U.S. GOVERNMENT PRINTING OFFICE

71–506 PS WASHINGTON : 2001

THE FINANCIAL HEALTH OF THE FEDERAL

HOUSING ADMINISTRATION’S SINGLE FAMILY

MUTUAL MORTGAGE INSURANCE FUND

HEARING

BEFORE THE

SUBCOMMITTEE ON

HOUSING AND COMMUNITY OPPORTUNITY

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

MARCH 20, 2001

Printed for the use of the Committee on Financial Services

Serial No. 107–6

(

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: (202) 512–1800 Fax: (202) 512–2550

Mail: Stop SSOP, Washington DC 20402–0001
(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

SUBCOMMITTEE ON HOUSING AND COMMUNITY OPPORTUNITY

MARGE ROUKEMA, New Jersey, Chair

MARK GREEN, Wisconsin, Vice Chairman

DOUG BEREUTER, Nebraska

SPENCER BACHUS, Alabama

PETER T. KING, New York

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

BOB RILEY, Alabama

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR, New York

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

BARNEY FRANK, Massachusetts

NYDIA M. VELA ́ ZQUEZ, New York

JULIA CARSON, Indiana

BARBARA LEE, California

JANICE D. SCHAKOWSKY, Illinois

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

MAXINE WATERS, California

BERNARD SANDERS, Vermont

MELVIN L. WATT, North Carolina

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York
(III)

C O N T E N T S

Page

Hearing held on:

March 20, 2001 ................................................................................................. 1

Appendix:

March 20, 2001 ................................................................................................. 29

WITNESSES

TUESDAY, MARCH 20, 2001

Gaffney, Hon. Susan, Inspector General, Department of Housing and Urban

Development ......................................................................................................... 11

McCool, Thomas J., Managing Director, Financial Markets and Community

Investment, U.S. General Accounting Office ..................................................... 8

Phaup, Marvin, Deputy Assistant Director for Microeconomic and Financial

Studies, Congressional Budget Office ................................................................. 13

APPENDIX

Prepared statements:

Roukema, Hon. Marge ...................................................................................... 30

Oxley, Hon. Michael G. .................................................................................... 39

LaFalce, Hon. John J. ...................................................................................... 33

Sanders, Hon. Bernard ..................................................................................... 40

Gaffney, Hon. Susan ......................................................................................... 73

McCool, Thomas J. ........................................................................................... 42

Phaup, Marvin .................................................................................................. 87

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Gaffney, Hon. Susan:

Written response to questions from Hon. Marge Roukema .......................... 80

McCool, Thomas J.:

Written response to questions from Hon. John J. LaFalce ........................... 71

Written response to questions from Hon. Marge Roukema .......................... 63

Phaup, Marvin:

Written response to questions from Hon. John J. LaFalce ........................... 94

Written response to questions from Hon. Marge Roukema .......................... 95

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THE FINANCIAL HEALTH OF THE FEDERAL

HOUSING ADMINISTRATION’S SINGLE FAMILY

MUTUAL MORTGAGE INSURANCE FUND

TUESDAY, MARCH 20, 2001

U.S. HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON HOUSING AND COMMUNITY OPPORTUNITY,

COMMITTEE ON FINANCIAL SERVICES,

Washington, DC.

The subcommittee met, pursuant to call, at 2:05 p.m., in room

2128, Rayburn House Office Building, Hon. Marge Roukema,

[chair of the subcommittee], presiding.

Present: Chair Roukema; Representatives Green, Bereuter,

Kelly, Cantor, Grucci, Rogers, Tiberi, Frank, Carson, S. Jones of

Ohio, Waters, Sanders and Watt.

Chairwoman ROUKEMA. Good afternoon. We will call this hearing

to order. And we do appreciate everyone who is here today. I am

Congresswoman Marge Roukema, the Chair of the subcommittee.

And, of course, we have Mr. Frank, the Ranking Member, here.

I guess I have to say to our panelists that I hope you don’t take

it personally that there are relatively few people here. It was unfortunate that in scheduling this as far ahead as we had to schedule

it, we did not realize that this would not be a voting session until

late this afternoon, and unfortunately, many Members are still en

route back to Washington today.

That does not mean, however, that our membership is not interested in this subject, and I am sure that there is considerable staff

attention being brought to it. And I certainly, and I am sure Mr.

Frank will be doing the same, will be informing our Members of

the importance and getting to them the record of this hearing, particularly since we are using it to build a foundation on which to

handle a number of other important housing issues this year.

So, again, don’t take it personally. We shall be certain that your

very essential and relevant information is passed on to all the subcommittee Members and certainly to the staff as we deal with

them.

As you probably recognize, this is the first hearing of the Housing Subcommittee in this 107th Congress, and I am pleased to be

the new Chair of the subcommittee. And as many of you know, or

you may remember, I am not a stranger to housing issues, having

served as the Ranking Member of the subcommittee from 1987 to

1994.

However, given the dynamic changes over the last 6 years, particularly related, for example, to the economy, whether it is a bull-
2

ish economy or a bearish economy, and the demographic population

shifts, and certainly the evolution of financial markets through innovation and technology and of course the legislation that we

passed, Gramm-Leach-Bliley last year, there appeared to be a lot

of developing issues confronting the Congress, and certainly we will

give them all a fresh look.

But I guess I must refer back to an old saying in this context and

acknowledge that saying. Quote: ‘‘The more things change, the

more they remain the same.’’ So we will see how that applies to

our housing issues.

Having said that, I look back on July 27th, 1993 at a subcommittee hearing where FHA Commissioner Nicholas Retsinas—

have I pronounced that correctly? I hope so—Retsinas testified that

the 2 percent capital ratio targets mandated by the statute: ‘‘Are

arbitrary to some extent since no one can define with precision

what constitutes a completely sound and healthy fund.’’

Mr. Retsinas’ statement sparked an almost decade-long debate

on this very issue as to whether or not the 2 percent capital ratio

requirements are adequate for the Mutual Mortgage Insurance

Fund and to protect it from financial collapse.

Today’s hearing, in which we are going to address this subject,

is entitled ‘‘The Financial Health of the Federal Housing Administration’s Mutual Mortgage Insurance Fund.’’ And it was certainly

prompted in part by the statement from Mr. Retsinas almost 8

years ago.

And in 1998, as a consequence of those continuing questions, it

was requested that we have a GAO study. And the February 28th

GAO report is a product of 2 years of work, and I am certain it

will, or at least I fully expect, that it will resolve some questions.

But at the same time, it may raise others regarding the simple

issue of how to measure and adequately protect the FHA Mutual

Mortgage Insurance Fund from adverse economic conditions.

And of course we have heard the reports of this past week, although I haven’t yet heard what Chairman Greenspan is announcing today. And I hope no one let us walk in here today if that announcement is being made. I understand that it will probably be

sometime mid-afternoon.

Anyway, this hearing is going to focus, regardless of what Greenspan’s action is or whether we are bullish or bearish, this hearing

is going to focus on essential elements of the questions that are before us.

The HUD Inspector General’s FHA financial audit for the year

2000, we are going to examine that. And there will be an examination of the explanation and review by the Congressional Budget Office of the Fund as it relates to its estimated economic value and

what that means to the Mutual Mortgage Fund.

While there may be some who have a different perspective or

perhaps disagree with these witnesses who are before us and their

findings, these are the Federal agencies most knowledgeable of the

intricate accounting and actuarial analyses necessary to assess the

viability of the FHA program.

However—and I want to stress this for all who are here—however, as the subcommittee moves forward on specific issues, there
3

will be an opportunity to hear other experts who may present a different point of view from today’s panel.

Questions most likely to be raised in this Congress, for example,

are whether the fund is healthy enough to absorb home ownership

programs tailored to municipal employees and/or teachers; should

the FHA provide premium refunds to those borrowers who paid too

much?

Another question: should the premium structure be risk-based?

Is the FHA encroaching—and this is a question that comes up

from time to time—is the FHA encroaching on the private sector

and its ability to provide low cost mortgage insurance for potential

borrowers historically left out of the traditional lending market?

That is an essential question.

Ultimately I believe that this debate will also turn on whether

or not the Mutual Mortgage Insurance Fund should sustain or contribute to proposed housing production programs.

While we can all agree that there is some extent a housing affordability or availability problem, we are far less certain on the solution to those problems or what the available tools may be of a

public policy nature.

I am planning to begin a series of hearings addressing those specific topics. The first hearing is scheduled for April 5th. By the

way, again, let me repeat what I said at the beginning. This panel

is laying the foundation for future consideration of a whole range

of issues.

But anyway, the first hearing is scheduled for April 5th and will

focus on two panels. The first panel will be academic experts who

have researched this issue and can help define the problem of affordability and/or availability.

The second panel will consist of local practitioners who are providing affordable housing.

Today we do know, however, that the financial soundness of the

Mutual Mortgage Insurance Fund is crucial to the FHA single-family program, the cornerstone of our country’s single-family mortgage market.

I am hopeful that this hearing will provide a foundation for future hearings on legislative remedies such as:

1. The GAO’s recommendation for Congress to specify the economic conditions under which the FHA Mutual Mortgage Fund is

expected to be actuarially sound;

2. The impact of new programs and initiatives on the soundness

of the Fund; and/or

3. The impact of rebates to borrowers who pre-pay their mortgages, also known as distributive shares.

These are among other issues that may arise.

I am certain that my colleagues will agree that we begin the

process today of improving a great home ownership program that

will advance the pursuit of the American Dream. And I don’t think

that we have abandoned or neglected nor should we neglect that

fundamental promise of our age, and that is, the American Dream

of home ownership.

And with that, I will yield to Mr. Frank, the Ranking Member.

[The prepared statement of Hon. Marge Roukema can be found

on page 30 in the appendix.]
4

Mr. FRANK. Thank you, Madam Chairwoman. And I appreciate

your calling this hearing, because it is a very useful one.

There is a terrible housing crisis in this country. Increasingly, it

is both a social and an economic problem. In many parts of the

country, the voucher program, which has been the major form of

housing assistance for the past number of years, is rendered ineffective, as the Chair herself noted in her original memo, because

the price of rental housing in so many markets has simply gone beyond what the Federal Government is prepared to support.

And indeed, in areas of very tight supply, the voucher program

is flawed on good conservative economic principles. It adds to the

demand for housing in a way that is guaranteed to have no positive

impact on supply. And the result is inevitably price increase.

It is worth supporting in the absence of an alternative, because

it provides some equity. But it clearly has an upward price movement.

So we have got to find ways to increase the supply of affordable

housing. And the FHA Fund clearly is one such potential source.

Now there are two issues here: How it is scored and how in fact

we decide to deal with it. The scoring is an important piece of the

action, but accounting does not dictate policy. Accounting should be

accurate. Accounting should give people an accurate discussion of

what policy is.

But, we in the Congress have a policy decision to make. There

does now appear to be in the Fund more money than can reasonably be expected to be needed, and it is a growing surplus. The

question is, what do we do with that growing surplus?

I believe that it makes sense to use some of it to deal with this

affordable housing crisis. What we have is the Federal Government

as an entity making some money off the FHA, more even than had

been anticipated by many. And it is entirely reasonable to look to

this housing crisis and try to deal with it.

Now I did note that according to what we were told by the scorekeepers that some use of these funds within the FHA could be done

without it being a charge against the surplus.

For example, we had a very successful program years ago, and

I think we did more through the Federal Government to create

home ownership in the economic levels where we don’t easily get

it through these programs.

It was selling off part of the inventory that the Federal Government took over from bank failures, both savings and loan failures

through the RTC and bank failures through the FDIC, and for lowend housing, we sold it off, not to the highest bidder, but to people

who met income qualifications, and it became home ownership.

If I read correctly some of the material I was given, if the FHA

were to decide at Congressional direction to take some part of the

inventory of recovered houses and put some of that into a program

whereby low-income people, people who were below a certain

level—80 percent of median is often the number we have used to

subsidize housing—if they were allowed to get that housing at a

less than highest bidder price, that that would not be a scoring

problem.

Now I would be interested in further comments on that. But if

that is the case, there is a way for us to get to what is a commonly
5

subscribed goal around here—home ownership for low-income people—using some of these FHA funds in a way that does not implicate the surplus.

That doesn’t mean that we shouldn’t do other things as well. But

we have a surplus being generated, and we have a terrible affording housing crisis, and I think it is incumbent on the Housing Subcommittee to see, as the Chair referred to in her remarks, how

these two could fit together.

Now obviously as part of that, I would also be interested in the

disaster scenarios and how likely people think they are. And obviously, a disaster scenario would mean that you couldn’t touch it.

But I would think that at the very least, the disaster scenario

we are told could endanger the FHA mortgage fund, would have an

even more important impact. It would probably make it unreasonable by anybody’s standards to enact the President’s tax cut.

So if we are in fact to govern on the basis of the worst case scenario, it is not just potential uses of the FHA surplus that would

be at risk. I think some elements of the President’s tax cut would

be at risk. And I think we can prudently dismiss some of the more

extreme possibilities of disaster. People were asked to tell us what

they are.

But I believe if we can show that in all likelihood we are going

to have a significant surplus continuing, that it is then our responsibility as the entity in this Congress charged with dealing with

our growing housing crisis to try and put that to the best use.

Thank you, Madam Chairwoman.

Chairwoman ROUKEMA. All right. Thank you.

Now I will say to the other Members of the subcommittee that

we are open for opening statements from you.

We will first have one, if Mr. Green, the Vice Chairman of the

subcommittee, has an opening statement. But for all Members, I

want you to know that the opening statements are restricted to 3

minutes by the rules of the Committee.

Mr. Green.

Mr. GREEN. No.

Chairwoman ROUKEMA. All right. Are there any opening statements on the other side of the aisle? All right.

Mr. Sanders.

Mr. SANDERS. Thank you, Madam Chairwoman, and thank you

for holding what is in fact a very important hearing.

I would hope that this subcommittee starts off all of its work

with the premise that we have a major housing crisis in this country and that this subcommittee is going to do its best to address

it. Certainly that is the case in the State of Vermont where we

have many, many people who are paying 50 or 60 percent of limited income for their housing.

It seems to me that one way that we can begin approaching this

crisis is to use a portion of the FHA and Ginnie Mae surplus to increase affordable housing in this country by creating an affordable

housing trust fund. And I will be introducing legislation soon, and

I hope Members of the subcommittee will join me in co-sponsoring

that legislation.

I think as you know, Madam Chairwoman, according to Deloitte

& Touche, FHA profits are expected to exceed $26 billion over the
6

next 7 years. Yet apparently the Congressional Budget Office has

testified today that Congress cannot use this funding to increase

affordable housing in this country, and I would like to ask why not.

Over recent years, Congress has said that money that is put into

the highway trust fund can only be used for highways. Money that

is put into the Social Security trust fund can only be used for Social Security. Money in the airway trust fund can be used for aviation needs. But when it comes to the FHA surplus, we are apparently being told that this money must be put back into the Treasury.

I think the time has come for Congress to, at the very least, put

a portion of the FHA profits into an affordable housing trust fund

to be used only for the purposes of increasing affordable housing

opportunities for the American people.

And I thank the Chair.

Chairwoman ROUKEMA. I thank Mr. Sanders.

Mr. FRANK. Madam Chairwoman?

Chairwoman ROUKEMA. Yes?

Mr. FRANK. Can I get unanimous consent to put into the record

the statement of the Ranking Member of the Full Committee, Mr.

LaFalce?

Chairwoman ROUKEMA. Without objection, so ordered.

[The prepared statement of Hon. John LaFalce can be found on

page 33 in the appendix.]

Chairwoman ROUKEMA. Are there any other opening statements?

Yes, Ms. Kelly. You are restricted to 3 minutes for an opening

statement. Thank you.

Ms. KELLY. Thank you, Madam Chairwoman. I thank both you

and Ranking Member Frank for holding the hearing today on the

Mutual Mortgage Insurance Fund.

I think that the FHA has been charged with a mission to assist

families of lesser means to realize the American Dream of home

ownership, and that is a noble mission.

By accomplishing this through the programs that allow families

to put less money down when they purchase their home, that is an

important way we get these people into the mainstream. And because of that low downpayment, the program carries a higher risk

to the Government.

I think the FHA has highly laudable goals that require the Government assistance to realize, and because of this, the program enjoys really broad bipartisan support.

I hope that we will continue to have that broad bipartisan support. But we also do need to monitor the safety and soundness of

the programs, and I do thank you, Madam Chairwoman, for having

this hearing today.

I think this issue is a very important one, and I look forward to

discussing with the witnesses whether there is, in fact, any real

surpluses here that can be used for other programs, as my colleague suggested.

I think obviously we all want to make sure that HUD is doing

everything it can to provide safe and clean, affordable housing to

people who have lesser means. But I think we also have to ensure

that we are not increasing the risk to the American taxpayers that

these high risk programs already entail.
7

So I thank you very much, and I yield back the balance of my

time.

Chairwoman ROUKEMA. All right. I thank you. Yes? Is there another opening statement? Yes, Congresswoman?

Ms. CARSON. Yes. I, too, appreciate very much the conveners of

this very vital discussion today with respect to the Federal Housing

Administration Mortgage Insurance Fund of the Department of

Housing and Urban Development. I am probably one of the few

people to sit on this panel who received FHA mortgage insurance

when I bought my first house. So I am very sensitive to the value

of having FHA there as an instrument to ensure that people in low

income status with families have an opportunity to embark upon

home ownership.

To date, I guess the FHA has insured mortgage loans for over 30

million American families and currently insures around one million

new mortgage loans each year with a total principal of around $100

billion, for which I am very proud.

FHA’s portfolio of insured loans, as I understand it, now stands at $480 billion, with $6.7 million outstanding loans. I understand

that FHA’s financial health is always called into question, and that

it is measured by the FHA Fund.

According to the General Accounting Office, the Fund’s balance

is sufficient to withstand moderately severe economic conditions

based on historical conditions, and even more severe economic scenarios would have to be accommodated in the event that that occurs. So I would simply echo what my dear friend from Vermont,

colleague from Vermont has pointed up. That we don’t need to use

any of FHA’s funds for anything other than for the intent of FHA

resources.

It is a good program. It should be maintained. And I did have

some concerns about what happened in Baltimore when some 1,400

persons went into foreclosure when they were insured by FHA, and

whether or not there has been any experience from that situation

that can be used in the future to counteract similar circumstances.

So thank you very much, Madam Chair, and I yield back the balance.

Chairwoman ROUKEMA. Thank you, Ms. Carson. I appreciate

that. Other opening statements on either side?

All right. With that, I would have hoped that Mr. Frank would

be back by this time. And if not—I don’t want to kill any time. Is

he coming? Is he on his way? All right.

Just for the record, 2 or 3 minute opening statement, Ms. Jones.

Thank you.

Ms. JONES. Thank you, Madam Chairwoman. I am pleased to

have an opportunity to be here to discuss the Federal Housing Administration. I am a sophomore in the Congress, and I serve as the

Chair of the Housing Committee for the Congressional Black Caucus in Housing, a very important issue as we come on the 107th

Congress, and I look forward to the opportunity to hear from each

of the presenters that are here today and to make inquiry as well.

Thank you very much, Madam Chairwoman. See, I am a good

filler for you.

Chairwoman ROUKEMA. Thank you very much. That is very cooperative. And with that, I would make that note that without objec-
8

tion, all Members’ opening statements will be made part of the

record.

Now I will turn to our panel now and note for them, I will introduce each one of you individually, but I would like to note for the

panel that your full written statements will be made part of the

record.

However, in the interest of time and recognizing that we have a

lot to do this afternoon with many Members who are interested in

asking questions, that you will be recognized for 5 minutes to summarize your testimony, but that the full statement of your testimony will be part of the record.

So I will recognize first Mr. Thomas J. McCool, who is presently

Managing Director of Financial Markets and Community Investment of the General Accounting Office, the GAO. We are very

pleased to have you here today with your testimony regarding the

Mutual Mortgage Insurance Fund and the balance of that and the

economic conditions that we are currently facing.

I introduce Mr. McCool, and we look forward to your testimony,

because it is central to what the future holds for us in this subject.

Thank you. Mr. McCool.

STATEMENT OF THOMAS J. McCOOL, MANAGING DIRECTOR,

FINANCIAL MARKETS AND COMMUNITY INVESTMENT, GENERAL ACCOUNTING OFFICE

Mr. MCCOOL. Thank you, Madam Chairwoman and Members of

the subcommittee. We are pleased to be here today to discuss the

results of our analysis of the financial health of the Mutual Mortgage Insurance Fund of the Department of Housing and Urban Development’s Federal Housing Administration.

Through the Fund, FHA operates a single family insurance program that helps millions of Americans buy homes, particularly lowincome families and first-time home buyers.

In fiscal year 1990, the Fund was estimated to have a negative

economic value and its future was in doubt. Congress enacted legislation that required the Secretary of HUD to take steps to achieve

a capital ratio of 2 percent by November 2000 and to maintain or

exceed that ratio at all times thereafter.

As a result of these reforms, the Fund must not only meet the

capital ratio requirements, it must also achieve actuarial soundness. That is, the Fund must contain sufficient reserves and funding to cover estimated future losses resulting from the payment of

claims on foreclosed mortgages and administrative costs.

However, the legislation does not define actuarial soundness.

The 1990 reforms require that an independent contractor conduct

an annual actuarial review of the fund. These reviews have shown

that during the 1990s, the estimated economic value of the fund,

its capital resources plus the net present value of future cash flows,

grew substantially.

As you can see from the figure to your left, by the end of the fiscal year 1995, the Fund attained an estimated economic value that

slightly exceeded the amount required for a 2 percent capital ratio.

On that graph, the gray area represents 2 percent of the

unamortized insurance-in-force. The white area represents the ac-
9

tual economic value. As you can see, after 1995, the economic value

is greater than 2 percent for all years.

In fact, this past year, for fiscal year 2000, Deloitte & Touche es- timated the economic value of the Fund to be about $17 billion,

which was 3.51 percent of the Fund’s insurance-in-force.

You asked us to estimate the economic value of the Fund and

also to determine the extent to which a 2 percent capital ratio

would allow the Fund to withstand worse-than-expected loan performance.

I am going to talk first a little bit about our measure of the value

of the Fund, which is actually quite comparable to Deloitte & Touche, so I won’t spend too much time on that, and then move onto

the potential stressors that we put the Fund through, at least in

a theoretical sense.

The economic value of the Fund consists of current capital resources and the net present value of future cash flows. Investments

in non-marketable Treasury securities represent the largest component of FHA’s current capital resources.

Estimating the net present value of future cash flows is a complex actuarial exercise that requires extensive professional judgment. Cash flows into the Fund from premiums and the sale of

foreclosed properties, as you can see again in the diagram to your

left. Cash flows out of the Fund to pay claims on foreclosed mortgages, premium refunds, and administrative expenses. We estimate that the Fund had an economic value of about $15.8

billion at the end of fiscal year 1999. This estimate implies a capital ratio of 3.2 percent of the unamortized insurance-in-force.

Although we did not evaluate the quality of Deloitte’s estimates,

which were prepared using a different method of analysis, we believe that our results and Deloitte’s are comparable because of the

uncertainty inherent in forecasting and the professional judgment

made in this type of analysis.

Much of the difference seems to be a result of performing the

analyses at different times. Deloitte had to do its analysis a little

earlier, before the fiscal year was over, and therefore had to estimate the capital resources, and Deloitte admits that it probably

overestimated the 1999 number by about $1 billion.

The Fund’s economic value principally reflects the large amount

of capital resources that the Fund has accrued. These capital resources are the result of previous cash flows which reflect the

robustness of the economy.

The estimated value of future cash flows also contributed to the

strength of the Fund at the end of fiscal 1999. Many of the loans

in the current portfolio were insured in recent years under conditions of low interest rates and a robust economy.

As a result, our models predict low levels of foreclosure and prepayment and that cash flowing into the Fund for mortgages already in the portfolio will be more than sufficient to cover the cash

outflows associated with these loans.

Now this again is all under certain assumptions about the economic future, that is the expected economic future.

However, to provide a framework within which actuarial soundness can be assessed, we need to move beyond estimates of the capital ratio under expected economic conditions. We believe that to
10

determine actuarial soundness, one should measure the Fund’s

ability to withstand worse-than-expected conditions, although how

much worse is a more difficult judgment.

We generated economic scenarios that were based on economic

events in the last 25 years, and other scenarios that could lead to

worse-than-expected loan performance in the future.

Most of the scenarios we looked at had only a small impact on

the capital ratio. For example, the worst historical scenario we tested, one based on the 1981-82 national recession, lowered the capital ratio by less than 4⁄10 of a percentage point, that is from about

3.2 to about 2.8, about 20 percent of the required 2 percent capital

ratio.

To see how the economic value of the Fund would change as the

extent of adversity increased, we extended regional scenarios based

on historical economic downturns experienced in three States to the

Nation as a whole. In two of these cases, the estimated capital

ratio was about 1 percentage point lower than in the base case,

which again was 3.2 percent.

However, our models estimated that extending the New England

downturn to the country as a whole would reduce the capital ratio

by almost 2.4 percentage points; again, this means from 3.2 to

about .8.

In another scenario in which we specify that interest rates fall

substantially, inducing refinancing, and a substantial recession

sets in that leads to increased foreclosures, the estimated capital

ratio also fell substantially, by over 1.8 percentage points.

Now in our economic scenarios, we didn’t always generate foreclosure rates that were as high as those that were actually experienced in the 1980s. So in one of our exercises, we actually imposed

historical foreclosure rates from the 1986 to 1990 timeframe on the

years 2000 through 2004. And again, historical foreclosure rates at

that level would reduce the capital ratio by over 2 percentage

points.

Chairwoman ROUKEMA. Mr. McCool, can you summarize your

testimony?

Mr. MCCOOL. Sure. I’m sorry. I’m just getting to the end here.

Chairwoman ROUKEMA. You’ve gone through 5 minutes, but this

is very important, so I’m going to be a little liberal with the time

commitment to you.

Mr. MCCOOL. That’s OK. I’m sorry I’m taking so long. I guess the

two final points that I’d like to make with respect to our results

are, first of all, while we think our models make good use of historical experience, there are some limitations that people need to be

aware of.

In particular, a lot of the portfolio, the current FHA portfolio, is

composed of fairly recent loans, and we have very little experience

with those loans, and so we don’t know how they’re going to perform in the future.

The second point is that there are changes that are being undertaken by the FHA program that could have effects on, again, the

performance of the portfolio, but they’re fairly recent changes, and

again, we don’t know how they’re going to affect the portfolio.
11

Also, we are not estimating the effect of new loans, that is to say,

loans made after the end of fiscal year 1999, which again will affect

the portfolio in the future.

And then the last point I’d like to make is simply that whether

actions should be taken to change the value of the Fund depends

on whether the Fund’s capital resources and expected revenues exceed the amount needed to meet its expected cash outflows under

designated stressful conditions, that is, whether the Fund is actuarially sound. Because we believe that actuarial soundness depends

on a variety of factors that could vary over time, setting a minimum or target capital ratio will not guarantee the Fund will be

actuarially sound over time.

We believe that to evaluate the actuarial soundness of the Fund,

one or more scenarios that the Fund is to withstand would need

to be specified. Then it would be appropriate to calculate the economic value of the Fund or the capital ratio under the scenarios.

As a result, we believe the Congress may wish to consider taking

action to specify criteria for determining when the Fund is actuarially sound. More specifically, Congress may want to consider defining the type of economic conditions under which the Mutual Mortgage Insurance Fund would be expected to meet its commitments

without borrowing from the Treasury.

Madam Chairwoman, this concludes my statement. I would be

pleased to answer any questions.

[The prepared statement of Thomas J. McCool can be found on

page 43 in the appendix.]

Chairwoman ROUKEMA. I thank you. I’m sure there will be a

number of questions. You have given a full menu of analyses there,

and I thank you.

Now we have Ms. Susan Gaffney, Inspector General of the U.S.

Department of Housing and Urban Development. Welcome, Ms.

Gaffney. You’ve been here before, and we appreciate your attendance today.

STATEMENT OF HON. SUSAN GAFFNEY, INSPECTOR GENERAL,

U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Ms. GAFFNEY. Thank you, Madam Chairwoman. As I’ve pointed

out in my written statement, we in the HUD OIG are not actuaries. And so my testimony is going to be a little to the side. It’s

going to be based on our audit and investigative work in the HUD

OIG.

Whatever the forecasts and assumptions are, I think we can all

say that the MMI Fund is in terrific shape relative to where it has

been.

What I want to talk to you about today is, please, don’t let that

disguise some of the problems that exist in the MMI. I would say

that Single Family has been our major preoccupation over the last

2 or 3 years in terms of audits and investigations.

We now have—these won’t sound like big numbers to you, but

they are big numbers for us—more than 250 criminal investigations ongoing involving more than 2,000 single family loans. And

what we are finding is that we cannot keep up with the number

of cases that keep coming to us.
12

Fraud seems to be growing in the Single Family Program. You’ve

heard about this. I’m telling you our numbers are small here, but

as we increase staff, we increase the cases.

What happens is that the people who are being victimized by this

kind of fraud are often the people that we’re trying to help with

the FHA program. And the other thing you see with this fraud, and

it was alluded to before, is that it tends to be concentrated in certain cities in certain neighborhoods.

So, you have seen the stories about Baltimore, where there is a

big problem, and Harlem, where we had 203(K) fraud really destroying major communities.

We have done a lot of audit work on the Single Family Program.

You can’t stop all fraud. Someone will always find a way to commit

fraud. But we believe that there are internal controls in the program that need to be tightened up to prevent it and to protect the

people we’re trying to help with FHA-insured mortgages.

If you look at the FHA financial audit that was just prepared by

KPMG and just issued by our office, what you see is that FHA has

been making progress. They’ve done a lot of good things, but they

still have some big problems.

To summarize that, they got an unqualified opinion, but they

have a material weakness in their information systems. They have

three other reportable conditions, which are other serious internal

control weaknesses. But, on the other hand, since last year, they’ve

corrected four other reportable conditions.

What I would like you to focus on, if not now, then in one of your

future hearings, is that there are two basic problems in FHA that

persist as shown in the financial audit. One is they have information systems that are 10 to 20 years old. They are locally based.

They are not integrated. It is very difficult to run a program of this

magnitude involving this amount of money without up-to-date information systems.

FHA has a plan to bring their information systems up to speed

by 2005. But if you look at the progress that has been made to

date, I think you would have to question that goal.

The second issue in FHA is personnel. In Single Family, their

personnel have been cut by half. But more than that, FHA Single

Family is big business. This isn’t like processing widgets. This is

big business. We need people who know the business, who are paid

so that we can attract them, and we need to know that we have

the right number of people.

The trouble is, neither FHA nor HUD knows right now how

many people they need.

So, I would ask you, as you consider FHA and MMI, to keep in

mind that FHA needs some flexibility. They need some flexibility

to solve their problems, to get their information systems up to

speed, to hire the right kind of people, to train them right, get

them on board. And with those attributes, I am convinced that we

can overcome the problems that the OIG audits and investigations

keep finding.

[The prepared statement of Hon. Susan Gaffney can be found on

page 73 in the appendix.]

Chairwoman ROUKEMA. Thank you, Ms. Gaffney. I appreciate

that testimony.
13

And now the final panelist is Mr. Marvin Phaup, Deputy Assistant Director for Microeconomic and Financial Studies, the Congressional Budget Office. We welcome you.

STATEMENT OF MARVIN PHAUP, DEPUTY ASSISTANT DIRECTOR FOR MICROECONOMIC AND FINANCIAL STUDIES, CONGRESSIONAL BUDGET OFFICE

Mr. PHAUP. Thank you, Madam Chairwoman. I am pleased to

participate in today’s hearing on the FHA’s Mutual Mortgage Insurance Fund.

Chairwoman ROUKEMA. Excuse me. Could you move the mike up

closer? We are not able to hear you.

Mr. PHAUP. I’m pleased to participate in this hearing.

Chairwoman ROUKEMA. That’s much better.

Mr. PHAUP. Your letter of invitation asked CBO to address a fairly narrow question. The question was, does the MMIF have a surplus that can be spent on meeting new housing needs? The answer

to that question is no.

Under current rules governing the budget process, rules to which

the Congress has at least tacitly agreed, it is absolutely clear that

MMIF balances do not constitute new budgetary resources available for new spending.

The rule that there are no free lunches applies fully here, because accumulations of premiums in excess of the required minimum are available under current law only for paying insurance

claims.

If the Congress decides to spend money to meet new housing

needs, it should do so independently of the estimated net position

of the MMIF. But, of course, if the Congress takes such action, this

would probably have a cost and reduce the budget surplus.

Fund balances do not constitute authority to enter into any new

obligations, not even for new guarantees. Appropriation action is

required before FHA can issue new commitments. Through the

budget process, the Congress approves the making of new FHA

loan guarantees by setting an annual limit on the loan volume. In

2001, that limit is $160 billion.

But it is that process and not the existence of any estimated net

balance in the Fund that provides the resources for FHA to make

new loan guarantees.

I would close my brief statement by making three additional observations. The first is that the MMIF provides policymakers with

information, not budgetary resources. Even though the MMIF is

not a source of funding for new housing needs, it can be a useful

accounting device. And accounting itself is not everything. As Mr.

Frank said, at best, it can only inform policy decisions.

The second point I would make is that these estimates of the economic value, or net position, of the MMIF provide policymakers

with information about the performance of these programs in terms

of an important objective; namely, that program costs under some

reasonable long-term economic scenarios will be covered by premiums. That is useful and important information.

The third thing I would say is that even though these long-term

estimates of Fund balances are uncertain and move around a lot—

you have heard much about re-estimates and estimates of the Fund
14

balances—and even though they’re not a source of new budgetary

resources, for a variety of good management and good policy reasons, they’re well worth making and monitoring carefully.

So while my answer to the narrow question is negative, but

based on the rules under which the Congress operates, I want to

emphasize that the FHA actuarial reviews have important program

and policy value nonetheless.

That concludes my statement.

[The prepared statement of Marvin Phaup can be found on page

87 in the appendix.]

Chairwoman ROUKEMA. All right. I thank you very much. I’ll tell

you, you’ve given us a lot to think about here and a lot of detail.

I will ask one or two questions, and I’m not sure, but that your testimony didn’t give me a full answer. But if it did, I didn’t hear it.

And I’m going to begin with Mr. McCool.

You did talk extensively about the actuarial soundness and the

questions of the reserve ratios. But may I ask the question this

way. Do you believe that Congress should take action? Is there an

action required here for Congress in terms of whether or not the

existing system meets your recommendations as to what should be

done with various types of economic conditions? You postulated a

few different circumstances. But I wasn’t quite sure as to whether

or not you absolutely agreed that the existing system is adequate,

or does Congress need to require a ratio that would cover catastrophic conditions that might be projected out there?

Mr. MCCOOL. Well, I think the answer is that 2 percent, as I

think everyone knows, is a fairly arbitrary number.

Chairwoman ROUKEMA. Yes. That is what we are trying to get

at here.

Mr. MCCOOL. Two percent could be actuarially sufficient under

certain circumstances, and it may not be sufficient under others,

both in terms of the composition of the portfolio and also with respect to, again, the risks that Congress is trying to ensure against.

Our recommendation is that Congress think about setting forth

some actuarial soundness criteria. What sort of scenarios the Congress wants the FHA Fund to be able to withstand, I think, is what

we’re asking for.

Just as an example, it’s not necessarily the perfect example. But

in the 1992 Act that set up OFHEO, the regulator of Fannie Mae

and Freddie Mac, Congress did set forth, maybe some would say,

a very specific set of scenarios that were to be the basis for a capital ratio for Fannie Mae and Freddie Mac. Again, it may have

been overly specific in some people’s mind or maybe not specific

enough. But it certainly is much more of a rigorous actuarial safety

and soundness standard, rather than just say 2 percent or put in

some number.

So I think what we’re looking for is something that sets forth a

little bit more criteria about what you mean by actuarial soundness

for the Fund.

Chairwoman ROUKEMA. What do you mean by actuarial soundness for the Fund?

Mr. MCCOOL. Well, again, we don’t know whether you want the

Fund to be able to protect against the Great Depression or to protect against a moderate downturn or a small downturn.
15

Chairwoman ROUKEMA. I see.

Mr. MCCOOL. You have to protect the taxpayers’ money. You

have to decide what the Fund should be—how big it should be to

protect that and what the risks are you are concerned about.

Chairwoman ROUKEMA. So there is a lot of discretion here and

a lot of—all right. All right. We will look over that again in some

detail.

Ms. Gaffney, I do have question for you. And I am not quite sure

whether—I don’t think you were explicit in your testimony. If so,

I kind of missed it. But you made inferences. In the context of the

fraud that you talked about, I am not quite sure how you account

for this increasing fraud.

But it raised in my mind the question is HUD contracting out

too much of its oversight responsibilities to private companies? Is

that what you were inferring here, or does that have no relationship to the increasing fraud questions that you are talking about?

And how that relates to the internal controls that you have existing

now.

Ms. GAFFNEY. I don’t think there is a right answer to how much

you contract out, but it’s clear that you shouldn’t contract out from

weakness. I think what all of us have learned is that when you

contract work out, you had better have people on your own staff

who know that work better than the contractors do—so they can

monitor and hold the contractors accountable.

I think what has happened sometimes in HUD is, because of the

downsizing of the staff, that we have contracted out without having

that component of in-house staff truly able to monitor and hold the

contractors accountable.

Chairwoman ROUKEMA. All right. You have alluded to the second

question that I had in mind. That was the question as to whether

or not we have provided adequate—have enough full time, qualified

employees to provide that lender oversight, adequate lender oversight. And you are indicating maybe we don’t.

Ms. GAFFNEY. We believe from what we have seen that FHA does

not have sufficient trained staff to provide adequate lender oversight. The problem, though, is that neither HUD, nor have we,

done a tight analysis to know what that right staffing level should

be.

I understand, though, that something may be in the works now

to do that. It is really very important.

Chairwoman ROUKEMA. Or maybe we should be giving more attention to how we select those private companies and what criteria

they have to meet.

Ms. GAFFNEY. That is also true.

Chairwoman ROUKEMA. Yes. All right. Thank you.

Mr. Frank.

Mr. FRANK. I want to begin by expressing my appreciation for

General Gaffney’s acknowledgement that sometimes we can cut too

far, and that this notion that less Government is always better and

that staff who are pejoratively called bureaucracy, can always be

cut and that you can have the private sector make it up.

I mean, I appreciate your pointing out the fallacy of that kind

of thinking. And I agree that we have cut the HUD staff too far,

and we then wind up blaming HUD, because having cut the staff
16

too far, we have an agency that is not able to fully carry out its

responsibilities.

I also do have to note that with all the problems, it does appear

that with the concerns we had about the FHA, that the previous

Administration did leave it in pretty good shape, and now the question is, how do we preserve and build on that?

And we have gotten some negative economic scenarios here

about, you know, what it would take to cause this fund to go negative. So, Mr. Phaup, I would be interested, CBO is in the business

of doing economic projections. According to CBO’s economic projections, how likely are we to see the disaster scenario in the economy

that would wipe out this fund?

Mr. PHAUP. Well, Mr. Frank, it is very unusual for us to predict

cyclical downturns. Our long-term budget projections almost always show some trend rate of growth, even for forecasts that look

1 and 2 years ahead. I can’t remember the last time that we predicted a recession that we weren’t already in.

Mr. FRANK. Is this some inherent institutional optimism that we

have here? What is this?

Mr. PHAUP. I think it is a matter of professional intellectual limitation. That it’s just very difficult.

Mr. FRANK. I’m reminded of our late colleague, former colleague,

Jake Pickle’s question, and maybe I would reform it: ‘‘Is Rosy Scenario the highest ranking woman at the CBO?’’ Mr. PHAUP. I’m not sure our scenarios are rosy with respect to

where we end up in the long run.

Mr. FRANK. All right. Well, now that you’ve discounted the CBO

forecasting, let me repeat my question.

Mr. PHAUP. All right.

Mr. FRANK. Given the inherent optimistic bias to which, for the

first time in my experience, CBO has now confessed, what in CBO’s

projections is the likelihood of the kind of disaster scenario that

would wipe out this Fund?

Mr. PHAUP. As far as I know, we do not have any projections that

would be sufficiently severe to do so.

Mr. FRANK. OK. In CBO’s range, I know we’ve all seen that

range of projections.

Mr. PHAUP. Or distribution projections.

Mr. FRANK. And even at the low end of CBO’s projections, you

would not see this Fund—— Mr. PHAUP. I could not say that. We generally focus on the midpoint.

Mr. FRANK. You’ve seen the projection. Let me say, I would be

interested at the low end of the projections whether you think

that’s like that. But you think it’s very unlikely, according to your

projections?

Mr. PHAUP. Certainly the ones that we base our baseline projections on, yes.

Mr. FRANK. All right. I appreciate that. And I think this. If you

look at this Fund and you look at the way things are going, not

only is it unlikely that we would have the kind of level of disaster

that would wipe us out, but if we were to legislate the FHA Fund

on that basis, it would be the only element in the Federal Government where we legislated on that basis.
17

That is, the extremely pessimistic assumptions that it would take

to see this being wiped out would be applied only for the purposes

of dealing with that.

Let me ask through the GAO to Mr. McCool, you’ve given on

page 18 some of the historical periods, but they were regional, sectional. Has there been in recent times—or let me put it this way.

When was the last time the economy was at the point overall

which would represent a scenario that would wipe out the Fund?

Mr. MCCOOL. That would wipe out the Fund? I’m not sure that

in the postwar period it has occurred.

Mr. FRANK. It’s never happened since the postwar period?

Mr. MCCOOL. No.

Mr. FRANK. Thank you. That reassures me that we can now

think about how to spend it. So let me now go back to Mr. Phaup

and the CBO. Nobody is projecting it. It has never happened, so I’ll

let somebody else worry about it.

If we were in fact to do some adjustment of prices within the

FHA’s inventory, is it possible to do that without triggering a scoring and and so forth?

Mr. PHAUP. My answer would be that if the Congress directed a

particular action, it would be scorable. If the Secretary took some

action under existing authority, it would not be a scorable act; we

would just adjust our baseline for it.

Mr. FRANK. What if Congress—you said if we directed it, it’s

scorable, and if it’s done under existing authority, it’s not scorable.

What if we changed existing authority to empower, but not direct

the Secretary?

Mr. PHAUP. We have some budget analysts here. They say they

would like to read the legislation before they offered an opinion.

[Laughter.]

Mr. FRANK. Oh, well, see, you want to read the legislation before

you decide whether to score it, and we want to read the opinion before we write the legislation.

[Laughter.]

Mr. PHAUP. I understand that.

Mr. FRANK. So we may get into it.

Thank you, Madam Chairwoman.

Chairwoman ROUKEMA. Isn’t that, giving that kind of discretion,

isn’t that—that’s rearranging all the chairs on the Titanic, isn’t it?

No?

Mr. FRANK. But we’re not on the Titanic, as we’ve just seen.

Chairwoman ROUKEMA. I’d like to ask the OMB Director that,

please. Is it?

Mr. FRANK. You’d better summon him, then, because he’s not

here.

Chairwoman ROUKEMA. I’m sorry. I’m sorry. You know who I’m

talking about. CBO. CBO. I’m sorry. I meant CBO.

Mr. PHAUP. Under existing law, the Secretary has the authority

to take certain actions that, as Mr. McCool can testify more fully,

would affect the net position of the fund, including actions such as

changing the premium, which he did in January of this year. And

he also can take action to resume the distributive shares program,

if he takes into account four or five statutorily imposed criteria

first.
18

So these possibilities are already a part of existing law.

Chairwoman ROUKEMA. All right. We will have to think about

that.

Mr. Green, please, the Vice Chairman.

Mr. GREEN. Thank you, Madam Chairwoman.

Ms. Gaffney, in your testimony you made reference to the increasing use of foreclosure avoidance techniques. I’m intrigued by

that. Can you tell me what those techniques include?

Ms. GAFFNEY. Well, the simplest, most straightforward one is the

lender would call the borrower and try to see what the problem is,

see whether there is a short-term fix, some kind of short-term hiatus in payments; whether there is a longer term fix, such as extending the term of the mortgage or counseling about how to budget funds in order to pay the mortgage, that kind of reaching out.

Mr. GREEN. So very much what is done in the private sector with

conventional lenders?

Ms. GAFFNEY. Exactly. That is what the Federal Government is

trying to emulate, yes.

Mr. GREEN. Can you tell me why it is that those techniques or

the use of them appear to be a recent occurrence with FHA?

Ms. GAFFNEY. I don’t know, but that is very much the case that

when we looked at this 2 years ago. FHA was really just starting.

We’re going to be looking at them again. But I’ll ask a colleague,

if you don’t mind.

Mr. GREEN. Sure.

Ms. GAFFNEY. Oh, the assignment program.

Chairwoman ROUKEMA. Excuse me. Could you speak into the

microphone, please?

Ms. GAFFNEY. Sorry. I should have known the answer to that

one. You’ll remember the assignment program under which defaulted loans were assigned to HUD, and then HUD kept them forever and ever and ever, and it created a huge problem, and then

the Congress finally stopped the assignment program.

It was at that time that we started loss prevention.

Mr. GREEN. OK. Is that also why FHA has had a much higher

foreclosure rate over the years than some of its private sector counterparts?

Ms. GAFFNEY. That’s one possibility. But FHA is trying to fill a

niche in the market that the private sector doesn’t. And I think all

the statistics show that FHA is meeting that need.

It’s the higher loan-to-value ratios, it’s targeting minority borrowers, it’s targeting portions of cities where other lenders fear to

go.

Mr. GREEN. I’m sure that may have some effect, but obviously

there are housing authorities around the Nation that serve those

sectors of the market very well and don’t have a higher foreclosure

rate. So I mean I think it’s a little bit dangerous to say that just

because you’re serving that sector of the market that you’re necessarily going to have a higher foreclosure rate.

Ms. GAFFNEY. No, absolutely. I didn’t mean to imply that. I

meant that HUD is—HUD/FHA—is willing to accept somewhat

lower standards in order to offer mortgage insurance to these

groups of people, particularly first-time homeowners.

Mr. GREEN. Thank you.
19

Mr. McCool, I guess I’m going to try to get at the same issues

or conditions that the previous questioners have had.

We’ve heard reference to something between the Great Depression and a moderate downturn in the economy. Given that breadth

there, is there anything you can do to help us learn more about

what kind of conditions the Fund at its current level could in fact

withstand?

Mr. MCCOOL. Well, again, within the scenarios that we played

out, the Fund, at least at 3.2 percent, was able to withstand the

shocks.

Now again, remember that a lot of what that results from is the

fact that we’re starting from a very good starting place. And so

we’re introducing shocks that are shocks of 4 or 5 years.

And what happened in the 1980s that actually caused the Fund

to become negative in 1990 was a series and a sequence of shocks

that also were played out in an economy that wasn’t in the same

situation to start with. It was an economy with very high interest

rates in the early 1980s, a national recession followed by some regional shocks.

So none of the individual shocks we introduced starting from

where we are was able to deplete the Fund. But again, that doesn’t

mean that a sequence of shocks, starting from a slightly different

place, couldn’t deplete the Fund.

Mr. GREEN. Could you help me a little bit?

Mr. MCCOOL. I’m sorry.

Mr. GREEN. Define a little bit more what a ‘‘shock’’ is.

Mr. MCCOOL. Well, again, in our scenarios, or in this case it’s effectively a substantial downturn in the economy, and in particular

one that generates falling housing prices and higher unemployment, and, as a result, leads to higher foreclosures for the FHA.

Mr. GREEN. OK. Madam Chairwoman, that’s it for my questions.

Chairwoman ROUKEMA. I thank the Vice Chairwoman.

Congresswoman Waters.

Ms. WATERS. Thank you very much, Madam Chairwoman. Most

of the questions have been raised I think. Most of us are interested

in knowing how we can take this good information about a surplus

and turn it into housing opportunities for the people who are in

such desperate need.

I’ve heard it described recently as a housing crisis out there in

America where we have people who are living four and five families

to one residence. We have people who have been waiting in line for

housing. We have underfunded Section 8, on and on and on.

So while we are very conscious that we must comply with the

law relative to the use of the surplus, we are looking for options

that can take us to the kind of outcomes that we are desirous of

having in order to deal with this crisis.

So I’m just wondering if I can hear some positive speculation

about how can we do this. I know we may have uncertain outcomes, but as you think about this, you think about the good and

you think about the bad. I want to hear what thoughts you may

have about what we can do to use this opportunity to increase

housing for people who are in desperate need. Anybody?

Mr. PHAUP. Well, Ms. Waters, I think my message is so limited

that I’m not sure it’s going to be responsive. But what I would say,
20

based on this statement, is simply that given these needs that you

describe, the right surplus to think about doing something with is

not the surplus in the MMIF but the on-budget surplus.

In other words, it’s the whole budget surplus that’s the right

number to look at in terms of what you want, what policy actions

you may want to take, rather than these balances in this Fund.

That’s a very narrow answer, but that’s the best I can do.

Ms. WATERS. What would you suggest, if the surpluses continue

to grow in this Fund, what would you suggest we do? Just watch

it grow and grow and grow? I mean, what would you suggest?

Mr. PHAUP. Well, I think that the 1990 Act actually envisioned

some downward adjustments. Perhaps one of the others here would

disagree, but it seems to me that the 1990 Act envisioned the use

of distributive shares as a way of keeping the balance from building up—the use of lower premiums to prevent the balance from

building up—and I think those actions are already authorized for

the Secretary.

Ms. WATERS. Well, it appears from my reading that we have

taken some of those actions, and we still have a growing surplus.

Are there any other thoughts about how we can utilize this for the

good of the consumers out there? For people—what else can we do?

Even if you do it on the front end.

For example, I’m listening to Ms. Gaffney talk about the fraud

and talk about people who are being qualified for loans who are not

able perhaps to pay back, some of those descriptions here.

But what we have learned about creative thinking in this area

is you can do no downpayments. As I understand it, there is nothing that has proven that people who make downpayments pay their

mortgages any better than people who perhaps would not make

any downpayments.

We are talking about, as you described, the processes that are

being used to try and keep people out of foreclosure. And you say

in your report that you are not sure it is working, that maybe it

may extend the length of time, but the foreclosure takes place anyway. What can we do with these funds on the front end to help people early who come in under special arrangements? What can we

do to help them avoid foreclosure, not waiting until they get in

trouble?

I mean, are there ways that we can assist first-time home buyers

and others so that we can do a better job that we are doing today

with this?

Ms. GAFFNEY. Ms. Waters, the answer to that is, absolutely, you

know that there are a number of things we can do.

I really lack expertise in what Marvin is talking about, which is

the legality of how you can use these funds. But, I always thought

that the Congress enacted laws, revised laws, and assuming that

the President signed those laws, that that’s what governed how we

operate.

Ms. WATERS. You are not incorrect. We look to those of you

who——

Chairwoman ROUKEMA. Excuse me. Will you conclude your question now? You’re long over your 5 minutes, Congresswoman.

Ms. WATERS. All right. Then I’ll yield back.

Chairwoman ROUKEMA. No, no. Just finish your last statement.
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Ms. WATERS. OK. We look to those of you who have some responsibility in these areas to help us understand as best we can what

is happening out there so we can try and fix it, we can try and promote ways by which to be more effective, all of that. So that is why

we inquire of you and query you in such ways so that we can gain

information about what we can do to be helpful to the American

citizens.

And when I said that I was looking for some discussion on positive incomes, I am very serious about that, because we want to

know how to be cost effective and effective period in helping consumers and people who want homes and loans and mortgages.

Ms. GAFFNEY. Right. I am restrained—those are all policy decisions, and I’m not supposed to be involved in policymaking decisions.

Obviously, everyone knows there is a crisis in affordable housing.

In my limited world of audits and investigations, there is a need

to help people from being the victims of fraud. And people really

are being victimized.

Ms. WATERS. We can use the surplus to do some of that.

Ms. GAFFNEY. Yes.

Ms. WATERS. All right. Thank you.

Chairwoman ROUKEMA. All right. Thank you.

Excuse me. May I just make the point for all Members that if

anyone has additional questions that you haven’t had time for,

aside from maybe a second round here, you may submit those questions to the panelists in writing for their response.

Congressman Bereuter, please.

Mr. BEREUTER. Thank you, Madam Chairwoman. Between trying

to do some things on the House floor and attending a hearing, this

has not been most successful day at a hearing. So I’m sorry I didn’t

hear all the testimony.

I’ve been trying to read some of the written material provided to

us. I’m wondering if I could cut through to what seems to me to

be a basic question, Mr. Phaup, if I could address you.

With respect to the Fund’s estimated economic value and the insurance-in-force, we’re at 3.66 in the 1999 economic value. That is

well over the requirement. And I am looking at the headline items

in the GAO report provided to us and seeing that the 2 percent

capital ratio appears sufficient to withstand some worse-than-expected loan performance.

What is ‘‘worse than expected’’? What kind of an economic downturn would give us something that would still say the 2 percent

capital ratio is sufficient? For example, are we talking about something more severe than the period between 1983 and 1985? Or how

steep an economic downturn would we have to have to find that 2

percent was not adequate? Can you help me with that, Mr. Phaup?

Mr. PHAUP. Mr. Bereuter, I am usually not reluctant to answer

questions, but I believe Mr. McCool should speak to that. Those are

his model simulations.

Mr. MCCOOL. Again, I think that when we put our models

through individual historical stresses, because of where we’re starting from, they did not generate the defaults and foreclosures that

we actually experienced in the mid-1980s. So part of it is a slight

disconnect.
22

If we look at the actual foreclosure rates that we experienced in

the 1980s, those rates can bring the Fund down, according to our

estimate, by more than 2 percent.

Mr. BEREUTER. Brings it down by more than 2 percent?

Mr. MCCOOL. By more than 2 percent. It would bring it down

from 3.2 to .9 in our scenario where we expose the Fund to the

same foreclosure rates that we experienced, the economy experienced in the 1986 to 1990 timeframe.

Again, that is just one scenario. It is not necessarily the right

scenario or the best scenario, but it is one scenario.

Mr. BEREUTER. Let me proceed to the next step. And maybe it

is you, Mr. Phaup, that ought to get this question. Maybe it is Mr.

McCool. I know that, Mr. Phaup, you’re not in a position where you

can give us policy recommendations.

But is there any out-of-the-box thinking about how we can bring

down the ratio and still provide adequate protection by a change

in legislation or some other mechanism that will enable us to bring

down those resources and to use them for other purposes and still

have a failsafe kind of approach in case we have a very severe economic downturn?

Have you done a survey which suggests that there is thinking

out there which gives us any kind of alternative to the current system that we have in place by statute?

Mr. PHAUP. We have not. I would like to pass on offering an answer to that.

Mr. BEREUTER. I think that Ms. Gaffney is not the person to answer this, unless she just happens to have run into something. But

Mr. McCool?

Mr. MCCOOL. Again, I think that our view is that it’s up to the

Congress to decide what minimum ratio it wants, what target ratio

it wants and then, again, what it wants to do with anything that

it feels is—I won’t say left over. That’s not the right way to think

about. But again, there is no right answer for minimums. There is

no right answer for targets. It depends on the riskiness of the portfolio.

Mr. BEREUTER. Well, we could set a different target if we understood that there was a different system that could be checked in

when we run into a really severe economic downturn. And I am

wondering if you can give us any guidance as to what people might

think as an alternative to relying strictly on the current statutory

mechanism we have in place.

Mr. MCCOOL. Well, again, our view is you should try to set the

Fund at a level that will protect you from a downturn that you

fear.

Mr. BEREUTER. That is almost a waste of resources in the meantime.

Mr. MCCOOL. Well, I understand that. But the problem is that

once things start to turn down, then it’s hard to build up the resources. That’s the reason why you, in a sense, prefund these systems.

I understand that that’s not necessarily the easiest way to think

about it. But part of the problem is that when things do start to

turn sour, it’s hard to build up funds.
23

Mr. BEREUTER. Madam Chairwoman, I hope we might look at

some less conventional approaches as a failsafe on this. I don’t

know what they might be, but surely someone must have thoughts

about this subject.

It seems to me this is a waste of resources to keep an excessive

amount here during all this period of time and yet in the possibility

that we’re going to have a very severe economic downturn.

Chairwoman ROUKEMA. Yes. There are pros and cons to that.

Mr. BEREUTER. And I yield back.

Chairwoman ROUKEMA. And I guess underlying all of it is what

someone said earlier on, and that is, there are no free lunches. But

we have to make some sound fiscal judgments about these things.

Mr. FRANK. If the gentleman would yield.

Chairwoman ROUKEMA. This hearing today opens up a whole

number of questions which we will take up in subsequent—I don’t

know whether or not you were here earlier. I know you were here

initially, but when I made the statement that this will be the foundation for probably a series of hearings maybe from others in the

field who have different perspectives.

So we’ll look to you to work with you on that.

Mr. BEREUTER. I did hear that, and that’s a good basis. If I had

time, I would yield to the gentleman.

Mr. FRANK. I think we’re well beyond it not being any free lunch.

At this point, we’re buying lunch for about 2077, and we’re putting

the money aside. And I think we’re not talking about free lunch,

we’re talking about, or alternatively, the most expensive lunch I

ever saw, or we’re assuming the price will go up.

But I think it’s not a case of a free lunch. I think the gentleman

from Nebraska is right. We’ve put aside far more money than by

any rational justification we’ve heard seems necessary.

Chairwoman ROUKEMA. Well, the question is, what do you do

with insurance policies? How broadly or how in-depth do you need

insurance policies?

We’ll go on now to our Congresswoman Jones here who is waiting patiently.

Ms. JONES. Thank you, Madam Chairwoman.

My first question goes to Ms. Gaffney. I was in my Congressional

district last week where I attended an event where a community

development corporation participated in the grant program to take

over HUD housing that had been in the community kind of standing on its own—not standing on its own—but was dilapidated, and

accepted a grant to be responsible for the oversight of rebuilding

and remodeling these homes.

And I want you to know, it was such a wonderful feeling to see

a woman, a single woman with five children, excited that she had

a chance to have a home of her own.

And the other thing that made it so good for me, it was in the

neighborhood that I live, but I also grew up in, but to walk into

this home. It was a five bedroom home in a low-, middle-income

neighborhood.

But the woodwork was mahogany. The third floor was wood slated from the floor to the ceiling with windows all around. I said a

lot of people would love to be able to get in these neighborhoods

and get these homes.
24

But my point is that your conversation about loans, trying to

work on loan mitigation with foreclosure—before it got to foreclosure—excuse me. Wouldn’t it make sense that we spend some of

these dollars on programs that educate people about what it means

to buy a home and how their credit will be spent and perhaps reduce the cost of high risk mortgages down the line?

Ms. GAFFNEY. I’m going to get myself in big trouble if I say how

these funds should be used.

Ms. JONES. I’m asking you a question so when you go back, tell

them I asked you the question so you were forced to answer. Then

you won’t have to worry about it.

Ms. GAFFNEY. Let me tell you, the educational part of it is so absolutely key. You know, really, the people who are being victimized

by this fraud, they are people who are being offered deals that you

and I would say, ‘‘Hey, that’s so crazy. That can’t possibly be true.’’ These people don’t know that.

Ms. JONES. And let me cut you off for a moment. Wouldn’t it

even make sense to spend some of these dollars dealing with the

predatory lenders that are preying on our communities and let

some of those dollars be used to pull them back in?

Because it’s clear that many of the foreclosures occur under circumstances where people who understood financing and who had

a little more education, and it doesn’t mean they shouldn’t be in

a home, but if they had a little more education, would never enter

into these loan agreements anyway.

Ms. GAFFNEY. I could not agree with you more.

Ms. JONES. Let me take it a little bit further. My experience as

a prosecutor doesn’t let you answer. I just ask the questions.

[Laughter.]

Ms. JONES. Wouldn’t it also be important that HUD spend some

time—and I see you made this in your statements somewhere— with regard to looking at the lenders themselves and saying you

cannot put them out of business.

When they enter into agreements that are causing the kind of

losses that you suggest might occur under the circumstances, that

they ought not be able to lend at all, and that way, some of us

wouldn’t be in the dilemma that we are in.

Ms. GAFFNEY. For sure.

Ms. JONES. Let me ask you, Mr. McCool. I’m not quite understanding—do I have your statement? Is this you? Yes, Mr. McCool.

On page 13 it says, ‘‘If, for example, FHA loosens underwriting

standards, future loans may perform worse than past experience

suggests. In addition the recent reduction in up-front premiums

could reduce cash inflows into the Fund, although it could also

lower the riskiness of the loans that FHA insures.’’ Upon what basis do you say that future loans may perform worse

that past experience suggests just because they loosen underwriting standards?

Mr. MCCOOL. Only in the sense that if you do lower underwriting

standards, you increase the pool and you increase the potential

riskiness of that pool. It doesn’t necessarily mean it’s a bad thing.

Ms. JONES. Well, let me ask you this. If the underwriting standard was—and at some point this is what it was in many AfricanAmerican communities—is you couldn’t be black and get a loan,
25

that didn’t cause any greater loss for people when African-Americans had a chance to purchase homes, right?

Mr. MCCOOL. No, no. Again, we’re talking about legitimate underwriting standards.

Ms. JONES. Well, I’m questioning the legitimacy of some of the

underwriting standards that denied low-income and minority persons opportunities to purchase homes that are still in place. The

race is not there, but it’s there still.

Mr. MCCOOL. I understand. I think that, again, we would presume that the underwriting standards were based on true estimates of financial risk. If they’re based on arbitrary rules of

thumb, that’s a very different issue.

Ms. JONES. Give me an example of what are true underwriting

standards for the record, please.

Mr. MCCOOL. Well, again, there are relationships between net

worth and income and likelihood of being able to maintain loans of

a particular size. Those sorts of things.

Ms. JONES. I mean we’ve very recently——

Chairwoman ROUKEMA. Mr. McCool, would you speak more closely into the microphone, please?

Ms. JONES. This is my question, Madam Chairwoman.

Chairwoman ROUKEMA. Please.

Ms. JONES. More recently last year HUD decided to allow Section

8 dollars to be used for downpayment for purchase of homes. By

them doing that, does that lower the underwriting standard, because these people previously didn’t have downpayment dollars to

buy homes?

Mr. MCCOOL. I wouldn’t think it would, no.

Ms. JONES. OK. So that’s a good program. Maybe we could use

some of the surplus then to allow for no downpayment loans. I

think someone else suggested that. But maybe we could use some

of these funds where we’ve got people in a dilemma where they

can’t afford to buy a home. I didn’t hear that answer.

Mr. MCCOOL. There’s lots of——

Ms. JONES. You’re like my son who’s 17. I say ‘‘Hello, Marvin,

how are you?’’ He’ll go——

Mr. MCCOOL. There’s lots of ability to increase flexibility, I’m

sure. And I don’t mean to be personal.

Chairwoman ROUKEMA. Excuse me.

Ms. JONES. I’m just trying to get some real issues, thank you,

Madam Chairwoman, on the record, with regard to the inability of

people to buy homes. I thank you very much for your time.

Chairwoman ROUKEMA. And I would remind the members of this

panel that you do have the opportunity to come back for the record

with fuller explanation or amplification if you feel you haven’t had

time.

But we will go on to Mr. Frank.

Mr. FRANK. Thank you, Madam Chairwoman. I got the distinct

impression from at least Mr. McCool and Mr. Phaup that a desire

to answer more fully is not one of the things that is greatly motivating them at this point.

[Laughter.]

Mr. MCCOOL. It depends on the question.
26

Mr. FRANK. I don’t think either one of them felt deprived. My

question, because it’s relevant to the kind of policy judgments that

might be made, in the pricing policies of FHA, they get revenues

from at least three sources. There’s the up-front premium, there’s

the annual payment and there’s sales, auction sales when they repossess.

How precisely is the internal pricing? That is, my impression is

that there might very well be elements of cross-subsidy and that

the goal is to produce an overall balance and that it’s not very carefully done from an internal pricing standpoint. Am I accurate on

that, Mr. Phaup, Mr. McCool?

I mean, when they say, you know, this class of property—is each

class of property sort of standing on its own or is it as long as it

comes out well in the end is that OK?

Mr. McCool.

Mr. MCCOOL. Well, again, my understanding is they have certain

flexibility, but it’s with respect to types of loan programs and the

extent of, for example, the loan-to-value ratio affects the premiums.

They are fairly broad categories though.

Mr. FRANK. Mr. Phaup.

Mr. PHAUP. I agree. That there are cross-subsidies in the FHA

program, no doubt.

Mr. FRANK. I appreciate that, Madam Chairwoman, because that

seems to me to give us some flexibility to urge the FHA administrator to—— Mr. PHAUP. Urge?

Mr. FRANK. Not us. I understand, Mr. Phaup, we can’t do it.

Only the Executive can do it by itself. But it does give us some

flexibility to urge the FHA administrator to take advantage of his

ability or her ability to cross-subsidize and have a different policy

outcome since there are cross-subsidies now.

That’s all. Thank you. And don’t elaborate on that in writing. I’m

happy with what you said.

[Laughter.]

Chairwoman ROUKEMA. If you can ask a real short question and

then I’ll conclude.

Ms. JONES. Mr. Phaup, I didn’t get to ask you this. And I’m new

at this. Who makes a decision as to how the funds of the MMI are

invested to make returns on those dollars?

Mr. PHAUP. The U.S. Congress. Current law requires that those

balances be held in Treasury securities.

Ms. JONES. Would you suggest that they be done somewhere else

to make it advantageous for the Fund or not?

Mr. PHAUP. I would not as a special case for FHA. That’s a big

overall question that the Congress now has before it and will deal

with further.

Ms. JONES. Anything but Social Security. Anyway, go ahead.

Mr. PHAUP. Yes. I’m thinking about Social Security. But there

are plenty of other cases where people have exactly the same interest, and that’s an important policy question that deserves careful

weighing. I wouldn’t make the change for one program only.

Ms. JONES. Thank you, Madam Chairwoman.

Chairwoman ROUKEMA. All right. Thank you. I do want to thank

this panel and also remind them that according to the rules of our
27

Committee, Members who have additional questions will have up

to 30 days to submit them to the panel members.

I would simply submit one more question to you, not for answer

now, but for you to supplement what was said in the panel concerning my question regarding the fraud that you have indicated

has been increasing and what we do with the private companies

that are dealing with these issues. Are they part of this fraud question? And how we deal with this growing problem and whether it

needs additional legislation or whether it’s strictly administrative

ways that we can do it.

Because I think it was indicated that fraud is increasing and

that there are more needs for internal controls, and I did acknowledge what you stated about the need for more full-time employees

to deal with this.

But I think we have to deal with the private sector as well, and

if we could get the advantage of your experience on the ground and

in the real world, whether or not it’s purely administrative or

whether there’s a need for legislative corrections.

And with that, I thank you very much, and we appreciate your

contribution. And as I said, it will be the foundation for future action. Thank you.

[Whereupon, at 3:35 p.m., the hearing was adjourned.]

(29)

A P P E N D I X

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