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[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

                  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

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71-506 PS                   WASHINGTON :  2001

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director

           Subcommittee on Housing and Community Opportunity

                    MARGE ROUKEMA, New Jersey, Chair

MARK GREEN, Wisconsin, Vice          BARNEY FRANK, Massachusetts
    Chairman                         NYDIA M. VELAZQUEZ, New York
DOUG BEREUTER, Nebraska              JULIA CARSON, Indiana
SPENCER BACHUS, Alabama              BARBARA LEE, California
PETER T. KING, New York              JANICE D. SCHAKOWSKY, Illinois
ROBERT W. NEY, Ohio                  STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia                    MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York               MAXINE WATERS, California
BOB RILEY, Alabama                   BERNARD SANDERS, Vermont
GARY G. MILLER, California           MELVIN L. WATT, North Carolina
ERIC CANTOR, Virginia                WILLIAM LACY CLAY, Missouri
FELIX J. GRUCCI, Jr, New York        STEVE ISRAEL, New York
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

                            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

 
   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 bullish 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 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.]
    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 low-end 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 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 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.
    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 
objection, 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 low-income 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 
actual 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 estimated 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 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.
    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.
    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.
    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 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.
    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 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.
    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.
    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.
    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, 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.
    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.
    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.
    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.
    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 
African-American communities--is you couldn't be black and get 
a loan, 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.
    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 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.]

                            A P P E N D I X

                             March 20, 2001
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