J. Murton, Director, Division of Insurance and Research,
Federal Deposit Insurance Corporation.......................... 13
Prepared statement........................................... 52
Scott M. Polakoff, Senior Deputy Director and Chief Operating
Officer, Office of Thrift Supervision.......................... 14
Prepared statement........................................... 75
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING PROPOSALS TO MITIGATE
FORECLOSURES AND RESTORE LIQUIDITY TO THE MORTGAGE MARKETS
----------
WEDNESDAY, APRIL 16, 2008
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. Let me thank our witnesses this morning and
those who have gathered in the Committee room to be here for
our hearing this morning entitled ``Turmoil in the U.S. Credit
Markets: Examining Proposals to Mitigate Foreclosures and
Restore Liquidity to the Mortgage Markets.'' And, again, I want
to thank everyone for their participation over the last several
weeks. We have had a very busy Committee activity, and it will
continue as such. We have an awful lot on our plate, obviously,
and so yesterday's hearing was, I thought, a very good one, and
I appreciate immensely the participation of as many Members.
I know everyone has conflicting schedules as well, with
other Committee assignments and responsibilities, but the fact
that we have had as much participation by the Committee as we
have had I think is an indication of how seriously every Member
of this Committee takes these issues that we have in front of
us. And I am particularly grateful to Senator Shelby and his
staff, as well as my own, obviously, for the tremendous work
being done and the effort made a week or so ago as we spent a
good deal of time on the floor of the Senate grappling with at
least our first efforts on trying to deal with the foreclosure
issues. And while it was not everything that Senator Shelby
wanted or I wanted or even things that are in there that we
would not have necessarily written on our own, I think it was a
major step in the right direction, and I am grateful to every
Member of this Committee for their support in that effort.
This morning, we will continue that discussion, obviously,
as we examine further the questions of how can we mitigate
foreclosures, how can we really help unleash the pent-up
capital that is out there. I mentioned to Senator Shelby that
yesterday morning I had the privilege of meeting with a large
group of people involved in commercial mortgage-backed
securities and heard an earful about their problems. Last year,
I think that business did some $230 billion worth of business
in 2007. As of the middle of April, they have done $5 billion
worth of business this year. It is just frozen up entirely.
We heard that about 15 percent of lenders are no longer
involved in the business of student loans, and those numbers
could continue to skyrocket over the next several weeks and
months. So any debate about whether or not there is a
contagious effect in this issue I think has been obviously
debunked by anyone who is listening to anybody else in various
other sectors of our economy and how this is affecting us.
So whether or not we can do something to play a worthwhile
and responsible role in trying to bring this to a halt and move
in a different direction is the critical question before us--
the liquidity, transparency, and, most of all, confidence in
our markets.
So this morning, the Senate Banking Committee is meeting to
hold its second hearing on the Hope for Homeownership Act and
other plans to address the historic levels of foreclosures the
American people are experiencing. This is Wednesday of this
week. By the end of business today, another 24,000 people in
this country will have filed for foreclosure, and roughly 1,000
a day will be in foreclosure. And every day that we move
forward without addressing that underlying question, those
problems will continue to grow.
There is a growing consensus that the Federal Government
needs to get more aggressively involved in helping American
families keep their homes. In addition to my legislation, the
Office of Thrift Supervision has put forward a plan. HUD has
proposed a plan. Senator McCain ha a plan. And these plans
embrace the key concepts, I would point out, in the legislation
that I have circulated, that Barney Frank and the House side
has also been working on and holding hearings on, including use
of the existing FHA platform to refinance distressed homeowners
into new loans.
It is my hope that we can work collectively to bring
together the best features of these various ideas and move
legislation quickly before we watch any more people have to
suffer the loss of losing the most important investment they
are ever going to have in their lives. Our failure to act
earlier has made the problems we now face more severe.
Mark Zandi, a well-known housing economist, put it this
way, and let me quote him. He said, ``Policymakers' initial
response to last summer's subprime financial shock was very
tentative as they misjudged its severity and the extent of its
economic fallout. Financial markets and the economy
subsequently eroded. Only if more homeowners are able to retain
or remain in their homes will the negative cycle of
foreclosures begetting house price declines begetting more
foreclosures be short-circuited. This in turn is necessary to
ending the down draft in the housing market that is weighing so
heavily on the economy and the financial system.''
Briefly, the legislation that I have proposed creates a new
fund at the FHA to insure new affordable mortgages for
distressed homeowners. These FHA mortgages would refinance the
old troubled loans at significant discount. The new loans would
be no larger than the borrowers could afford to pay and no more
than 90 percent of the current value of the home. This formula
is very similar to the one laid out by Federal Reserve Chairman
Bernanke in his speech several weeks ago when he noted that
creating new equity for underwater borrowers may be a more
effective way to prevent foreclosures. The administration has
also embraced the concept. Under my proposal, no one--I repeat,
no one--gets what would be described as a bailout. Lenders and
investors will have to take a serious haircut to participate in
the program. But, in return, they will receive more than they
would recover through foreclosure. Borrowers get to keep their
homes, but they must pay for the FHA insurance and share the
newly created equity and future appreciation with the FHA
program to help offset any possible losses. Only owner-
occupiers would be eligible for this new program, and only
those who clearly cannot afford their current mortgages.
There will be no speculators or investors allowed in this
program. Not only would this initiative help deserving
homeowners and the communities in which they live, this program
would help stabilize capital markets, put a floor on excessive
downward spiral of housing prices, and get capital flowing once
again, which is absolutely critical, in my view.
In addition to the witnesses we heard from last week's
hearing, the staff has been consulting widely with investors,
lenders, servicers, economists, securitizers, regulators, and
other Senate offices to improve the draft legislation. And we
continue to seek input in order to make this product as strong
as possible and move it forward as soon as possible. It is
increasingly difficult to explain to the American people why it
is that their government can act so quickly to put taxpayer
dollars at risk to bail out, if you will, large financial
institutions on Wall Street without making a more robust effort
to help Americans keep their homes. In my own view, these
efforts must go hand in hand. Before financial institutions can
really get back on a steady course, we need to address the
subprime and nontraditional mortgages underlying the alphabet
soup of complex securities. While not a silver bullet, the Hope
for Homeownership Act would, I think, help to do so.
The need for action continues to be acute. Yesterday,
RealtyTrac released new data which showed that foreclosures
filings jumped 57 percent in March from a year ago. This marks
the 27th consecutive month of year-over-year increases in
national foreclosure filings. And as I said a moment ago,
another 8,000 families today in America will file for
foreclosure; 8,000, roughly, did yesterday, the day before, and
will tomorrow. At some point we have to step up and decide we
are going to try and do something about that, and allowing it
just to hemorrhage day after day after day is not an answer.
Inaction is not an answer. And failure is not an answer.
So today we are gathering once again to try and think about
ways in which we can make a difference. In America, in our
America, this should not be acceptable. If we do not take
effective action, we risk being forced to take more dramatic
and costlier action to respond to more dire consequences down
the road. That is what happened with Bear Stearns, obviously.
As I said last week, I understand that some people oppose
this kind of program on the ground that we should not reward
people who, in their view, acted irresponsibly. Let me respond
by quoting Scott Stern, who testified last week on this very
subject matter. To remind my colleagues, Mr. Stern is the CEO
of Lenders One, a coalition of 110 small and medium-sized
mortgage lenders. Mr. Stern explained that he feels that the
``condemnation of borrowers that took out risky loans is
misplaced because of the growing practice of pushing high-risk
loans on borrowers who had no reasonable expectation of being
able to repay the mortgage.'' Mr. Stern called this ``mortgage
malpractice.'' He went on to say, ``In our industry, we have
frankly seen too much mortgage malpractice. Curing a loan that
had a high risk of failure creates no moral hazard. Just the
opposite. Modifying a loan which probably should not have been
made in the first place is the kind of action that can help
restore integrity and trust in the mortgage market.''
Of course, some borrowers who might benefit from this
program might not be deserving, according to some. But if we do
nothing, we know for certain that hundreds of thousands of
homeowners who need and deserve our help will lose their homes.
That is why I believe we should act, and I look forward to
working with my colleagues to craft the best possible solution
to this problem.
And, again, I want to thank Senator Shelby immensely for
supporting the idea of these hearings for us to listen to
people who can offer some sound advice and counsel on how we
move forward, and with that, let me turn to the Ranking Member.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
As we continue our examination of the mortgage market and
various proposals for further Government intervention, I
believe we must ensure that our actions do not reward, and
thereby facilitate, imprudent financial decisionmaking. As this
Committee heard in testimony last week, many areas of this
country are likely to experience further price declines. In
States such as California, a mortgage writedown of 10 or even
20 percent could likely still leave borrowers with negative
equity in just a year or two. Encouraging a family with no real
equity to remain in a depreciating asset may not make sense.
Mr. Chairman, I believe there is widespread agreement that
many families, particularly those receiving subprime loans,
were not quite ready for homeownership. If these same families
were not ready for homeownership in a booming market, it is not
clear to me how they become ready in a declining market. This,
of course, begs the question. Who should qualify for taxpayer-
backed assistance?
We continue to hear that over 2 million homeowners may be
facing foreclosure. The pressure to act in the face of such a
dire prediction can be overwhelming. But before we act, Mr.
Chairman, I believe there needs to be a frank discussion about
equity and moral hazard. If the Government is going to step in
and prevent foreclosures, who will qualify for this taxpayer-
backed borrowing? Are all these borrowers deserving? If not,
which ones are and why? What do we know about the households
facing foreclosure? What information is relevant and what is
not? The answers to these questions should drive our policy
choices because we will undoubtedly be rewarding some while
penalizing others.
Mr. Chairman, I believe there is a consensus that we should
not be bailing out investors or speculators, but there are
other important questions that need answers here. How many of
these households made minimal or no downpayments on the
properties they hold? How many of these households did a cash-
out refinance on the same property and now face difficulty
paying the higher mortgage cost? How many of these households
have poor credit scores and have significant credit card debt?
How many of these households face foreclosure because of an
income decrease due to a voluntary job loss? Yes, how many
homebuyers used exotic mortgage products, gambling on the
ability to refinance in future years?
What do we tell the family that waited and made prudent
financial decisions when we bail out the people who
overreached? When did we decide that the overextended homebuyer
is more deserving than the potential homebuyer who can now take
advantage of declining home prices? What is the FHA's current
financial condition? What impact would another significant
expansion of the FHA have on the mutual mortgage insurance
fund?
Mr. Chairman, I hope we can get answers to some of these
questions at today's hearing. If we do not, I would encourage
the Committee to continue exploring thoroughly all facets of
your proposal before we act. I would also urge the Committee to
expand significantly its examination of the in-time mortgage
cycle.
Mr. Chairman, we are facing one of the most significant
economic events in decades, and I believe we have a
responsibility to understand how we got there, who is at fault,
and whether we can prevent it from ever happening again. I
believe the Committee needs to examine comprehensively the
reasons behind the ongoing liquidity crisis and the downturn in
the housing market. The examination, Mr. Chairman, I believe
should start with the origination of home loans and proceed
through the securitization process that you referenced to the
ultimate holders of such loans. It should examine the role
played by all market participants, including commercial banks,
investment banks, credit rating agencies, mortgage brokers,
realtors, home builders, finance companies, and Federal and
State regulators.
I believe we should also examine the secondary effects of
the downturn in the housing market, including the impact on the
municipal credit markets, the availability of credit, and the
condition of our financial institutions. The examination here
should aim to provide, to the extent possible, an empirical
basis for any conclusions reached so that any actions the
Committee decides to take in the future are grounded in fact
and not anecdotal evidence.
Among the topics that should be examined, I believe, Mr.
Chairman, are: Who were the largest underwriters of structured
finance products? Did investment banks conduct proper due
diligence when structuring asset-backed securities? Were
underwriters aware of the poor quality of many of the loans
they were securitizing? And if so, did they properly disclose
the risk to investors? Was the Securities and Exchange
Commission properly overseeing the activities of investment
banks and ensuring that the disclosures of structured finance
products were accurate?
Were bank regulators properly monitoring the structured
finance and derivatives activities of financial institutions?
What role did bank capital requirements play in encouraging
banks to move assets off their balance sheets through the use
of securitization? And will the new Basel II capital
requirements eliminate or reduce the incentives banks have for
securitizing assets merely to avoid capital requirements?
What benefit did structured finance products provide? Did
out-of-date accounting standards lead to structured finance
products being reported in an inaccurate or misleading manner
on financial statements? Have accounting standards kept pace
with innovations in financial products to ensure that the value
of the new products is accurately reflected on balance sheets?
Further questions: How often was securitization used for
regulatory arbitrage purposes, such as avoiding capital
requirements, reducing taxes, or securing beneficial accounting
treatment? And who were the largest investors in structured
finance products? Were they conducting proper due diligence on
the products they were buying? And is there any evidence of
widespread misleading or fraudulent sales practices of
structured products to investors? And why have the credit
rating agencies downgraded so many structured finance products?
And to what extent did foreign investment or the Federal
Reserve's monetary policy fuel the sharp increase in housing
prices? Did our current regulatory structure fail? If so, did
it fail because it was not restrictive enough? Or did it fail
because it was too restrictive, providing a false sense of
security to market participants? And how significant was the
role of real estate speculators in the run-up of housing
prices? And to what extent did the practice of mortgage
brokers, realtors, and home builders fuel the frenzy? And how
often did buyers simply reach beyond their means when they
purchased a home?
Mr. Chairman, after a thorough examination of the full
spectrum that I have gone through of the collapsing mortgage
market, the Committee, I believe, should examine potential
reforms to restore confidence in and improve the operation of
our financial markets. Mr. Chairman, as you do, I believe the
responsibility of understanding what happened rests solely with
this Committee. We are uniquely positioned on this Committee to
inform the American people, and it is incumbent upon us to do
so.
Thank you.
Chairman Dodd. I thank you very much. Certainly we have
been doing that, and we are going to act as well, I hope.
Let me ask if any other members here would like to be heard
before we start. All your opening statements will be included
in the record, but does anyone want to be heard? Tom. Jack.
STATEMENT OF SENATOR JACK REED
Senator Reed. Just briefly, Mr. Chairman. Again, I want to
commend you and Senator Shelby for holding the hearing and for
your comments.
The fundamental assumption that most people on Wall Street
had and most people around the kitchen tables of America had
was that housing prices would not go down, and for the last
decade or more, they had been formulating their economic
strategies based on that assumption. And that assumption is not
valid, and as long as they feel that there is no floor on
housing prices, I think both decisionmakers on Wall Street and
Americans across the country will not get their financial
traction, will not start spending again, will not start feeling
comfortable about the future. And we have to act, I think,
promptly to restore a floor.
There are various proposals. I think we can do an analysis,
we must do an analysis, but we have to act. And, to date, the
voluntary efforts of the administration have been modest at
best in terms of reaching people who are in danger of
foreclosure, and also reaching people who are paying their
mortgages but they are underwater. Their mortgage is much
greater than the value of their home. And that means they are
not going to go out and take money out to send children to
college; they are not going to go out and take money out to buy
something. And, again, this is all adding to a recession that
is upon us.
So I think we have to act, and I hope this hearing will
give us insights for prompt and timely action. Thank you, Mr.
Chairman.
Chairman Dodd. Thank you very much.
I would remind the Committee we are going to have Chairman
Cox here next week to be talking about the role of the SEC and
the credit agencies. We have had a series of hearings, and we
will continue. Obviously, as Senator Shelby points out very
accurately here, we have an obligation to know how this all
happened, and certainly that is an important role and an
ongoing one.
I would also suggest we have a commensurate responsibility,
of course, to act to make sure this problem does not grow
worse. And my concern is it is. We had Larry Summers the other
day talking about--I think, Jack, to pick up on your point--
some 15 million homes now are underwater; that is, debt exceeds
equity, and those numbers are growing. And, obviously, you go
back to what values were before, Bob Corker likes to point out,
and rightly so, that, you know, we are looking at values today
versus where they were a few years ago in terms of reality and
all of that. In the meantime, obviously, a lot of wealth is
being lost.
So we have two roles: one, to find out what happened; and,
two, to make sure we take steps to see to it that we short-
circuit this problem before it gets completely out of hand.
Wayne, do you want to----
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I would like to just say that
both you and Senator Shelby are bringing up some very credible
questions that we need to continue to work on finding the
answers on.
I do have some reservations on taking FHA, which has a
troubled past, and adding more risk to a newly recovering
agency which would put taxpayers on the hook. So I hope we can
be cautious about that.
Chairman Dodd. Thanks very much for that.
Anyone else want to be heard? Tom.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. I am happy today to welcome our witnesses,
and I look forward to your testimony. Some of you have already
given us plenty of food for thought.
I would just remind my colleagues as we approach this
hearing, we had the opportunity during the debate on the
Housing Recovery Act, which we passed by a wide margin a week
or so ago, and I applaud the Chairman and Ranking Member and
others who helped to make that happen.
You will recall that we had an opportunity to consider a
proposal by Senator Durbin to empower a bankruptcy judge to
modify the amount of principal that is owed in a primary
mortgage, and we decided, by a fairly wide margin, that we are
not going to do that. That was one effort to try to address the
problem here that the Chairman would have us consider, and that
is, where people owe more money on their home than their home
is worth, and the value of the home might still be dropping.
I am not interested in rewarding bad behavior. I am not
interested in rewarding bad behavior on the part of borrowers
or lenders or investors. I do not think any of us are
interested in doing that. But I know that if Bob Menendez and I
were neighbors and my home goes into foreclosure, there is a
problem certainly for my family, but there is also a problem
for him and his family and other people who live in my
neighborhood because the value of their homes are going to go
down as my home in foreclosure decays and is deteriorated.
There are a number of good, constructive ideas of how to
move forward on this. I think the Chairman's proposal is
certainly that. I think Congressman Frank has that. OTS has
suggested a good idea. FHASecure is a good idea. Somewhere in
the mix of all that is, I think, very good public policy that
will help address the problem, the dilemma that is faced not
just by the folks that are going into foreclosure, but also by
the people who live in those neighborhoods, and to do it in a
way that does not put taxpayers needlessly at risk.
There is a way to do this, and I am very hopeful that we
will find that way.
Chairman Dodd. I hope so as well.
Anyone else want to be heard on this? Bob.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman. I only wish I
could live next to Senator Carper. I just cannot afford it.
[Laughter.]
Senator Carper. We would have to change the Constitution.
There would be three Senators from Delaware.
Senator Menendez. It would be a pleasure to live next door
to him. But I just want to say I appreciate you continuing this
series of hearings. You know, I have to be honest with you, Mr.
Chairman. The terms of the administration's proposals, both
past and present, I am somewhat at a loss for words. I do not
know what else Members of the Committee can say or the
economists can say or the consumers can say that presents and
convinces the administration the size of the crisis that we are
facing. And I think a serious crisis deserves a serious and
significant committed solution. So I am glad that the
administration is on board with the idea of an expanded FHA
plan, but I think your plan, Mr. Chairman, does a lot more to
help a wider range of homeowners than some of what the
administration is talking about.
And I will just take a moment just to remind us again about
what Senator Carper was saying. This is far beyond the
individual. It is about all of us. At the end of the day, it is
about all of us. We had an economy that lost 80,000 jobs in
March; the unemployment rate rose to 5.1 percent; the housing
crisis has already subtracted 1.2 percent from the GDP growth;
and home prices declined for the first year since the Great
Depression. The first year since the Great Depression.
We have $460 billion in adjustable rate mortgages scheduled
to reset this year, which means that the number of padlocks on
doors are only going to grow. And there were 8,000 filings for
foreclosure per day in the month of February; 3 million
mortgage loans are expected to default this year and next; and
of these, 2 million are expected to result in foreclosures.
And, finally, yesterday RealtyTrac reported that there was
a 5-percent increase in foreclosure filings last month and a
57-percent increase from last year. And their report shows that
one in every 538 American households received a foreclosure
filing last month. One out of 538.
Mr. Chairman, we need to do everything that Senator Shelby
and you have talked about in terms of protecting so that we do
not find ourselves in this circumstance again. But the urgency
of the moment is now, and I hope that, you know, we can
convince the administration to move quickly and more
significantly than it has talked about today, and we look
forward to hearing the panel.
Chairman Dodd. Thank you.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. I typically do not make opening comments,
but there has been so much, I will just follow up on Senator
Menendez and say that I agree with him. I think his last
sentence was dead on, that the administration does have a plan,
and I hope that they will move quickly to implement it. I read
it last night. It actually makes a lot of sense.
I just would say that, in general, our efforts so far have
been incredibly clumsy. We have spent $168 billion with our
first stimulus package, which is a boon for Walmart and Sears
and others, but not for the economy in general. And this last
effort, to me, while I applaud the bipartisan efforts, it was,
again, incredibly clumsy, and we are spending lots of money
doing things that have nothing to do with the problem. And I
applaud you today for having a hearing that is surgically
focused on the actual problem. But I hope as we move through
this we remember how clumsy our efforts can be legislatively
and that we encourage efforts by the administration that can
move swiftly and actually do things hopefully that make more
sense and do not have long-term lingering problems for others
to pay for down the road.
So this is a surgical meeting. I thank you for this.
Yesterday's hearing to me was outstanding, and I look forward
to some good discussion today. But I hope we will keep in mind
and look back at what we have done over the last couple months
knowing that we have not even come close to hitting the target,
and sometimes when we do things legislatively, that is what
occurs.
Chairman Dodd. Well, I could not agree more. We certainly
have been trying to hit that target, and it is awfully
difficult sometimes to get all the players aiming in the same
direction.
Senator Tester, any comments.
STATEMENT OF SENATOR JON TESTER
Senator Tester. Yes, well, thank you, Mr. Chairman. The
questions that Senator Shelby asked are good questions. I hope
you submit them so we can get answers for them.
Truthfully, I know some of them are global and some may not
be able to be answered, but the truth is that for that 2 or 3
minutes you asked questions, they are all critically important,
and they are questions I want to know, too.
I think it is interesting because, you know, we talk about
folks, if they can afford to get into a home, and then you have
got bankers that allow them to get into a home on an interest-
only loan with no down. So who is really at fault here? And I
really revert back to personal experience.
When I moved here 16 months ago and we were looking to buy
a house instead of renting, for obvious reasons, I was offered
a no-down, interest-only loan, and I was very tempted. If I had
been 20 years old, I would have probably jumped on it. It is
goofy. It is goofy that they would offer that. And it is also
goofy that you get checks in the mail for 5,000 bucks and you
just go put them in the bank and you have got money. And if you
are hard up, you do it.
There are people that are responsible for this, and I want
to--and I do not think the administration has done any kind of
job at all over the last few years, having any oversight of
what is going on in the industry. And it is very disturbing to
me. And I do not know if what we have done is clumsy or not. I
have not been totally happy with it either, Senator Corker, but
the fact is that when Bear Stearns got into trouble, it took 3
days. And I just wonder how much due diligence was done there.
Thank you, Mr. Chairman.
Chairman Dodd. Great question. Ninety-six hours, moved
pretty fast, put $29 billion right on the block pretty fast,
and no collateral last, except hoping the assets there are
going to turn out to be worth something down the road. And here
we are 1 year later, having sat in this very room with all the
stakeholders, trying to get them to do something on this damn
thing, and nothing happened. According to Moody's, 1 percent
may be workouts. Nothing. And the administration sat back in
August, and all they wanted to talk about was the debt ceiling
when we had the meeting on this issue. And using their
language, it was ``contained.''
So clumsy is what I am getting from the administration in
not responding to this because we are failing to address what
is going on here, and it is getting worse, daily getting worse.
So my hope is--and we are going to be able to act fairly soon
on some of these ideas, and simultaneously obviously go back
and try and figure out as much as we can about what happened.
And that is clearly an important function of the Committee. But
that is not going to be--we are not going to be judged
historically by just examining what happened if, in fact, in
the process we do not do something to short-circuit this. And
if we do not do that, then history will indict us if we end up
with an economic mess on our hands that takes a generation to
correct. And I am worried that is going to be the case.
So, with that, we welcome our witnesses this morning. We
are delighted to welcome the Honorable Brian Montgomery,
Assistant Secretary for Housing, Federal Housing Commissioner.
Mr. Montgomery formerly served as Deputy Assistant to the
President in the Cabinet of the Secretary before coming to HUD.
His duties included oversight of FHA's $400 billion insurance
portfolio and HUD's various regulatory responsibilities.
Arthur Murton is Director of the Division of Insurance and
Research for the Federal Deposit Insurance Corporation. Mr.
Murton has a Ph.D. in Economics from the University of
Virginia, served at the FDIC since 1986--22 years. The Division
of Insurance and Research directs the FDIC's efforts in banking
research and policy development, and let me just say Sheila
Bair wanted to be here, but there has been a death in her
family, and we extend, all of us do, our deepest sympathies to
Sheila. She has been a wonderful public servant, has been
before this Committee many, many times. We welcome you here
today, Mr. Murton, but please extend our condolences to Sheila.
Mr. Murton. Thank you. I will do that.
Chairman Dodd. Scott Polakoff is the Senior Deputy Director
and Chief Operating Officer of the Office of Thrift
Supervision. He joined OTS in 2005 after serving the FDIC for
over two decades. The OTS is the primary regulator of Federal
and State chartered savings associations.
We thank all three of you for being here this morning, and
we will begin with you, Brian. Thanks for coming before the
Committee.
STATEMENT OF BRIAN MONTGOMERY, ASSISTANT SECRETARY FOR HOUSING/
FEDERAL HOUSING COMMISSIONER, DEPARTMENT OF HOUSING AND URBAN
DEVELOPMENT
Mr. Montgomery. Thank you very much, Mr. Chairman and
Ranking Member Shelby, for this invitation, and I want to say I
think the time is now for some clear vision and some wise
policy as we go forward.
I do want to say I am confident that we can find some
common ground to address this housing crisis, given our mutual
interest in breaking the cycle of foreclosure. You and I agree
that what the Nation needs is a solution that restores
desperately needed liquidity for the credit markets and some
price stability to the local real estate markets, and I know
that we all want to find a way for FHA to help hundreds of
thousands of Americans keep their homes and certainly avoid
foreclosure.
I believe we must help responsible families and communities
in need without transferring risks and costs that should be
borne by the private sector to the taxpayers. In fact, I
believe most Americans want to protect homeowners who play by
the rules. They don't want to have to pay for the risky
financial behavior of others, and they don't want to make the
Federal Government the lender of last resort, with the private
sector dumping bad paper on FHA and on the taxpayers.
The taxpayers do not want us to Federalize the housing
market, which would be unwise economically. I believe FHA
should remain true to its mission. And we must not harm our
economy through solutions that, however well intentioned,
further erode the foundation of the nation's housing market,
hurt homeowners who are meeting their mortgage obligations, or
even perhaps prolong the correction.
I will say this. For more than 2 years, the administration
has suggested legislative ways to improve the agency's ability
to fulfill its mission to help low- and moderate-income and
also first-time home buyers who are not served by the
conventional mortgage market. The administration continues to
urge Congress to reach agreement on a bill to modernize FHA so
that the President can sign it into law.
Mr. Chairman, in the meantime, FHA has been able to use its
administrative authority to help hundreds of thousands of
Americans refinance their home loan. In August of last year,
the President introduced an effort known as FHASecure to help
more Americans facing foreclosure refinance into a safer, more
secure FHA-insured loan. Since then, close to 160,000 families
have been able to refinance with FHA. We have always said that
we are open to further expansion of FHASecure, but done so in a
responsible way.
Thus, last week at a hearing before a House Financial
Services Committee, I announced some further administrative
steps that will extend FHA opportunities to more homeowners
that will help break the cycle of foreclosure. These efforts,
using current regulatory authority, are targeted to distressed
homeowners struggling to make their current mortgage payments
and have no place to turn to refinance their homes as they
continue to lose value.
And our efforts will not create an unacceptable level of
financial risk for FHA. I believe that some of the
Congressional approaches often have unforseen consequences. For
example, we believe mandatory write-offs of all existing
mortgage debt will severely limit participation by existing
lien holders. In addition, home buyers who speculated with a
high-risk, high-leverage product would under this bill be
rewarded with the deed to an upper-end house for a cost well
below its long-term value. They can live in this house and
later sell it for a substantial profit at the expense of the
investors, who will take the write-down losses. The proposal
does create significant inequity for the neighbors of such
speculators.
Also, the equity-sharing arrangements in this bill, we
think are wrongly directed. The equity arrangements to prevent
windfall profits to homeowners should not benefit the Federal
Government, but the existing lien holder to minimize their
losses. To be blunt, this is not our money.
As well, creation of a new fund and board to expand the
existing cap is redundant and, we believe, unnecessary because
the existing FHA framework could achieve the same goal and much
faster.
Finally, Mr. Chairman, establishment of new GSE and
suspension of the existing goals should be handled by HUD
alone, the agency most familiar with the process. We believe
adding extra cooks to that kitchen will unnecessarily
complicate a process that we believe is currently working.
I should add that the administration opposes any provision
which will provide billions of dollars in loans or grants to
States and local governments, whether through the CDBG program
or other programs, for the purchase and rehab of vacant
foreclosed homes. We believe in addition to being extremely
costly, such a program would constitute a taxpayer bail-out of
lenders and speculators while doing little to help keep
struggling families in their homes.
These are my initial thoughts about the bill. Let me say in
closing, I will reiterate that. We do have some common ground
to explore here and I want to say I look forward to working
with you and the entire committee to do just that. There is a
lot riding on this, Senator and Mr. Chairman. Thank you.
Chairman Dodd. Thank you very much, Brian, for that, and we
look forward to your ideas and thoughts in exploring some of
the differences.
Mr. Murton.
STATEMENT OF ART MURTON, DIRECTOR, DIVISION OF INSURANCE AND
RESEARCH, FEDERAL DEPOSIT INSURANCE COMPANY
Mr. Murton. Chairman Dodd, Ranking Member Shelby, Members
of the Committee, I appreciate the opportunity to testify today
on behalf of the FDIC.
The problems we face in the housing and credit markets were
caused by a complex set of interrelated concerns. The FDIC is
concerned that we face a continuing cycle of default,
foreclosures, declining home prices, and uncertainty, thus
leading to potential for further losses, preventing recovery of
the credit markets, and impairing the performance of the U.S.
economy. Avoiding this result will require well-designed
approaches to help distressed borrowers and to restore
secondary market liquidity.
No single solution can fully address the circumstances
confronting us. Proposals addressing the current problems in
the mortgage markets will raise issues of fairness, especially
on the part of borrowers who have remained timely on their
mortgage payments. However, properly structured proposals will
provide benefits beyond the immediate participants by
preventing a large number of foreclosures that would adversely
affect other homeowners, other communities, and the broader
economy.
The FDIC has advocated systematic voluntary loan
modifications to deal with poorly underwritten and unaffordable
loans, particularly in the subprime market. While some progress
has been made, the pace has been too slow to achieve the
results that we were hoping for and to contain the broader harm
to our communities and the economy. As Chairman Bair has
stated, we are at a point where we need more intervention and
it probably will cost some money.
In the remaining time, I would like to make a few comments
about the Hope for Home Owners Act of 2008. The proposal by
Chairman Dodd addresses many of the principles the FDIC
considers necessary for an effective program. It restructures
troubled mortgages into loans that should be affordable and
sustainable over the long term. It requires that investors
recognize current losses while preventing borrowers from being
unduly enriched if home prices appreciate. It uses existing
government and market structures, which should allow the
program to be implemented quickly. And it includes a financial
cushion to help insulate the FHA and the taxpayers from losses.
Still, there are some specific issues that need to be
addressed. A major obstacle to refinancing many troubled first
mortgages is that a significant number of them are subject to
second liens. Resolving this issue is essential.
A second concern is whether the FHA in the short-term will
have the capacity to run the program.
Third, there is the potential for adverse selection. The
concern here is that investors will have economic incentives to
cherry-pick the better loans and push the weaker loans into the
FHA program, thereby increasing the cost.
A final issue relates to the lack of financial incentive
for servicers to modify loans.
In addition, my prepared testimony contains a few
suggestions that go beyond the scope of the bill before the
committee.
So in conclusion, the FDIC supports long-term solutions
that fairly share the costs and risks of modifying or
restructuring loans, that use existing government and market
structures, and that mitigate the potential exposure to
taxpayers. The FDIC is committed to working with Congress and
others on solutions that address the immediate problems and
that look to the future.
Thank you, and I would welcome any questions the committee
would have.
Chairman Dodd. Thank you very much, Mr. Murton.
Mr. Polakoff.
STATEMENT OF SCOTT M. POLAKOFF, SENIOR DEPUTY DIRECTOR AND
CHIEF OPERATING OFFICER, OFFICE OF THRIFT SUPERVISION
Mr. Polakoff. Good morning, Chairman Dodd, Ranking Member
Shelby, and Members of the Committee. Thank you for inviting me
here today to testify on behalf of OTS on preventing home
foreclosures in America.
We are in the midst of a stressed real estate environment.
Home sales have deteriorated sharply, with sales down by 36
percent since 2006, resulting in nearly a 10-month inventory.
An increasing number of borrowers are having difficulty making
their mortgage payments. Of the $11 trillion in mortgage loans
outstanding, approximately $1 trillion are subprime loans. As
of January 2008, 21 percent of subprime borrowers are
delinquent, compared to 14 percent 1 year ago.
Foreclosure data suggests an increasing number of home
owners are losing their homes, as the rate of foreclosure on
all mortgage loans has doubled in the past 2 years and for
subprime loans has risen to 9 percent from 4 percent in the 12
months ending January 2008.
Adding to the problem is the unprecedented home price
depreciation. With home prices down 10 percent from their peak
in 2006, approximately nine million home owners are expected to
have no or negative equity in their homes. Our observation is
that numerous borrowers who would benefit from refinancing
their mortgages can no longer qualify, as the equity has
disintegrated over the past years.
I should point out that a significant concentration of
these non-performing loans resides in private-label
securitizations. A private-label securitization has many
stakeholders. The borrower, the investor, trustee, and the
servicer all play critical roles in this secondary market
funding vehicle. Any proposal to help prevent avoidable
foreclosures should consider the interests of each of these
components and opportunities to align various interests for the
good of our housing economy.
As you know, OTS announced its foreclosure prevention
proposal in February of this year. Since then, we have been
meeting with other financial regulators, major mortgage
servicers, the American Securitization Forum, and other
industry experts in an attempt to refine our proposal to assist
with these efforts. These meetings, particularly with the
servicers and investors, have given us insight into what I
consider to be the key question at hand, and that is how to
provide the right incentives to all of the stakeholders.
If the proposal is too rich to borrowers, then we risk
moral hazard. If the proposal ignores the interest of
investors, then we risk inactivity by servicers. And if we
ignore the legal documents, specifically the pooling and
servicing agreements, then we risk excessive litigation and
potentially impair future liquidity in the secondary market.
But if we don't create an effective tool, then foreclosures
will continue and the negative impact on neighborhoods and
communities will be severe.
As you know, the OTS plan has a good deal in common with
the Chairman's bill. Both seek to prevent foreclosures by
refinancing the mortgages of distressed borrowers with loans
guaranteed by the FHA. Both proposals suggest a conservative
loan-to-value ratio based on the home's current fair market
value. We recognize that this current fair market value may be
less than the principal owed on a loan due to home price
depreciation. Under the OTS plan, the holder of the original
loan would sustain a loss and receive a negative equity
certificate for a sizable portion of the difference between the
outstanding loan amount and the short refinance amount. The
original loan holder could recover an amount up to the full
value of the negative equity certificate when the home is
eventually sold.
I should point out that we have refined our proposal to
allow the home owner to share in this negative equity interest
as an incentive to stay in the home, maintain it, and perhaps
even make improvements to get the best possible price upon
resale. This borrower incentive is another important part in
searching for the proper equilibrium of interests.
Recently, we have heard stories where the second mortgage
holder has prevented a borrower from entering a short refinance
by refusing to subordinate its lien interest. It seems worthy
to explore the possibility that such second mortgage holders
could also share to some small degree in the negative equity
certificate as an incentive to subordinate their position for a
refinance opportunity.
Last, there are two key components of our proposal that
deserve mention. First, this vehicle would apply only to
situations where default is reasonably foreseeable. While it
has the ability to assist borrowers who may be underwater in
their mortgage, it is not intended to aid borrowers who have
the ability to repay but lack the willingness to repay.
Second, this model is intended to help owner-occupied
borrowers, not investors.
We recognize that there are multiple causes for real estate
stress and there need to be multiple tools available to work
through this crisis.
Thank you for having me here today, Mr. Chairman, and I
look forward to answering your questions.
Chairman Dodd. Thank you very, very much, and I thank all
three of you for your comments. I should have said at the
outset, if I didn't, any supporting data, materials you want
the committee to have as a part of the testimony we will
certainly include as part of the record.
I will put 7 minutes on here and see if we can't hold to
that so we give everyone who is here a chance to raise some of
these very important questions that members have.
Let me, if I can, just start out quickly with you, Mr.
Montgomery, obviously to try to get as much information as we
can about what is working and what is not working. And again, I
want to emphasize the point, I know a lot of people are trying
to figure out what best to do in all of this, and I welcome
that and I am deeply appreciative of the various ideas that
have been surfaced.
Let me state as clearly as I can, there is no ideological
position here. I am trying to be as practical as I can as to
what can work, make a difference. And so I am less interested
in people's ideological framework than recognizing there are
moments when an intervention is necessary. Ideally, I don't
like it. I would like the market to work. And if the market can
work, there is no reason for us to act. But when the market is
not working, then it becomes incumbent upon us, I think, to try
and figure out a responsible way to intervene intelligently,
thoughtfully, and responsibly, obviously understanding at the
time you are never quite sure what is going to happen, but you
hope you are smart enough that you are going to be a positive
influence on it.
But to do that, you have got to know what the data is. I am
looking at an article that was entitled, ``HUD Acknowledges
Inability to Help Many Borrowers.'' This was an article that
appeared about a month ago, and the Director of FHA's Office of
Single-Family Program Development said that there had been only
1,500 FHA-secured financings. From March 1 to the 15th, HUD
reported that just 242 loans were made for delinquent
borrowers, or just 17 loans per day.
I mentioned earlier we are getting some, according to Track
Realty, in the neighborhood of 7,000 to 8,000 filings a day and
as many as 1,000 of those 7,000 or 8,000 are actually going
into foreclosure. At least those are the numbers we are getting
on all of this.
So instead of 17 a day, as opposed to the numbers we are
looking at--let me ask, first of all, the two other witnesses.
Do you agree with that general overview here, that the program
is not--FHASecure, while it is a good idea, it is not
addressing the magnitude of the problem. Is that your
conclusion, as well, as you have looked at this issue?
Mr. Polakoff. Mr. Chairman, I wouldn't be prepared to say
that at this point. As we reach out to the servicers, we
understand that the servicers themselves are modifying a number
of loans in an attempt to do the right thing. Borrowers are
using FHASecure as a vehicle. There still seems to be an
incredible difficulty to reach a number of borrowers as they
approach default and a foreclosure situation, sir.
Chairman Dodd. How about you, Mr. Murton?
Mr. Murton. Well, I think as I said in my statement, I
think as Chairman Bair said, we are at the point where we do
think more steps are needed. We think the efforts so far have
been important, but we do think that more may be needed.
Chairman Dodd. Well, in your testimony, Mr. Montgomery, you
state that FHASecure and HOPE NOW initiatives have together
helped more than 1.3 million home owners. I would like to get
that data, if I can, or the committee would, for the record
that breaks out exactly how many borrowers are getting
repayment loans and modifications, what kind of repayment plans
and modifications they are getting. All of us hear, I think,
that too many loans are being reclassified as modifications
where no long-term interest rate freezes are involved or other
considerations. The word ``modification'' is being rather used
loosely, and it would be very helpful if we could at your
earliest convenience here to get us the data that supports that
conclusion of 1.3 million.
Do you want to add any comments here in terms of the
concerns I have about them?
Mr. Montgomery. Yes. Absolutely, Mr. Chairman. Thank you.
When we announced FHASecure on August 31----
Chairman Dodd. I point out, by the way, the industry itself
has raised some concerns in the press about what they call
cooking the books on these numbers, so----
Mr. Montgomery. Anybody can look at our books who want to,
sir, any time, any day. Let me just say that when we rolled out
FHASecure, again, we are an insurance company. We needed to
have a measure of response backing our actuarial soundness. But
we did say going forward that we would make improvements as we
saw fit.
There have been 163,000 mostly subprime borrowers who are
heading toward the slippery slope of delinquency--we know this
because they tell us--who had never even heard of the FHA.
Remember, for many years, and your staff will attest to this,
FHA, I think a lot of people thought we were the Federal
Highway Administration. We are almost an afterthought for many
borrowers. A lot of publicity around the announcement. Again,
borrowers tell us this. They thought they had no other option.
So I will say this. We way overestimated the number who
would come in delinquent, and I will get to that in a second.
We way underestimated the numbers that would come in current.
By the end of the fiscal year, we believe we will have 400,000
borrowers--remember, these were not FHA borrowers--that will
refinance through a safe and secure FHA loan.
Now let me fast-forward to last week. Moving forward, we
wanted to make some more improvements to FHASecure, again
coming at it from the sense of delinquencies, keeping our debt-
to-income ratios and the like. We think we will add another
100,000 to that number. Remember, a lot of these folks were
never going to qualify anyway. They had no document loans. They
had stripped out a lot of the equity in their homes. So going
forward, I think a lot of those families who refinance will
disagree that they have not been helped.
Chairman Dodd. Well, again, I think getting the data here
would help us get a better picture on all of this.
One of the things being raised, a concern about it, is, of
course, that we are protecting taxpayers. Obviously, all of us
want to do that. When this program or something similar was
tried years ago, it actually produced a modest amount of income
for the Federal Government in those days, in 1920s, 1930s
dollars. We are not looking to make money off this, but
obviously we want to avoid having great exposure for the
American taxpayer, as well, that has been raised by many,
including Senator Shelby and others.
And one of the ways we try to protect the taxpayer in this
plan--the three ways we try to do it, I would like to know how
you feel about these and if there are any other ideas you would
have that we ought to include as part of the proposal.
One, it increases the maximum up-front and annual premiums
in the proposal. It calls for FHA to share in future
appreciation. So you are getting resources back to the program.
And it limits the maximum loan-to-value of the new loan to 90
percent of the current value of the property, something Mr.
Polakoff addressed.
Do any of you have any other additional factors or
reactions to these ideas and is there anything else you would
add? How about you, Mr. Montgomery?
Mr. Montgomery. I would say on the LTV, again, sir, there
is some common ground here. I can't stress that enough.
Chairman Dodd. Yes.
Mr. Montgomery. We think there needs to be an incentive for
the current lien holder as part of those agreements that were
referenced earlier to want to do the write-off down to some
certain number. I think a mandatory complete write-off, where
the FHA refinance is accepted as payment in full, I don't know
that you will get the participation that you are looking. We
think by coming at it a little differently that FHA steps in,
there is a second lien for a part of that charge-off, we think
is a more prudent approach. Ninety percent LTV loans perform
very well for FHA.
I would also say on the debt-to-income, I know that you
give that authority to a board----
Chairman Dodd. Yes.
Mr. Montgomery [continuing]. Which again we, speaking for
our excellent career staff at FHA, believe strongly we have
that expertise. But we feel very secure in keeping those debt-
to-income ratios the same, and I know you would have this board
do that, 31 being the front end, 43 being the back end.
Chairman Dodd. Right.
Mr. Montgomery. On the shared equity component, again, as I
mentioned in my oral statement and the written, we were not
party to that original transaction. This is not FHA's money.
Chairman Dodd. Yes.
Mr. Montgomery. I think we share in the goal that we want
to keep that borrower in the home so they don't experience some
windfall profit. We think the 90 percent with the soft second
supports that. But we could also have some sort of recapture
provision, some sort of resell restriction to perhaps
accomplish the same thing.
Chairman Dodd. I agree with that. That is not a bad idea.
Mr. Murton.
Mr. Murton. Yes. In our written testimony, we did mention
that perhaps increasing the fee from 3 percent to 5 percent, or
in that direction, may be important. We are concerned about
making sure that the government is protected to the extent
possible. So I think there may be room for discussion on that.
We do recognize that you do have to provide incentives for the
investors to participate.
Chairman Dodd. Right. Exactly.
Mr. Polakoff. Mr. Chairman, we would urge very strongly
consideration that the negative equity certificate or the
potential of sharing upside appreciation reside with the
original loan holder, potentially also with the second and with
the borrower. Whether 90 percent LTV, whether that 10 percent
cushion is the right amount, the key here for these FHA
refinance, we believe, is insured financial institutions are
going to be the ones that underwrite these loans. It should be
fully documented, properly underwritten, with a 10-percent
margin. We believe they should be safe and sound loans.
Chairman Dodd. Yes. Well, in fact, on the incentive idea, I
think there is some real value in that, as well, striking that
balance, because this is voluntary, and to the extent you want
both the investor and obviously the borrower--the incentive of
the borrower is there. You get to stay in your home. But the
incentive for the investor to step up and say, I am willing to
take that haircut and do this, I think you have got to have a
proper incentive in there. It gets to the issue rather well of
the safe harbor provisions, which I will come back in a later
round since we have already gone over the time here. But I
appreciate your comments on that.
Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Mr. Montgomery, you stated in your testimony that some
ideas stretch FHA beyond its role or ability to serve the
American people appropriately. Today, I will ask you, does FHA
have the institutional capacity in terms of expertise, staff
numbers, available funding, among other things, to be able to
handle the proposed increases in its activities?
Mr. Montgomery. Well, not to get sideways with the budget
folks, I guess the only good news in the fact that we are still
waiting for FHA modernization is we have been able to take 2
years----
Senator Shelby. Some of us serve on the Appropriations
Committee, too, so if you wouldn't mind----
Mr. Montgomery. Sorry, Senator. That we have been able to
upgrade our systems, even though their average age is about 18
years. So yes, we do need some systems upgrades.
Senator Shelby. Which is going to cost money, that
capacity.
Mr. Montgomery. Yes, sir.
Senator Shelby. OK. Would you explain to the committee what
you believe constitutes underwriting flexibility? As some might
say, underwriting flexibility is a euphemism for the loose
underwriting standards that led many to present difficulties in
the mortgage markets. What do you mean by underwriting
flexibility?
Mr. Montgomery. Well, I will agree with some of what
Senator Tester mentioned before. It was almost free money,
these no docs, income-stated asset. Remember, FHA----
Senator Shelby. That is asking for trouble, isn't it?
Mr. Montgomery. Absolutely, sir. That is part of why we are
in this predicament we are in, and FHA doesn't do that. We have
this crazy notion you have to prove your job history. You have
to verify your income. We have rigid debt-to-income ratios that
we are not going to change.
Senator Shelby. Mr. Murton, some have suggested that
Congress should set up a board to oversee an expansion of FHA.
On that board, some would say, should sit the FDIC, the
Treasury, and Housing and Urban Development Secretary. Would
you tell the committee here or in writing later what unique
expertise the FDIC posses in the area of mortgage insurance? I
know that is part of your portfolio, a big part. Go ahead.
Mr. Murton. Yes. I would be happy to provide a fuller
answer in writing, but I think that when you look at our
experience as safety and soundness supervisors, as supervisors
for consumer protection, I think we have experience, a great
deal of experience in the mortgage markets. And then in our
capacity as the receiver of failed institutions, we have people
who have dealt with these problems, who have tried to work out
loans with borrowers, who have tried to avoid foreclosures and
who have seen the effects of these kind of problems on
communities and the economy.
Senator Shelby. Mr. Murton, you also mentioned in your
testimony that one of the first principles for solutions is
that the solution be sustained over the long term. In other
words, doing something just for expediency generally won't
work. Do you believe that it is a sustainable solution to write
down a mortgage and refinance it when many housing markets are
likely to see future price declines of ten, 15, 20 percent? In
other words, where is the bottom? Are we rushing too soon?
Where are we?
Mr. Murton. I don't know that anyone knows when we will get
to the bottom. I think that we have borrowers who are not in
affordable mortgages and I think they are facing the decision
of whether to end up in a foreclosure, and I think that needs
to be addressed and that we need to address that sooner rather
than later is our perspective.
Senator Shelby. Mr. Montgomery, appraisal controls. A
critical component of all of the write-down plans that have
been presented is the integrity of the appraisal process.
Lenders still will have a strong and clear incentive for
properties to be over-appraised in order to shift as much risk
as possible to the government. HUD's Inspector General recently
reported that FHA did not have adequate internal controls over
its appraiser roster. What steps, Mr. Montgomery, is FHA
planning to take to minimize the adverse impact of inflated
appraisals on the Mutual Mortgage Insurance Fund? I think it is
very important that we get realistic, honest appraisals.
Mr. Montgomery. Absolutely, Senator. I agree 100 percent on
that. We have had roughly 1,400 or so sanctions against
appraisers in the last 3 years, and, in fact, stood up a
program that would help using a risk analysis identify
appraisers that we were getting high default rates, things of
that nature.
Back to your question. On the stimulus package, the
increased loan limits for FHA, for that jumbo FHA product, as
some are calling it, we just put out guidance a week-and-a-half
ago that we are going to require two appraisals for those.
Although remember, an appraisal is just an opinion of value. We
are considering doing the same going forward on this FHASecure
expansion.
Senator Shelby. Mr. Montgomery, were FHA to lower its
underwriting standards in order to serve more borrowers, the
most likely result is an increase in losses to the Federal
Housing Administration, which could ultimately be borne by the
taxpayer. What level of delinquencies and losses are you
projecting for your planned expansion of the FHASecure program?
Mr. Montgomery. Well, by doing----
Senator Shelby. Have you done some modeling there?
Mr. Montgomery. Well, sir, we have done modeling and more
modeling. But there is about a five-legged stool here, and in
the interest of time, I will be very brief.
Senator Shelby. That is OK.
Mr. Montgomery. We need to do some sensible risk-based
pricing, and this is something that was in the original FHA
bill a year ago--excuse me, 2 years ago. The seller-funded
downpayment assistance, which I know the Senate has included
prohibitions on that twice, that is, as you know, a lot in the
predicament that we are in, long-term financial solvency. But
remember, on our proposal for the delinquencies, if you have
one 90-day or three 30-day delinquencies, that now has a 90-
percent LTV requirement. That is a tighter restriction, because
our existing product is only 97 LTV. And, again, historically,
those 90-percent LTV products perform very well for us from an
actuarial standpoint.
Senator Shelby. Mr. Chairman, I just want to wrap this up,
if I can, in a few seconds. In my opening statement, I asked
several questions that I believe this Committee--the Committee
on Banking, Housing, and Urban Affairs--needs to have answered,
and I commend the Chairman for his comprehensive approach to
this. Before we can proceed to crafting good legislation--and I
am going to go over this again--how many of these households
made minimal or no downpayments on the properties they hold?
That is something we need to find out, and perhaps some of you
can help us with. How many of these households did a cash-out
refinance on that same property and now face difficulty paying
the higher mortgage costs? How many of the households have poor
credit scores and have significant credit card debt--in other
words, are overburdened? How many homeowners used exotic
mortgage products, gambling on the ability to refinance in
future years? You know, betting on the ever rising stuff out
there. I do not know the answer to that, but I think that is
all part and parcel of our dilemma here facing that. Do you
disagree with that, Mr. Montgomery?
Mr. Montgomery. No, sir. I agree with that statement.
Senator Shelby. Mr. Murton.
Mr. Murton. I agree with that.
Senator Shelby. Do you agree?
Mr. Polakoff. Yes, sir. It is the question as to whether
the borrower was a victim or an accomplice.
Senator Shelby. And sometimes a victim, sometimes right in
there with them?
Mr. Polakoff. Yes, sir.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Shelby. And,
again, I have said over and over again that I think if you
break these borrowers down to three groups of people, you have
got those that were speculators, and there is nothing that I am
proposing that is designed to provide any relief for the
speculator. I feel badly for them, but they are not included.
This has to be owner-occupied so you are not sitting there
buying properties that you do not live in that you are just
trying to make a buck off of.
The second group of people that, frankly, never would
qualify under any restructuring you could provide for would not
be able to fit into this, and we cannot, tragically--maybe
there are some other ideas that people have on how to help
those people, but I cannot see how we can necessarily fit them
into this idea we are talking about. What we are talking about
is that constituency, those groups of people who are in
situations that they can afford to stay in there with a
workout, that will allow the investor to get something back so
they do not lose everything, so that neighbors will not be
adversely affected by foreclosed properties in the
neighborhood. They may have, you know, chosen or should have
chosen a wiser course to follow but, nonetheless, are in the
situation they are in, and the moral hazard is not only--should
not only be focused on whether or not that individual should
have been more conscious of the kind of problems they could get
into, but also the moral hazard is to the other people that
will be adversely affected if we do not act and do something
about this as well. And that is really the target audience we
are trying to get at. The benefit is obviously to keep people
in their homes where we can. The added benefit is, of course,
that enough transactions will occur that you can actually
determine what the floor and the bottom is. That may be the
more important point from a macroeconomic standpoint so that
the credit crisis begins to lessen and capital begins to flow
and the problems begin to address themselves not only in this
area but in other areas of the economy that are feeling this as
a result of this particular problem. That is the idea behind
this more than anything else, and getting at it.
So I--and we know from the Wall Street Journal study, which
I do not know how accurate it was, but there were some 60
percent of these borrowers that would have qualified for prime
loans at a lot less cost to them than these subprime deals that
they were talked into. And, again, you know, it is the relation
of doctor and patient. I mean, I probably should ask all the
right questions of my doctor before he operates on me. But,
candidly, I am not a doctor. And I am sitting there and I am
relying on someone across that table from me in a sense who is
holding themselves out as a financial adviser to--probably I am
anticipating more than I should, but when a doctor does not do
their job, there is something called medical malpractice, and
we do not turn to the patient and say, ``You should have asked
better questions before you got into this.'' In a sense, that
same analogy can apply to some degree here; when you are
sitting across that table, it is not exactly a level playing
field in many ways. And I think to sort of suggest as such is
to misunderstand what occurs when people are trying to get into
a home, trying to stay afloat. Most of these are second
mortgages, as we know, not first-time homebuyers. And people
are underwater financially. There are two or three incomes.
They are using credit cards. The Chairman is absolutely
correct. We know now--what is it? I think something--I was
stunned yesterday that a quarter of students are paying for
their student loans through credit cards. The average is almost
close to $10,000 per household in credit card debt and
obligation. So it is a mounting problem, the consumer debt
issue, and that is not going to go away here, and I do not know
if we are ever going to find the exact numbers of the economic
profile of that individual caught in that situation that today
is finding themselves facing foreclosure and moving out of
their homes.
So I want to make clear that is what we are targeting,
trying to get to that audience that has the benefit, obviously,
of keeping their family there, stabilizing that neighborhood,
property taxes coming in, as well as not allowing this problem
to spread throughout that neighborhood and getting the
spiraling effect where foreclosures beget more problems beget
more foreclosures, and you get that spiraling down problem, and
the problem gets a lot worse and a lot more costly in many
ways.
And, again, anyone who claims they have cornered the wisdom
on all of this or knows exactly the right thing to do, you
ought to be immediately suspicious of them. I certainly do not.
I am relying on smart people who have been through this and
understand it, trying to come up with a formulation here that
could make some sense and work for us. That is my job here, the
practical applications of trying to short-circuit a problem
that is growing worse.
Senator Menendez.
Senator Menendez. Mr. Chairman, I think Senator Carper is
next.
Chairman Dodd. I am sorry. I apologize. You are exactly
right. My apologies.
Senator Carper. Thank you, my colleague and neighbor.
Chairman Dodd. You have moved in already. That was pretty
quick.
[Laughter.]
Senator Menendez. Just a summer home.
Chairman Dodd. Just a summer home, OK.
Senator Carper. Again, we appreciate your being here and
your testimony today.
Mr. Montgomery, right at the end of your testimony, you
said these words. You said, ``In conclusion, these are our
initial thoughts about the bill. I again stress that there is a
lot of common ground here given our shared interest in using
FHA to help many Americans.''
I am going to ask each of you to talk about the common
ground.
Mr. Montgomery. Do you want me to go first?
Senator Carper. Why don't you go first?
Mr. Montgomery. I would say first and foremost I think we
agree a lot of folks are in the right house but the wrong
mortgage. No one is promised instant equity when they buy their
home. There is also no doubt that we have not had a nationwide,
almost, with some small exceptions, decline in home prices like
we have seen recently.
Going forward--and I agree with the Chairman and the
Ranking Member. I think we all agree on who we want to help and
who we do not want to help, as unfortunate as those other
circumstances may be. So we think going forward if there is
some sort of writedown to a number with a new appraisal,
perhaps two appraisals, that FHA--and there is a reason we have
an FHA, and this is a good one, I think--can insure a portion
of that loan, recognizing that this does not happen in a
vacuum. There are servicing agreements, pooling agreements.
There are investors. There are these second liens, which a lot
of these were piggyback loans. Everybody has a stake in this if
we are going to do the ultimate thing, and that is, keep the
home and the borrower out of foreclosure.
So that is why we think, as well intentioned as doing this
mandatory write-off is, I would just question how many lenders
and servicers would want to participate versus what we want to
do is put that option that exists today to have that soft
second. It does not accumulate interest. There are no payments
made on it. But it is out there so that some portion of that
debt is resolved when the home is refinanced or sold, and
ultimately we will turn this corner, whenever that may be, and
prices go back up. And I think that is something we all--maybe
not to the pace that we just saw recently, but I would say that
is certainly some common ground. We shared this with House
Financial Services Committee as well.
Senator Carper. All right. Thank you.
Mr. Murton, where do you see the common ground?
Mr. Murton. Well, I think in our testimony we laid out four
principles that we would like to see that people----
Senator Carper. Go ahead and restate those. I saw those in
your testimony. State them again.
Mr. Murton. That people be put in sustainable mortgages;
people who can be in those should be in sustainable mortgages.
The burden should be shared appropriately, that parties should
take--third parties are going to have to take losses, and the
burden will have to be shared.
Senator Carper. Who would you include among those third
parties?
Mr. Murton. Can I come back to that in a minute, please?
Senator Carper. Sure.
Mr. Murton. Just let me get through--I am sorry. We would
like to see it use existing structures, market and Government
structures, so it can be done quickly. And we would like to
make sure that we limit the liability to the Government, and I
think there is common ground on most of those.
And I think going back to the second one, that is where
there may be more work to be done, because the burden sharing
of this is quite complicated to figure out. It is absolutely
clear that you need to provide the appropriate incentives so
that investors will encourage the participation on their behalf
by servicers. That is absolutely critical. It is also critical
that you protect the Government's interest in this if the
Government is going to provide funding. And I think finding the
right sharing of those arrangements is one of the trickier
issues.
And then, finally, I think there is common ground or
agreement that dealing with the question of second liens is
going to be a complex problem, and we need to figure that out.
Senator Carper. All right. Thank you.
Mr. Polakoff.
Mr. Polakoff. Senator, we have to find ways to prevent
avoidable foreclosures. Not all foreclosures are avoidable.
There are multiple tools right now for servicers to consider.
This bill offers another tool.
I would say that our conversations with servicers suggests
that servicers are trying to do the right thing, trying to
reach out to the borrowers who are in financial distress right
now. The common elements along those lines I think fit with
much of what I heard today.
I go back to the discussion that I think is very worthy of
if a servicer is going to take a significant write-off in
allowing the borrower, the distressed borrower, to be able to
refinance, whether it is with an FHA guaranteed product. I also
think there is a benefit to talk about the role of private
mortgage insurance with loans underwritten at 90 percent with
insured financial institutions. But the question that I would
submit, the topic that deserves more discussion potentially is
who can benefit from the home price appreciation, which will
return at some point.
Senator Carper. I was talking with one of our leading
bankers in our State, and we were talking about, among other
things, the amount of money that a mortgage servicer is paid.
And he suggested to me that their take, if you will, is 25
basis points in most situations, but in a foreclosure, the
mortgage servicer can realize as much as 6 times that income.
Can you confirm or correct that for me, anybody?
Mr. Polakoff. Well, I cannot confirm it. I certainly would
not be so bold as to correct it. But I would submit that
typically a servicer in a subprime portfolio gets 50 basis
points for servicing that portfolio, and typically in a
foreclosure process, the servicer gets--or the servicer
receives any out-of-pocket costs associated with the
foreclosure. All of our investigation with servicers does not
reveal that a servicer benefits going through a foreclosure
process.
Senator Carper. Could anyone else comment on that?
Mr. Murton. I am not an expert on those numbers. As I
understand it, they are compensated at a higher rate in a
foreclosure, but there are offsetting costs and so forth so
that it may not be profitable. But the concern that we have or
the point we have made is they are paid some administrative
expenses to compensate for those costs in foreclosures. It is
not clear they are incented to do the same for modifications
and other solutions that may be preferable.
Senator Carper. All right. Share with us your best thoughts
of how we should deal with second liens or second mortgages.
Everybody agrees that this may be among the stickiest wickets.
Mr. Montgomery. Well, and you have probably heard some of
the same concerns that we have from the investor and the lender
community out there. But, yes, they absolutely have a stake
going forward, and I think a lot of them will tell you there is
no way they think they are going to get 70 cents on the dollar,
80, 50, 40, whatever. But the fact that there would be a
mandatory discharge of all of that I think might be what would
keep this from going forward.
Senator Carper. All right. Thank you.
Mr. Murton.
Mr. Murton. I think that we agree that most of these
seconds are not worth very much. Nevertheless, they have some
power over taking the loans out of the mortgage--out of the
pools and restructuring them. So one thought that we had is
whether we can look at ways, some other solutions that might
involve working with loans in the pools under other
circumstances and finding arrangements that might work there,
because you may have less of an issue on the second there. But
it is--we wish we could have come with an answer there, but we
would like to explore that.
Senator Carper. Mr. Polakoff.
Mr. Polakoff. Senator, if I could offer a thought with the
seconds, because we have heard these stories, I would submit
that for loan modification purposes, the seconds are irrelevant
from a power perspective. And certainly they are relevant if a
borrower is going to pursue an FHA loan, a refinance. But
everything that we are talking about with an FHA refinance a
servicer can do with a modification, and by doing so eliminates
the power of the second.
So I would suggest very important to address from a
refinance perspective, not necessary to address from a
modification perspective.
Senator Carper. All right. Thank you.
I think, Mr. Chairman, in your bill one other issue is the
issue of a safe harbor for mortgage servicers, as I recall,
that is in your bill, is it not?
Chairman Dodd. It is in our bill.
Senator Carper. Let me just ask, if I could on that, the
inclusion of safe harbor as a part of what we do going forward,
I think, to incentivize the--or at least to take away
disincentive for the servicers to enter into these agreements.
How important do you think safe harbor is?
Mr. Polakoff. Well, I would offer that there is a real
important element of the safe harbor. The servicer must abide
by the pooling and servicing agreement, which obviously has a
couple very important effects. One of them is maximizing
proceeds. The other is for REMIC tax purposes. In order to
define a reasonable, foreseeable default, we have to be sure
that whatever we submit does encounter an IRS ruling for REMIC
purposes.
So I think there are a lot of very important elements to
discuss with that.
Senator Carper. All right. Thanks.
Mr. Murton.
Mr. Murton. Chairman Bair held a number of roundtables last
year to explore the complicated issues in this, and it is
pretty clear that the contracts allow the servicer to act on
behalf of all the investors in the group. And I think that
anything that reinforces that we are very supportive of.
Senator Carper. All right. Mr. Montgomery.
Mr. Montgomery. That is a little out of FHA's realm. We are
not a banking regulator.
Senator Carper. OK. I understand.
Mr. Montgomery. But I would concur with their comments.
Senator Carper. All right. Thanks.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Corker.
Senator Corker. Mr. Chairman, thank you. I am going to
follow along the same line of questions as Senator Carper, and
statements. I think that there is a lot of common ground. By
the way, my ``not neighbor.'' As a matter of fact, sitting
where I sit over here, I wonder if I am part of the continental
United States sometimes.
[Laughter.]
Chairman Dodd. We have all been there.
Senator Corker. I understand. I understand.
Chairman Dodd. You sometimes think you are part of the
press corps over there.
Senator Corker. Well, I know these cameramen very well.
Chairman Dodd. They are slipping you notes all the time, I
think.
Senator Corker. You know, I think that line of questioning
was actually very good, and I know that I have shown my bias in
regards to what we have done thus far on the economic stimulus
efforts that have taken place. I think it has actually been my
most discouraging moments here to see how we sometimes try to
wrestle with issues and then come to conclusions that do not
even really address the issue.
This meeting to me, much like yesterday's where I thought
we had an opportunity and think we do to basically try to push
the FFB into doing some things that would really solve the
problem, I think has some of the same ingredients. And I think
it has been an excellent hearing. And I think that sometimes
the most productive things we do legislatively are not to
legislate necessarily, but to place a marker out there that
causes other organizations that exist to move toward that. And
I think in many ways that is what you have done with your
proposal, is to lay a marker out there that addresses a
problem.
I think there are a lot of commonalities in the approach
between the administration, the witnesses today, and yours, and
I think that, you know, keeping ownership is certainly a goal
that has been laid out.
It seems to me that the negative equity certificates are a
very elegant way, if you will, of dealing with writing a loan
down and getting a mortgage into a position that somebody can
actually pay for it. And yet it does not create all those other
issues of joint ownership. Many people have referred this bill
to be something--referred to this bill in a way to make it
similar to what happened with RTC. But it is not. It is very
different, because in that case there was a severance of
ownership. The people no longer owned the property. In this
case, they are actually going to be in the property. And I
thought testimony we have had over the last few days where
people were concerned about what do you do about home
appreciation that occurs by somebody actually investing in
their property, improving their kitchen, adding a garage. How
do you deal with that? And then how do you deal with the
possibility of the neighbor issue that was referred to earlier
where one neighbor keeps their loan, the other neighbor does
what is proposed in this bill and has a quick sale and actually
benefits from doing the writedown? I think that in many ways
these negative equity certificates really do deal with the
issue far more elegantly and, again, keep us out of dealing
with it.
So the biggest issue--and it seems to me that Chairman
Dodd's bill also builds upon the FHA to actually do this. Is
that correct? I mean, it is within the FHA, a new organization,
a new entity inside the FHA per this bill, per his bill would
actually carry out the efforts proposed in this bill. Is that
correct?
Mr. Montgomery. As I understand, there is a board that is
created that would set, you know, debt-to-income ratios, things
of that nature. We would just submit, since time is of the
essence here, that we have that existing----
Senator Corker. So it seems to me also if this bill becomes
law that there actually has to be an appropriations process to
actually fund it. And it seems to me that everything that the
bill lays out can be done within the FHA today. And it seems
that the negative equity certificates are a much more elegant
way of making sure we have no moral hazard.
In addition, I guess the whole issue of debt forgiveness
creates income, does it not?
Mr. Montgomery. Well, in our case, there would be some debt
forgiveness. I think a lot of lenders and others are looking to
see, to the Chairman's point, where the floor is. But, you
know, once it is written down to an appraised value, we come in
and insure 90 percent of that. That other equity is held as a
soft second.
Senator Corker. But since it is held as a soft second, the
borrower, who already has financial issues, does not owe the
IRS money; whereas, if there is debt forgiveness, my
understanding is that is income. It always has been income in
the past. Is that not an issue that would have to be dealt
with?
Mr. Murton. I believe that was taken care of in recent
legislation.
Senator Corker. For a short window of time.
Chairman Dodd. It was taken care of.
Mr. Polakoff. Senator, I believe there is a 2-year window,
I think, for debt forgiveness not being considered income to
the borrower.
Senator Corker. OK. And I would just say that it seems to
me, then, on that note, though, that this is something that is
set up to actually go forward, per the administration, for a
longer period of time. We are only about a third of the way
through resets at this moment in time. Is that correct? We
still have tremendous numbers of resets to be dealt with. So it
seems to me that the issue is urgent, that the FHA is set up at
this point to deal with it, that it, in fact, takes no
appropriations process for this to occur. And I guess the big
question comes back to a question Senator Menendez offered in
his opening statements. But is the FHA set up to plunge into
this and deal with this plan in a way that would alleviate the
need for any legislation of the type that is being discussed
today?
Mr. Montgomery. The only difference being that we have a
2.25-percent premium cap right now to expand the fence line out
a little further. We would need some flexibility in that
premium structure since we are a self-sustaining entity that
does not take taxpayer funds. Again, we are coming at it from a
delinquency standpoint, things of that nature.
So, yes, we are doing a lot of this now. We think in the
interest of time the best thing is to let the Federal Housing
Administration, perhaps with some legislative fixes, move
forward.
Senator Corker. And could you be very specific about what
those legislative fixes would need to be to cause us to move
forward immediately in a way that appears to me to really be at
no taxpayer expense?
Mr. Montgomery. Well, on the risk-based pricing, we have
this guiding principle that we do not want to raise premiums on
some family in Alabama or Texas who today is saving their money
to buy a home in October, that we do not want to pay for this
by raising their premiums and we want to wall them off from
this. The only way that we can do that is to have some flexible
pricing in that premium, recognizing the differences between
the highest and lowest premiums. You know, our average borrower
has a $50,000 income, buys $140,000 home. Those are very subtle
dollar amounts, but they help our actuarial soundness, because
we do not want to be back here later this year going to the
appropriators saying we need money to keep our doors open,
which I know seems almost counterintuitive because right now us
and the GSEs are about the only game in town, so to speak. Our
volume is up significantly. But, you know, we continue to have
a drag on us with these seller-funded gift downpayments, and I
cannot overstate that enough. And, again, this body has been
great to address that.
Chairman Dodd. Bob, can I just add, you know--here is what
I am thinking. We have asked, by the way, CBO to score this,
because obviously that is an important issue. And we do not
know, but we believe that between the annual and the up-front
premiums that we are talking about and the shared equity
component that you have addressed here, we believe there is a
real possibility that in terms of exposure, it would be
minimal, and the tax provisions we think we have--the idea is
to have a short window on this. Partly the idea of not setting
up a whole new operation is exactly the point you are making.
To go through that would be--we have an organization that knows
how to do this in a way, and we are giving it a window of time.
And you are right, we have resets coming. But if we can limit
this in time and sunset this whole thing so you are in that
window we are talking about on tax and we can avoid some of the
very issues. I just offer that as a thought. But we are asking
CBO to score it.
Senator Corker. Well, you are addressing the specific
legislative issues. You addressed one, and I think--I know my
time is up, and I know we are probably going to have another
round. But I will defer to Senator Menendez and come back and
follow back up.
Chairman Dodd. Bob.
Senator Menendez. Thank you, Mr. Chairman.
Mr. Secretary, a lot of questions have been raised here,
and I appreciate the definitions of where there is common
ground on the legislation and where there might be some
differences. But I think some overarching questions were raised
that we need to deal with as well, so let me go to the very
beginning of your opening statement.
You said, ``Yesterday, Americans paid their taxes. That
payment is a responsible action by each citizen, a necessary
duty to pay for the services provided by the Government. Our
citizens expect us to spend that money wisely, carefully,
judiciously. After all, it is their money. They don't want us
to use tax dollars to reward risky behavior or irresponsible
lending or to create moral hazard. We all have a duty to be
good fiscal stewards.'' And I cannot think of anyone on the
Committee who would disagree with you. But that should be
across a spectrum, should it not?
Mr. Montgomery. Absolutely.
Senator Menendez. So when we gave $29 billion to JPMorgan
to buy Bear Stearns, did we create a moral hazard?
Mr. Montgomery. Sir, that is a little out of my lane. I am
the Federal Housing Commissioner.
Senator Menendez. I understand that, but I think you have
some sense of it. I mean, we had the Chairman of the Federal
Reserve here, and I asked him questions about, well, what is
the liability to American taxpayers, couldn't define it for the
Committee. Twenty-nine billion dollars in record time.
Now, what message does that send to Wall Street about
responsible behavior? See, if we are going to have a standard,
which I think is an exemplary standard, then it has to be a
standard across the spectrum. It is very hard for American
homeowners--and, you know, I understand--Senator Shelby, whom I
have a great deal of respect for, raised a question. Who is a
victim? Who is an accomplice?
Well, let me ask you, gentlemen: In a score of 1 to 100,
with 100 being the best score, what would you say is the
average American's financial literacy score? Anyone want to
venture to give us a sense of it?
Mr. Montgomery. I would--rather than giving you an exact
score, I would say probably not very high, sadly.
Senator Menendez. Would you all agree that would be the
case?
Mr. Murton. I would agree.
Mr. Polakoff. Yes, sir, I would agree.
Senator Menendez. And that is one of our great challenges,
because the reality is, having practiced real estate law for a
fair amount of time before I came to the Congress, I have to
tell you that I had many hard-working people who I had to go to
great pains to describe what their mortgage commitment was and
what they were getting into, because they had absolutely no
sense whatsoever. And the reality is that they were trying to
reach for their dream, and they were trying to do it
responsibly.
And what I am saying here is, you know, the financial
literacy is something I hope the Committee will increasingly
pursue, Mr. Chairman, something I know I am personally
interested in and have some initiatives on. The reality is this
is a critical component because at the end of the day, whether
someone is a victim or an accomplice, you know, depends upon in
part what is their financial literacy. And I would venture to
say that a great number of people--I have read from my own case
files, individuals, including people who had standard mortgages
for a long period of time, and, in fact, were good credit
scores and had been responsible payers, and then were lured
because they were told, ``You are paying too much on your
fixed-rate mortgage. You can actually get this lower rate,''
and were told a whole series of things that led them to
believe, they thought responsibly that, in fact, making that
move made sense, and now they find themselves retired with
their income stream fixed, and in the process of losing a home
they otherwise would have kept just by continuing to pay their
conventional rate mortgage. And I have got a whole bunch of
stories like that.
So moral hazard, you know, I have a problem with $29
billion to JPMorgan for Bear Stearns where the Chairman of the
Federal Reserve cannot tell me what American taxpayers who paid
their taxes yesterday liability is, and yet we can say to our
millions of homeowners in this country that are going to affect
our economy, all of our economy, that we think that 3 percent
in the latest report from the Center for Responsible Lending
still has that the industry plan reaches only 3 percent of at-
risk homes. That means a 97-percent correction rate. Are we
willing to take a 97-percent correction rate in the
marketplace, not just for those millions of Americans who will
lose their homes but the consequence to the rest of us? That is
the essence here, Mr. Chairman, of how we look at the issue.
And I think it is very important how we look at the issue.
You know, why did we go ahead and do that for Bear
Stearns--or for JPMorgan to purchase Bear Stearns? Because
there was a general consensus that there is a consequence to
the broader economy if we did not, right? Isn't that basically
what was the argument? Well, there is a consequence to the
economy of what happens if we do not do something significant
about these mortgages?
So where is the difference between the moral dilemma, the
duty to be good stewards, and rewarding risky behavior? And, by
the way, where are the regulators who have the power to stop or
intercede in a whole host of these instruments that, in fact,
would not have brought us to the point we are? Where is their
responsibility? Where is the risky behavior, good fiscal
stewards standard for them?
So as we apply these standards that we want to say this
about homeowners whose, admittedly, financial literacy rate is
on the lower side, and say we go to rescue Bear Stearns, and we
say to the regulators, oh, well, we are the clean-up brigade
versus the preventers of what is happening, let's apply that
across the spectrum, and then I think it will be fair. But if
we are only going to apply that to the spectrum of those people
who made decisions that largely are victims, I have a real
problem with that.
Last, Mr. Chairman, I just want to ask one substantive
question in addition to making--because I think the broader
statement, if we are going to move forward on this, we have to
have the parameters of what is, you know, good for the goose is
good for the gander, so to speak here, and knowing what the
standards are that we are going to apply across the board.
But I want to ask you, Mr. Montgomery, I have heard reports
that the FHA is no longer accepting borrowers without a credit
score. Is that the case?
Mr. Montgomery. Well, FHA is about the only entity that
does not base a decision solely on the credit score. That has
been one of the hallmarks of FHA for generations.
Senator Menendez. Is that still your standard?
Mr. Montgomery. Yes, that still is.
Senator Menendez. So you are accepting individuals who do
not necessary have a credit score?
Mr. Montgomery. Yes. They are a very, very small portion of
our portfolio, less than 1 percent, probably.
Senator Menendez. Because there is a fair number of
borrowers who do not have a credit score, but who use payment
history such as rent, utilities, and other bills that are well
documented or solid, responsible payers that, in fact, can hit
a 620 score, FICO score, and are well within the FHA
parameters. Those people are not being eliminated at this
point?
Mr. Montgomery. No, sir. As a matter of fact, we support
the provision in the Senate bill that would--assuming it is
still in there on a pilot program going forward for non-
traditional----
Senator Menendez. Is the secondary market changing their
standards in that respect?
Mr. Montgomery. Well, a lot of the pricing from private
mortgage insurance companies, certainly from Fannie and
Freddie, we are seeing a lot of cutoff points on FICO scores,
absolutely, and certainly a repricing if not a retreat from the
higher LTV/lower FICO score market.
Senator Menendez. Well, we look to see what exactly is
happening there. You know, 22 percent of Latinos in this
country have no credit score whatsoever. But yet they, in fact,
have some great records of establishing due payments on time,
long periods of time that would give them access to an
opportunity to be considered. If we start eliminating that
without looking at the substance of their abilities to pay, we
are going to deny a whole host of people in the rush to now
respond to some of what has happened before.
So we have to be, you know, cautious, but at the same time
we do not want to just eliminate opportunities for people
across the spectrum who otherwise can be responsible lenders
and good payees.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Reed.
Senator Reed. Well, thank you, Mr. Chairman. And thank you,
gentlemen.
Mr. Montgomery, all these different proposals anticipate an
expanded role for the FHA and raise several issues, but two
major categories: first, financial capacity and, second,
managerial capacity.
With respect to financial capacity, it was reported
recently that for the first time in the 74-year history of FHA,
you might be running a deficit with respect to your portfolio.
Can you comment on that, how it would affect you going forward
or what steps you are taking to reverse that troubling trend?
Mr. Montgomery. And I have commented extensively on this
and met with a good bit of the staff that is sitting behind you
who have been very supportive in this. That is the irony here,
as FHA's volume continues to grow, that we continue to have a
drag on our solvency because of the proliferation of seller-
funded downpayment assistance. Six, 7 years ago, it was barely
5, 7 percent of our portfolio. It is as high as 33 percent
overall, and in some States--Texas--it is about 45 percent of
our FHA portfolio.
The IRS has put these organizations on notice that circular
financial arrangements, things of that nature, it is clearly an
inducement by all parties that you do not see in any other
501(c)(3). We could be the largest mortgage insurance entity in
the world, but as long as we have that large a percentage of
loans that use that sort of assistance--we are the only
customer, by the way--then we will continue to have the drag on
our financial solvency. And I have been sounding those alarms
now for some time.
Senator Reed. Now, let us talk about managerial capacity,
which is the resources, and many times, I suspect, you know, in
comparison to a major mortgage lender and insurance company,
your software, your hardware, your employee base is not as
robust as you would like it to be, I suspect. Can you comment
on that also?
Mr. Montgomery. You are absolutely correct, Senator. I
mean, we have made some improvements to our existing systems--
the average age of which, by the way, is about 18 years. And we
can handle it. But I will say going forward we need a long-term
fix to our information technology.
The good thing about HUD is we have a very, very
experienced and hard-working, dedicated career staff. But they
have been there many, many years, and a lot of them are
retiring. Just this year, I have to hire 400 people. That is
just to keep even to where I was last year. And it is a problem
we have been trying to address.
The good news is--I guess the bad news is while there have
been a lot of layoffs in this industry, we are getting a lot of
high-quality candidates.
Senator Reed. Right. I mean, one of the unfortunate
consequences of the economic climate and the meltdown of
several major mortgage entities is that there are very talented
people out there, unfortunately, that might be available. But I
think this goes to part of the effort of reform to reauthorize
FHA is that there has to be, I think, both the authorization of
resources to modernize your information systems, to make sure
you have appropriate staff, and also, I think, going back to
the point about the seller-financed downpayments, did you have
any discretion with respect to those products? Can you limit it
within your portfolio? Or the other question would be it grew
from 5 percent to 35 percent. Just in the general portfolio of
management, having an asset like that becomes so large so
quickly it would raise questions. Can you comment?
Mr. Montgomery. Well, it would certainly raise questions.
Obviously, we are bound by the Administrative Procedures Act.
That process, as you know, can be quite time-consuming. I will
briefly summarize here. We have put out a proposed rule. It
went out for public comment. We put out a rule that was going
to basically eliminate that sort of assistance. We were sued.
There are various movants and intervenors within those cases,
and the judge--it is the Eastern District Court of California,
the Federal District Court of Washington. Both ruled against
us. They enjoined us from implementing the rule.
I will say this: If you read both of those decisions, I do
not think the judges attacked us on the merits of the case, the
evidence of the case, but they certainly hit us on the
Administrative Procedures Act. And I will say this: They gave
us a good road map to get it right.
Senator Reed. OK.
Mr. Montgomery. It was not good enough for us to be 97
percent right in their mind. We have to be 100 percent right.
And we will continue to move forward.
Senator Reed. Thank you. Just let me raise another general
question or a comment for the panel. I was listening intently
to Senator Tester, who I think made a very profound point about
these types of arrangements where people could buy a home
without any money down. I had to buy a home, too, and, you
know, we put down money because one thing we wanted to do is
avoid paying mortgage insurance. So we put 20 percent down,
and, you know, fortunately, we had it. But the whole mortgage
insurance market is not there to help out now for some of these
defaults because of the second mortgages which are issued
simultaneously.
It suggests to me that a lot of this was--the people who
were writing not just the first mortgage, but also encouraging
the borrower to take a second mortgage for a 100-percent
financed house with zero down and also not looking carefully at
the income capacity of the borrower, I mean, it goes back to
the point the Chairman made. That seems to be mortgage
malpractice, writ large. And, you know, one of the issues that
struck me here is that, you know, a lot--in the old days, and I
will date myself, if you--you know, you had to put the money
down or you had to have mortgage insurance. If the mortgage
went bad, you know, you lost the house, but the financial
system recouped the mortgage.
Any comments in terms of this problem, or reactions? Mr.
Murton or Mr. Polakoff.
Mr. Murton. Well, perhaps it goes back to the point I think
you made earlier, Senator, that people believed housing prices
would always go up, and I think we got ourselves into that
mind-set starting with the low interest rates, and then
following that the unsustainable credit expansion.
Mr. Polakoff. Senator, I agree that there was much
irresponsible lending by mortgage companies and mortgage
brokers, and I do believe that there were some poor decisions
made by some borrowers who should have known better and were
taking advantage of the system as well.
Senator Reed. I mean, one of the things pointed out to me
is that, you know, if you have a stable income stream, getting
a second could be a financially shrewd move because you avoid
the monthly mortgage fees and mortgage payments, et cetera. But
in the case of so many of these borrowers, particularly the
subprime, where they did not have those assets, did not have
those income streams, and getting into a second and being--and
having someone underwriting that mortgage, that first mortgage,
knowing that there was no equity, was a serious, I think, lapse
of judgment.
But, Mr. Chairman, again, thank you for this hearing. I
have learned much. Thank you.
Chairman Dodd. Thank you very much, Senator.
Just picking up on Senator Reed's point, I think, you know,
what was the underlying thinking of people in all of this? And
one is a sense of optimism. I mean, you could say that they
should have had better judgment in some cases, but that sense
of optimism and confidence about their country, about
themselves, about their futures is a valuable and tangible
asset in all of this. And why are people doing this? Why were
they taking that second? And you go back and you realize what
tremendous economic pressure people have been under.
I cite these statistics, and when I do, every time I say
them I find myself questioning, and I go back and confirm them
again. Between 2000 and 2006, if you exclude supervisory jobs
in the country and speak only about 124 million Americans in
non-supervisory jobs, their wages went up $1.60 in 6 years--
$1.60. Not a year, not an hour. That was the total wage
increase for 124 million people. That is $200 million in wage
increases in that 6-year period of time. I might point out the
five investment banks gave bonuses of $35 billion in that same
6-year period, by the way. And so when people have that limited
income growth--and you are looking at energy, health, food,
other matters going up--this idea of taking that second
mortgage and doing--it was not out of greed. They are doing so
because they are trying to stay afloat. That is why there are
second family jobs, that third job, that fourth job. That is
why credit cards in many cases people are financing these
things. It is not just irresponsible behavior. It is people
trying to keep their families together in very difficult
economic times for a lot of them. And there are other things
they probably should not be doing. I am not trying to create
some image of a person who has been absolutely perfect, but the
motivations here are not just about greed. They are about
surviving in many cases. And they are about optimism, and it is
about confidence about their futures.
I think before we just decry all of this, we ought to
understand the framework and the understanding of what
motivated people in those moments to do what they did, the idea
of having a home, raising a family in a place you call your
own. I am a provider. I take care of my family. My wife and my
children would love to have their own house. And that has been
a strong emotion in our country from the founding days of this
republic. Today, we find ourselves at a lot of risk of all of
this.
So just this idea of indicting people out there because
they got themselves into bad deals, as we heard a minute ago,
we have had people talking them into this stuff. I mean, I
still go back--every time I look at that website of the brokers
that the first rule is, hold yourself out as the financial
advisor of the borrower. A complete lie, because you are being
paid based on yield spread premiums that reward you for how
high a rate you can convince that borrower to take. And when
you are looking across the table at someone who is a borrower
who believes this person is their advisor, you know, there
isn't exactly a level playing field in that sense, either.
Let me address, before I turn to Senator Corker, I know
Senator Corker has some questions, Bob asked some very good
questions. He asked about is there new legislation required
here, and I asked my staff to kind of do a quick run-down here
and let me share some thoughts we have on this and whether new
legislation is needed.
HUD is claiming--and Brian, you are correct on this--that
it will serve up to 500,000 people with the new expanded
FHASecure program. At least that is the number I have been
given. Is that right?
Mr. Montgomery. Yes. With this expanded FHASecure, by the
end of the calendar year----
Chairman Dodd. Right. OK. And I think Senator Corker raised
a very good point earlier, and I appreciate it, as well. I
mean, I don't know how we are going to do with this bill. I am
going to try and move this idea. But I know in the process, we
are also moving people probably to do some things they weren't
going to do in the absence of suggesting some ideas here, as
well. So to some extent, I guess I ought to be taking a degree
of satisfaction in that people are moving in a direction that I
am not sure they would have been moving in had we not been
proposing some of these ideas.
But the administration was very slow to acknowledge the
mortgage problem, as I mentioned at the outset of my remarks,
and I say this respectfully, but there was just a failure going
back more than a year ago. I might add, by the way, when I took
over the Chairmanship of this committee a year and 2 months ago
and my staff met with Federal Reserve Board staff, stunningly,
they told us, the staff, they were aware of this problem
emerging at that point, three-and-a-half years earlier.
And so when we talk about this problem popping up last
year, in fact, knowledgeable people claim they were beginning
to get concerned about this issue, broadly, some time before
then, and I just share that with you this morning.
Congressman Frank and I have been talking about a larger
scale and a more aggressive government program to assist home
owners since late January, and last week, April 9, the
administration announced its plan to expand FHASecure. We
welcome that. I am just pointing out, this was a year and a
month after we have been raising the issue. It is good to get
it, but if you won't mind me saying, I wish we had had a little
earlier reaction to all of this. And in short, by pushing the
Hope for Home Owners Act, I think we have been helping the
administration move in the right direction.
The Dodd bill expands the universe of eligible borrowers
beyond the recent expansion of FHASecure. It gives the
authority to FHA to raise fees beyond the current level, which
I think is a benefit. I appreciate your point, Brian, that the
levels are where they are, but we think by going a little
higher, we actually address some of the underlying questions
about taxpayer exposure and the like and making sure that
borrower is going to have some skin in this so that they are
going to get covered, as well. So giving HUD the authority to
charge more will allow it to expand the universe of eligible
borrowers.
In our discussions with servicers and lenders, there is a
strong sense that our program could be effective even for
borrowers who are more than 90 days delinquent. The HUD program
would not extend to those borrowers, which is a limitation. I
don't know if that requires new legislation or not, but that is
one of the things we are talking about.
Third, the legislation also creates a safe harbor for
servicers so they will be more willing to participate. That
requires legislation because that doesn't exist.
And fourth, our plan creates a board, as you have been
pointing out and talking about, that doesn't exist, obviously,
that includes Treasury, FDIC, as well as HUD, and we provide
for lending of staff from other Federal agencies to help
implement the program, one of the things we don't do enough
around here, because while this isn't the only universe to deal
with, we understand there are others that can come into this
process that could be helpful and we do that. I don't know
whether you need to do that by regulation or legislatively, but
it is one of the things we include legislatively to try and
cover some of those questions that I think you properly raise.
Do we need more authority under law to allow us to do some of
the things we are doing?
I have a lot of faith in FHA to be able to do this. I think
you run a great shop. I think you make a huge difference for
people. I think the modernization effort is going to be a major
step in the right direction. And I don't think you have to go
out and recreate some agency to do this. I have a lot of
confidence you and the wonderful staff you have can handle this
idea, and as long as CBO gives us a mark here we can work with,
then we may not even need to go through an appropriation
process.
So the last thing I want to do is go out and start some
whole new ballgame here in town that you never get rid of. The
old axiom in Washington was, you create something new, it never
goes away. And the last thing we want to do is create something
new that won't go away. So just to address a couple of those
questions.
With that, let me turn to Senator Corker.
Senator Corker. Well, thank you for those comments. I think
they are very helpful, and actually, I was confused, I guess,
at the end of my last questioning as to what did need to happen
to allow FHA to do what it has proposed through this Secure
program. My understanding is if we were to pass the FHA
Modernization Act, that that covers all the things that need to
occur to handle the portions that you have described, not the
additional portions Senator Dodd has described, is that
correct?
Mr. Montgomery. That is correct. But to go above the
premium structure, we would need--to do risk-based pricing, we
would need some----
Senator Corker. But we already have legislation that moved
a little ways and is now bogged down. But, in fact, if FHA
modernization passes, you have the frames you need to continue
on with this aggressive effort you have laid out?
Mr. Montgomery. By and large, yes.
Senator Corker. OK. So just to gain again more common
ground, I would like for you to address what our Chairman has
laid out regarding expanding the program in the means that he
has talked about and then give a little bit of an explanation
regarding this safe harbor component that he also has laid out
in his legislation.
Mr. Montgomery. I will just say that the safe harbor, we
can expand more on in writing. It is a little out of my area
and more to the gentleman to my left.
Again, going forward, I would just say, I think in concept
we agree. A lot of families are in the right house with the
wrong mortgage. There are some issues of predatory lending,
too, where there is no doubt a lot of people were steered
toward higher-cost loans. But trying to thread the needle,
there are some very good things in the Frank proposal, there
are some very good things in this proposal. I say personally
there are some very good things in our proposal. But just going
forward with the things the gentleman to my left had mentioned,
there are a lot of players. There are a lot of legs on the
stool and how can we make sure, whether it is a piggy-back loan
that the Senator over here discussed, there are a lot of
players here that can bollix the whole thing up, so to speak.
So going forward, we think doing the 90 percent LTV is good
with a subordinate lien, but it will do us no good if whoever
is holding the second on that piggy-back loan right now doesn't
want to go forward with it. And so that is why I think
extinguishing those loans with a mandatory write-down, I think
may limit the ability of this program to go forward.
Senator Corker. But that issue exists under the Dodd
proposal and your proposal, is that correct?
Mr. Montgomery. Well, in ours, we would allow--certainly
people could do write-offs today, by the way. I think the point
was made earlier, a lot of people are waiting to see where the
floor is. There is no mystery there are a lot of proposals
floating out there. But in our proposal, FHA would only insure
90 percent of whatever the appraised value is, so that 10
percent equity would be in the soft second with a note, due-on-
sale clause, something of that nature. Now, certainly the
lender could put all that in a soft second. Eventually, home
prices will go up. Again, I would just say we are trying to get
to the same thing here but just a little differently.
I would also say I think we need some rigid debt-to-income
ratios for underwriting. We don't want FHA to throw the baby
out with the bath water here. We need, I think, to insert some
fairly rigid debt-to-income ratios in there, as well.
Chairman Dodd. Can I bump just on this, because this piggy-
back loan issue, and I should have mentioned this earlier, sort
of make this more free-wheeling, is we required in the
legislation that that second lien be extinguished. That
requires a negotiation between the first lien holder and the
second to work that out, because it is not going to happen if
it doesn't. So there is no fancy I know of how to deal with
this other than require that before you can participate in the
program, if you want to, you have got to negotiate that out,
and----
Senator Corker. But that is on a voluntary basis.
Chairman Dodd. That is a voluntary basis, yes. Otherwise,
it can't work, obviously. You have got a huge problem there. So
the law says, in effect, resolve that before you step up. Now,
I realize there may be those who can't, so that is going to
strike out a certain number. But otherwise, it wouldn't work. I
don't know how you resolve the problem otherwise.
Senator Corker. Since we are in this free-wheeling mode,
the negative equity certificate notion does seem to do away
with the issue of moral hazard. In other words, the debt is
still there. It has no interest that is being borne on that
debt. But at any time in the future should the home sell, that
debt is repaid and so you do away with the moral hazard issue.
I would just be curious what your response to that is----
Chairman Dodd. I welcome that idea. I think that idea has
value. That is the carrot. I have got to get that investor to
come up to the plate here. Obviously, the borrower wants to be
here, although he is going to pay insurance, he is going to
have to share back. The question is, can I get those piggy-back
loans worked out. That is no small hurdle to get over, but let
us assume he can do that.
And then I have got to get that investor to do what
culturally they have never been inclined to do. It is almost a
cultural problem, in my view, and that is culturally,
experience has told you in the past, get him out of the house.
We do better under those circumstances than fooling around with
a delinquent mortgage holder, or payer, rather, in this case he
is. So there has got to be an incentive for that person to come
forward.
So I find that idea very appealing as a way of drawing in,
for less of a moral hazard reason than I am--if I don't get
people to participate, this is just a lot of paper----
Senator Corker. But it is also more streamlined in that you
basically keep the arrangement between the lenders and the home
owner instead of having a third party that is benefiting
somehow from the sale or the value down the road and then
figuring out who made it worth more. Was it things the
homeowner did? It seems like to me, it is just a more elegant
way of dealing with that particular cumbersome sort of problem
there.
Chairman Dodd. And I want to, again, I don't want to
overstate a case to you in how you work that out, but I like
the idea because some of that is involved. I will leave it
there.
Mr. Montgomery. I would just say, we allow that under
FHASecure, depending on whether they want to do a write-off,
because they know they will certainly take a larger hit if it
goes to foreclosure. But again, you couldn't put it on the part
of the soft second because the prices will go up and you will
make some of this moral hazard that they had this windfall, so
to speak.
Senator Corker. So I will summarize. I know Senator Carper
is here, too. But it seems to me that actually, there is
tremendous agreement here. In essence, it is a voluntary
program.
Chairman Dodd. Right.
Senator Corker. It is one that the lenders participate in
with their own desire. They have to work out things with the
second and third or fourth and fifth mortgage holders, as they
may be. They have to work it out with them.
Chairman Dodd. Right.
Senator Corker. What is----
Chairman Dodd. Owner-occupied.
Senator Corker. Owner-occupied. The fact is that it gets
the person in the home in a position, again, on a voluntary
basis by the lender, that allows them to actually make mortgage
payments, OK----
Chairman Dodd. They can afford.
Senator Corker. Ones that they can afford. There is no
moral hazard if, in fact, we adopt this principle because there
is a negative equity certificate, so the value of the home has
to come back up at least to where the indebtedness was before
there is any profit made by the home owner. And it just seems
to me there is a lot of mutuality that we somehow ought to
figure out a way to do, hopefully without legislation. I know
you are talking to your staff. This is the part I wanted you to
hear. Hopefully, without legislation. But it sounds like there
may be some tweaking someplace.
I would love for you all, if you would, at least to our
staff and hopefully everyone, get back with us on the two
issues, I guess, that Senator Dodd has brought up that I am not
sure that I still fully understand how we would deal with the
expansion piece and the safe harbor piece. But it seems to me
we have had 2 days of streamlined surgical-type approaches to
problems that really affect people.
Chairman Dodd. The bill hasn't changed in the last month.
Senator Corker. Well, I think the issue of sharing--I think
that sharing issue is a major, major--I think that is a major
issue, and I think bringing in a third party to be involved in
that is just something that is very troubling and very
cumbersome, just for what it is worth. But I think that laying
that marker out has caused other people to think about it in a
different way and I think all these things are good.
Chairman Dodd. Thank you very much.
Senator Carper.
Senator Carper. Thank you. On the issue of the negative
equity contract, or negative equity certificate, when I first
heard about it, I thought that this sounds like an elegant
solution. In fact, those were my words, too.
Let me just ask. Is there some precedent in the last decade
or two where something like a negative equity certificate was
used in another day and another way, maybe with the S&L crisis?
Is there a precedent for that so we can actually look back and
see how it was used and if it was to good effect or not? For
some reason, in the back of my mind, I am thinking that there
may have been a precedent for this that we can learn from.
Mr. Murton. Well, it may not be an exact analogy, but
certainly the FDIC and the RTC when they resolved failed
institutions and had to pay off the insured depositors and took
assets and we had people work those assets, we had arrangements
where on day one you didn't know the value of it, but if it
turned out that the properties we realized more value from, or
the person working it for us realized higher value, we shared
in that. So we have worked out a number of different sharing
arrangements when values are uncertain and they worked quite
well for us, I would say.
Senator Carper. OK.
Chairman Dodd. I might say, Tom, on the Bear Stearns-J.P.
Morgan Chase, I wish we had had some warrants coming back. We
did that with Chrysler.
Senator Carper. We did that with Chrysler.
Chairman Dodd. We didn't get anything out of that thing.
You talk about these certificates coming back, the people
putting a lot of skin in the game are the very people we are
worried about here right now. We have got virtually nothing
coming back on it except the hope. So I believe it will work
out, but very little protection.
Senator Carper. Yes. Mr. Polakoff.
Mr. Polakoff. Senator, if I could dive down to the weeds
for a moment without boring you----
Senator Carper. Go ahead. We will try to go with you.
Mr. Polakoff. The concept from an OTS perspective allows
the servicer in the securitization to literally write down the
amount of the loan to the negative equity aspect of it,
subordinated to the first, which would be an FHA-guaranteed
first. So while the term negative equity certificate has gained
a lot of traction, really what we are talking about is writing
down the principal to that amount and then subordinating it to
the first, making it non-interest bearing, changing the terms
so that the maturity would either align with the current terms
of the note or when the borrower sold the home.
Senator Carper. All right. I think I understood most of
that. Thank you. An elegant explanation.
I had an interesting conversation. The Chairman and I and
some of our colleagues were able to discuss issues of the
economy, some of the housing issues that were before us this
past weekend. One of the folks who was there with us was the
former, I think, Chief of President Clinton's Council of
Economic Advisors, Laura Tyson, and we talked a little bit
about the issue of how do we--the sharing, if you will, after a
second mortgage note, after a mortgage is reworked and you have
a foreclosure avoided and then you have an appreciation over a
period of time, to what extent does the borrower share in that
and to what extent would FHA. If FHA is involved, to what
extent would they share in it.
I think Chairman Frank has a proposal that would say the
first year, FHA, I think, would get 100 percent of the uptake,
and that would be phased out over 5 years until FHA would get
zero. I think I am on the right track here. I believe in
Chairman Dodd's mark that it is a little different take. Say
the first year, FHA would get maybe 100 percent, 90 percent the
second year, and then down to 50 percent, and for an indefinite
period of time beyond that, it would be split 50-50 between the
borrower and FHA. There are a variety of different proposals.
Ms. Tyson suggested to me--I guess it is Dr. Tyson
suggested that maybe a better approach, she said, you need more
than 5 years, and she was talking to Chairman Frank's idea. She
said, you need more than 5 years, maybe 10 years. So the first
year would be 100 percent FHA and then down and by the tenth
year be 10 percent FHA and then the home owner would realize
the entire amount.
But there are different ideas here. Which of these
approaches makes most sense to our panelists?
Mr. Polakoff. Well, I would offer that what makes most
sense is for the servicer in the securitization who is taking
the write-down, and in this case taking a write-down beyond the
current fair market value to 87 percent of the fair market
value, deserves the upside potential of a negative equity
certificate to be shared with the borrower. The borrower needs
to have an incentive to stay in the house, improve the house,
look to eventually, if he or she wishes, sell the house, and I
think we should at least discuss the benefits of some sort of
interest for the second lien holder to once again be willing to
subordinate their position.
Chairman Dodd. That is a very good point, by the way, and
one that Ben Bernanke has made, as well, in talking about that.
Senator Carper. OK. Good. Mr. Murton.
Mr. Murton. I think I agree that the negative equity
certificates help address some of the moral hazard problem, and
then I think the question is who do you share it with, the FHA
or the investor, and I think there are arguments on both sides
and maybe you can work out some arrangement where if the
government is taken care of, maybe then it goes to the
investor. There are lots of ways to structure things like that.
On the issue of 5 years versus 10 years, perhaps Dr. Tyson
was thinking that in the past, it has taken quite a while for
home values to recover and the longer horizon may add value to
that and that is a legitimate point.
Senator Carper. OK, thanks. Mr. Montgomery, a quick
comment?
Mr. Montgomery. Just real quickly. There is not a lot of
difference between the negative equity certificate and what we
are proposing and rolled out last week with FHASecure, just we
would put it in the form of a second subordinate lien. I just
want to make that valid point.
Also, I do want to say that on principal, we weren't a
party, FHA wasn't a party to the original transaction. I am not
so sure we should be sharing in equity, so to speak. If a
borrower today buys a home with FHA insurance and 10 years from
now they have a profit from it, we don't come back saying, hey,
we need a cut of that. That is why they pay premiums, up-front
premiums and annual premiums. I think we can accomplish the
same thing.
I think we all agree, yes, owner-occupied homes. We want to
keep that borrower in the home so they will realize some
profit. We just would maybe do a re-sell restriction, due on-
sale clause, something of that nature.
Senator Carper. All right. Just a closing thought on this,
Mr. Chairman. I am looking here at this glass of water. Some
people would look at this glass of water and say it is half-
empty. I think in terms of actually finding common ground and
moving legislation, the glass is half-full and I think we have
an obligation to work very hard to find the middle ground in
some of these areas. To the extent that some legislation is
needed to complement what FHA is doing on their own and others,
so be it. But I am encouraged.
Chairman Dodd. Senator Corker.
Senator Corker. Unless you need to go to lunch or
something, I will ask one more question. When I was mentioning
third party earlier, I really meant FHA playing a role in
equity sharing, which I think was just addressed. I don't think
that is an appropriate thing, but yet maybe having the interest
payments due to the second mortgage holders at some point down
in the future, maybe that does make sense, and I think we all
nod our head in that regard.
Getting back, though, to the debt forgiveness issue that I
brought up earlier, and I realize our first stimulus package
addressed that for a period of time, whether it is a second
mortgage, as was just laid out by Mr. Montgomery, or whether it
is a negative equity certificate, those do address the loan
forgiveness issues in different ways. I assume if it was second
mortgage, as you have laid out, there is no debt forgiveness,
and so that is not triggered. If it is a negative equity
certificate, I guess there would be a question, is that like a
financial instrument that is a lien and is there still debt or
not?
But I think that while we are all here and while you all
are all here, since something may happen soon, it would be
interesting again just to sort of revisit the issue of debt
forgiveness and how that ought to be addressed and I would love
to hear from all three of you.
Mr. Polakoff. Senator, I would say that under the negative
equity certificate, if the borrower sells the home for an
amount less than the negative equity certificate, then there
could very well be--there would be a portion of debt
forgiveness associated with that, yes, sir.
Senator Corker. And that would occur, like, way down the
road?
Mr. Polakoff. Potentially, but----
Senator Corker. And I am just wondering if that is
something we actually addressed appropriately, if you will, in
the first economic stimulus package. But that is something that
could happen 8 years from now, is that correct?
Mr. Polakoff. Yes, sir, though one would hope in 8 years
there is much home appreciation.
Senator Corker. Do you want to address that, Mr.
Montgomery? I mean, there are two different approaches. It
seems that yours, you never forgive the debt, is that correct?
Mr. Montgomery. Well, whoever the existing servicer and
lender is, I mean, there may be a charge-off going on. The home
is worth--there is a $120,000 mortgage and the home is only
worth $100,000. We insure 90 percent of it. They could put that
delta, all of it in the form of a soft second, recognizing that
prices ultimately go back up. They may decide going forward
with an agreement there is a charge-off of $20,000 of that
$120,000 and there is just 10 percent in----
Senator Corker. And again, that is a voluntary decision----
Mr. Montgomery. Yes, absolutely. So there are a lot of ways
to come at it. I mean, there are circumstances that will be
unique for a lot of borrowers. They will be unique regionally.
I think getting all the players involved to agree that they may
ultimately--the current lien holders get something out of this,
maybe the second lien holder is five cents on the dollar, I
think is probably all they are looking for, 10 percent, maybe
more. But we think going at it a little differently, I think we
seem to be moving in the right direction.
Senator Corker. Thank you very much.
Chairman Dodd. And that point, as well. I appreciate
Senator Carper raising the issue earlier. Again, obviously
getting the investor, but also you want that borrower to feel
not only they are getting their home, but that this is also--
that home represents a secure economic future, as well. And so
that incentive--and there will be those who may turn around and
say, look, you are far better if I just walk away from this
whole thing. So we want to make sure that we are incentivizing
that in ways that keeps both parties to the conclusion that it
is in your neighbor's interest and your interest and there is a
financial reward for taking on this responsibility, and also
from the investor side.
So striking that balance is probably never going to be
absolutely perfect, but you try to keep that in mind, as well,
as we go forward.
This has been very productive and very helpful, and great
witnesses. I appreciate it very much.
We are going to try and move at some point here, I just
say, on this. There is a sense of urgency about all of this.
And again, Senator Shelby had to move on to another hearing he
had to go to, and I appreciate his opening statement and
talking about the very legitimate questions which this
committee is raising at every aspect we can while
simultaneously trying to come up with some answers. So we are
going to continue to explore what happened. We have got some
legislation dealing with the practices that got us to this
point which have to be addressed. But if I had to prioritize
what our agenda ought to be, it is trying to step up and doing
something that hits the target and how do we short-circuit this
problem from getting worse. Obviously, it is important to make
sure we shut the door so it doesn't ever happen again, but if
you had to choose which of those two is deserving more of this
committee's time and attention, it is the first one. It is
dealing with the problem, and so we are going to try and deal
with that, also as well as focus on the other questions of how
we got into this mess and what steps we ought to be taking to
make sure we don't repeat it.
I thank everyone very much. The committee stands adjourned.
[Whereupon, at 12:18 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM BRIAN
MONTGOMERY
Q.1. There have been a variety of reports regarding the number
of loans made under the original FHA Secure program. That
program was designed to provide FHA-insured loans to borrowers
who became delinquent because of interest rate resets.
According to the press report I quoted in the hearing, HUD
officials have said that this program has insured only 1,500
loans. In fact, according to a HUD report on FHA activity,
``just 242'' loans were made for delinquent borrowers (the key
parameter of the original FHA Secure program) in the two-week
period of March 1 to March 15. Exactly how many loans have been
made to date that meet the original parameters of the
FHASecure?
A.1. As of May 13, 2008, there have been 3,068 endorsements of
loans to borrowers who became delinquent because of mortgage
resets and refinanced through FHASecure.
Q.2. In your testimony, you state that the FHASecure and HOPE
NOW initiatives have together helped more than 1.3 million
homeowners. Please provide the HOPE NOW data that breaks out
exactly how many borrowers are getting repayment plans and
modifications, and what kind of repayment plans and
modifications they are getting.
A.2. As of February, 27 servicers were part of the HOPE NOW
Alliance, representing more than 90 percent of all subprime
loans and a substantial percentage of all mortgage loans.
Results of the HOPE NOW Alliance include:
An estimated 1,035,000 homeowners were helped to
avoid foreclosure from July 2007 through January 2008. This
includes 758,000 formal repayment plans and 278,000
modifications. Subprime modifications increased from 19 percent
of total workouts in the 3rd quarter and 35 percent in the 4th
quarter to nearly 50 percent in January from 19% of total
workouts in the 3rd quarter of 2007.
Since November 2007, HOPE NOW servicers have sent
over one million outreach letters to at-risk borrowers who have
not previously been in contact with their servicer.
16 percent responded in November.
21 percent responded in December.
When servicers send similar letters to their
borrowers, the normal response rate is 2-3 percent.
Homeowner calls have increased to 5,000 per day
through the Homeownership Preservation Foundation's Homeowner's
HOPE Hotline. Over 37,000 counseling sessions were completed
through the Homeowner's HOPE Hotline in the 4th quarter of
2007. To date, the HOPE Hotline has received 456,243 calls,
which led to counseling for 165,755 homeowners. Nearly half of
those counseled have avoided foreclosure by working out new
loan terms or by selling their home.
Q.3. How many people do you expect the expanded FHASecure
program to serve? I have seen estimates that range between
100,000 and 500,000. Please provide the analysis that explains
how you reached your estimate.
A.3. Our estimate is 500,000 by December 31, 2008. The analysis
is based on True Standings data on the mortgage characteristics
of current and upcoming mortgage resets of nonprime loans.
Q.4. If I understand your new proposal, the FHASecure program
would allow subordinate liens to remain on the homes, leading
to combined loan-to-value ratios after the first mortgage is
written down and receives FHA insurance of 100% or more. Is
this correct? What kind of performance do you expect these
loans to exhibit? Please explain the basis for this analysis.
A.4. Allowance for the re-subordination of junior liens has
always been FHA policy on refinance loans. There have not been
any performance problems associated with that policy. What is
new here is to permit the holder of the original first-lien
mortgage to create a second-lien position from any excess
indebtedness, over what is permissible in a new, FHA-insured
first-lien. HUD's performance expectations start with
experience with re-performing loans in the FHA portfolio. They
are loans that were seriously delinquent (three or more months
delinquent) and received loss mitigation work-out assistance.
Some of that assistance involved creating second liens on the
borrowers' extended arrearages, after HUD brought the loan
current via a ``partial'' claim. HUD expects an 18 percent
ultimate claim rate on those re-performing loans, based upon
experience to date. Because of the uncertainty surrounding the
new loans that will be insured under the expansion of
FHASecure, the Administration has decided to score these loans
for budget purposes with a 24 percent ultimate claim rate
potential. That reflects uncertainties surrounding house price
and economic stability in the short run, which is tempered by
an expectation that borrower monthly payments will be lower
after they refinance--even with a bifurcated mortgage--than
they were on the original mortgage.