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USING FHA FOR HOUSING STABILIZATION 

AND HOMEOWNERSHIP RETENTION, PART I 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

April 9, 2008 

Printed for the use of the Committee on Financial Services 

Serial No. 110–103 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

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 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin, 

LINCOLN DAVIS, Tennessee 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

ROBERT WEXLER, Florida 

JIM MARSHALL, Georgia 

DAN BOREN, Oklahoma 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

SPENCER BACHUS, Alabama 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

DEAN HELLER, Nevada 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

April 9, 2008 ..................................................................................................... 1 

Appendix: 

April 9, 2008 ..................................................................................................... 89 

WITNESSES 

WEDNESDAY, APRIL 9, 2008 

Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance Corporation .......... 13 

Blinder, Alan S., Ph.D., Gordon S. Rentschler Memorial Professor of Economics and Public Affairs, Princeton University ...................................................... 66 

Dugan, Hon. John C., Comptroller, Office of the Comptroller of the Currency . 15 

Kroszner, Hon. Randall S., Board Member, Board of Governors of the Federal 

Reserve System .................................................................................................... 18 

Montgomery, Hon. Brian D., Assistant Secretary for Housing-Federal Housing 

Commissioner, U.S. Department of Housing and Urban Development ........... 20 

Reich, Hon. John M., Director, Office of Thrift Supervision ................................ 16 

Sinai, Allen, Chief Global Economist, Strategist and President, Decision Economics, Inc. ........................................................................................................... 71 

Wesbury, Brian S., Chief Economist, First Trust Advisors L.P. .......................... 69 

APPENDIX 

Prepared statements: 

Neugebauer, Hon. Randy ................................................................................. 90 

Putnam, Hon. Adam H. .................................................................................... 91 

Bair, Hon. Sheila C. ......................................................................................... 94 

Blinder, Alan S. ................................................................................................ 114 

Dugan, Hon. John C. ........................................................................................ 123 

Kroszner, Hon. Randall S. ............................................................................... 144 

Montgomery, Hon. Brian D. ............................................................................ 160 

Reich, Hon. John M. ......................................................................................... 165 

Sinai, Allen ........................................................................................................ 185 

Wesbury, Brian S. ............................................................................................ 198 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Frank, Hon. Barney: 

Letter from Larry Lindsey, dated April 12, 1995 .......................................... 206 

Letter from the National Association of Realtors, dated April 9, 2008 ....... 208 

Statement of Marc H. Morial, President and CEO, National Urban 

League, Inc. ................................................................................................... 210 

Barrett, Hon. J. Gresham: 

Responses to questions submitted to Hon. Sheila C. Bair ............................ 214 

Responses to questions submitted to Hon. John C. Dugan ........................... 217 

Responses to questions submitted to Hon. Randall S. Kroszner .................. 219 

Responses to questions submitted to Hon. John M. Reich ............................ 222 

Kanjorski, Hon. Paul E.: 

Letter from Hon. John C. Dugan, dated May 16, 2008, providing additional information for the record ................................................................. 224 

Price, Hon. Tom: 

Article from The Wall Street Journal, dated April 3, 2008, entitled, 

‘‘Uncle Subprime’’ .......................................................................................... 226 

(1) 

USING FHA FOR HOUSING STABILIZATION 

AND HOMEOWNERSHIP RETENTION, PART I 

Wednesday, April 9, 2008 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10:03 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. 

Members present: Representatives Frank, Kanjorski, Waters, 

Maloney, Velazquez, Watt, Sherman, Moore of Kansas, Capuano, 

Clay, McCarthy of New York, Baca, Lynch, Miller of North Carolina, Scott, Green, Cleaver, Bean, Moore of Wisconsin, Ellison, 

Klein, Mahoney, Wilson, Perlmutter, Murphy, Donnelly, Foster; 

Bachus, Castle, Royce, Lucas, Manzullo, Biggert, Miller of California, Capito, Hensarling, Garrett, Barrett, Neugebauer, Price, 

McHenry, Campbell, Putnam, Bachmann, Marchant, and Heller. 

The CHAIRMAN. The hearing will come to order. I said, the hearing will come to order; that means people will please be quiet and 

shut the doors. People can come in or out, but the door has to be 

shut. Members of the staff, please go and shut that door. There is 

an overflow room. There isn’t an overflow room? I apologize for the 

misinformation. We do share our room with the Appropriations 

Subcommittee, and that apparently preempted it. 

First, procedurally, under the rules of the—excuse me. Do not 

stand in the doorway. The door is either to be open or closed. Are 

there any empty seats? I would urge people to take empty seats. 

If they are set aside for someone who is not here, feel free to take 

them. There are some seats over there; there is a seat in the front 

row; and all seats are available. I apologize for the overflow room. 

We will have to make some arrangements in the future. 

First, procedurally, under the rules of this committee, opening 

statements are 10 minutes on each side, with each side having the 

ability to ask questions for an additional 10 minutes. Regrettably, 

that is the case today, so we are going to have 20 minutes of opening statements on each side. I apologize to the witnesses. It is an 

important subject. I would urge members to be as brief as possible, 

but we will proceed now with opening statements, and I will begin 

with mine. 

First of all, I do want to say that those who don’t believe in coincidence have been undercut today by the remarkable coincidence of 

the announcement by the Bush Administration of substantial 

changes in the FHA Secure Program on the day before our hearing. 

We had heretofore heard from them that they were pretty satisfied 

2 

with it, that it was doing wonderful work. In February, the thenSecretary said it helped 100,000 people. We had heard some in the 

Administration say that they did not think that we should do anything to increase taxpayer risk. 

Now the proposal we are considering today would urge those who 

hold the loans to reduce the principal amount, a suggestion made 

first by the Chairman of the Federal Reserve, Mr. Bernanke, and 

we then said that if the principal amount was reduced sufficiently 

by the securitizers with no order from us, since we are not eligible 

or able to do that, that we would broaden the eligibility of the FHA 

and let these people come to the FHA with the mortgages to be financed. Some said, correctly, that is putting taxpayers at risk, and 

some pointed out that there are people who borrowed more money 

than it turns out they can now repay, who would be the beneficiaries of this. That is, they would be the beneficiaries of their 

mortgages being written down in principal by the holder, and they 

would then be able to come to the FHA under more liberal terms 

than previously. And I am pleased to see that the Bush Administration now agrees with that approach. 

We have some differences, obviously, in degree, but there does 

now appear to be agreement that it would be a good thing for the 

servicers to write down the principal. And the reason for that is, 

the original Administration approach was simply to hold off increases in the interest rate so that people could refinance. 

But we discovered that people who now have house equity less 

than the mortgage could not be financed, so that some approach 

has to be made to the principal. We have a substantial amount of 

agreement now, and those who think that we should do nothing 

that could theoretically or even actually expose taxpayers to more 

risk will have to deal with me and the Bush Administration together and we will work this out. 

There are still some differences, and we will address them. There 

is the notion of an auction mechanism, and that is something 

which evolved out of discussions we had with the Federal Reserve 

System. I know Governor Kroszner talks about that, and we will 

talk about that some more in the conversation. There is a question 

of the speed. 

But now I have one other issue I want to address. The linchpin 

of what we are doing, of what Secretary Paulson began doing, of 

what HUD Secure does, all of it begins with a decision by the people who hold the mortgages to write them down in some way, to 

defer. We recognize the sanctity of a contract. We have passed legislation in this House that will make it less likely that some of 

these mortgages will go forward in the future, but we are not empowered, nor should we be, to abrogate existing contracts, and we 

are not trying to do that. This begins with voluntary action on the 

part of the holders. 

We believe that what many of them will discover is that going 

to foreclosure would leave them worse off than if they were to 

make these arrangements. And so we encourage them to do that, 

and both the approach we take, and the approach the Administration is now taking offer them incentives to do that. It basically 

deals in part with the economist problem of the commons. That is, 

there are things which you might not want to do if you were the 

3 

only one doing them, which you might be more willing to do if you 

knew that a lot of other people were doing them because there 

could be a cumulative beneficial effect. So we have agreed on that, 

but it still requires voluntary action. 

We have recently heard from some of those who are in the business of servicing mortgages that there is a reluctance to go along. 

One of the neighborhood advocacy groups most involved in this 

said, well, they have run into problems because they find that it’s 

not the investors who are so resistant as it is some of the servicers. 

Our colleague from Delaware, not yet with us, Mr. Castle, proposed 

a bill to try and immunize the servicers from lawsuits if they in 

fact did what was economically responsible. But the securitizers 

say, well, they don’t want that. They think it might be—as I read 

in yesterday’s Congress Daily—pressure on them. 

I am troubled, and there have been people who argue that from 

the securitizer’s standpoint, some of them have transaction fees 

that might be lost if these things were resolved. We cannot compel 

the securitizers—the servicers. I keep saying securitizers, but I 

mean servicers. We cannot compel the servicers to take certain actions, because they have rights. On the other hand, this committee 

and the House and the Congress are considering legislation going 

forward. We in fact put some obligations in the bill that passed this 

House which were somewhat controversial, but the bill passed the 

House by well over two-thirds, to put some obligations on those 

who did the securitizing. 

We will be acting next year, and as is now clear—Secretary 

Paulson and others have said so—we are going to have to do a substantial redo of financial institution regulation. I want to put the 

servicers on notice. We can’t make them cooperate. But if we see 

a widespread refusal on the part of servicers to cooperate voluntarily in what we think is an important economy problem, and in 

which are trying to accommodate their interests and not be coercive, they can expect much tougher regulation in the future. Tough 

regulation is no one’s first choice, and it should not be anyone’s 

first choice. But if we do not get the degree of voluntary cooperation we want—and we are asking. We are trying to give incentives. 

We are trying to make this—the gentleman from Delaware who 

has now joined us has a bill that would help them to not be sued. 

We are trying to give them some economic incentive to help us stabilize the whole economy. But if the anecdotal evidence I have 

heard, that the servicers are resistant to cooperating, turns out to 

be the case, and if we were to get this approach adopted—and 

there are differences, but some commonality between ourselves and 

the Administration—and we don’t get much of a voluntary buy-in 

to this, then I have to say that the response will have to be probably more regulation than people might like to see. 

So I do want to put that element on notice, that they have the 

ability to influence what this Congress will do going forward. Because like I say, we will work as hard as we can to respect their 

contract rights to create conditions in which it will be in their interest to cooperate. And if that doesn’t work, then we can’t abrogate contracts, but going forward, we can be much more restrictive. 

The gentleman from Alabama. 

4 

Mr. BACHUS. I thank the chairman for holding today’s hearing on 

proposals to stabilize the housing market, prevent avoidable foreclosures, and therefore stabilize the economy. 

It is important for the committee to continue to focus its attention on the housing market and its effect on borrowers, financial 

institutions, the economy, and communities at large. And we have, 

I think, if anything else in this past year, come to appreciate the 

interconnectivity of our different industries; a problem in one area 

becomes a problem in all areas. 

We have a situation today, and whether you call it a short-term 

liquidity and credit crisis or whether you say we are in the throes 

of a recession, it is a serious problem, and we have alternatives. 

Any time you are confronted with a crisis, one alternative economically is the laissez-faire approach. You can let the market sort it 

out. Capitulation can be a very painful thing—sometimes refer to 

that as a washout—can be very costly. We have already apparently 

chosen not to do that in the intervention in Bear Stearns where 

counterparties at least have been—in a sense, their losses have 

been mitigated or prevented on at least a short-term basis. So we 

have intervened on Wall Street, maybe not on Main Street, but we 

have intervened. We have stepped in between what could be a very 

painful self-regulation by the markets, which can be very efficient 

and very quick. 

And another approach is—another approach and the approach 

we have done, is to intervene after the fact, after we have a problem, after the problem has already happened. And we—that’s what 

we’re faced with. We all agree the problem is here. So you can intervene after the fact, or you can just let the market sort it out. 

There is a third approach, and the chairman mentioned this approach. I’m not—we don’t have this approach in this situation, but 

we ought to remind ourselves that there’s always a more reasonable approach than letting the market sort it out or government 

intervention, which carries with it terms like ‘‘bailout’’ and ‘‘taxpayer expense.’’ And that third alternative is a regulatory environment approach where you have reasonable regulations, where the 

government sets standards of transparency and operations within 

well-defined boundaries. 

For example, in the subprime market, to prevent the fraud, misconduct, and misrepresentation which was rampant in the 

subprime lending market, Chairman Frank and I together began to 

collectively warn that this was happening. The industry said they 

were regulating themselves. They were doing a good job of it. We 

found that—and that’s always a wonderful approach, if it works. If 

the industry will regulate itself, that’s great, but they didn’t do 

that. 

We passed a licensing and registration for brokers, for all mortgage originators. That’s still over in the Senate. That hasn’t happened. The problems we had with renegade brokers and mortgage 

originators within the banks still exist. We have done nothing to 

prevent future crises in that regard. As we talk about this, I hope 

all the regulators—and these problems, I have been here 17 years, 

and we have problems that we have all agreed on when I came 

here that still have not been collectively addressed. And one, I 

think, is one that right now has been some period of time, is past 

5 

due, is getting together and coming up with some comprehensive 

solution that sees we don’t—we’re not up here again with a whole 

new round of these things, once the market gets liquidity again. 

Warren Buffet said that it is only when the tide goes out that 

you learn who has been swimming naked. The tide on home price 

appreciation has ebbed, and unfortunately, we are now seeing that 

everyone is exposed. The ingredients of the current turmoil in our 

economy were individual loans of borrowers and lenders who did 

not appreciate the risk. Mortgage-backed securities that investors 

and financial institutions overvalued, and complex structured financial instruments that regulators, credit reporting agencies, and 

investors did not understand. 

The consequences of these market and regulatory failures continue to resonate through the global economy. The focus of today’s 

hearing is Chairman Frank’s proposal to encourage lenders and investors to write down the principal on certain mortgages to a percentage of current market value and refinance those loans with an 

FHA guarantee, with the goal of permitting borrowers to remain in 

their homes, thus stabilizing house prices. He should be commended for developing a proposal that addresses a complex problem in a creative and ambitious way. 

Nonetheless, any plan that would require American taxpayers to 

assume the risk incurred by mortgage lenders, investors, and other 

borrowers during the runup in housing prices earlier this decade 

raises serious questions. The fundamental question and issue is 

fairness. Out of 55 million mortgages currently outstanding, 51 

million are being paid on time. Now the challenge is, there are 4 

million that aren’t. Some of those are just lenders who borrowed 

money, and knew they shouldn’t have borrowed it, speculators. 

There are others who were truly the victim of fraud and misrepresentation. 

But does the chairman’s plan unfairly confer a benefit on these 

borrowers, some of them trying to do the right thing, others being 

very reckless, at the expense of all taxpayers? As I understand it, 

the proposal rewards some homeowners who assumed housing 

prices would continue to rise by permitting them to avoid the consequences of their wrong assumption. For these homeowners, the 

chairman’s plan seems to me to be a heads I win, tails you lose, 

proposition. The losers are the homeowners and renters, investors 

and speculators who behaved irresponsibly, or who were the victims in certain cases of fraud, and those are the real hard cases. 

The losers, however, are going to be the homeowners and renters 

who behaved responsibly, yet will now be required or could be required to pony up their hard-earned dollars in a time of rising gas 

prices and other stresses to bail out those who did not act responsibly or were the victims of fraud. And if housing prices continue 

to decline and borrowers prove incapable of making the payments 

on their FHA-insured mortgages, under this plan, the taxpayers 

would pay. 

Mr. Chairman, this sends a dangerous message. When financial 

institutions and individuals take on excessive and ill-advised risk, 

the government will always ride to the rescue, or so they will assume. Sending this message now will only incentivize such behavVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
6 

ior in the future, encouraging future severe market disruptions like 

the one we’re living through today. 

None of us who owns a home enjoys watching the value of that 

asset decline. But the simple fact of the matter is that housing 

prices rose at an unsustainable rate over the past few years, far 

outstripping gains in personal income and the long-term trend in 

housing price appreciation. Until the markets stabilize, prices will 

need to return to the levels ordinary Americans can afford. That 

is a beneficial effect of what we’re seeing now. This process of market correction, while undeniably painful, is a necessary and unavoidable reality. 

Government intervention to impede the return to the long-term 

trend line, no matter how well-intentioned, is likely to do more 

harm than good. I think kicking the can down the road for even 

a more severe day of reckoning, particularly with our—the deficits 

in government spending for the government to assume more liability is particularly risky. 

Finally, in addition to asking whether proposals like the chairman’s represent good public policy, we must also ask ourself whether they can be implemented in practice. Critics have pointed out 

the enormous cost and time it would require to re-underwrite millions of new mortgages. And there remains the problem of existing 

second liens on existing mortgages while the chairman’s discussion 

draft addresses—or does not address these issues, or not adequately. 

Thank you again, Mr. Chairman, for holding this hearing. I 

thank all of our witnesses for joining us this morning. We look forward to your testimony. 

The CHAIRMAN. The gentlewoman from California, chairman of 

the Housing Subcommittee. 

Ms. WATERS. Thank you very much, Mr. Chairman. I’m very 

pleased about these hearings that you are holding. I think that 

we’re almost a day late and a dollar short on helping the citizens 

of this country who have been foreclosed on and others who are facing foreclosure. And I think the proposals that you are bringing 

forth, that I am bringing forth, are good proposals that will finally 

give real assistance to the citizens who have been wondering what 

are we waiting for here in Washington, D.C. 

I understand that the President, this Administration, is announcing some proposal as of yesterday. I don’t know what it is, but let 

me just say that we have all been fiddling while Rome has been 

burning. And I want to thank you for convening this hearing on the 

Federal Housing Administration and homeownership retention. 

The Administration’s efforts to deal with this crisis have fallen 

short. The so-called HOPE NOW Alliance is clearly a failure. 

HOPE NOW states that it helped 545,000 homeowners in the last 

half of 2007, but 33 percent more homeowners actually lost their 

homes to foreclosure during the same time period. In addition, 

through January of this year, HOPE NOW servicers have been 

loathe to reduce interest rates or to otherwise modify loans that are 

unaffordable. Instead, 72 percent of the homeowners being helped 

by HOPE NOW are only receiving repayment plans. 

Our current tactics, be they the Fed’s monetary policy of reducing interest rates, or HOPE NOW’s workout program, are simply 

7 

coming up short. Plummeting home prices have left many homeowners with negative equity, meaning they owe more on their 

homes than they are worth. According to Moody’s Economy, 8.8 

million homeowners, or 10.3 percent of all borrowers, are upside 

down on their mortgages. Goldman Sachs estimates that 15 million 

homeowners could be upside down by the end of the year. However, 

these families cannot refinance into more affordable or sustainable 

loans because of tighter lending standards and their lack of equity. 

For months now, I have called on the Administration to do more 

to keep families in their homes. I agree with Chairman Frank that 

the time has come for the Federal Government to take a more active role in preventing foreclosures and rescuing our economy from 

the effects of mass foreclosures. 

We have long recognized that FHA has the potential to assist 

families in staying in their homes. That is why we moved quickly 

to pass FHA reform legislation on September 18th of last year. The 

chairman’s proposal would create a mechanism to get lenders and 

mortgage holders to work with FHA and FHA-approved lenders to 

write down the principal on a significant number of these 

unsustainable mortgages and allow families to benefit from a more 

affordable loan that is guaranteed by FHA. Using FHA as a tool 

for assisting homeowners to stay in their homes is a natural progression of the overall reform of FHA that Chairman Frank and I 

have been pushing since early in this Congress when I introduced 

H.R. 1852, the Expanding American Homeownership Act of 2007. 

I’m disappointed that the Senate failed to include a similar proposal to use FHA to write down mortgages in its housing stimulus 

bill. 

The proposal put forth by Chairman Frank would give servicers 

a much-needed incentive to stop the wave of foreclosures currently 

overtaking our country. In today’s market, servicers still have reasons to either let the property go into foreclosure or, as it is said, 

kick the can down the road and hope that homeowners can catch 

up on missed payments. 

Under the chairman’s plan, the lender or mortgage holder can 

have a bad loan removed from their books at a discounted price. 

Using FHA-approved lenders to buy these mortgages at no more 

than 85 percent of their appraised value would improve the poor 

decisionmaking of some servicers who still see foreclosure as their 

only alternative. 

In addition, because FHA will guarantee these loans, the market 

and home prices will begin to stabilize. The family would get to 

stay in their homes with a mortgage they can afford, and the Federal Government could potentially make a profit on these loans if 

and when home prices begin to appreciate and the homeowner decides to sell. 

Of course, I’m interested to hear the views of the witnesses on 

how this program would work in bulk. Chairman Frank has proposed allowing for a bulk refinance facility that would allow 

servicers to submit large numbers of loans to HUD, Treasury, and 

to the Fed for refinancing. 

Let me just say that while I appreciate very much all of the effort that is going into the chairman’s bill, I still have another bill 

that I think may be a bit more controversial, but it will help the 

8 

servicers to really do good mitigation. As a matter of fact, many of 

our financial institutions supposedly have mitigation departments, 

but when you call, you can’t find a mitigator. You can’t find anybody. So I have a mitigation bill, and the first thing in that bill, 

the first point of that bill is there has to be a telephone number, 

identifiable telephone number, that has been well-promoted, that 

the homeowners can locate and try and get some help with their 

mortgage before it goes into foreclosure. 

Of course, my mitigation bill includes in it several other things 

that I think will be very helpful in determining whether or not real 

mitigation is going on. As I mentioned earlier, many of the 

servicers are doing these very limited, almost fake workouts where 

they say, ‘‘We will extend the payment.’’ They are doing nothing to 

allow homeowners to do workouts that would allow them to continue the mortgage payments that they had when they got into the 

loan and before the ARMs reset. 

And so having said that, it is just fair warning that while we 

have waited too long to really get tough on this issue, some of us 

are going to have to go beyond what would be considered even reasonable to force some real discussion on this issue and see if we 

can’t get the Members of Congress so serious about this issue that 

everybody is prepared to fight as hard as they can to assist the 

homeowners who have been waiting for us. 

I yield back the balance of my time. 

The CHAIRMAN. The gentleman from California, Mr. Royce, is 

recognized for 3 minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. This hearing of course is 

being held during a very troubling time for our housing sector, a 

very troubling time for our capital markets. And I think the potential wave of foreclosures will continue to threaten our economy 

until these troubled mortgages are restructured. 

Because of the significant costs associated with a foreclosed property, we have a situation where the investors, the servicers, the 

lenders, and the borrowers all have an enormous monetary incentive to come to the table and try to restructure those loans. And 

to that end, much progress has been made since last fall. The numbers I have since March 3rd is that the 18 loan servicers, which 

are the biggest part of the HOPE NOW Alliance, that’s two-thirds 

of the mortgage industry for both prime and subprime loans, have 

helped over one million homeowners, 1,035,000 people, rework 

their loans and stay in their homes. 

Now if you look instead at the proposals being discussed here to 

empower the FHA to ensure a greater share of the outstanding 

mortgages, one of the concerns I have there is that this would 

transfer a lot of this risk—which is currently spread to investors 

all over the globe; institutions all over the world hold this risk, 

many institutions in Europe and many in Asia—onto the backs of 

the American taxpayers. And parties would be discouraged, in all 

probability, from renegotiating the terms of their contract through 

the HOPE NOW Alliance. In other words, if you’re a lender or 

you’re a borrower and you understand that rather than a reduction 

in the interest rate and restructuring that loan, there’s the opportunity potentially to be bailed out. My concern is that takes the 

pressure off the servicers, off the borrowers, off the lenders to stay 

9 

at the table and work out the workouts that we have seen in over 

a million loans. 

Also, the FHA and the CDBG, these are two government agencies which are expanded under the various proposals being discussed, and these are agencies that have struggled with mismanagement and improper uses of funds over the years and have 

cost the taxpayers billions of dollars in that regard. 

So, in closing, we have a program that we know have helped restructure over a million loans. We have raised the conforming loan 

limit for the GSEs through the end of the year. The Federal Reserve has lowered the Fed Fund’s rate by 300 basis points, which 

continues to provide more needed liquidity to the market, and I believe Congress should avoid undermining the progress being made. 

We should do more to encourage those lenders and servicers and 

borrowers to get to the table, but we should allow those actions to 

play out rather than pull the rug out of the incentives that we 

want to create there and instead send a different message, a different message to the market to pull back away from those agreements and instead wait to see if you can have a bailout. I think 

that is a bad policy. I look forward to hearing from our panel of 

witnesses today, and I yield back the balance of my time. 

The CHAIRMAN. The gentlewoman from New York, the chairman 

of the Financial Institutions Subcommittee, is recognized for 2 minutes. 

Mrs. MALONEY. Thank you. I welcome this hearing and support 

this very necessary legislation. New problems in the economy are 

popping up like a not very funny version of whack-a-mole, as Alan 

Blinder, a former Vice Chair of the Fed, recently observed, who will 

be testifying on the second panel. 

The decline in home prices is causing banks to readjust their balance sheets and to build up capital, which is at the core of the liquidity crisis. Economists warn that containing financial volatility 

will be difficult until housing prices stop falling, which is why Congress is working on solutions to keep people in their homes and 

avoid a deep downturn. 

The Administration says it wants to use the FHA to help people 

and to help homeowners, too, but to date, the Administration’s 

plan, FHA Secure, has helped fewer than 3,000 people, a tiny and 

inadequate drop in the bucket. Today we learned that the Administration plans to expand FHA Secure without, they say, any investment of government funds. But to me, their math just does not add 

up. I have serious questions as to how substantially more homeowners can be helped through the FHA without an infusion of government funds. And I refer to an article in the Wall Street Journal 

that outlines this new program. 

The crisis in the housing market has brought to light the inability of our most sophisticated and respected institutions to measure 

their exposure to opaque assets, and more importantly, to manage 

the risk associated with them. The Federal Reserve has recently 

come under fire for making a $29 billion line of credit available to 

J.P. Morgan Chase to acquire the investment giant Bear Stearns. 

This action to head off a sudden collapse of one of the Nation’s 

largest investment banks very likely prevented widespread finanVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
10 

cial panic, and a potential domino effect among other financial institutions. 

Now that we have helped Wall Street, I believe it is time that 

we help Main Street. And we have a bill, an important bill before 

us today that does just that. 

I just wanted to mention—I would like to reference a report on 

the need to have helped Bear Stearns, and I will put it in the 

record without any comment. 

But just finally, we need to move quickly to keep families in their 

homes and to blunt the devastating effects of this weakening economy. 

The CHAIRMAN. The gentleman from Texas is recognized for 2 

minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman. I fear the bill before 

us may offer short-term gain to a few and promise long-term pain 

to many. We all know that there has been an economic wreck in 

our housing market. And as a Nation, the sooner we can clear 

away the rubble, the sooner that we can rebuild this market. However, that is unlikely to happen, as many borrowers and lenders 

and investors and trustees all sit on the sideline awaiting their expected congressional bailout. 

I mean, why should anyone help clear away the rubble that they 

may have helped cause if somebody else can be forced to do it for 

them, namely the U.S. taxpayer. And we cannot legislate away 

losses as much as we would like to. But apparently, we can redistribute them. And I fear that is the thrust of the bill that is before 

us today; putting taxpayers at risk for over $300 billion, which 

could be equivalent to a tax increase of at least $2,000 per American family. Now this is on top of the tax increase that American 

families will see that was included in the last budget passed by 

Congress, which is roughly $3,000 per family. 

This bill can also exacerbate even a greater crisis, and that is the 

spending crisis which CBO, OMB, and GAO all say threatens the 

next generation with a tax burden double our own, meaning that 

there could be fewer housing opportunities for future generations. 

Again, short-term gain for some, long-term pain for many. 

This bill has many interesting features, not the least of which is 

that it will clearly help bail out Wall Street as investors quickly 

dump their worst performing assets on taxpayers, yet it will ignore 

much of Main Street, those who paid off their homes, those who 

rent their homes, or those who made prudent decisions not to buy 

more home than they can afford; in other words, 98 to 99 percent 

of America. 

The most important policy decisions we could make to help the 

housing market would be to forestall the automatic huge tax increases that are in the system, bring certainty to the marketplace, 

and lower capital gains tax rates to add liquidity to the market. 

I yield back, Mr. Chairman. 

The CHAIRMAN. The gentleman from Georgia is recognized for 2 

minutes. 

Mr. SCOTT. Thank you, Mr. Chairman. This is indeed a very 

timely and an important hearing, and I think that just to set it in 

its stark reality, we are faced, ladies and gentlemen, with the worst 

economic crisis, particularly in terms of liquidity, since the Great 

11 

Depression. And we need to face this urgency with that stark reality. 

One of the examples that we moved very swiftly with in terms 

of helping Bear Stearns, that was important logic. That was important to do. But we need to apply that same logic to helping homeowners and families. And that logic was this. If we failed to help 

Bear Stearns, it would have had a cascading effect. We are the 

leading financial world market in the world here in the United 

States. If we had not worked very vociferously in the government 

with a strong arm to come in and to save Bear Stearns, there 

would have been a worldwide collapse. 

Well, that same logic must apply to home mortgages and families. And it’s particularly true because within the next 3 or 4 years, 

there are going to be about 2 million mortgages that are going to 

be reset because of these teaser rates, and these adjustable mortgage rates are going to be reset, and that’s going to have a very 

serious, calamitous effect on the economy. 

So this move, this bill, is very important. FHA is at the centerpiece of it. It’s very important that we move forthrightly and deal 

with this housing and mortgage crisis with the urgency that we 

moved with Bear Stearns. To do otherwise would be forfeiting our 

great responsibility to the American people. And the American people are watching to see if we apply the same logic. If it works for 

Bear Stearns, then it ought to work to help American families and 

homeowners. 

Thank you, Mr. Chairman. 

The CHAIRMAN. We are running out of time on this side, but we 

will accommodate the last three members for 1 minute each, but 

we are going to have to hold to that. The gentleman from Texas, 

Mr. Neugebauer, for 1 minute. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Several points 

have been made that I would make, but what I would say is that 

we have to be very careful that we make policy in this country that 

starts picking winners and losers. Many people have suffered the 

devaluations of their stock portfolios, but it’s not the role of government to come in and make sure that everybody makes a profit, nor 

is it the role of government to make sure that everybody’s home 

value goes up. 

A lot of people are currently making their mortgage payments 

today all across the country and the value of their homes has gone 

down. What the marketplace is really waiting for Congress to do 

is get out of the way. How we got to the highest homeownership 

in the history of country was not because the Federal Government 

was providing opportunities for people to own homes. It was because the marketplace was providing opportunities for people to 

own homes, and we had a financial market that was financing 

those. 

One of the things that we cannot do is take people and create 

equity for them. That is not the role of government, nor do the 

American taxpayers who have been paying their mortgage payments, who bought their homes at a certain time, think it is fair 

that now because they bought theirs last year or 2 years ago, that 

somehow the Federal Government now is going to make these new 

homeowners whole. And so I think we’re going down a very slipVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
12 

pery slope here, and I would hope members would give serious consideration to what we are doing here. 

Thank you. 

The CHAIRMAN. I apologize, but, you know, it’s 20 minutes that’s 

coming out of other members’ time on your side when we do this, 

because we’re already slightly over, frankly. The gentleman from 

Texas, Mr. Green, for 2 minutes. 

Mr. GREEN. Thank you, Mr. Chairman. Mr. Chairman, there are 

many who conclude that we’re in this crisis because of some of the 

deregulation that took place in the 1980’s, which allowed exotic 

products such as 3/27s and 2/28s to come into existence. And as a 

result, there are persons who conclude that we ought to have some 

hand in trying to make whole or make right the circumstance that 

we in part created. 

I believe that this plan, as I have viewed it, is voluntary, and it 

does not require that institutions who hold loans do certain things. 

It merely gives them an inducement to do things that can be of 

benefit to the consumer, who happens to be the borrower. In my 

district, I hear hue and cry from persons who are concerned about 

this issue, and they are indeed asking that Congress get involved 

and do something to help prevent this crisis from becoming an even 

more severe crisis. We’re talking about the possibility of a recession. There are some people who are already living in a depression. 

I yield back the balance of my time. 

The CHAIRMAN. The gentleman from California, Mr. Miller, for 1 

minute. 

Mr. MILLER OF CALIFORNIA. Thank you very much. There is no 

doubt that we are facing a severe liquidity problem today. Every 

housing recession I have experienced has been a little different. 

The mid-1970’s was one way, the 1981 recession, prime went to 21 

percent. You could get money, you just couldn’t afford to borrow the 

money. The recession of the 1990’s, very difficult recession also. 

And I guess it’s a housing recession if your house is in foreclosure. 

If it’s not, you aren’t that concerned about it. 

The biggest problem we have today is liquidity. We have to do 

something to create liquidity within the marketplace, and that’s 

the whole purpose of GSEs to begin with, to make sure we do have 

liquidity. I think we made a right move and we need to make it 

permanent in raising conforming loan limits in high-cost areas, 

FHA, Freddie Mac, and Fannie Mae, those are hugely important to 

getting the market to turn around. 

I don’t understand the bulk refinancing programs proposed in 

this bill. I need to talk to the chairman about that to understand. 

I am kind of concerned about that a little bit. I don’t know also how 

we impact the market if we’re taking 85 percent of what the home 

is worth in the market value. Does that somehow in the future impact appraisers when they’re going out appraising the market 

value of a home? Is the appraiser going to say, well, the market 

value should be 500 but it’s now 425, because that’s what lenders 

are taking to pay off the debt? I don’t know those answers to those 

questions, but I think it is something we have to get to. 

Thank you. 

The CHAIRMAN. I thank the gentleman. The final 1 minute goes 

to the gentleman from California, Mr. Campbell. 

13 

Mr. CAMPBELL. Thank you, Mr. Chairman. Mr. Chairman, you 

referenced a coincidence with the Bush Administration yesterday. 

I think there was another coincidence yesterday, which was the information that apparently Citibank may have reached a deal with 

private equity firms to buy $12 billion of their troubled loans. And 

it raises for me three questions here, which I hope to ask over the 

next 2 days as we have these hearings. One is, who are we bailing 

out here? Are we really bailing out truly disadvantaged troubled 

homeowners, or are we bailing out Citibank? Are we adding advantage to private equity firms? What are we doing here? 

Second, how do we avoid adverse selection if we are offering to 

have the FHA to take over certain loans? And third, is this kind 

of—I would say secondary, except it’s really kind of a third tier 

market for these troubled mortgages developing already as we saw 

yesterday with some private equity firms. 

And so with that, I yield back, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman, and we will now begin 

with our panel. Let me say as we begin that I am very grateful, 

especially to our colleagues in the bank regulatory area. I don’t 

want to put words in anybody’s mouth, and people have their own 

independent views, but every one of the agencies represented here 

has been very helpful. And without signing on in principle, we have 

found both the public and private comments and the availability of 

the staffs of all the agencies very helpful. Because I think there are 

a number of ideological issues, there are some practical issues, and 

I am very grateful to the staffs of all the regulatory agencies and 

to the heads of them for making them available so that we can 

come together. And I will say that there are comments that were 

made by all the regulators that, frankly, before we began to put 

this bill together I think you will find much of what you said reflected in the bill, not always necessarily the way you like it, but 

then, as we age in particular, we are not always entirely pleased 

by our reflections, but they are nonetheless our reflections. 

We will begin with the Chair of the Federal Deposit Insurance 

Corporation, Ms. Bair. 

STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN, 

FEDERAL DEPOSIT INSURANCE CORPORATION 

Ms. BAIR. Thank you, Chairman Frank, Congressman Miller, 

amd members of the committee. I appreciate the opportunity to testify today. 

The problems we face in the housing and credit markets were 

caused by a very complex set of interrelated events. Steps taken to 

date have helped, but more proactive approaches are needed to 

stop the escalation in foreclosures and to restore stability to housing markets. We do need more intervention, and to be honest, it 

will probably cost some money. No single solution can fully address 

the problem. Resolving these issues will require a number of strategies for the different segments of the mortgage market. 

The FDIC has aggressively advocated systematic, voluntary loan 

modifications to deal with millions of unaffordable loans, particularly in the subprime market. While significant progress has been 

made, it must be acknowledged that the pace has been too slow to 

14 

achieve the scale necessary to contain broader harm to communities and our economy. 

I think all of us are painfully aware of the extent of the damage 

and the ongoing effects on virtually every State in the union. So 

in the time remaining, I would like to make a few comments about 

the pending legislation. 

The proposal by Chairman Frank addresses many of the principles the FDIC considers necessary for an effective program. It 

converts troubled mortgages into loans that should be sustainable 

over the long term and convertible into securities. It requires that 

investors recognize current losses, while preventing borrowers from 

being unjustly enriched if home prices appreciate. It uses existing 

government and market structures, which should allow the program to be implemented more quickly. And the legislation provides 

a financial cushion in the program to help insulate the Federal 

Housing Administration and taxpayers from losses. 

Still, there are some specific issues that need to be addressed, we 

feel. A major obstacle to refinancing many troubled first mortgages 

is that a significant percentage of them are subject to second liens. 

Resolving this issue is essential to ensuring the effectiveness of any 

proposal. 

A second concern is whether the FHA, at least in the short term, 

will have adequate capacity to run the program. 

Third is the unintended consequence of promoting adverse loan 

selection, which could increase the potential of losses for the program. 

And a final issue, which Chairman Frank already mentioned, 

was the incentives or lack of incentives for servicers to modify 

loans. The reality is that the success of this proposal in achieving 

scale restructurings depends on servicers devoting significant resources to writing down these loans. 

In my prepared testimony, we have made suggestions for addressing many of these issues. These include holding back a certain 

portion of refinancing proceeds which would then be released to investors and servicers over time, depending on the continued performance of the loan. 

The FDIC supports long-term solutions that fairly share the costs 

and risks of modifying or restructuring loans that use existing government market systems and that mitigate the potential exposure 

to taxpayers. The FDIC is committed to working with this committee and others in Congress to find the right combination of 

strategies to stem the rising tide of foreclosures and corresponding 

declines in home values. 

I think all of us share the goal of restoring health and vibrancy 

to mortgage markets and to repairing the damage done to America’s promise of owning a home. 

Thank you very much. 

[The prepared statement of Chairman Bair can be found on page 

94 of the appendix.] 

The CHAIRMAN. The Comptroller of the Currency, Mr. Dugan. 

15 

STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

Mr. DUGAN. I appreciate the opportunity to testify today concerning the draft FHA Housing Stabilization and Home Ownership 

Retention Act of 2008. 

Today’s hearing takes place in the context of broad efforts by the 

government, the industry, and community organizations to respond 

to challenges presented by rising rates of foreclosure. The Act 

would establish a new program that would provide a distressed 

borrower who could no longer afford his or her mortgage and the 

holder of the mortgage with an alternative to the costly prospect 

of foreclosure. 

This program has three key elements. First, if the borrower and 

mortgage holder agreed, and the borrower met certain criteria, the 

mortgage holder would reduce the mortgage principal to an amount 

that would be affordable for the borrower. Second, the mortgage 

holder would accept the corresponding loss. And third, the mortgage would then be refinanced into a new FHA-insured mortgage 

product at the lower amount. 

The concept is that the alternative would be less costly than foreclosure for many such loans, which would be the incentive for mortgage holders to agree to it; that it would allow borrowers to remain 

in their homes with lower mortgage payments, which would be 

their incentive for agreeing to it; and that the written-down mortgage would be an acceptable risk for the government to assume in 

order to lessen the prospect of widespread foreclosures and all their 

related costs. 

Because the program is voluntary, the Act could be a useful new 

tool, and safety and soundness considerations for banks would be 

manageable. Each bank or mortgage holder could evaluate the 

range of risks and benefits of the new program relevant to its particular situation. 

If the option proved to be an attractive and less costly alternative 

to foreclosure, as intended, it could save national banks significant 

amounts of time and money, and benefit their borrowers and their 

communities. The pivotal question is the extent to which borrowers 

and mortgage holders would actually choose this new voluntary option. This will depend on a potentially complex mix of factors. 

On one hand, the direct cost of foreclosure is steep in most cases, 

with lenders’ and investors’ losses on foreclosure typically in the 

range of 40 percent, although this number can vary. On the other 

hand, depending on particular circumstances such as the amount 

of home price decline and the borrower’s documented income, the 

direct cost from exercising the program’s refinancing option may 

also be steep. We include a number of specific examples in our 

written statement to show that in some very plausible circumstances, exercising that option may or may not be less costly 

than foreclosure. 

Another variable is the extent of payment shock faced by some 

borrowers with adjustable rate mortgages, or ARMs. Initial fixed 

interest rates on hybrid ARMs reset to higher variable rates, but 

these rates have recently declined as key ARM interest reference 

rates dropped sharply this year. Thus, more ARMs may be affordVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
16 

able than previously envisioned so long as interest rates remain 

low. 

Nevertheless, recent property value declines have left many borrowers owing more than their houses are worth, sometimes referred to as negative equity. Foreclosures are still up, and it appears that negative equity is contributing significantly to that problem. 

Where second mortgage holders are present, refinancing under 

the new program faces additional challenges. As I explain in my 

written testimony, when a borrower has insufficient equity in his 

or her home to cover first and second mortgages, the second mortgage holder’s objectives and incentives are very different from the 

first mortgage holder. This suggests that it will be essential to understand the concerns that second mortgage holders have and to 

identify incentives they regard as workable. The existence of private mortgage insurance further complicates matters. 

In conclusion, I would note that designing incentives that balance the needs of borrowers, lenders, and investors is a very complex and delicate task. There is no easy solution, and we have 

made suggestions in our written statement to address some of the 

issues we have identified. 

At the end of the day, the more constructive the options that 

stakeholders have to address the prospect of foreclosure, the greater the chance that homeowners can remain in their homes. 

Thank you very much. 

[The prepared statement of Comptroller Dugan can be found on 

page 123 of the appendix.] 

The CHAIRMAN. Next, the Director of the Office of Thrift Supervision, John Reich. 

STATEMENT OF THE HONORABLE JOHN M. REICH, DIRECTOR, 

OFFICE OF THRIFT SUPERVISION 

Mr. REICH. Good morning, Chairman Frank, and members of the 

committee. I appreciate the opportunity to testify on how to turn 

back the rising tide of home foreclosures in America, and particularly to offer the views of the Office of Thrift Supervision on the 

FHA Housing Stabilization and Home Ownership Retention Act of 

2008. 

I would like to commend you, Mr. Chairman, for your diligence 

and leadership on this important subject, and also to thank you for 

the cooperative approach and exchange of ideas that my staff has 

had with yours as we and others work towards this essential common goal. 

In my comments, I would like to share a few thoughts about loan 

modifications, and then speak to the similarities and the points of 

departure between the OTS foreclosure prevention proposal and 

the FHA Housing Stabilization and Home Ownership Retention 

Act, which I will refer to as the chairman’s bill. 

Regarding loan modifications, the data that we are seeing confirms that the sheer volume of foreclosures is overwhelming normal 

resolution channels. In addition, foreclosures are reducing the 

prices of other homes in affected neighborhoods, creating a cascading problem. We are at a crossroads in addressing the combined 

17 

effects of reduced home prices and the next wave of rate resets for 

subprime, 2/28, and 3/27 mortgage loans. 

About 1.3 million American families have subprime mortgages 

that are scheduled to reset by the end of 2008. Despite a decline 

in interest rates, foreclosures among subprime borrowers holding 

these types of mortgages are expected to continue to rise. 

Although some loan modification programs have been reasonably 

effective, more needs to be done, and soon. That being said, any solutions must preserve the integrity of the broader mortgage markets. Although some might argue that these markets fuel speculative and unsafe mortgage lending, many U.S. consumers own 

homes solely because of favorable mortgage rates and terms received through the efficiency of the U.S. capital markets. We must 

ensure that efforts on behalf of consumers who entered into bad 

deals do not compromise the greater collective interest of all consumers for affordable housing finance. 

Regarding the chairman’s bill, and the OTS foreclosure prevention proposal, both seek to preserve homeownership and prevent 

foreclosures through the use of the new FHA-guaranteed loans 

based on the current fair market value of the property. 

As we have met during recent weeks with major servicers, investors, and fellow regulators about the OTS proposal, we have done 

some fine-tuning in some ways that has brought our proposal closer 

to the proposed legislation. For example, we now think that it 

makes sense for borrowers to share in the potential upside when 

their home appreciates in value in the future as an incentive not 

only to remain in the home, but to maintain it as well, and even 

make improvements to get the best possible price upon resale. 

However, we still think that the key to success for this approach 

is for the loan servicer to have enough incentive through a stake 

in the future upside potential to be moved to action to save the 

home from foreclosure. If the servicer, acting on behalf of the original loan holder, does not have sufficient incentive, then no action 

will be taken, more homes will be lost to foreclosure, and this crucial foreclosure prevention effort will fall painfully short of the 

mark. 

In another example of fine-tuning the OTS proposal, we originally proposed the new FHA loan be at almost 100 percent of the 

fair market value of the home. We now believe that there is merit 

in lowering that amount to minimize risk to the FHA. However, if 

the holder of the loan takes this bigger haircut up front, it makes 

all the more sense to provide a potential share of the upside down 

the road. 

While we do not think that using FHA as a financing vehicle to 

prevent foreclosures will be the silver bullet that stops the housing 

slide, we do think that it is an important additional tool that lenders can use to stem the rise in foreclosures. 

Thank you again for having me here today, Mr. Chairman. I look 

forward to your questions. 

[The prepared statement of Director Reich can be found on page 

165 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Reich. And you accurately reported the degree of cooperation between the staffs, as is the case 

18 

also, and we are very grateful to the Federal Reserve System, and 

we welcome Governor Kroszner. 

STATEMENT OF THE HONORABLE RANDALL S. KROSZNER, 

BOARD MEMBER, BOARD OF GOVERNORS OF THE FEDERAL 

RESERVE SYSTEM 

Mr. KROSZNER. Chairman Frank, Ranking Member Bachus, and 

other members of the committee, I am pleased to be here to discuss 

the efforts to address current problems in the mortgage and housing markets, including some aspects of the discussion draft of the 

FHA Housing Stabilization and Home Ownership Retention Act of 

2008. 

The mortgage market has long been a source of strength in the 

U.S. economy, but it is facing very significant challenges today. 

Both delinquency and foreclosure are dramatic experiences for the 

families and communities who are affected. Recent declines in 

house prices have eroded the equity that homeowners have in their 

homes, and this has made it difficult or impossible for many of 

them to be able to refinance their mortgage. Tighter lending standards have also limited opportunities for these families to refinance. 

Moreover, when struggling homeowners cannot put themselves 

on a sustainable financial footing, neighborhoods also suffer because the properties are not maintained and because foreclosure 

puts further downward pressure on housing prices. 

The fact is that many borrowers having trouble making payments also have mortgages that are underwater, that is, have negative equity. This suggests that principal reductions can be an appropriate option in a loan modification toolkit. In the discussion 

draft, principal reductions would be facilitated by providing the 

FHA with the flexibility to ensure a broad range of refinancing 

products for a larger number of at-risk borrowers. 

The voluntary nature of the program assures that not only borrowers whom the servicer believes cannot successfully carry their 

current mortgage contracts would be considered for such a program. 

If the Congress decides to move down this road, it should carefully consider five very important issues: 

First, mitigating moral hazard. Homeowners who can afford to 

pay their current mortgage should not be encouraged to default in 

order to qualify for a write-down. 

Second, mitigating adverse selection. A robust defense against 

adverse selection, that is, the incentive of current servicers or lenders to send only their worst credits to government-insured mortgage programs, is necessary to protect the interests of the taxpayer. 

Third, turning the FHA into a world-class mortgage insurer. 

With modernization and expansion, the FHA could play an important role in relieving stress in the mortgage and housing markets 

as well as restarting the securitization markets. 

Fourth, protecting the taxpayer. Any government-insured mortgage offered under a refinance program needs to be prudently underwritten, regardless of whether the principal write-down is part 

of the deal or not. First and foremost, this means establishing a 

meaningful amount of homeownership equity. Second, it means 

19 

using sound underwriting criteria to ensure that borrowers are reasonably likely to be able to repay the government-insured loan on 

a sustainable basis. Third, it means allowing the FHA to engage 

in sensible risk-based pricing of its mortgage insured products, including substantial flexibility in setting its initial premium and annual premiums. 

Fifth, negotiating the junior liens. Typically, the junior lien holder must agree to remove his lien in order for a portion of the proceeds from the refinancing or resubordinate his claim to the new 

loan. The valuation of the junior lien holder’s claim on the property 

is often very difficult to renegotiate. 

Elements of these considerations are already reflected in many 

parts of the discussion draft. For example, Title 1 of the discussion 

draft includes exit fees, shared appreciation mortgages, and a relatively high debt payment to income ratio before the program 

starts in order to address concerns about borrower moral hazard. 

It also contains features to protect the taxpayer, such as widening the range of insurance premiums and creating a meaningful 

amount of borrower home equity. As for adverse selection, the riskbased insurance premiums paid by the servicer are crucial, and 

Title 1 could be clearer about the FHA’s authority to use risk-based 

premiums. 

Other steps to guard against adverse selection could include adding a loan seasoning requirement, that is, for example, a period 

during which a new loan could be sent back to the original servicer 

or lender if it redefaults, and a fee structure that imposes costs on 

the original servicer or lender if the new government-insured loan 

goes bad within a specified period or probationary period. 

In the design and details of a principal reduction program based 

on a government-insured refinancing, it is critical to strike the 

right balance between the interests of borrowers, servicers, investors, and taxpayers by seriously considering the issues I have outlined above. 

Moreover, although principal write-downs may be especially germane today given the prevalence of negative equity positions, they 

are not necessary or appropriate for all borrowers who have negative home equity or who become delinquent on their mortgage. 

Given the magnitude of the potential foreclosures on the horizon, 

Congress should carefully evaluate whether to take additional actions to reduce the rate of preventable foreclosures. Properly designed, such steps could promote economic stability for households, 

neighborhoods, and the Nation as a whole. 

Thank you very much. 

[The prepared statement of Governor Kroszner can be found on 

page 144 of the appendix.] 

The CHAIRMAN. Thank you, Governor. 

And finally, the Commissioner of the Federal Housing Administration, Assistant Secretary Brian Montgomery. 

20 

STATEMENT OF THE HONORABLE BRIAN D. MONTGOMERY, 

ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING 

COMMISSIONER, U.S. DEPARTMENT OF HOUSING AND 

URBAN DEVELOPMENT 

Mr. MONTGOMERY. Thank you very much, Mr. Chairman, and 

Ranking Member Bachus, for inviting me to testify this morning. 

Mr. Chairman, I want to say that we are aligned in our goals for 

addressing this mortgage crisis. We agree that we must restore liquidity to the credit markets and stability to the real estate markets. 

We agree that there is an appropriate role for the government to 

play, and that we must use government resources wisely. And we 

agree that we must help families in need without transferring risks 

and costs from the private sector to taxpayers. 

As you well know, for more than 2 years, the Administration has 

requested FHA modernization legislation to prevent the very circumstances in which we now find ourselves. And I want to reiterate that it is even more critical now that this bill be enacted. 

I am grateful for the support that you, Ranking Member Bachus, 

and bipartisan majorities of this committee have given to this important legislation. And I would urge you, I would ask you, to 

quickly reach an agreement with the Senate so the final bill can 

be sent to the President’s desk. 

As you have heard previously, Mr. Chairman, there are two key 

components that must be part of the final bill. To ensure the future 

solvency of the FHA fund, the legislation must permit risk-based 

premiums, and it must prohibit seller-funded downpayment assistance. Foreclosures on these loans are 3 times as high as loans for 

borrowers who make their own downpayments. We can no longer 

sustain the mutual mortgage insurance fund without an appropriation if we do not address these problems. 

Now, while modernization should be the highest legislative priority, expanding the FHA Secure program administratively is the 

most appropriate and fastest means to help more families in need. 

As you know, we have been exploring options, and I would like to 

share the Administration’s plan. 

We believe it is appropriately tailored to reach homeowners who 

have demonstrated their commitment to making on-time payments, 

even during times of financial stress. I want to emphasize that we 

believe it is critically important to focus on those homeowners who 

are working hard to fulfill their obligations. 

FHA will now back loans for borrowers who are financially capable, but who have a spotty credit record. To qualify for a standard 

97 percent LTV loan, borrowers will still be eligible if they were 

late on two monthly payments, either consecutively or at different 

times over the previous 12 months. 

For borrowers who cannot meet this standard, FHA will permit 

up to 3 months of delinquency, but FHA will limit the LTV ratio 

for these borrowers to 90 percent. We will permit and we will encourage lenders to voluntarily write down outstanding principal. 

Lenders will also be allowed to make other arrangements, including new subordinate liens, to fill the gap between an existing loan 

balance and the new loan amount, be it a 97 percent or a 90 percent LTV loan. 

21 

These underwriting changes will also be coupled with a new and 

more flexible pricing policy at FHA. As you know, the FHA program is funded through insurance premiums that homeowners pay 

themselves. And we are rolling out a new pricing plan that will 

base new premiums on an individual’s risk profile. 

This new administrative change will ensure the integrity of the 

FHA insurance fund over the long term, it will protect the taxpayer, and it will guarantee that FHA will be around in the future 

to help struggling homeowners. We believe that by year’s end, this 

new version of FHA Secure will reach more than half-a-million 

homeowners. This figure represents a substantial portion of the 

total universe of homeowners with subprime ARMs who are owner 

occupants, have documentation to demonstrate their ability to 

repay the loan, and who are not already in foreclosure. 

While I believe that these actions are consistent with parts of 

your proposal, I want to point out some areas where we do not 

agree. 

The mandatory write-downs remove any ability of a subordinate 

lienholder to negotiate a short payoff, and would severely restrict 

the number of lenders and borrowers who would participate. A simpler approach, more in line with existing market practices, we believe, would be more effective. 

Underwriting standards should also not be set in statute, and we 

don’t believe the current proposal is sufficiently targeted. It mandates a loosening of the underwriting criteria that could also saddle 

FHA with too much risk. For example, the proposal would have 

lenders disregard some underwriting criteria, and allow borrowers 

with much higher debt to income ratios to be eligible. Preserving 

our administrative flexibility to help homeowners and protect taxpayers is critically important. 

The Administration also strongly opposes the $10 billion in loans 

and grants for the purchase and rehab of vacant and foreclosed 

homes. The principal beneficiaries of this type of plan will be private lenders who are now the owners of the vacant or foreclosed 

properties. 

Finally, we do not support proposals to create a system where 

lenders would have an opportunity to sell bad loans to FHA and 

to the taxpayer through an auction process, a clearinghouse, or 

some other wholesale mechanism. We do not believe that it is necessary to encourage mortgage holders to sell portfolios at a discount to new investors. The market does not need a government 

entity to play this role. 

Again, Mr. Chairman, and Ranking Member Bachus, while we 

disagree with some components of the bill, other elements are similar to the expansion of FHA Secure. These are my thoughts on the 

bill. I again stress that our common ground can be used to help 

FHA become a safe harbor for many more Americans, and I look 

forward to working with you on this committee. Thank you. 

[The prepared statement of Assistant Secretary Montgomery can 

be found on page 160 of the appendix.] 

The CHAIRMAN. Let me begin with that, Mr. Montgomery. You 

are right, there is some common ground. In particular, as I understand it, you are going to use your administrative authority to 

22 

broaden the universe of people who can come to the FHA, and they 

would be people who had defaults. 

You are also agreeing that we should be asking the servicers or 

telling the servicers that were they to write down the principal, 

then the FHA would take on, I think it is fair to say, a greater degree of risk than before. 

Now, you have heard several members of the committee today be 

very critical of this notion of the taxpayers being at risk. What you 

are talking about is an FHA guarantee. How do you respond to the 

criticisms we have heard that we should not be at this right now? 

Again, these are people who, to quote some of the members 

today, borrowed more money than they can pay back. And we agree 

with you, we should be asking the holders of those loans to write 

them down, and we should let them into the FHA and give them 

a federally taxpayer-based guarantee more than we would have in 

the past. We would differ about how much. 

How do you respond to the criticism that this is putting taxpayers’ funds at risk for people who had imprudently borrowed? 

Mr. MONTGOMERY. That is precisely what we don’t want to do, 

put taxpayers at risk. FHA is an insurance fund, sir, as you know. 

We have to balance the risk characteristics of all of our borrowers, 

and we want to be able to help borrowers in the future. There is 

a family somewhere in— 

The CHAIRMAN. Mr. Montgomery, let’s not filibuster. I understand we want to help people in the future. We all want to do a 

lot of things. How do you answer the criticism that by expanding 

the eligibility so that people who have mortgage loans they cannot 

now make, we ask that they be written down in the principal. They 

now come to the FHA, and you are now going to extend an FHA 

guarantee, according to the announcement of yesterday, to people 

who hadn’t previously been eligible because they had a default, etc. 

How do you answer the argument that this is taking people who 

borrowed imprudently, giving the lender an incentive to relax it, 

and then giving them a Federal guarantee? 

Mr. MONTGOMERY. Yes. The point I was getting to, sir, is that 

90 percent LTV loans in the FHA’s portfolio perform very well. In 

going forward, whatever a lender and whatever the current borrower want to agree to, if they are underwater, as long as they 

don’t have more delinquencies than I have outlined before, I am 

saying today FHA, assuming they pass our underwriting criteria, 

will step in and take 90 percent of that— 

The CHAIRMAN. I understand that. You are just repeating it. But 

does that not expose us to greater risk than we were before you announced this program? 

Mr. MONTGOMERY. Look, there were borrowers who had no-doc 

loans, low-doc loans. Many of those— 

The CHAIRMAN. Mr. Montgomery, please just answer my question. 

Mr. MONTGOMERY. I am answering. Many of them will qualify. 

The CHAIRMAN. No, you are not. Does this change, which expands the eligibility, waives some of the objections on default—does 

it expose us to people who are riskier than previously we had taken 

into the FHA program? 

Mr. MONTGOMERY. Yes. Yes, sir, it does. 

23 

The CHAIRMAN. It does. Thank you. 

Mr. MONTGOMERY. Yes. 

The CHAIRMAN. Okay. That is the answer. And I appreciate your 

doing that. I think it is appropriate. But while there are some differences, we are in agreement that the current crisis calls for a 

greater risk tolerance on the pat of the taxpayer, which puts some 

taxpayer funds at risk, and the beneficiaries of that greater risk 

tolerance are going to be people who borrowed more than they 

should have. 

Let me just ask Governor Kroszner now, because one of the criticisms that we have heard was on this federally funded mechanism, 

essentially the notion that we should have in the bill, as we do, an 

auction mechanism. That is actually something, as you know, Governor, that we discussed with the Federal Reserve. 

You mentioned it favorably in your testimony. Would you explain 

why you think that would be a useful option for us to have an auction? Let me say, and I have drawn this from Chairman Bair, the 

problem with the original approach was that you do these loans 

one at a time. I mean, FHA Secure has done about 2,400 loans. We 

are talking about a very long time before they are done. 

There are a couple of things about the auction mechanism. One 

is a price-setting, but also, it allows you to move more than by 

onesies and twosies. But I wonder if you would address that issue 

about the desirability of that as an option, Governor Kroszner. 

Mr. KROSZNER. Sure. Thank you, Mr. Chairman. If Congress is 

concerned that a loan-by-loan approach will not address the problem sufficiently, it certainly could consider adding what is in Title 

2, and the ability to expand the program quite significantly so that 

it could operate on a larger scale. 

If properly structured, and of course this is going to be very difficult to address all of the concerns of moral hazard, protecting the 

taxpayer, adverse selection, in developing such a mechanism, it 

could have the potential to mitigate some of the turmoil in the 

housing market. 

And so, if you do decide to go ahead on this, it is very important 

that the agencies that are given the ability to implement this have 

the full latitude of such authority and a great deal of flexibility to 

do the implementation. 

The CHAIRMAN. Thank you, and my time is expired. I am going 

to hold members to time. We have a lot of members, a lot of witnesses, and a lot of interest. 

The ranking member, the gentleman from Alabama. 

Mr. BACHUS. Thank you. I appreciate your testimony here this 

morning. And Chairman Bair, I thought on page 2, your paragraph 

about the complex set of interrelated causes was a very succinct 

and very accurate description, at least in my opinion, of what happened leading into this. And it—well, I will just say that. I won’t 

go into more detail. 

I appreciate everyone’s testimony. I thought it was all very 

thoughtful. And Mr. Montgomery, I want to commend you for 

streamlining FHA and making it more user-friendly. You have 

heard a lot of compliments from both sides of the aisle about that 

process, and I thank you. 

24 

Governor Kroszner, let me ask you the first question. I read in 

the Wall Street Journal where Senator Clinton had compared our 

present situation—equated it to the lost decade in Japan, the Japanese economy of the 1990’s. It is getting a lot of currency recently. 

I don’t see that. I think it is just the opposite. I think that the 

banks are being aggressive in writing down their losses, that the 

regulators are being responsive. You are supplying liquidity. I don’t 

think the banks or the regulators are in denial. 

But what are your thoughts on that? Is that, in your opinion, accurate? 

Mr. KROSZNER. I think the various government entities have 

taken a much more aggressive stance in the United States than 

Japan did during their lost decade. I mean, just for example, the 

Federal Reserve alone has cut interest rates by 300 basis points. 

We have provided a great deal of liquidity to the financial system 

through traditional and new mechanisms, providing liquidity to 

longer term, taking a larger number of—different types of collateral, and expanding the number of types of institutions that could 

borrow from us. 

Firms have been much more aggressive now than they were in 

Japan in writing down the problem loans. We have seen tens of billions, literally hundreds of billions of dollars of write-downs that 

have occurred in the last 6 months alone. We didn’t see that in 

Japan for many, many years. 

And also, the Congress was able to, and the Administration was 

able to move very quickly with a targeted fiscal stimulus package. 

I think all of these are very different kinds of responses in the last 

6 months to this turmoil than we saw in Japan during their lost 

decade. 

Mr. BACHUS. Thank you. I think they are very different, too. I 

think they are comparing two very different situations. So I agree 

with your response. 

Commissioner Montgomery, today—and this is the Wall Street 

Journal again; I do read things other than the Wall Street Journal, 

by the way, but I will just use it as kind of a basis of the question—they said ‘‘The expansion of FHA Secure will be funded by 

risk-based premiums rather than up-front cost, between $10 billion 

and $20 billion in Chairman Frank’s plan.’’ So that is not me. That 

is at least— 

The CHAIRMAN. That is the objective Wall Street Journal. 

Mr. BACHUS. Yes. But can you explain the difference? Is that a 

valid comparison? Explain the difference between the funding 

mechanisms for the Administration’s plan versus Chairman 

Frank’s plan? 

Mr. MONTGOMERY. Well, going forward, we think our premium 

structure, as Governor Kroszner also said, needs to be based on 

risk. This is not a new concept. It is something we have been discussing for 2 years. 

I am going to tie in the seller-funded downpayment for one second because that is what is driving us to the brink of financial insolvency. We cannot continue to accept that without having some 

flexibility in our pricing. Now, we think we can do this proposal administratively, going to our statutory limit of 2.25 on the up-front 

premium. 

25 

I understand the chairman’s proposal would go to 5 percent for 

those borrowers. That is something that we can certainly discuss 

going forward if it means in an actuarial standpoint that we could 

help more borrowers. Certainly that is on the table. I am just 

bound to what my current constraints are on premiums. 

Mr. BACHUS. So this would be paid for by premiums? 

Mr. MONTGOMERY. We are a self-sustaining agency. We take no 

taxpayer funds except to pay our salaries and expenses. 

Mr. BACHUS. Will all homeowners, through the payment of higher premiums, will they all pay more for the default of a few? Many 

on this side of the aisle, you heard this morning— 

Mr. MONTGOMERY. I am going to say—I am sorry, sir, but I am 

going to say, going forward, a lot of the borrowers—remember, 

these are not FHA borrowers. These are subprime borrowers who 

have defaults. 

Mr. BACHUS. Well, yes. 

Mr. MONTGOMERY. It is safe to say many of them would pay at 

the higher range of that 2.25. But going forward, some purchase 

borrowers may also realize a small discount that they would not 

see today. 

Mr. BACHUS. So if they have a good credit history— 

Mr. MONTGOMERY. Yes, sir. That is correct. 

The CHAIRMAN. The gentleman’s time has expired. 

Mr. BACHUS. Thank you. 

The CHAIRMAN. The gentlewoman from California. 

Ms. WATERS. Thank you very much. 

Chairman Bair, I want to focus on the servicers. They are kind 

of in the driver’s seat here. We have been talking a lot about them, 

and I think you mentioned something about incentives. I am not 

clear because I have heard that the servicers actually earn a profit 

on foreclosures. And then I am hearing that in order to foreclose, 

it costs so much money that you lose a lot of money on foreclosures. 

I want to know, what do you know about the truth in all of this, 

and what other kinds of incentives do the servicers need to do 

modifications? We are told we can’t interfere with that contract 

that they have with the investors. So what other kinds of incentives do we have to get them to do real modifications? 

Ms. BAIR. Well, in terms of incentives for foreclosure versus 

modification, most of the pooling and servicing agreements that we 

have looked at will provide for servicer reimbursement for administrative costs associated with foreclosure. They should not be making a profit, but they do provide for reimbursement from the pool 

for administrative costs associated with foreclosure. 

There are no such provisions for administrative costs associated 

with loan modifications. So, even though it is the fiduciary obligation of the servicer to maximize the economic benefit to the pool as 

a whole, in terms of the reimbursement structure, there is reimbursement for administrative foreclosure costs generally, and not 

for modification costs. 

We recommend, going forward, that pooling and servicing agreements be changed so that servicers can get reimbursed for costs associated with modification as well. But again, I reiterate that our 

view is that regardless of the reimbursement structure, it is the fiduciary obligation of the servicer to maximize the benefit to the 

26 

pool as a whole. And generally that will mean a modified loan will 

perform better and have more economic value than a foreclosed 

loan. 

But we do think that—as Chairman Frank mentioned—there 

may be a way to build in some ability to reimburse the servicer’s 

costs for performing loans. But we think that it should be tied to 

whether the loan actually performs once it is written down. I think 

Governor Kroszner referred to that type of incentive as well. I 

think you want to make sure that if you try to enhance economic 

incentives for servicers, that they are doing real write-downs and 

giving FHA a loan that will re-perform over the long term. 

Ms. WATERS. Have you or anybody taken a look at these administrative costs? One of the problems we have up here is with our 

regulators. We knew nothing about the no-doc loans. We didn’t 

know the extent to which the ARMs were being offered. We didn’t 

know about these exotic products. And our regulators didn’t oversee them. They didn’t tell us anything. They didn’t warn us. They 

didn’t vet them. 

Now we are being told that the servicers are making money on 

foreclosures. And you are saying no, they are reimbursed only for 

administrative costs. Are the administrative costs truly administrative costs? Do you know that? Can you represent to us that they 

are not making a profit on it, that there are simply administrative 

costs being reimbursed? 

Ms. BAIR. Some servicers are parts of large organizations that 

have affiliate units that do foreclosures. There has been some publicity surrounding that, and there have been issues raised. These 

are not institutions that we regulate, so I can’t really comment. 

But there are some servicers that have affiliates that perform 

foreclosure functions, and— 

Ms. WATERS. Who regulates— 

Ms. BAIR. I don’t talk about specific institutions, but we would 

be happy to talk with your staff. 

Ms. WATERS. Does anyone know who has the responsibility for 

knowing the question that I am asking about whether or not the 

servicers are making a profit on foreclosures? Who can give us information on that? Anybody? 

Mr. DUGAN. Ms. Waters, it is my understanding that most of the 

agreements with servicers, and a number of the national banks 

that we regulate do perform servicing functions, provide for normal 

servicing costs, which is generally about 50 basis points, plus administrative costs. And it may include some overhead. 

But the whole point here is that they do have to be compensated 

for the services that they are providing. 

Ms. WATERS. Yes. I don’t mind compensation, if I may. 

Mr. DUGAN. Sure. 

Ms. WATERS. But I asked a question about whether or not they 

are making money. The problem that we have here is we don’t understand the details and the nuances of all of the servicing. And 

I simply want to know who understands it, and who knows it, and 

it seems as if nobody does. 

I yield back. 

The CHAIRMAN. The gentleman from Illinois, Mr. Manzullo, is 

next on the list I was given. 

27 

Mr. MANZULLO. Thank you. I appreciate your coming here. And 

Mr. Chairman, I appreciate your putting out a working draft before 

moving to the exact language on your proposal. 

I have some issues dealing with the liens. The draft talks about 

eliminating existing liens on mortgages—I am sorry, existing liens 

on the title, and that those would be extinguished when the mortgage is refinanced. At any given time, I am assuming that there 

could be a typical mechanics lien on the property from somebody 

who put in new windows and was not paid for it, to a home equity 

lien, to a property tax lien because of failure to pay real estate 

taxes. 

I am very much interested in how eliminating these liens would 

be resolved, and if it could be resolved in something like that, 

which is similar to an 11 cramdown in bankruptcy in a corporate 

setting, the impact that this would have on the people who possibly 

gave the liens, such as the home equity lien, or the people who obtained the liens by way of a judgment, or a mechanics lien. Anybody can answer. 

Mr. DUGAN. Well, I will start. It is my understanding that it is 

voluntary for the lienholder. 

The CHAIRMAN. If the gentleman would yield, that is correct. It 

is a voluntary— 

Mr. DUGAN. And so what that means is in order to get the second 

lienholder to participate, I think that there is going to have to be 

some kind of concession made as a matter of negotiation. The reality is it would probably mean a bigger write-down in the value 

of the first loan with some negotiated payments to second 

lienholders. 

Mr. MANZULLO. So it is a composition? 

Mr. DUGAN. Pardon me? 

Mr. MANZULLO. You are talking about a composition. 

Mr. DUGAN. Well, it is a voluntary negotiated structure to see 

what it would take for them to extinguish the— 

Mr. MANZULLO. Okay. And that would apply to judgment creditors and property tax liens and mechanics liens, anybody who has 

a lien on title? 

Mr. DUGAN. I am most familiar with the second—the home equity lien. I don’t know about the other liens. 

The CHAIRMAN. If the gentleman would yield to me? 

Mr. MANZULLO. Of course. 

The CHAIRMAN. I guess the important question—yes, the assumption at this point is it would be—if anybody had a valid lien, 

we couldn’t extinguish it. We wouldn’t try to extinguish it. It would 

be voluntary. The servicer who was making the overall deal would 

have the obligation to pay it down. And if it was too much, and it 

didn’t pay, then we wouldn’t have a deal. But it would come out 

of the servicer’s—it would be the servicer’s obligation, or the borrower’s, to make the deal with those people. 

Mr. MANZULLO. The second question would be: If you have one 

of these proposals and there is a write-down on the mortgage because the property has decreased in value, what happens after 5 

years if the property increases dramatically in value? Does the taxpayer get stuck because they in effect put this into effect? 

28 

Or does the homeowner make out like a bandit because he 

bought the house at ‘‘X’’ price, the property fell in value dramatically, then he got a mortgage refinancing at a reduced price, and 

then the property went up in value again. I mean, what happens 

after 5 years? 

Under the first 5 years, there is a sliding scale. But why should 

the U.S. taxpayer step in, rewrite somebody’s mortgage because 

there is a loss of equity in the property, and then when the person 

goes to sell the property, there is actually a profit, and the taxpayer gets stuck? Anybody? 

Ms. BAIR. I don’t want to speak for Chairman Frank, but my understanding of the rationale behind it was to give the borrower an 

incentive to stay in the house and keep making mortgage payments. I don’t think any aspect of this situation is fair, frankly. I 

think, as has been pointed out, most people do make their mortgage payments on time. We just have a very difficult situation. 

Now we have a situation where we have a lot of unaffordable 

mortgages out there, and because they are going underwater, there 

are more and more loan defaults. We are moving from an ability 

to pay to a willingness to pay situation. 

So I think even though this bill focuses on affordability, it recognizes that negative equity can impact the borrower’s willingness to 

stick with a mortgage. 

The CHAIRMAN. If the gentleman would yield to me? 

Mr. MANZULLO. Yes. 

The CHAIRMAN. I think I can address that. It is a very good 

point. There is no magic to the 5 years, and that would be one of 

the issues that— 

Mr. MANZULLO. Well, my issue would be, for me to go along with 

something as dramatic like this, if you want a handout from the 

taxpayer, then be prepared to hand it back when you sell the property at a profit. 

The CHAIRMAN. I was trying to agree with the gentleman. 

Mr. MANZULLO. That is what really bothers me about this legislation, Mr. Chairman, is— 

The CHAIRMAN. I was trying—if the gentleman would yield, I 

have been trying to agree with that point. But I will withdraw that 

effort if he doesn’t want to be agreed with. 

Mr. MANZULLO. Thank you. 

The CHAIRMAN. What I am saying is that there is no magic to 

the 5 years. And yes, that is open for discussion, but I don’t want 

to say that it is not fair to put it on them because— 

Mr. MANZULLO. No. I just want to make another comment is, you 

know, anybody who has bought a brand-new automobile at 100 percent financing, the very next day it drops 20 percent in value. So, 

I mean, what is wrong about making payments on an item when 

your lien is more than the value of the property? It is done on $25- 

and $30,000 automobiles. And what is wrong with doing that on a 

house? Because the house eventually will appreciate in value. Just 

a point, Mr. Chairman. Anybody want to handle that one? 

Mr. DUGAN. Well, I guess I was going to say that there is nothing 

wrong with that. I think the assumption is if a borrower can afford 

to make the payments, they should continue making the payments. 

29 

It is only when they can’t afford to make the payments, and are 

in threat of foreclosure, that they shouldn’t. 

But one of the concerns expressed by servicers, and I know you 

will have a chance to ask them that question, is it may give an incentive for people who can afford to pay not to do so in the hope 

of getting a written-down mortgage at a lower amount. That is one 

of the issues. 

Mr. MANZULLO. Thank you. 

Ms. BAIR. I would also say that the write-down is designed to 

protect the government, because if FHA is refinancing these loans, 

you are building an extra cushion in case there is a default. There 

is a much better chance that, if FHA has to go into a foreclosure, 

they are going to recoup their costs. 

So building in that cushion protects the government, even though 

you are right—if the loan continues to perform, then under this 

bill, the borrower will be able to capture that appreciation if they 

remain current on their loan. But if they stay current on their loan, 

there will be no cost to the government. The loan will perform and 

FHA will not have a credit loss. 

Mr. MANZULLO. Thank you. 

The CHAIRMAN. The gentlewoman from New York. 

Mrs. MALONEY. Thank you very much. 

In order to forestall a meltdown of the financial sector, the Fed 

recently employed some creative, unprecedented, and I would say 

controversial steps to ease the credit crunch. But the Fed does not 

have a tool to address the real problem, the decline in home prices 

that is causing the banks to have a need to readjust their balance 

sheets and build up capital. And therefore, we have this proposal 

that Chairman Frank and the Democrats have put forward. 

I would like to thank Chairwoman Bair and Governor Kroszner 

for your supportive comments of our efforts. And I would like both 

of you to comment further on the legislation on the very important 

need that, Chairwoman Bair, you pointed out in your testimony, 

that we need to encourage incentives for lenders and servicers to 

buy in and to support this program. 

What other steps need to be taken? Obviously, if there is a foreclosure, there is a loss to all concerned. And what does the future 

hold for us. Is this going to work, or will the economy continue to 

decline? Will this stabilize the economy? Your comments, please, 

Chairwoman Bair and Governor Kroszner, and then anyone else 

who would like to comment. 

Ms. BAIR. I think this is an important additional tool, an important initiative. I think Chairman Frank has tried to very thoughtfully structure it to build in the right incentives for investors and 

servicers and borrowers, and protect the government. 

It is one tool. I think we need a combination of strategies. But, 

I think this is a very thoughtful proposal. We have some additional 

suggestions. The trick will be to convince investors who frankly, at 

this point, have not been showing an eagerness to realize losses on 

these loans. 

And so the question will be whether they are willing to go ahead, 

take the principal write-down, realize the loss, and enable the loan 

to be refinanced out of the pool. The benefit to them, of course, is 

that then the credit risk is gone. 

30 

Finding that magic number, finding those right incentives, I 

think, is very challenging. But this is a very, very thoughtful approach, and I think it will be a very important tool. I think perhaps 

it needs some further fine-tuning, which is why he has proposed it 

as a discussion draft. I think it will be a very important tool, but, 

we do need a combination of strategies. This could be very, very 

important. 

You know, FHA traditionally did this. Traditionally, they were 

the guarantor of low- and moderate-income loans with their nice, 

stodgy 30-year fixed mortgages, which we all fondly remember now. 

I think bringing some of this market share back to FHA makes 

sense. If there is a policy reason for government providing support 

in the mortgage area, it is probably the strongest with an entity 

like FHA and its role of supporting low- and moderate-income 

housing. 

Mrs. MALONEY. Governor Kroszner? 

Mr. KROSZNER. Thank you. Yes, I think it is important to remember that the Fed does have limited tools. Some people think that 

we have every tool available, but there are many tools that we 

don’t have. I think it is important to be considering other actions, 

and that is why we have been working very closely with the committee on thinking about alternatives. 

The incentive issue is really the key issue, and I am really glad 

that you focused on that, because in my testimony I emphasize the 

role of moral hazard, of people taking advantage of a program like 

this. And that would be for the borrowers trying to get into this 

program inappropriately, or for servicers putting bad loans into the 

program. 

These issues have come up, and I think the bill tries to address 

some of these concerns through exit fees. This also addresses an 

earlier question that, my understanding is from the draft legislation, that anyone who got into this, a borrower who got into this 

program, whenever they would leave the home or refinance, would 

have to pay an exit fee of 3 percent, even if that were beyond the 

5-year horizon. So there would be some sort of fee that would be 

collected by the government. 

There is some risk-sharing that goes on up to 5 years, and obviously that could be—there is no particular magic about those 5 

years. 

With respect to adverse selection of putting bad loans onto the 

taxpayers’ books, it is very important, as a number of us have emphasized, to make sure that the risk premium that is charged, the 

insurance premium that is charged, is risk-based. And so that is 

one important way to protect the taxpayer, and clarifying that in 

the bill would be valuable. 

But there could be other things, things that are standard parts 

of loan servicing contracts, that if something were to go wrong with 

a loan within a specified period of time, they would be able to put 

the loan back into the servicer. So they couldn’t just get away with 

putting bad loans back on. 

Given the challenges and the turmoil in the financial market, I 

think it is important for Congress to be considering alternative options. 

Mrs. MALONEY. Thank you. My time has expired. 

31 

The CHAIRMAN. The gentleman from Texas, Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. Undoubtedly, we on 

this committee and in the entire Congress have some very important policy decisions to make. And as we make these decisions, it 

is always nice to make sure that we also know the facts. 

I would like to review the facts as I know them, and see if anybody on the panel has substantial disagreement. As I understand 

it, if we took a snapshot today, we still—we have roughly 5 percent 

of mortgage borrowers who are delinquent, roughly 2 percent who 

are in the process of foreclosure. Is that a fairly accurate snapshot 

of where we are today? I don’t see any dissent. 

I also understand that we have roughly—of 108 million occupied 

housing units in America, roughly 25 million have paid off their 

mortgage, and roughly 33 million are renters, which means the 

universe of those with mortgages is less than half of the families 

in America. Is that a fairly good ballpark figures for the numbers? 

I see a lot heads nodding in assent. 

One question I have, clearly I am troubled by certain moral hazard aspects of various policy solutions that I have seen put before 

me. I am curious if any of you on the panel are familiar with this 

report from FinCEN, the Financial Crimes Enforcement Network, 

entitled, ‘‘Mortgage Loan Fraud.’’ It is a fairly recent report. Is anybody familiar with the report from FinCEN? I know you are all acquainted with FinCEN. No one has read this specific report? 

Mr. DUGAN. I am familiar with it. I have seen the press reports, 

but I have not read the report itself. 

Mr. HENSARLING. Well, I reviewed this report last evening. And 

when we are looking at the different people who may be assisted 

under various legislative proposals—and I am unfamiliar with who 

might have greater credibility on the subject of these activities; I 

am sure there are folks at HUD who would be well acquainted as 

well—but according to a FinCEN analysis, as I read it, fraud is up 

over 1,000 percent. Mortgage fraud is up over 1,000 percent in the 

last 4 years, with over half of it being attributable to misrepresentation of income, assets, debts, and occupancy fraud, with a fair 

amount, 28 percent, attributable to forged and fraudulent documents. 

At almost every hearing we have in this committee room, we 

hear the phrase ‘‘predatory lending.’’ But I am curious whether this 

might suggest that a fair amount of ‘‘predatory borrowing’’ has 

taken place, and that there are many borrowers who do not have 

clean hands who still might benefit substantially under a bill that 

we are considering now. 

Is anybody troubled by the moral hazard aspect of that and how 

that could affect future behavior? Does anybody care to offer an 

opinion on the subject? 

Mr. DUGAN. We have seen a very sharp rise in mortgage fraud 

from a variety of different directions, not just from the borrowers, 

as you suggested, but from the purveyors of the products as well. 

I do think it’s quite important that the bill have standards in it to 

screen out people who have not only had fraud in the past, but 

can’t find their way into an FHA loan that they can’t afford to 

repay, and I think that is what the standards are intended to do 

by the underwriting strictures that are in it. 

32 

But I think, going forward, the whole notion of having to document income, which is I think a critical feature of this bill and certain of the guidance that had been put out by the Federal banking 

agencies, is part of that process and is absolutely critical. 

Mr. HENSARLING. Although I don’t have a copy of it, I was also 

reviewing a Fed study from the Boston Fed that I think is maybe 

a month or two old, dealing with the reason for subprime defaults. 

And in that particular report, it seems to make the point that it’s 

not so much the reset that is causing the default; it is the devaluation or diminution of the value of the asset, which would seemingly suggest that a number of people entered into these financial 

transactions, never intending on being able to pay the reset, but 

they were banking on the appreciation of the asset. 

Mr. Kroszner, I suppose you may be familiar with this study, and 

if so, is that a proper take-away? 

Mr. KROSZNER. Yes. I think that study really tried to look very 

carefully at the role of resets versus the role of the asset prices, 

and I think what the study suggested is that at least through 2007, 

the resets were not the key to driving the increase in the delinquencies and the foreclosures, but really these were early payment 

defaults, in many cases within just a few months of initially taking 

out the loan. That suggests that it’s not the reset, which comes 2 

to 3 years later, but the value of the property or the reduction in 

the value of the property that is driving the consumer behavior 

here. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. 

Let me direct a couple questions to Mr. Montgomery and Mr. 

Kroszner. First of all, Mr. Montgomery, I’m having a little trouble 

understanding your response to an earlier question from the chairman that this program would have the effect of exposing taxpayers 

to greater risk. As I understand it, this is an FHA-insured program, which has increased flexibility to set rates by FHA, and then 

subsequently has the potential that FHA can share in the sale appreciation value if there is sale appreciation value. I don’t understand how we get under those circumstances to increased risk for 

taxpayers over what FHA currently has in place. 

Mr. MONTGOMERY. FHA is a self-sustaining entity and we want 

to remain that way, so by pricing our premiums based on risk from 

an actuarial standpoint, these new modifications we want to make 

will allow us to remain a self-sustaining entity. 

In our proposal, there would be no profit at the end of it, so to 

speak. 

Mr. WATT. No, I am not talking about your proposal. I am talking about the proposal contained in the chairman’s bill. I don’t understand your earlier response that this bill increases taxpayer 

risk. 

Mr. MONTGOMERY. Oh, I’m sorry if you heard that. I didn’t say 

that. I said that the chairman’s premium structure contains risk 

within that structure. We do the same. 

Mr. WATT. Okay. That’s fine. If I misunderstood what you said, 

I just misunderstood what you said. I thought you said that this 

program would increase the risk to taxpayer— 

The CHAIRMAN. Would the gentleman yield briefly? 

33 

Mr. WATT. I am happy to yield. 

The CHAIRMAN. I caused the confusion, so let me clarify it. There 

was some criticism aimed at the bill we had, and my point was 

that it would be aimed at the Administration—namely, that if we 

greatly underestimated the default rate, it would break through 

the barrier of the premiums, and that is where the taxpayer would 

be exposed, because the taxpayer is the backup to the FHA. And 

I was simply trying to make the point that would be a common factor of both. 

Mr. WATT. Okay. That helps me because—but that’s the risk that 

we have now, I suppose, through the regular FHA process. 

Mr. MONTGOMERY. That is correct. 

Mr. WATT. Okay. To the extent that insurance premiums have to 

go up or GSE is being encouraged under various programs—GSEs 

are being encouraged to either take greater risks or help build 

some of these properties out, one of the concerns always is that we 

are increasing risk to other entities that are designed to shield the 

government against risk or shield taxpayers against additional 

risk. 

I’m looking at a 1999 report called, ‘‘Over-The-Counter Derivatives Markets, A Report of the President’s Working Group on Financial Markets.’’ There were a series of suggestions made back in 

1999 about how to shield GSEs, FHA, and anybody who is doing 

swaps and derivatives against greater exposure. One of those was 

to encourage a clearing process that allowed those swaps and derivatives to be put on a platform just like stocks. What is happening with that, Mr. Kroszner? Are we making any progress on 

that currently? 

Mr. KROSZNER. These are very important issues, and I’m very 

glad that you raised them, because this is often what is characterized as the plumbing of the system, sort of the background that 

people don’t see, but is crucial to the functioning of the system. 

And actually, in all of the credit market turmoil that we have 

seen, we so far haven’t seen a problem with the clearance and settlement of these types of contracts. I think part of that is because 

there has been an initiative in the Federal Reserve System headed 

by the New York Fed that tried to address some of these issues, 

making sure that the clearing and settlement process is well-functioning, to make sure that trades are settled rapidly, to know who 

the responsible person is if that trade needs to go through quickly. 

There is still a large growth of over-the-counter derivatives, but 

there is still a very robust market of things that are on exchanges, 

a healthy competition between the two. But we have been working 

tirelessly to try to make sure that background plumbing in the 

over-the-counter market works as smoothly as it can. And so we 

have been heartened, at least so far, that the credit market turmoil 

hasn’t turned up problems there, but we still need to do more work. 

Mr. WATT. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. The gentleman from California, Mr. 

Campbell. 

Mr. CAMPBELL. Thank you, Mr. Chairman. I think three out of 

five of you mentioned adverse selection as a potential problem with 

this, and several of you mentioned proposed ways to mitigate that. 

And I guess my question, which is for the entire panel, is that no 

34 

matter what you do in terms of mitigation, doesn’t someone holding 

this loan, Merrill, CitiBank, UBS, WAMU, or now Blackstone, 

TPG, or whomever, sit here and say, if it’s voluntary and loan-byloan, they say, ‘‘All right, we have this loan, and the FHA will pay 

us ‘X.’ If we think we’re going to get less than ‘X,’ give it to you. 

If we think we’re going to get more than ‘X,’ keep it.’’ So that no 

matter what mitigation you do, you will have adverse selection; you 

must reduce the amount of it, based on what the money center 

banks believe the loan is worth. And I am asking any of you that. 

Mr. MONTGOMERY. I would just say that in the case of FHA, one 

corner that we will never cut is our underwriting criteria. By the 

way, we currently have an adverse selection within FHA to the 

point I referenced earlier on the seller-funded downpayment assistance. By mitigating that risk, by pricing that risk accordingly with 

the premiums, we can mitigate going further and helping more 

subprime borrowers refinance through FHA. 

I want to be very clear that not everyone is going to be able to 

qualify because of our very rigid front-end and our very rigid backend ratios. So we think we can mitigate a lot of that going forward. 

Mr. CAMPBELL. Under the chairman’s proposal? The President’s 

proposal? Or both? 

Mr. MONTGOMERY. Well, certainly under our proposal we—and I 

won’t speak for the chairman—he has some form of risk-based pricing that goes even higher than us, so I’m assuming he’s probably 

going to get at the same issue. 

Mr. CAMPBELL. Yes, Governor? 

Mr. KROSZNER. Yes, on this issue, adverse selection is extremely 

important, and it is a problem that is never fully solved even in 

private insurance contracts, because there is always the case if you 

were buying insurance, you’re going to the insurance company, you 

may know a little bit more about yourself than the insurance company does. They may ask you a lot of questions, but they can’t ask 

every possible question. And so, who is most likely to buy any type 

of insurance at a current rate? Well, the person who finds it most 

valuable for themselves. 

That is why insurance companies in the private sector charge 

risk-based premiuns; they use a variety of other criteria to try to 

screen out people who are just trying to put bad activities to them. 

And that is why something like what I have proposed here, if you 

were to go down this path, to make sure that there is an ability 

to put back a loan that goes badly quickly. Because if it goes badly 

within just a few months, that suggests that the servicer knew 

something about that loan that was very difficult for the FHA to 

find out, and so to have that option to put that back would be valuable. 

That’s a standard part of private-sector service contracts, to try 

to mitigate exactly this moral hazard problem. It’s not perfect, but 

it’s an attempt to address it. 

Mr. CAMPBELL. Anybody else with to comment? Yes, Chairman 

Bair? 

Ms. BAIR. Yes. I would just note that I think it’s an inherent 

issue, and it is with any kind of government program along these 

lines. We think it is important to have strong DTI standards—underwriting standards—as part of this, while recognizing that you 

35 

want to be flexible to reach out to a broad range of borrowers. Also, 

put-back provisions are a common private-sector tool. In addition, 

holding some portion of loan proceeds back and releasing them 

later if the loan continues to perform is another way you can try 

to address this problem. 

Mr. CAMPBELL. Okay. My second and final question is related to 

what I mentioned earlier in my opening statement about Citibank’s 

apparent sale of $12 million of leverage loans off to private equity. 

I am aware of some other smaller transactions going on where 

there appears to be a market developing out there now where there 

appear to be buyers, and I have heard 50 cents on the dollar. I 

don’t know what the numbers are, but there appear to be buyers 

for loan portfolios that are out there now. 

If this is developing, and this is going on, first, do we really need 

to do what is being proposed here? Or does this mean the private 

market is going to deal with it? And second, if you are Blackstone 

or TPG, and you buy this thing for 50 cents on the dollar, and 

along comes an FHA guarantee that enables you to get 60 or 65 

cents—and you know, maybe these numbers are wrong—but 60 

cents on the dollar, then aren’t we really providing an exit strategy 

for this secondary or tertiary, if you will, market? 

Mr. MONTGOMERY. I have heard some of the same—and this is 

Title II of the chairman’s bill—but we would just submit that FHA 

is not there to do these wholesale auctions of loans. I do want to 

say that obviously you do bring up one, some have called another 

moral hazard, but I want to say from our perspective, from the 

Federal Housing Administration, we just want to do what we can 

to keep that family in the home, and by putting these parameters 

around it, yes, some may benefit as you have described, but we 

think going forward, the important thing is that we help mitigate 

the ripple effect, but more importantly give the family a lifeline to 

stay in their home. 

Mr. CAMPBELL. Governor Kroszner, do you have any comment? 

Or anybody else? 

Mr. KROSZNER. Yes. I think it is very important to make sure 

that the taxpayer would be protected in any program that goes forward to take care of the moral hazard and adverse selection problems, so that the risk premia that the FHA can charge would accurately reflect risk on average. They may get individual ones wrong, 

but it’s trying to get right on average, trying to deal with the moral 

hazard problem. That is extremely important. 

The CHAIRMAN. The gentleman’s time has expired. Mr. Capuano? 

Mr. CAPUANO. Thank you, Mr. Chairman. Gentleman, I’m having 

a hard time following some of this, and I just want to ask some 

questions particularly relative to the moral hazard, and some of the 

concerns that I have heard mentioned. I want to be specific, if I 

can. The moral hazard you are concerned with is it somehow rewarding people who engaged in bad behavior, or is it being concerned about making sure that no one else engages in similar bad 

behavior in the future? Or is there something else? 

Mr. KROSZNER. Well, in particular, what I had been focusing on 

with respect to the draft legislation is that you would get people 

to come into this program who otherwise aren’t in trouble and who 

36 

don’t need a program like this. And so that is why having standards about the high— 

Mr. CAPUANO. So you are concerned about helping people who 

don’t need the help? 

Mr. KROSZNER. Yes, exactly. 

Mr. CAPUANO. Okay. And Mr. Montgomery, is that the same for 

you? Your concerns are that we are concerned about helping people 

who may not need the help? 

Mr. MONTGOMERY. Yes. I would share in that concern. Ours is 

focused more at those who have missed payments and those who 

are now also underwater in their loan as well. 

Mr. CAPUANO. All right. So neither one of you are opposed to the 

concept of helping people. If we could all come up with a clear definition of who is deserving of help, or who is in deep trouble, would 

you be opposed to helping them a well? 

Mr. MONTGOMERY. Certainly that’s something we can discuss 

going forward. You know, again, ours is a measured response that 

is targeted at those— 

Mr. CAPUANO. I understand that. But you wouldn’t be opposed to 

the concept of helping somebody? 

Mr. MONTGOMERY. We can certainly discuss any options you 

would ask, Congressman. 

Mr. CAPUANO. Mr. Kroszner, would the Fed be opposed? 

Mr. KROSZNER. As I said in my testimony, I think we need to 

think of creative ways to try to deal with preventable foreclosures, 

and so if there’s a way to get the servicers to come up with good 

standards, to be more proactive in doing principal write-downs and 

other modifications, these are one of the many types— 

Mr. CAPUANO. So you’re saying that if we get into helping somebody, we should then hold the industry to some sort of standards 

and requirements going forward? 

Mr. KROSZNER. Well, I think one of the things that the industry 

has started already with the Treasury Department is the HOPE 

NOW Project focusing on resets, but in response to the earlier 

question— 

Mr. CAPUANO. No, no. I want you to respond to my question. Are 

you saying that if we get involved right now, we should hold people 

that we are going to help to certain standards, going forward? 

Mr. KROSZNER. Absolutely. 

Mr. CAPUANO. All right. So then, I don’t disagree with the general concept, but if that is the case for individual homeowners who 

are losing their homes, could you explain to me, then, why as we 

speak, right now, right this minute, the Fed is loaning money, billions of dollars, to people who are held to no standards, who are 

not regulated by anybody at this table or anybody else, and we 

don’t even know whether they meet any capital requirements? 

Could you explain to me why we’re doing that? 

If it’s so important on the individual homeowner to hold them to 

certain financial standards, why are we not holding investment 

banks and hedge funds and others to those same standards as we 

are loaning them billions of dollars? Not we might, we are. Right 

now, right this very minute we are doing it. 

Mr. KROSZNER. With respect to the lending facility to the primary dealers and lending supporting the Bear Stearns transaction, 

37 

Congress has given us the power in unusual and exigent circumstances to make exactly such loans. 

Mr. CAPUANO. Well, that’s not responsive. First of all, I’m not so 

sure we have, which is a discussion for a different day. If it’s 

okay—and I don’t disagree with you—I absolutely agree with the 

concept, if we’re going to do something extraordinary that we 

should ask those that we are helping, both the borrowers and the 

lenders, to be held to certain standards—I have no problem with 

that, yet for some reason it’s okay for homeowners, but it doesn’t 

apply to investment banks. And I’m just curious as to why that is. 

Mr. KROSZNER. Well, I don’t think that’s true. The— 

Mr. CAPUANO. So you’re telling me that right now the Fed is 

holding people who are coming to the discount window that you do 

not regulate, that you’re holding them to different standards than 

you held them to yesterday? 

Mr. KROSZNER. You had suggested that there was no regulation 

of the investment banks. There is regulation of the investment 

banks. 

Mr. CAPUANO. Virtually none. I should have been more clear. 

Virtually none. 

Mr. KROSZNER. The SEC does have a number of standards out 

there. They are the regulator of those institutions. 

Mr. CAPUANO. Yes. I know who regulates them. I know what a 

great job they have done thus far, which is exactly why you had 

to come in to save Bear Stearns. Now, I don’t have any problem 

with saving Bear Stearns, and I would argue that maybe the law 

allows that; but I have some concerns about the Fed opening the 

discount window for 60 days, and not a single person here has said 

anything about it. We’re all concerned about maybe taking a risky 

loan from some working stiff who is about to lose their home, but 

we’re not concerned at all, we don’t seem to be concerned one bit 

about making loans in the billions of dollars to people who actually 

participated and encouraged and made the profits, the billions of 

dollars of profits on those very same risky loans. 

And that’s what bothers me. We have several standards, one for 

the typical homeowner—let’s hold them to a higher standard—and 

another standard, which for all intents and purposes doesn’t exist, 

to investment banks and others who engage in the very same risky 

behavior that you and the rest of the regulators did nothing about 

for the last 6 years. My time has expired. 

The CHAIRMAN. The gentleman’s time has expired. 

Mr. Marchant, you are next on the list. 

Mr. MARCHANT. Thank you, Mr. Chairman. My question is for 

HUD, Mr. Montgomery. Mr. Montgomery, in my time on this committee and in watching all the programs, HOPE NOW, and all of 

these programs that come out, it seems that the major problem 

comes in the implementation stage, and I’m trying to get a handle 

on who would be the person in Mr. Frank’s draft bill, what party 

will instigate the request for the loan to be reappraised, bought, 

and then recast? 

Mr. MONTGOMERY. I don’t want to speak for the chairman, but 

I could say for FHA’s part, what is happening now with people who 

are looking to refinance, either they contact us, or they contact a 

lender or a servicer. It all depends on the borrower’s behavior. You 

38 

know, a lot of borrowers who are in dire straits never contact anyone. So for our part, it could be any number of parties who would 

initiate it. 

Mr. MARCHANT. So it couldn’t solely be the servicer? The servicer 

could not come forward and say I have this loan, this loan is in 

trouble. I would be willing to put this loan into this program and 

will HUD buy the loan from me? 

Mr. MONTGOMERY. As is the case now, there’s a current mortgage 

or obviously they have to agree to some sort of refinancing mechanism, and any subsequent other lienholders as well. 

Mr. MARCHANT. So in this bill, how much does the homeowner 

have to say about the actual refinancing? Because if you have, let’s 

say you have 2 million loans that are rolling over in the next 6 

months, and let’s say that there’s a reasonable expectation that for 

a good number of those, the interest rate will put the borrower into 

a situation where they may have to default. Will it be the borrower 

who will step forward and say, ‘‘I would like to take advantage of 

the provisions of the Frank bill?’’ Or will it be the servicer who 

steps forward and says, ‘‘I would like to take advantage of the provisions of the Frank bill?’’ 

Mr. MONTGOMERY. I can’t speak to what the chairman’s bill does 

in that respect. I would say that as is the current practice, in most 

cases it is the mortgagor who is in the subprime loan, or whatever 

loan right now, who wants to refinance with FHA, and does so 

through their lender, who then works—it has to be an FHA-approved lender, obviously, who then starts the process there. 

So certainly a servicer, as we have discussed, has a say in that 

process as well, especially to the degree that we want to do a writedown of that principal, again whether it’s a first lien or second lien. 

Mr. MARCHANT. So what is the practicality of $300 billion worth 

of loans being—either the servicer or the borrower coming forward 

and saying, ‘‘We want to rework this loan; we need to go get an 

appraisal; we need to get title work; we need to knock out the seconds, and we need to re-originate this loan with sophisticated loan 

documents that carry a silent second,’’ and you know, what is the 

practicality of getting those loans? Are they going to come one by 

one? Are they going to come in big bundles? Is the servicer going 

to have the ability to advertise on TV that, you know, if you qualify 

for this program, come in, and then they are going to bundle them 

up and send them to you like in a Ginnie Mae commitment? What 

are the mechanics of how HUD will end up with those—will they 

be Ginnie Mae instruments eventually? 

Mr. MONTGOMERY. Well, for our part, they would certainly be, 

you know, backed by the full faith in credit. They would be Ginnie 

Mae’s. You know, one or two, whatever particular pool. 

But you did bring up the issue of the $300 billion, and again I 

don’t want to speak for the chairman’s bill, but that is a loan allocation amount. Congress gives this amount every year. Since I 

have been FHA Commissioner, that number has been about $185 

billion. I do want to say going forward that we expect for the first 

time in several years to exceed that amount for this fiscal year. I 

think ultimately we’ll probably get to about $230 to $235 billion. 

So I don’t know, again under his bill whether he has a separate allocation just of $300 billion, or it raises our allocation to $300 bilVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
39 

lion. To put the number in perspective, our overall insurance in 

force today is roughly 4 million homes with a value of a little more 

than $400 billion, to put that $300 billion— 

Mr. MARCHANT. But do you foresee— 

The CHAIRMAN. The gentleman’s time has expired. I was trying 

to allow the response, but are you all through responding? 

Mr. MONTGOMERY. I could certainly follow up with the Congressman afterward, if he’d like. 

The CHAIRMAN. The gentlelady from New York, Ms. McCarthy. 

Mrs. MCCARTHY OF NEW YORK. One of the questions that I’m 

concerned with is, because obviously all of us care about our constituents back at home—and this can go to everybody—is how will 

this bill assist homeowners in high-cost areas, such as where I live 

on Long Island? So even though I have a small part of it, I’m going 

to look at Long Island as a whole, because what affects a district 

right next door to me is going to affect my district and so forth. 

Right now, we see almost a 33 percent increase of foreclosures 

just in Nassau County. My concern is too because I tend to look 

at things out, with 33 percent foreclosures, that is going to hurt the 

tax base in the county and in the towns, and that is going to reflect 

again on police service, school service, and everything else like 

that. 

So for a high-cost area, you know, I will use my little home as 

an example—I have been in it for 58 years, it is a tiny home, and 

I am assessed for an amount that I know I could never sell it for— 

I think they had me assessed for maybe $885,000—it is now down 

to, I think, $468,000. But I’m still being assessed on the higher 

level. I am going to fight that, but that means it is going to come 

down. 

But how is this going to help someone to buy a home in Nassau 

County, even a starter home? The cheapest you are going to find 

as long as it has, you know, doors and a frame—is probably almost 

$350,000, but most of them are much higher—how will this help 

them and how are we going to stop the bleeding that is going on? 

If one house goes down, that lowers the whole neighborhood. That’s 

the problem that I think this Nation is going to be seeing, not just 

the losing of one home, but how it’s going to affect the neighborhood, how it’s going to affect the community, the stores, the tax 

bases, and everything. 

I don’t hear a lot of people talking about that kind of stuff. 

Ms. BAIR. Well, I think there are a lot of external costs to foreclosures—to neighborhoods, to communities and to local tax bases. 

And I think that is exactly the public policy rationale for moving 

forward with a proposal like this. 

I think this proposal, in particular, is focused on those who are 

currently in unaffordable mortgages and cannot refinance because 

their loans are underwater. They would be subject, I assume, to the 

FHA conforming loan limits. So in very high-cost areas, it may or 

may not be relevant. 

A lot of the foreclosure activity is being driven by subprime 

loans, particularly the subprime hybrid ARMs. On a national basis, 

the average subprime loan is $200,000. So, I think for this particular proposal, the impact would be more in that sector—again 

40 

people who have unaffordable loans and who are underwater and 

can’t refinance out of these unaffordable loans. 

I don’t know, Brian, if you want to— 

Mr. MONTGOMERY. Yes. Congresswoman, your Nassau County, 

Suffolk County are both in the—they are 2 of the 75 counties in 

the United States that went to the maximum ceiling for FHA and 

the GSEs as a result of the stimulus. So up to $729,000, they 

would now be eligible to apply. 

Mrs. MCCARTHY OF NEW YORK. Thank you. 

The CHAIRMAN. Does the gentlelady yield back? 

Mrs. MCCARTHY OF NEW YORK. I’m sorry, yes. I turned my 

microphone off before. Yes. 

The CHAIRMAN. Okay. Then the gentleman from California, Mr. 

Miller, for 5 minutes. 

Mr. MILLER OF CALIFORNIA. Thank you very much, Mr. Chairman. 

A lot of the problems we have in the marketplace with people 

trying to buy today is that they can’t get a loan. There is no liquidity. And I have always strongly supported raising conforming in 

high-cost areas for Freddie Mae, Fannie Mac, and FHA. I think 

that is really something we need to do. 

But I have some questions based on some different testimony. 

Mr. Montgomery—and you were very clear in what you said, you 

were talking about when FHA makes a loan of 90 percent based 

on market value—that’s generally a very safe loan, because you use 

the standard underwriting criteria and you use risk-based criteria 

as it applies to loans. Is that not true? Would you consider a 90 

percent loan using your standard criteria and the criteria applied 

to this bill? Would that be a reasonable loan for FHA to make? 

Mr. MONTGOMERY. Yes. Certainly. We propose 90 percent LTV. 

I believe the chairman has an 85 percent LTV— 

Mr. MILLER OF CALIFORNIA. But the concept is the same. You— 

95 percent would be held in retention, but—my concern that Governor Kroszner, you have stated in your testimony that you believe 

that there should be some form of a loan seasoning requirement or 

other form of warranties on the part of the lender, who currently 

has the loan that is probably going into default because the person 

can’t make the payment based on a trigger or whatever. 

And I have a real problem with that, because my concern is that 

you are then placing an obligation on the previous lender to guarantee FHA that there would be a repayment, and I’m sure there 

is some risk associated with that, and if the lender is trying to cut 

a deal where he says, ‘‘Okay, I’ll take 85 percent,’’ what is the bank 

regulator going to do? There has to be a risk. Is he going to require 

some sort of reserves on the lender, who thinks they’re getting out 

from underneath the loan, but they possibly might not be getting 

out from underneath from the loan. 

That’s problematic. I don’t know how we do that. Maybe you can 

explain that a little more. 

Mr. KROSZNER. Sure. I mean one of the reasons for doing this is 

that we don’t want the taxpayer to just take all of the very highrisk— 

Mr. MILLER OF CALIFORNIA. Yes, but the FHA is not going to let 

that happen. FHA is using a risk-based criteria. FHA—Mr. MontVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
41 

gomery, you’re going to go make sure the person has an income, 

they have the ability to repay that loan, and the loan is based on 

sound underwriting criteria and an appraiser that reflects what the 

value of the home is. Is that not true, Mr. Montgomery? 

Mr. MONTGOMERY. Yes, sir. 

Mr. MILLER OF CALIFORNIA. Then, my position is that the lender 

should be out of this loan at that point in time; he should not have 

to be obligated to FHA, if FHA has done their job and done proper 

appraisals and used underwriting criteria. If the person is not 

qualified, FHA should not make them the loan. So I’m having a 

real problem with the concept of taking a previous lender and leaving them on the hook in some fashion if something goes wrong because we are basically charging a 5 percent reserve on the loan— 

because we’re lending 90, we’re reserving 5 back because we’re only 

paying 85 percent of what the value is—I think the lender should 

be out of this. 

So, Mr. Chairman, I have real, real concerns with leaving a lender on the hook when FHA has done a proper job on their appraisal 

standards and they have come up with a loan that is qualified. Because if it’s not qualified, Mr. Montgomery, don’t make the loan. 

And I think you’re saying we’re not going to. So I have a real problem with leaving the lender on the hook, because there’s going to 

be some reserve set aside on the lender’s part, and lenders today 

are having problems with liquidity, with money in the system. So 

I think we need to really look at that. 

I think there are some reasons why this could be a very popular 

program with lenders, more than most people might assume. If you 

figure what the lenders’ costs are when they go through a foreclosure, the cost of foreclosure, they’re going to generally employ a 

Realtor to handle the transaction; they’re going to have to set up 

reserves and the costs of carry associated with that loan when it’s 

not producing; title and escrow fees that are going to be normal to 

any transaction on any foreclosures they have; damage that occurs 

to the unit, and in some cases people do vandalize units because 

they’re angry because they got evicted from a home—not everybody 

but some people do it, and we have seen that happen. 

Some even have to go to the cost of using an auction to unload 

a unit because it sit on the books too long and it’s not moving. And 

then there’s a maintenance cost and a risk associated with holding 

that house. 

So some lenders are going to say 85 percent? Hmm, I’ll take 85 

percent. And I think you’re going to see more people looking to do 

that than not. 

I guess I have a concern that we’re talking about how we’re going 

to deal with eliminating or extinguishing a second trust deed that 

might exist on a home. The concern I have is that some people 

have used their home as an ATM; they borrowed for vacations and 

other costs. I think we need to look at what some of those seconds 

are, if we’re asking some lender to take a bath on it and not really 

do much to encourage it when it has been used for personal reasons. 

A question I have is: If we implement a program like this where 

we say the lender is going to taking 85 percent of market value, 

my concern is: Is there some undisclosed occurrence that could hapVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
42 

pen where an appraiser down the road says, ‘‘Well, the house really 

is only worth—if it was $500,000 before if the lender took $425,000, 

really the market value is—’’ 

The CHAIRMAN. We will have to wrap that up so they can answer, please. 

Mr. MILLER OF CALIFORNIA. Okay. Could it somehow impact the market, you saying it’s no longer worth $500000, it’s really worth 

$425,000, because the lender took $425,000 for that? 

Mr. MONTGOMERY. Well, in this case, whatever that delta is between the appraised value and our 90 percent insurance could be 

put in the form of a soft second with a note due on sale clause. 

Mr. MILLER OF CALIFORNIA. Does it impact the value of the marketplace? 

Mr. MONTGOMERY. No, sir. That second lien would have to be resolved to— 

Mr. MILLER OF CALIFORNIA. Too many questions, and so little 

time. Mr. Chairman, thank you. 

The CHAIRMAN. Let me, before turning the gentleman from Pennsylvania, ask unanimous consent to put in the record a letter we 

received from the National Association of Realtors saying with regard to the discussion draft, ‘‘Your measure will allow homebuyers 

to refinance their mortgage with an FHA loan at a rate and level 

they can afford to pay. We commend your efforts.’’ And also, a letter from Marc Morial on behalf of the National Urban League, also 

expressing support for the discussion draft. 

I ask unanimous consent to put these items in the record. Without objection, they will be, and the gentleman from Pennsylvania 

is recognized for 5 minutes. 

Mr. KANJORSKI. Thank you, Mr. Chairman. I am not sure to 

whom on the panel I should direct this question. Anybody can take 

it. But, it seems to me for the chairman’s proposal to be successful, 

there are two major elements that are required to be adopted in 

the law: One would be encouraging a loan modification. We have 

to do something about getting a servicer’s liability worked out to 

create a safe harbor. And of course, we have, Mr. Castle and myself 

have proposed a bill to accomplish that. Would you agree as a 

panel that it is essential that we have a loan modification safe harbor in place if we are to implement the chairman’s bill here on 

servicing? 

Ms. BAIR. We are very supportive of your and Congressman Castle’s efforts, and yes, the servicer will have to write down the principal amount. They will have to modify these loans to facilitate 

them being refinanced out of the pool. So at a minimum, I would 

assume you would want to have some insulation from liability for 

that and also for other long-term sustainable loan modifications, 

even when the loan stays in the pool. So yes, we’re highly supportive of that. 

Mr. KANJORSKI. All right. Yes? 

Mr. DUGAN. We support it as well, Mr. Kanjorski, because as you 

know, we have done some work on our staff. We think it clarifies 

what is the legal authority already that you have to support, and 

protects the interests of the whole pool and not an individual 

tranche or investor within that pool. We do think that is quite an 

important principle, going forward. 

43 

Mr. KANJORSKI. Thank you. 

The other major area I throw out, which is now pending over in 

the Senate and which we passed in the House, is independent appraisals. Everywhere I look, one of the major failures in subprime 

lending is the abuse, fraud, and mistake of not having appropriate, 

independent appraisals. If we go through this process again and do 

not have the proper appraisals, all we are going to do is compound 

the problem. 

Is there anybody who disagrees that the now pending amendment in the Senate—I think it is the Casey amendment, which incorporates a lot of the issues that we have passed in the House— 

should go through? 

Mr. DUGAN. Mr. Kanjorski, we don’t agree with this point. We do 

think you have to have independence and structures within organizations to make sure that there is independence between the person who underwrites the loan and the person who appraises it. But 

there are circumstances in which you can have better appraisers 

and be able to control the risk better by having it within your organization than get it from a third party. I don’t think it is necessary 

or that it is even a good idea to mandate that every single appraisal be separate from the entire lending organization. 

Mr. REICH. At the Office of Thrift Supervision, I agree 100 percent with the comments that Comptroller Dugan just made. There 

are excellent appraisals being made within many institutions that 

we supervise and we believe that they ought to be able to continue 

to be able to utilize those facilities. 

Mr. KANJORSKI. I think there may be a little confusion between 

what we do in our bill and the attorney general of New York’s 

agreement. I understand your disagreement with some of the stringent positions that he has adopted, but our bill is quite different. 

Do you see that distinction? Or should we take that up later? 

Mr. DUGAN. We will take that up later. 

Mr. KANJORSKI. Okay. Good. 

Let me ask one question of the Federal Reserve. I just had a very 

upsetting meeting in my office with a hedge fund operator who 

called to my attention the fact that that some people may be using 

the Federal Reserve Bank, some folks in the investment banking 

industry, to draw down billions of dollars in funds, and then turning around and issuing dividends based on the use of those funds. 

Do you know, Governor, whether that is true? What does the 

Federal Reserve intend to do, as quickly as possible, to put some 

constraints on the use of these funds? Tell me whether or not you 

need legislative authority to do so? Do we have some pieces of legislation suggested by the Federal Reserve to get control? 

I, myself, will be incensed if after going to the rescue of these institutions, there are these types of abuses occurring. I will be particularly incensed if the Federal Reserve has not marched up here 

with an emergency siren, saying there is something happening that 

should not happen, and it is to the great jeopardy of the American 

taxpayer. Can we get a response? 

Mr. KROSZNER. Those are very important questions. I think that 

I do not know of such circumstances, but certainly will be delighted 

to work with you and your staff to see if there are such circumstances. I agree that they should not be tolerated. We are 

44 

working very closely with Securities and Exchange Commission in 

analyzing and reviewing the financial statements and the financial 

health of the primary dealers to which the new facility is available. 

There are very high standards for becoming a primary dealer, so 

it’s a limited number of institutions with which we have had a 

long-standing relationship that now have access to this facility. We 

only make loans on a fully collateralized basis, and it is going to 

be an issue going forward that Congress will need to consider 

whether there will be additional regulatory authority needed if this 

facility were to continue. 

The CHAIRMAN. The gentlewoman from Illinois, Ms. Biggert. 

Mrs. BIGGERT. Thank you very much, Mr. Chairman. And let me 

just say that I have a real concern that while the House and Senate leadership are engaged, it seems, to outbid each other on how 

much taxpayer funding they can spend to bail out various actors, 

that I think we should instead being passing FHA reform, GSE reform, and the other basic reforms that can start to help homeowners now. And my hope is that the leadership will move what 

is right in front of them instead of grasping, looking for new giveaways that may or may not help those who are actually now in 

trouble. 

With that said, I want to turn to FHA Secure, and I would really 

like to compliment Mr. Montgomery and HUD for their work on 

FHA Secure and for already helping 150,000 families to stay in 

their homes, and for projecting that they will help 400,000 families 

by the end of this year. Congratulations. I think you are doing a 

great job. 

I have a question for Mr. Kroszner and for Mr. Montgomery. In 

your testimony, Mr. Kroszner, you mentioned the importance of 

Congress giving FHA the flexibility to price FHA loans, especially 

loans being refinanced through FHA Secure. Why is this flexibility 

necessary? And do any of the current FHA modernization proposals 

under consideration provide FHA with the flexibility it needs to a 

risk-based price so that the FHA can serve more borrowers without 

jeopardizing the financial stability of the program and putting taxpayers on the hook for the money? 

Mr. KROSZNER. Well, I think very much consistent with the last 

part of your question, that is the reason for thinking about riskbased pricing. Just as in the private sector, people who are riskier 

drivers have to pay higher premia; if you are a riskier borrower, 

you will have to pay a higher insurance premium in order to get 

a mortgage, all other things being equal. And if the FHA is going 

to be a world class mortgage insurer, it needs to have that flexibility to charge a higher price when there are more risks and also 

to charge a lower price when there are lower risks. And so this 

should be a very important part of any FHA modernization and reform proposal. 

Mrs. BIGGERT. And so this can be done without legislation? FHA 

Secure? 

Mr. KROSZNER. Well, FHA Secure certainly is being undertaken 

without further legislation. I believe there are statutory limits that 

exist in current legislation, and I know the Administration and Mr. 

Montgomery have been thinking of ways to deal with greater flexibility within those limits. 

45 

Mrs. BIGGERT. Okay. Now, Mr. Montgomery, do you want to comment on the flexibility? 

Mr. MONTGOMERY. The pricing flexibility is key going forward, 

especially if we’re going to take on more risk. And I do want to say 

that in the House bill that passed on FHA modernization, a lot of 

the pricing categories were not way off between what this committee has passed, and I thank you again for that. 

I do want to say going forward, though, that it is an interesting 

dynamic that the borrowers in FHA’s world who have the higher 

FICO scores—above 680—are our lowest income group. I know that 

seems counterintuitive, but they are the hard-working families who 

save their money for the downpayment, and enjoy the many benefits of FHA. Our proposal we’re going to submit soon is a little different than we originally were going to do administratively. But we 

just want to give those families a small little price break, going forward. 

Mrs. BIGGERT. So for those families to refinance, they will have 

to come up with more of a downpayment? 

Mr. KROSZNER. For some families going forward, especially, 

again, as we take on more risk, yes, some of those would go to our 

statutory ceiling, which is 2.25 percent. 

Mrs. BIGGERT. Thank you. Then, Mr. Kroszner, you also talked 

about FHA needing substantial flexibility in providing incentives to 

the servicers to negotiate with junior lienholders. Does Congress 

need to provide FHA with this flexibility? Or does FHA already 

have the authority to do that? 

Mr. KROSZNER. That is, I think, a legal question that I am not 

sure of the answer to. I think it’s perhaps—Mr. Montgomery would 

know the specifics better. 

Mrs. BIGGERT. Mr. Montgomery? 

Mr. MONTGOMERY. If you could repeat that? I’m sorry. 

Mrs. BIGGERT. It’s just whether you have the authority to negotiate with the junior lien providers. 

Mr. MONTGOMERY. Certainly. That would be whatever, between 

the current mortgagor and the mortgagee, because certainly whomever is holding that second lien has a stake going forward as well. 

Mrs. BIGGERT. But you could negotiate with them? 

Mr. MONTGOMERY. Certainly. 

Mrs. BIGGERT. Without legislation? 

Mr. MONTGOMERY. Let me triple-check that for you, please. 

Mrs. BIGGERT. Thank you. Yes, my time has expired. 

The CHAIRMAN. The gentleman from California, Mr. Baca. 

Mr. BACA. Thank you very much, Mr. Chairman. My question is 

for Governor Kroszner and Mr. Montgomery. One key issue is the 

extent to which voluntary loan modification programs are working. 

The New Hope Initiative, for example, is shared by Secretary 

Paulson, and is widely cited by industries as evidence of good work. 

While it is good that they got everything together, the fact is that 

voluntary programs aren’t working. 

So my question is what impacts have the voluntary loan modifications had on the efforts of reduced foreclosure rates? That’s 

question number one. Number two, are there other efforts the regulators are pursuing to help families retain their homes? Governor 

Kroszner first, and then Mr. Montgomery? 

46 

Mr. KROSZNER. There has been some progress that has been 

made. The number of modifications has gone up. But as we were 

discussing in some of the earlier questions, the HOPE NOW Alliance Focus initially was on the resets. The resets are less of a challenge now for a variety of reasons, including the reduction in interest rates that the FOMC has undertaken. Because now the most— 

the so-called 2/28 and 3/27 subprime mortgages would reset to a 

fixed amount, usually 600 basis points, over a short-term interest 

rate. Now that we have taken the short-term interest rates down 

significantly, the payment shock has been mitigated dramatically, 

and so it’s now in most cases—or I should say on average less than 

1 percentage point. So that has been helpful. 

We have been undertaking a number of other programs with 

NeighborWorks America, on which a number of us sit on the board, 

to try to expand counseling programs, to try to deal with real estate challenges after the properties go into foreclosure. The regional Federal Reserve Banks, all 12 of them, have very active programs working with local governments and local community groups 

to try to keep people in their homes, to try to provide counseling 

services. 

And so we have been doing a lot in a lot of different areas, and 

continue to do a lot, and more needs to be done. 

Mr. BACA. Mr. Montgomery? 

Mr. MONTGOMERY. FHA Secure has been a part of the options 

available to people going through the HOPE NOW Alliance, and 

again borrowers contacting us on their own. Before today we required 6 months on-time payments before the interest rate reset; 

that was one of the barriers that we heard in the comments as to 

why families wouldn’t qualify. And again with our announcement 

today, we are making exceptions to that, going forward. 

Mr. BACA. Thank you. The next question I have is for Sheila Bair 

and for the Honorable John Dugan, and of course John Reich. Minority communities have been disproportionately affected by the 

downturn in the housing industry due to the large number of recent first-time homebuyers and the wide-spread use of subprimes 

and Alt-A loans among minority homebuyers. Additionally, the 

foreclosure rate of subprime loans has had a disproportionate impact on minorities and has put our communities at risk for losing 

their homes. 

The question would be: What polices or procedures and incentives can we anticipate your respective organizations are developing as part of the CRA in a fair lending examination process to 

ensure disciplatory and financial institutions assist depressed borrowers to prevent foreclosures? Any one of you three may answer. 

And then, I have a second question. 

The CHAIRMAN. We won’t have time for a second question. 

Ms. BAIR. Well, Congressman, you’re absolutely right. The disparities that we see in neighborhoods that are getting high-cost 

loans are completely unacceptable, if you look at the HMDA data. 

We are trying to tackle this through a variety of means. First of 

all, working with the other regulators, we issued subprime guidance to address the abusive nature of many of these products. The 

Federal Reserve Board has proposed rules under the Home Owners 

Equity Protection Act, applying stronger lending standards acrossVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
47 

the-board. We have commented on those. One of the issues tackled 

there is yield spread premiums, which affirmatively, I believe, give 

incentives to steer people into higher cost loans. I think we should 

aggressively address that. 

We are having a conference this summer, in July actually, on responsible ways to serve low- and moderate-income communities 

with mortgage lending—getting away from these abusive payment 

shock products, getting to fixed-rate mortgages, those that do not 

have payment shock, that are affordable. There are other product 

innovations, such as shared equity, extended amortization, where 

we believe you can, in a responsible way, make mortgages more affordable to low- and moderate-income communities. But it needs to 

be done the right way. 

And finally we are looking very aggressively at CRA, to determine whether we should look at both quality as well as quantity 

of lending that qualifies for CRA, and whether a broader range of 

financial services needed by lower-income communities is adequately addressed under CRA. 

The CHAIRMAN. We have time for either the Comptroller or the 

Director. Comptroller? Please. 

Mr. DUGAN. Just in direct response and very quickly, I have in 

fact given a speech in support of expanding CRA to widen its scope 

to cover distressed mortgage communities in a broader array of circumstances that I think could help address this. And in addition, 

this committee has passed legislation that has expanded the public 

welfare investment authority of national banks, and so has the full 

House; it’s still pending in the United States Senate. But if we 

could get that legislation passed, it would also help bring, we believe, even more investment from banks to distressed communities, 

and particularly minority and low-income communities. 

Mr. BACA. Thank you. 

The CHAIRMAN. Let me just clarify that when we talk about public welfare, we are talking about giving the banks more ability to 

do housing and other community-related activities, which has become a constraint. How will it take the—quickly please. 

Mr. REICH. I could be mistaken about what I’m about to say, but 

I believe that we have authorized our financial institutions that we 

supervise to give double CRA credit to investments in low- to moderate-income communities, which would include, of course, many 

minority communities. 

The CHAIRMAN. But let’s put it this way, Director, if you were 

mistaken, you won’t be tomorrow, because you could do it. So, we 

will consider that as done. 

The gentleman from Georgia, Mr. Price. 

Mr. PRICE. Thank you, Mr. Chairman. Before I begin, I would 

like to ask unanimous consent to include in the record a recent 

Wall Street Journal article from April 3rd of this year, entitled 

‘‘Uncle Sub-Prime.’’ 

The CHAIRMAN. Without objection, it is so ordered. 

Mr. PRICE. I know it is hard to believe, but I, for one, am proud 

to live in the greatest nation on the face of the Earth, a nation that 

has created more prosperity for more individuals across all demographic sectors of society than any nation in the history of the 

world. I think it is important that we put things in context, espeVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
48 

cially as we hear some of the dour predictions and dour assessments on the need for remarkable intervention by the Federal Government. We have been the most prosperous nation ever in the history of the world for a reason. If we meddle with that reason, we 

risk significant changes to our society and to the opportunities that 

all Americans currently enjoy. 

I was meeting with a group of high school seniors, bright high 

school seniors last week, and they wanted to know about the housing crisis, and I asked them what percent of individuals do you believe who currently hold a mortgage are current on their payments? These were bright high school seniors, and the highest anybody would give me was 17 percent—17 percent. 

The media has been adept, as have many in Congress, at a remarkable, remarkable misrepresentation of the entire market. 

Ninety-two percent, as you all know, are current on their mortgage 

right now. Ninety-two percent of homeowners in this Nation are 

current on their payments. 

There has also been an impression that nothing has been done, 

that the FHA—that none of you at this table have done anything 

to try to assist Americans and homeowners across this Nation. Just 

to highlight a couple of items, in August of last year, FHA Secure 

was launched. As of March 19th of this year, 126,000 homeowners 

have been assisted, and they expect to help more than 300,000 

families by the end of 2008. In October, the HOPE NOW Alliance 

was formed, a group of lenders, investors, and mortgage counselors 

working to help keep Americans in their homes. Since July of last 

year, they have assisted more than a million homeowners The 

number of borrowers receiving help is now rising faster than the 

number of foreclosures. We may be seeing some significant effect 

of the work that has already been done. 

The Mortgage Forgiveness Debt Relief Act of 2007 was signed 

into law on December 20, 2007, protecting individuals from higher 

taxes as they refinance, and on, and on, and on. The Fed has attempted to increase liquidity. Project Lifeline was announced with 

HOPE NOW in February of this year. 

So the question really becomes to us what else needs to be done, 

if anything? As a physician, I am always reminded that if I don’t 

make the right diagnosis, it is difficult to treat the right problem. 

Some on this panel, on this committee, have talked about the excessive and dangerous deregulation that has occurred in the past. 

Governor Kroszner, I was interested to read about the Boston 

Fed Reserve recently studying or determining that they felt that 

much of the challenge that we currently have is due to declining 

housing prices, as opposed to the excessive ‘‘deregulation.’’ I wondered if you have any comment about the input of those two items 

in terms of the challenges that we are currently facing. 

Mr. KROSZNER. Well, if I recall correctly, the Boston Fed study 

was not looking at the broader question that you’re trying to address on the role of regulation or deregulation, but trying to look 

at some more narrow issues on is it interest rate resets, is it house 

price changes, is it a number of sort of economic, current economic 

factors. 

And so what they determined is that housing price changes are 

really a primary determinant, at least in the data set that they had 

49 

looked at, for driving the foreclosure and delinquency rates. I don’t 

think they were addressing the bigger question that you are raising. 

Mr. PRICE. And would you care to address that bigger question? 

Mr. KROSZNER. I think that is one that is a very, very difficult 

one to address but an extremely important one to address, to try 

to bring together the data and analysis to try to understand exactly 

what were the issues that may have driven some of these challenges. And I don’t have a specific answer for you today. 

Mr. PRICE. I thank you. I would be interested in the thoughts of 

the Board as we move forward. In my brief time left, I would like 

to ask Mr. Montgomery about legislating specific underwriting 

standards and decreasing the ability of FHA or anybody to look at 

risk in terms of covering a mortgage. 

Mr. MONTGOMERY. You know, one of the reasons we were championing FHA reform way back when is there were some things that 

were set in statute that I, as Commissioner, was performing, did 

not have the ability to change, because they were set in statute. 

And we would like to keep underwriting as part of that—those 

things that the FHA Commissioner going forward would have the 

flexibility to change. The same on premium pricing structures. Certainly Congress, through our normal reporting channels, would 

have a say in that process. But I think going forward, flexibility is 

a key thing, whether it’s underwriting, setting premiums and the 

like. 

Mr. PRICE. Thank you. 

The CHAIRMAN. The gentleman from North Carolina will be our 

last questioner before we break. 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. I 

don’t want to talk about the turmoil in the markets. I want to talk 

about the original sin of our mortgage lending problems now, and 

what it did to borrowers. 

First, about fraud. The question that Mr. Hensarling asked earlier about fraud and mortgage lending, the statistics I have seen 

are that the subprime loans made in 2006–2007 when things went 

to hell in a handbasket, that 43 to 50 percent of those loans were 

made without full income verification, full income documentation. 

Is that correct? Is that range about right? 

[Panel nods in the affirmative] 

Mr. MILLER OF NORTH CAROLINA. Now, it is very easy to document income for a mortgage. You can get employer verification. 

You can show a wage statement. You can show your tax returns. 

You can show bank statements, and you pay more if you don’t fully 

document your income. You pay a higher interest rate if you do 

not—does anyone really think that the New York investment banks 

that were buying these mortgages to securitize them really had no 

clue something was up? 

They were really getting half of all loans, subprime loans, without full income verification. And the people who were taking out 

those loans were middle-middle to lower-middle class. They weren’t 

investors. They weren’t self-employed. They didn’t own a business. 

They weren’t professionals. They worked for an employer who paid 

them wages. The easiest possible income to verify. Do any of you 

50 

really think that no one buying those loans really had a clue that 

there was a problem there? Chairman Bair? 

Ms. BAIR. I don’t think they looked. It’s amazing to me. Investors 

were holding the ultimate risk in these loans, and I don’t think 

they looked. I don’t think the rating agencies looked. It is one of 

the breakdowns of the system we have that that market discipline 

was not there. Nobody was looking. 

Mr. MILLER OF NORTH CAROLINA. Okay. Does anyone here think 

that the masters of the universe on Wall Street who bought these 

loans really were played for chumps by the middle-class families 

who were borrowing? 

Mr. DUGAN. If I may? 

Mr. MILLER OF NORTH CAROLINA. Mr. Dugan? 

Mr. DUGAN. Yes. What I would say is this: I think there was this 

belief that income was no longer predictive of people paying their 

loans back, that you could rely on this history of house prices going 

up. And so they ignored it. And I think that proved to be a very 

dangerous decline in underwriting standards. 

Mr. MILLER OF NORTH CAROLINA. Well, and in fact the reason for 

that was—no one involved in mortgage lending, in subprime lending, expected for a second that people would actually pay off those 

loans over the course of 30 years. 

The loans were designed to become unaffordable, become 

unpayable, so that people would have to borrow again. And when 

they borrowed again, they would have to pay a prepayment penalty 

to get out of the last loan. They would have to pay points and fees 

cost to get into the next loan, and every time they did it, they lost 

more of the equity in their home. That was the intent, that was 

the design. What went wrong was not that people couldn’t pay the 

loans according to their terms. What went wrong from the industry 

point of view was that the housing prices stopped appreciating and 

you could no longer count on people getting out, either refinancing 

or just selling their house. 

These loans were not about homeownership. That is one of the 

claims made, the arguments made is that these were loans that 

were made to allow homeownership for people who otherwise would 

not have qualified for traditional mortgages, and what we have 

seen, in fact, is a decline in homeownership. 

The rate, according to the Census Bureau, for the fourth quarter 

of 2004, was 69.2 percent. For the last quarter it was 67.8 percent. 

When the figures come out for last quarter, first quarter of this 

year later this month, it’s going to be down again, down again in 

the second quarter, down again in the third quarter, down again 

in the fourth quarter. It will continue to decline. 

Those are millions of American families who owned a home and 

no longer own a home. The worst cases were the foreclosures. 

There are also a lot of people who sold their homes, could sell their 

homes, had some equity still, could sell their homes, who quietly 

sold their homes, and a lot of them are embarrassed about it, because they couldn’t pay the mortgage. 

And then finally, the question I have is about the millions of 

American families who were able to get out but were stripped of 

the equity by equity-stripping practices like prepayment penalties. 

Do you—what I have seen is that the lenders have only agreed volVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
51 

untarily to what is in their obvious self-interest. But they continued to enforce equity-stripping provisions where they could extract 

the money still from the borrower. Should we pay some attention 

to what is happening in the other loans when we agree to buy some 

of the loans, the ones that obviously cannot—are not being paid? 

Ms. BAIR. I’m not sure— 

The CHAIRMAN. The gentleman’s time has expired. Maybe he can 

submit it in writing and get an answer, but we are out of time. 

Mr. MILLER OF NORTH CAROLINA. All right. 

The CHAIRMAN. And we have to go vote. Why don’t we—the gentleman from North Carolina will submit that question in writing, 

and we would like an answer for the hearing record. 

Ms. BAIR. Could I— 

The CHAIRMAN. Ms. Bair, quickly. 

Ms. BAIR. Just to respond briefly. The FDIC is opposed to stated 

income. We think that should apply across-the-board. We are suggesting that you get rid of prepayment penalties completely, and 

also that we think all originators, bank and non-bank, should underwrite at the full indexed rate to make sure that the borrower 

can make the reset rate. I just want to make sure we’re on the 

record. 

The CHAIRMAN. Thank you. We will be in recess for 35 minutes. 

And 2 words of encouragement—fewer members. We will ask you 

to stay if you could for—we will be gone about 35 minutes probably, and then we will come back and finish up. Fewer members 

come back, so it will be quick. There are three votes. I would say 

we will be back here in a half hour or less. 

[Recess] 

The CHAIRMAN. We will reconvene. I apologize for the delay. I got 

stuck trying to get an elevator. We will now hear from the gentleman from Delaware, Mr. Castle, for 5 minutes. Please take your 

seats. 

Mr. CASTLE. Thank you, Mr. Chairman. Comptroller Dugan, I 

was not here for your testimony. I had to duck in and out to another markup at another meeting, but I have read your testimony, 

which I understand you did not discuss orally, with respect to legislation which I have been involved with, which is H.R. 5579. It’s on 

pages 7 and 8 of your testimony. 

And basically, without spending all our time summarizing the 

legislation, it sets standards by which—the legislation would set 

standards by which lenders, who may be assignees or whatever of 

the mortgage, could renegotiate the mortgage terms with the borrower. And, obviously, if they could meet those standards, they 

could use that in defense with respect to possible litigation. 

This would be open for some period of time, and it essentially 

would I think serve the purpose of allowing the individual lenders 

or assignees of the mortgages or whatever to be able to sit down 

and negotiate terms that might be favorable to the borrowers and 

perhaps lock in a lower rate or a different rate than the lower rate 

and whatever the adjustable rate may be. 

But from experience in this area, it seems to me that nobody 

wins in a foreclosure. Clearly, the banks don’t want to take back 

property which may be worth less. Obviously, homeowners don’t 

want to give up property. And the only issue that has been raised 

52 

by anybody that is somewhat negative to all this are obviously the 

downstream noteholders as they take the various mortgages and 

whack them up into principal and interest or whatever. I guess 

there are those who potentially could lose in all this, although I 

would argue that if you’re going into a foreclosure, you may lose 

even more than you would if you had a reduced interest circumstance. 

I would be interested in your comments concerning this legislation, which is not directly a part of the legislation before us, I don’t 

believe, at this time, but it has been under discussion in this committee, as to the benefits of possibly doing this, either together 

with legislation that might emanate from this committee or separately, and legislation that might emanate from this committee, 

and in terms of any potential downsides that we should worry 

about in that legislation. 

Mr. DUGAN. Well, Mr. Castle, we support this legislative effort, 

as I indicated in the testimony, and we have tried to provide some 

comments to your staff earlier before it got put in its current form. 

We think it clarifies the basic principle that is already in the 

law, which is that when a servicer is acting to restructure a loan, 

that they do so on behalf of the whole loan pool rather than try 

to be guided by different interests of different investors in the pool 

that have different interests, under the principle that you can’t 

serve two or three masters. You have to serve the whole pool at 

once. And we think your legislation clarifies that point, and we 

think it’s helpful in that regard, because I think it does remove 

some of the ambiguity that people have had about this point. I 

think it would be useful to remove that friction point so that when 

it makes sense and services want to voluntarily enter into a modification that benefits the pool more than would be the cost of foreclosure, they should be able to do so. 

Mr. CASTLE. And what are your—you sort of spoke generally to 

that, and I appreciate that, but what about the argument that 

there are those who would be hurt by it? That is, noteholders further down the line who would not receive what they might have 

received otherwise or whatever. Is there a response to that? 

Mr. DUGAN. Well, I think the point again is it is different interests within the pool. And the issue is that I think the servicer can 

only act on behalf of the whole pool. They can’t act on behalf of one 

group of investors and also at the same time serve another group 

within the pool that has a slightly different interest. It’s just impossible to do both, and I don’t think they’re legally bound to do 

both now, although that could be different in different agreements. 

And I think this just clarifies that they can. 

It will always be the case that if you have different interests in 

the pool, some will be hurt or harmed, depending on whether you 

go to foreclosure first or last. But you could have a situation where 

one investor would benefit by going to foreclosure, even though it 

would be more expensive to the pool as a whole, while another investor would never want foreclosure in the pool, just because of the 

way payment streams work. This is a simple test that says if the 

net present value of the savings by doing this is more to the pool 

than foreclosure would be, then they can go ahead and do it. And 

I believe that makes sense, and I think others do as well. 

53 

Mr. CASTLE. Thank you. I’m not sure if other members of the 

panel are even familiar with this, but does anybody else have any 

comments they wish to make on it? 

Ms. BAIR. Yes. We are highly supportive of it. I think you and 

I actually discussed this some months ago in your office when the 

original bill that Chairman Frank was putting together was under 

consideration. And I think some of the political resistance, frankly, 

that you are running into now comes from those same senior 

tranche holders who have been pushing back before. 

So I am disappointed, because the American Securitization 

Forum in June of last year said very clearly that servicers’ obligations are to the pool as a whole. There are some who think this is 

an excuse and others who think it is real. I have heard it enough 

to think it’s real. But clearly, servicers are concerned about potential investor liability. So I think this could be a carrot incentive to 

further the loan modification process along, and we’re happy to 

keep working with you on it. 

Mr. CASTLE. Okay. Thank you. 

The CHAIRMAN. If the gentleman would— 

Mr. CASTLE. I yield back, Mr. Chairman. 

The CHAIRMAN. Let me just briefly say, and I want to repeat 

what I began by saying, we cannot order anybody to go along with 

this, and the gentleman’s bill doesn’t try to do that, because we’re 

dealing with contracts already written. But I do want to make it 

clear to the American Securitization Forum and everybody else 

that if in fact we are not able to get substantial progress in this 

kind of voluntary situation, then I can pretty much guarantee them 

that going forward, they will face a very tough set of rules. If this 

can’t be worked out voluntarily now with existing contracts, then 

it will be our obligation to give a set of rules and priorities for contracts going forward. 

So I hope they will take the opportunity to work this out, because if they don’t, I think you’re going to see a more prescriptive 

regulatory framework going forward. It is not the ideal, but if that 

is the only choice, then that is what I think you will see pressure 

to do. And that is what I want to do. You never know. As this 

thing—if things continue to deteriorate, if the gentlewoman from 

California, Ms. Waters, gets into mitigation, then people are going 

to really get mitigated in ways they don’t like. 

[Laughter] 

The CHAIRMAN. So, I do urge people to take this into account. 

The gentlewoman from Illinois, Ms. Bean. 

Ms. BEAN. Thank you, Mr. Chairman. Thank you to our panelists 

for sharing your expertise on a very critical issue facing our Nation. My question to the panel is to address the moral hazard and 

recoup risk for the Federal Government. The chairman’s bill has an 

aggressive exit fee structure in the first 5 years, 100 percent of equity gained in year one, up to 20 percent of equity gained in year 

five. After the fifth year, borrowers are assessed an exit fee equal 

to 3 percent of the loan amount. 

Do you believe this fee structure is aggressive enough to prevent 

moral hazard and deter the perception of nonparticipating taxpayers that the government is unjustly bailing out troubled borrowers? 

54 

Mr. KROSZNER. The moral hazard issue is an extremely important one, and I’m glad you have emphasized it, and I’m also very 

pleased to see that the draft legislation tries to deal with it. 

I think there are three pieces that try to deal with it. One is the 

exit fees that you spoke about, the 3 percent that whenever someone will leave the loan, they will have to pay that 3 percent. Second, that there’s some sharing of the appreciation that would go on 

over a 5-year period. I don’t think that is particularly set in stone, 

whether that’s the exact appropriate level or not, is something that 

I think is open to discussion. But that type of feature is a sensible 

one to try to protect against moral hazard. And also that there has 

to be a high debt payment-to-income ratio before the legislation has 

been contemplated, and that there’s no—you can’t intentionally default to get into the program. 

So I think there are a number of issues that are there. The exact 

levels of them, I can’t tell you what the right levels are, but it’s important to at least be considering those and thinking very seriously 

about them. 

Ms. BEAN. Thank you. Are there any other panelists who want 

to comment? And I would also throw in that the Senate proposal 

has a 50 percent exit fee on equity gained, if you have a comment 

on the contrast between those two. 

The CHAIRMAN. Will the gentlewoman yield briefly before they 

do, just for me to point out that— 

Ms. BEAN. Certainly. 

The CHAIRMAN. And certainly that is a serious issue. There is 

one other thing that we think deals with moral hazard, and that 

is the bill we passed last year, so that going forward, you are likely 

to have—we have a set of rules in place governing mortgage brokers and others so that there will be much less opportunity. In 

other words, it is not purely a disincentive. Many of the loans that 

caused the problems, there will be laws about there. So that is a 

piece of it. 

Ms. BEAN. You’re talking about the mortgage reform bill. Okay. 

Ms. BAIR. I think like anything, it’s a balancing act. If you give 

the borrower the prospect of getting 100 percent of that home price 

appreciation after 5 years, you have more of an incentive for them 

to stay—stick with that loan, perform on the loan, keep paying, but 

then you have—perhaps exacerbate potential hazard, so I think the 

Senate takes a different approach with only 50 percent equity. I 

think you can argue it either way. 

I would point out, though, that there’s a moral hazard with investors here, too, I think—but there’s been a lot of focus on borrower moral hazard, and clearly that’s, you know, an issue. But an 

85 percent payoff of appraised value, there are probably still for a 

lot of loans getting paid more than they would if they had gone to 

foreclosure. And I think again one of the reasons why you have to 

have this writedown that creates this 15 percent equity piece to 

begin with is that you need to protect the government and also 

guard against moral hazard with investors. 

So it’s a balancing act. It’s a complex process, but I think this 

bill does a good job of trying to juggle the different interests. 

Ms. BEAN. Thank you. Does anybody else want to comment? 

55 

Mr. DUGAN. I would agree with both sets of comments. I guess 

I would just say, it’s hard to know. We don’t really have experience 

with which of the numbers that you set it at are going to work 

best. I think actually the FHA probably has the most experience 

about what over time has created the right incentives without creating undue losses and moral hazard. 

Ms. BEAN. All right. I guess I would like to also comment that 

the chairman mentioned previous bills that we have passed to address this area. We did the mortgage reform bill; we had FHA reform and GSE reform. How important do you feel it is that we 

move forward on those as well? As the chairman said, we need to 

go back to moving forward on newly originated loans. What’s your 

sense of urgency? 

Mr. MONTGOMERY. Certainly on FHA reform—I am preaching to 

the choir on that issue, obviously—if I could just go back to your 

previous point real quickly, we’re coming at it from a little different 

direction. We share in the goal that people shouldn’t benefit or 

profit from this. We do want to keep the homeowner in the home. 

We would probably propose some sort of resale restrictions, some 

recapture provision, similar to what a lot of State housing finance 

agencies do. I think we share the same goal. We just conceptually 

might come at it a little differently. 

Ms. BEAN. Yes? 

Mr. DUGAN. On your other question, I think the most important 

part of the mortgage reform legislation, is that it basically takes 

the Federal standards that have been adopted by the bank regulators on guidance and it tries to extend them in a uniform way 

to all loans, not just loans originated by banks, but loans originated 

under the purview of State regulators. 

I think that’s the single most important part of it. And it’s the 

single thing that really needs to go forward so we do have a uniform standard going forward. I think right now the market, frankly, has already adjusted. There aren’t many subprime loans being 

made, but that will change someday, and when it does, we do want 

to be in a world where they’re basically underwritten so that borrowers can repay their loans without having to rely on the price 

of their house going up. 

Mrs. MALONEY. [presiding] The gentlelady’s time has expired. 

Ms. BEAN. Thank you. I yield back. I see I’m over my time. 

Mrs. MALONEY. The Chair recognizes Congresswoman Capito for 

5 minutes. 

Mrs. CAPITO. Thank you, Madam Chairwoman. I thank the panelists for their length and depth of their answers. I would like to 

thank Mr. Montgomery for his dedicated service in trying to help 

us get this FHA modernization bill through. I know that many of 

us on this committee have worked on hard on that, and we are 

frustrated that we have not been able to reach an agreement, but 

I think this is giving us more impetus to keep moving forward on 

it. 

In light of the fact that legislation probably will not be passed 

as quickly and in light of the fact of the announcements that you 

have made today to expand FHA Secure, which I congratulate you 

on finding a way to help another 100,000 homeowners, particularly 

those who might have some delinquencies, particularly those who 

56 

might have some extenuating circumstances, particularly those 

whose property’s value is now way below what their loan is. And 

these are probably that get up probably in a panic every month trying to figure out how to meet their obligations. What is the 

timeline for implementing these administrative policies that you 

put forward today? 

Mr. MONTGOMERY. Well, heretofore, we have charged a uniform 

premium and part of this proposal to make it work from an actuarial standpoint, as previously mentioned, is the risk-based pricing 

structure. FHA, as you know, is not the mortgage company, we are 

the mortgage insurer, so we operate through our network of FHAapproved lenders and certainly they have to make some systems 

changes to now as we define the various risk tranche and price 

those accordingly, probably anywhere from 60 to 70 days before we 

would be able to stand this up completely. 

Mrs. CAPITO. Thank you, certainly it would be nice to think our 

legislation could move as swiftly but it looks like with the situation 

in the Senate, the Administration’s position on that bill and then 

Mr. Frank’s bill, it looks like we are probably going to have a 

lengthier discussion here. 

One of the questions I wanted to ask you as well is a point that 

you brought up in your opening statement about the seller-funded 

downpayments and that FHA is the only organization that is still 

accepting that. Could you elaborate on that? And you mentioned 

that those who received the seller-funded downpayment assistance 

go to foreclosure as many as three times the rate of the loans made 

to the borrowers, could you explain that a little bit? 

Mr. MONTGOMERY. Well, we have looked at similar years to what 

FHA has seen right now in terms of purchase and re-finance transactions, I will put reverse mortgages to the side for now. We went 

back and looked at the books of business from about 1995 to 2003, 

before the proliferation of the seller-funded, and to look at the credit subsidy rates and the claim rates, we did not have such a high 

percentage of our book of business as seller funded to a point in 

time where now we have about 33 percent of that, the claim rate 

almost doubled. In fact, it actually a little more than doubled. And 

our credit subsidy rate, which was averaging about minus 2.0, 

which as we know in government parlance, a negative subsidy rate 

is good, actually trended more positive. And there is probably a 

reason that no one else accepts this form of assistance because they 

have really hurt our ability to function and also have a lot to do 

with the fact we have to do this risk-based pricing. 

The Internal Revenue Service has also addressed this issue, and 

we are going to continue to look forward because we need to be 

able to function without taxpayer support. 

Mrs. CAPITO. Thank you. I just want to say that this issue is 

something that even though my State is 47th in foreclosure, the 

State of West Virginia, it has a cascading effect really in all areas 

of the credit markets and it is important that I think that we, as 

you and I mentioned in discussions before, that the floor is established so that we can then begin building back. So I thank you for 

your efforts in that behalf, and I would like to mention on behalf 

of my constituents, who do all of the IT for this program and for 

57 

HUD and for FHA, I have 100 people who are working hard and 

they are seeing the fruits of their efforts, so thank you. 

Mrs. MALONEY. Thank you. The Chair recognizes Congressman 

Ellison for 5 minutes. 

Mr. ELLISON. Thank you, Madam Chairwoman. And also let me 

join in thanking the panelists. Mr. Montgomery, in my City of Minneapolis, we have obviously a number of foreclosed homes and our 

Public Housing Authority would like to be able to acquire some of 

those homes and use those to fill the backlog they have for people 

who have applied for public housing. What is the public housing 

backlog like around the country? 

Mr. MONTGOMERY. The public housing backlog? 

Mr. ELLISON. Yes, for public housing and also these scattered site 

type housing as well. 

Mr. MONTGOMERY. Sorry, I don’t have the answer. Public housing 

is not under my realm, and I apologize. 

Mr. ELLISON. But what about institutions like the Minneapolis 

Public Housing Authority being able to get loans from the government to get some of these homes to put people in them, do you 

think that would help advance the cause of trying to address this 

burgeoning housing issue we have? 

Mr. MONTGOMERY. Certainly, Congressman. In fact, we have a 

similar program. Within the Federal Housing Administration, we 

have done pilot programs across America where we have a concentration but again I can only speak for the HUD-foreclosed inventory. 

Mr. ELLISON. If a local housing authority were able to get loans 

to buy up these properties, would not that advance—would that not 

be something that Title 3 of the proposed legislation would help to 

correct, if they have the availability of that—if that was available 

to them? 

Mr. MONTGOMERY. Certainly, again, I can only speak for the 

FHA inventory, but principally lenders would be benefitting, so 

many of these are government resources, FHA or otherwise, and I 

think we just need to be cautious. While we all want to see these 

homes, especially those that need some repair, be occupied, again 

we have to ask where would the source of funds come from to provide loans or grants. 

Mr. ELLISON. I will yield back at this time, Madam Chairwoman. 

Mrs. MALONEY. Congressman Garrett, for 5 minutes. 

Mr. GARRETT. I thank the Chair and I thank the members of the 

panel as well. I appreciate your coming for this forum. I think it 

is important. I will begin where Secretary Montgomery was cut off 

at his initial testimony or answering a question. I think we all 

agree on the same point, that at the end of the day we want to do 

all that we can to address the situation to make sure that we have 

a secure system now but also our housing plans in the future as 

well. 

When we look at the economy today, as we have it, it is somewhat clearer now that we may be moving into a recession. I heard 

the former chairman just on TV the other day, former Chairman 

Greenspan, saying that we are now moving into a recession, and 

so we have the experts telling us that and the folks on TV, Larry 

Kudlow, who was always the epitome of the optimist, whom I folVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00061 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
58 

lowed up until 2 days ago when he went 180 degrees the other day 

and says he even agrees that we are in a recession now as well, 

so everyone is on the same page, I guess, to that extent. 

But even when you move those words away, when I look at my 

constituents back at home, however you define it, they are hurting. 

I am from the State of New Jersey and it is not just the housing 

situation, we are a commuter State, so we are paying at the pump 

continuously. And just in this session alone we have seen the price 

of gas go up by almost a buck and so when you are in a commuting 

State, you are seeing your cost of living going up. That is tied of 

course to other energy costs, and food prices are going through the 

roof. Mr. Kroszer, you can probably tell us about the inflationary 

pressures, and I could probably have a debate with you as far some 

monetary policy on that as well, but we see the inflationary pressures just impacting the family budget in so many ways and housing then is just—these housing prices just exacerbates it. 

But what you miss sometimes, I think, or the media misses 

sometimes is that on this housing situation, things have been done 

already. The Administration came out with a program a while ago 

to remediate the situation. The Administration has a new proposal 

now. This committee, of course, has done—we just discussed the 

issue as far FHA reform and the private sector, I believe, has also 

stepped up to the plate to a pretty large extent as well to address 

it. I am wondering, besides the proposal on the table right now, 

and, Chairman Bair, I will throw this out to you, are there other 

avenues that we should be looking at specifically that might be in 

your bailiwick, if you will, to provide some more credit relief in a 

way that would address the overall economic situation and maybe 

indirectly to this and that is in the area of covered bonds. Could 

you bring us up to date on what you are doing and what the outlook calls for that? 

Ms. BAIR. Sure. Well, actually, we will be having a board meeting 

next week, and I expect the Board will be putting out for comment 

a policy statement to facilitate more covered bond offerings here in 

the United States. It will help. It is not a magic bullet, but I think 

it will help provide some additional capital market liquidity given 

the problems the private label securitization market has had. We 

think it is a mixed bag for the FDIC. If a bank who does the covered bond offering would eventually get into trouble, it would increase our resolution costs because these are secured offerings. It 

removes some high quality assets that we could otherwise sell off. 

Mr. GARRETT. Okay. 

Ms. BAIR. But that is a fairly remote possibility. I think for the 

institutions that we are looking at, who would probably be interested in doing this, we will be building in some conditions such as 

primary regulator approval in order to make the covered bond offering. But I think it is something we should facilitate. 

On the positive side from a regulatory standpoint, those mortgage assets do stay on banks’ balance sheets, so hopefully there is 

more underwriting discipline than we have seen in the 

securitization market. Also they would have to hold capital against 

these assets, whereas if they are securitized again, they move off 

balance sheets. So I think there are some positives from a supervisory standpoint and certainly anything we can do to help provide 

59 

liquidity for mortgage funding right now is something we want to 

encourage. 

Mr. GARRETT. Two quick questions: First, is there a timeline on 

any of this; and, second, is there any legislative action that we 

should be working with you on this end? 

Ms. BAIR. No, I don’t think so. I think this is something we can 

do by regulation, by policy statement and, as I said, the FDIC 

Board will be formally considering this matter. I have two of my 

Board members here with me, but I think it is generally known 

publicly that we are going to be moving ahead with this. The Board 

will vote next week and it will be out for comment for a period, but 

I think just the fact that we put it out will immediately send a signal to banks that might want to do these and provide information 

to rating agencies regarding what the conditions are. 

Mr. GARRETT. Okay, if there is anything we can do on that, 

please let us know. 

Ms. BAIR. I will. 

Mr. GARRETT. And my final question in the time remaining is, 

the action that we are doing here and continuing the debate on 

this, does this do anything to the broader marketplace which is basically holding their assets on the sidelines at this point as far as 

the credit markets are concerned and saying we are really waiting 

to see what Congress does, all the time keeping the credit market 

tighter than maybe it should be, do any of you have an opinion that 

we may be exacerbating this problem, if you will, by just continuously throwing out new proposals and not moving—either not moving on them or just continuing the debate? 

Mr. REICH. I do believe that servicers may be among those that 

are waiting to see what is likely to come from current discussions. 

We have been talking with them about a proposal that we put on 

the table that is very similar to the chairman’s proposal but it includes a negative equity piece that would offer to servicers the opportunity to hold the amount that is underwater and opportunity 

to recoup the potential value on down the road when the house is 

ultimately sold. Providing the servicer some incentive, in our opinion, is one of the keys to incentivizing them to be more aggressive 

in offering and working with the borrowers that are within the 

securitizations. 

Mr. GARRETT. Anyone else? 

The CHAIRMAN. Thank you. 

Mr. GARRETT. Thank you. 

The CHAIRMAN. The gentleman from Colorado? 

Mr. PERLMUTTER. Thank you, Mr. Chairman. And, Mr. Montgomery, I appreciate your comments about looking out for the taxpayer, you have to do that in your organization, and we have to do 

that as Members of Congress. But the FHA is not an island unto 

itself, and so I want to start with Chairman Bair and just ask if 

we do not do anything, and I see that there are some pitfalls to the 

legislation the chairman has proposed, but if we do not do anything, how many claims do you think are going to be made against 

the FDIC? 

Ms. BAIR. Congressman, as a matter of policy, I really do not 

make those kinds of predictions, but I do think we are in a very 

serious situation here. It may sort itself out sooner rather than 

60 

later. We do not know. There are a lot of uncertainties, but I think 

the situation is getting serious enough that we do need—as I said 

in my written and oral statement—to be more proactively instituting government programs to try to stabilize the situation. 

Mr. PERLMUTTER. And really, again, Mr. Montgomery, that is 

where I am coming from, having been a product of the 1980’s, the 

RTC and the FHA suffered some pretty heavy losses during those 

years as well. Ultimately, the taxpayer of this country steps behind 

things and so when the Federal Reserve steps in to underwrite $30 

billion for Bear Stearns because at the heart of it was mortgagebacked securities that seemed to be questionable for everybody, I 

feel like we have already stepped in on Wall Street, so we better 

also help on Main Street to some degree. So I am going to ask the 

Governor, of the $30 billion, and I understand that there is $1 billion that JP Morgan is on the hook for and $29 billion that the taxpayers may be on the hook for, what if we do not do anything, how 

solid do you think your $29 billion underwriting of Bear Stearns 

is going to be? 

Mr. KROSZNER. Well, this is, as you said, exactly why we wanted 

to put the acquirer in the first loss position on the first $1 billion. 

We have hired an expert on doing valuation, and we are assessing 

that. We believe that good collateral has been pledged, but obviously we will depend on the evolution of the markets over time to 

know what the extent of payouts are, either positive or negative. 

Mr. PERLMUTTER. And if I understood that particular deal, the 

underwriting comes at a figure where there has been a write-down 

of the Bear Stearns assets, right, to market at this time? We do 

not know if it is going to get worse or better or whatever. 

Mr. KROSZNER. Yes, a haircut has been taken on the assets. 

Mr. PERLMUTTER. And as I understand the chairman’s bill, there 

would be a haircut or write-down or whatever to some appraised 

value, and I feel sorry for the appraisers in this deal. There is a 

lot of pressure and, Mr. Chairman, I do not know—I am concerned 

about the pressure that is placed on the appraisal industry, whether it is independent or within the institution, to establish that market price. But here, and Mr. Montgomery, this is my question to 

you, if there is this write-down to market and then 90 percent of 

that is guaranteed, I understand there is some risk to the taxpayer 

if in fact the market continues to fall, but I am sure—how in what 

you are doing, in what the Administration has proposed is there 

any less risk than what is proposed in this bill? 

Mr. MONTGOMERY. Well, there is certainly risk with the existing 

FHA portfolio, the non-subprime part that we are talking about assisting more of, so we have that concern today. Again, I think we 

share some of the ultimate goal that there needs to be some sort 

of write-down to get to a more realistic number in between, whether it is 85 percent LTV or 90 percent LTV, again, based on actuarial modeling, those loans perform fairly well for us. I would say 

the timing is probably good for these. My opinion is, I think prices 

may go down a little more, but I think we are kind of near the bottom of that trough, and I think we all want prices to go back, 

maybe not the run-up we just saw, but the timing might be good 

for doing this type of proposal. 

61 

Mr. PERLMUTTER. Okay, and I guess the last comment, and this 

is to you, Mr. Comptroller, I think one of the biggest problems that 

I have seen here is just the way, whether it is Bear Stearns or how 

it was capitalized in this thing, whether it was a 1 percent, you can 

borrow 99 percent against the 1 percent on these mortgage-backed 

securities, and so I just think there needs to be some stiffer regulation within the capitalizing these mortgage-backed securities, and 

I yield back. 

The CHAIRMAN. The gentleman from North Carolina, Mr. 

McHenry? 

Mr. MCHENRY. I thank the chairman. I do want to start by saying I disagree with my colleague. I believe that we should not feel 

sorry for the appraisers; they are going to make a mint under this 

House bill. Talk about pressure, their pressure will be being able 

to get enough hours in the day to process all their checks. But I 

digress. 

Mr. Montgomery, in terms of FHA action, I wanted to bring up 

an article, a recent Wall Street Journal article entitled, ‘‘Uncle 

Subprime.’’ It contends that Mr. Frank’s bill waters down the FHA 

underwriting standards, namely, ‘‘Borrowers cannot be denied FHA 

insurance due to low credit scores or a delinquency on existing 

mortgages. It also cannot be the sole reason to deny FHA insurance.’’ 

In the fourth quarter of 2007, FHA, you all were the only component to see a decline in foreclosures in the mortgage market, isn’t 

that correct? 

Mr. MONTGOMERY. That is correct. It has gone up and down a 

tenth or a hundredth of a percent but very little. 

Mr. MCHENRY. Okay, but it is less than the rest of the mortgage 

marketplace. 

Mr. MONTGOMERY. Way less than subprime, it is about 2.15 right 

now. 

Mr. MCHENRY. But less than the whole rest of the marketplace. 

So how would you expect this rate to change under the chairman’s 

mark, this discussion draft before us? 

Mr. MONTGOMERY. Well, the beauty of FHA for decades has been 

there is no FICO score requirement. There is not one FICO cutoff. 

We look at the totality of what the borrower’s portfolio is. I would 

say we are looking at risk identifiers maybe a little differently. We 

are more concerned about the number of delinquencies going forward. I think the chairman’s bill is looking at it from a DTI aspect 

as well, which we are doing similarly. But, again, I do not think 

we are looking to throw the baby out with the bath water here in 

underwriting. We are going to continue to put some parameters 

around who qualifies and who does not, and there will be some who 

will not qualify. 

Mr. MCHENRY. How would you expect the rate of foreclosures, 

would it go up or go down, under the legislation before us in the 

House? 

Mr. MONTGOMERY. I think given the narrow constraints that we 

are putting on, again, I cannot control market dynamics, but as our 

foreclosure rate does and has for many years, sometimes it will uptick a little, sometimes it will go back down. I cannot see that it 

would measurably change a lot one way or the other. 

62 

Mr. MCHENRY. Okay. 

Mr. MONTGOMERY. At least in the short term. That is just my 

opinion. 

Mr. MCHENRY. So just a guess is what you are saying, okay. 

Mr. MONTGOMERY. A little better than a guess. 

Mr. MCHENRY. Okay, but based on my reading of it, it looks like 

the underwriting standards would be watered down based on legislative action and FHA would be forced to ensure loans that they 

normally would not and that is a contention that we will make. 

But I will go on to Governor Kroszner. We have some discussion 

today that Citigroup—there is a report today that Citigroup has 

$12 billion in loans. A private equity firm has stepped forward and 

offered them 80 cents on the dollar. How would this proposal from 

the House affect a proposition like that? Could this private equity 

firm in fact make money off of this proposal? Instead of being 

worth 80 cents on the dollar, it would be worth 85 cents on the dollar? 

Mr. KROSZNER. Well, I cannot comment on anything specific to 

this transaction because I do not have any details on that, but the 

issues that you raise are important ones because we do not want 

an adverse selection problem where the government only gets the 

bad assets, or a moral hazard problem to arise. And so that is why 

it is very important in contemplating any such legislation, that 

there are very important ways of trying to deal with some of the 

adverse selection problem. One way of doing that is giving more 

flexibility to the FHA to do risk-based pricing, so that if a riskier 

loan comes to them, they can charge a higher premium, just as in 

the private markets, if you are a riskier driver, a higher premium 

is charged to you. And there are a number of aspects of the proposal that I think are in important in thinking about that. 

One thing that is done very often in the private sector is a socalled loan seasoning or put-back provision so that if a loan is sold 

to someone else, here it would be sold to the FHA, if it were to go 

delinquent very quickly within a few month time period, it could 

be put back to the person who gave it. 

Mr. MCHENRY. Sure, you mentioned that earlier in your testimony. Is the private sector beginning to sort out some of this debt 

question? Are there groups being formed that are trying to do some 

assessment of purchasing some of the loan packages, mortgage 

packages, and trying to make some profit by doing some workouts 

by purchasing this? 

Mr. KROSZNER. Again, I am not familiar with any particular circumstances. 

Mr. MCHENRY. Sure, well, Ms. Bair, if you could comment on 

that, and I appreciate your rapping the gavel but she was interested in answering. 

The CHAIRMAN. We generally allow the last answer. Go ahead. 

Mr. MCHENRY. Well, Ms. Bair is the last answer, thank you. 

The CHAIRMAN. Ms. Bair, please go ahead. 

Ms. BAIR. Yes, I just want to add that I think those were leveraged loans that were sold; I am only familiar with the published 

press accounts. Those are corporate loans, they were leveraged 

loans, they were not mortgage loans or mortgage-related assets, so 

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63 

gages or mortgage-related securities are finding their bottom, so to 

speak, the economic analysis that I am getting from our staff indicates that we are still looking at very, very steep discounts. Home 

prices themselves continue to go down. We had very steep declines 

last year, in some areas 15 to 20 percent, and the futures markets 

are still predicting declines as well as most of the analysts I am 

reading. So I think for housing and housing-related assets, there 

are a lot of uncertainties about where this is still going to go. 

The CHAIRMAN. The gentleman from Illinois? Let me ask the gentleman to yield me 30 seconds first. The gentleman from North 

Carolina talked about weakening of standards and delinquencies. 

The changes that are proposed permit a borrower—because now delinquencies keep you out of this—permit a borrower to have either 

one 60-day delinquency or two 30-day delinquencies if it is 97.75 

LTV, and permit borrowers who exceed such delinquency histories 

with extenuating circumstances. 

The proposed changes also permit borrowers who only borrow 90 

percent LTV to have as many as one 90-day delinquency or three 

30-day delinquencies. That is the FHA’s proposal from the Administration. So the tolerance for delinquencies, and I appreciate the 

Commissioner’s answers, what I have just read would be a weakening of standards, if that is what you want to call it, which is the 

Administration’s proposal. 

The gentleman from Illinois? 

Mr. FOSTER. I would like to thank the panel for staying around 

to the point where you are now listening to the first-ever questions 

from a 3-week old Congressman. 

[Laughter] 

Mr. FOSTER. The first question has to do with the regional and 

State balance and mortgage relief. In the discussion draft, the allocation of grant amounts and loan authority goes preferentially to 

States first that have high real estate prices because they are 

scaled to the median home price. And, secondly, to States that have 

a high fraction of failing mortgages since they are scaled to the 

total number of mortgages in trouble or foreclosure. The problems 

that occur to me are that, first, you are allocating funds preferentially to States with high real estate prices, and so maybe you are 

not allocating funds in a way to help the greatest number of people 

since it presumably is cheaper to bail out homeowners in low-cost 

real estate markets than in higher cost real estate markets. And 

in a related issue, you are implementing what amounts to a differential Federal subsidy, which has the effect of supporting real 

estate prices in areas where the prices are already high and thereby making a bigger spread in real estate prices than the market 

might normally support. 

And the second problem that I have with this is that if you allocate funds to States with high fractions of bad mortgages, then you 

may be creating a State-by-State moral hazard in which States 

that have lots of bad actors in them get a preferentially large bailout. And I was wondering, this sort of discussion has to come up 

over and over again in things like the FHA and if any of you have 

comments on this, how it is handled and whether there are issues 

are that could be handled differently? 

64 

Ms. BAIR. Congressman, I used to work in the Senate for many 

years for Bob Dole and one thing I learned is never get involved 

in congressional debates about where money is allocated among 

States, so I think you raise legitimate issues, but I think it is really 

more one of congressional policy than it is regulatory or supervisory issues. 

Mr. FOSTER. Fair enough, okay. I will ask a hopefully simpler 

question, which is that when this is all played out, would we have 

been better off to simply ban ARMs or maybe reduce the range 

over which they can be reset? 

Ms. BAIR. I think that is an excellent question. I think what the 

bank regulators have told the banks is that they underwrite loans 

at the fully indexed rate, meaning you can do an adjustable rate 

mortgage but you need to make sure that the borrower has the income to make the reset. The Federal Reserve Board has proposed 

similar rules that would apply to all mortgage originators, not just 

banks. So, yes, adjustable rate mortgages may be a good product, 

but the underwriter—the originator—needs to make sure that the 

borrower can make the reset rate when the payments adjust up. 

Mr. DUGAN. I would just add that I do not think it is a good idea 

to ban adjustable rate mortgages. There have been many that have 

been very good consumer products that have saved consumers a lot 

of money. Some have performed better than others. I think it has 

really been the underwriting features, as my colleague just suggested, that have been the big problem with this, and I think adjusting the underwriting standards through guidance and through 

regulation is really the fundamental way to get at this. 

Mr. REICH. I agree with that. I think that banning specific products is not a good idea. I think that you could name almost every 

product and find that there is significant responsible borrower utilization of those products and it is the underwriting on which we 

need to focus our attention. 

Mr. FOSTER. Okay, I yield back. 

The CHAIRMAN. I would ask the gentleman, since we have some 

time, on the first part of the question in terms of the State-by-State 

allocation, I just want to be clear, with regard to buying up property that is already foreclosed there is an allocation, but in the first 

part, there is no allocation formula. The part about the FHA, going 

to the FHA, there is no State-by-State allocation formula. The 

State-by-State allocation— 

Mr. FOSTER. I believe that there is language in there that indexed, this index that was constructed related to the average— 

The CHAIRMAN. Yes, that is for the part of it that distributes the 

funds to buy a property already foreclosed, not for the foreclosure 

avoidance. 

Mr. FOSTER. Okay. 

The CHAIRMAN. Yes, of course, the foreclosure avoids pieces case 

by case by case. The gentleman is correct as to the formula but 

that goes in the distribution—of course, there is no distribution of 

Federal funds in the first two titles. In the last title, that is to buy 

up property already foreclosed and that is according to that formula. But the first part of where there is a write-down, presumably 

an FHA guarantee, there is no formula there. It is on a case-bycase basis. 

65 

The gentlewoman from Minnesota? You are the last questioner. 

Mrs. BACHMANN. Thank you, Mr. Chairman. And I thank the 

panel members who are here as well. I wish I could have been here 

for all of your testimony today, but I do have a question for you. 

You may be familiar with today’s edition of the New York Times 

and the headline that read, ‘‘Looming Deficit Impedes Federal 

Housing Agency.’’ I would like to read two quotes from the New 

York Times article from this morning. The article said, ‘‘Housing 

officials say the agency will face a deficit for the first time in its 

74 year history starting in the fiscal year that begins in October 

of this year. They blame the seller-financed downpayment loan program, which has suffered from high delinquency and foreclosure 

rates in recent years.’’ And as I went on to read the article, it is 

stunning, the level of the delinquency under this program. 

Here is a second quote from the article: ‘‘The program continues 

without any changes. Congressional officials say the FHA would 

face a $1.4 billion shortfall in fiscal 2009. This would mean that 

Congress and American taxpayers would have to subsidize the 

FHA for the very first time.’’ I am concerned and I am wondering 

whether you are concerned that this proposal that we are now considering today will only add to or lead to this scenario? We are in 

a weakened condition now, and I am a little nervous that a bill of 

this magnitude would only add to this scenario. I would be happy 

to hear from any of you, particularly Mr. Montgomery. 

Mr. MONTGOMERY. Thank you, Congresswoman. I have a very 

simple solution, and that is to just eliminate seller-funded downpayment assistance. If our portfolio was 100 percent seller-financed 

downpayment assistance, we would not be in business. And everybody has heard my opinion so I will probably defer to someone else 

but that would be a simple solution. We are their only customer 

by the way. No one else will accept it. 

Mrs. BACHMANN. And as I understand it, the Senate has that 

provision included in their bill, is that right? 

Mr. MONTGOMERY. That is correct. 

Mrs. BACHMANN. But the House does not? 

Mr. MONTGOMERY. That is correct. 

Mrs. BACHMANN. Okay, is there any other comment on that? 

Ms. BAIR. Well, I think Chairman Frank’s proposal, especially 

with the 15 percent cushion for FHA, does provide additional protection in terms of this particular program. I think the chairman 

is making real efforts to build in some safeguards to protect the 

government from future losses. There may be some other areas 

that can be adjusted, but I think that there are some protections 

built into this proposal. 

Mrs. BACHMANN. Anyone else? It is a concern of mine because it 

seems that there is a tendency to have the American taxpayer be 

the insurer of last resort, the banker of last resort, and we saw recently, and this is unrelated to the Federal Reserve, in their move 

putting essentially $29 billion worth of taxpayer money on the hook 

regarding the Bear Stearns, JP Morgan, Chase contract arrangement that was made and that was unprecedented. That was the 

first time since 1932 that something like that had occurred. That 

was the first time that the Fed had exercised that power, so the 

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66 

cial position but it seems very easy to put the taxpayer in some 

unique positions that we have never seen before: to be banker of 

last resort; and to be insurer of last resort. 

I am concerned that we will be setting a precedent where we can 

go back to the deep pocket every time there is a blip on the screen. 

And, again, I am not trying to say that the current situation where 

we are dealing with foreclosures is a blip; it is not a blip. This is 

very real. People are suffering, and we recognize that, but at the 

same time, this is a private contract, these are private contracts 

that were entered into by borrowers and by lenders, and so I am 

concerned that now we are going to be bringing the American taxpayer into a contract that they neither began nor did they ask to 

be invited to be a part of. Do you have any comments about that? 

Mr. MONTGOMERY. Well, in some ways the loans with that type 

of assistance are almost a subprime product. And the IRS has 

moved toward eliminating, they had some concerns about the circular financial arrangement, and we tried to do the same with a 

proposed rule, but we did not prevail on that. And, again, I had one 

request and that is that the House would follow the Senate in this 

respect and eliminate them altogether. 

Mrs. BACHMANN. Mr. Montgomery, what do you foresee for the 

FHA as far as solvency goes, down the road? What are you seeing? 

It appears that the American taxpayer will have to be bailing out 

the FHA. 

Mr. MONTGOMERY. I have immense faith in Congress that they 

will finally pass FHA reform, and we can price according to risk 

and we will thus eliminate hopefully this problem on October 1st 

of this year. 

Mrs. BACHMANN. Thank you. 

The CHAIRMAN. I thank the panel. It has been a long day but I 

appreciate the candor and thoughtfulness with which you have answered questions. I do have one disclaimer: To the extent that several of the panelists paid tribute to some pieces of the bill that we 

have, they were basically reflecting the fact that we listened to 

them. So I thank them for the nice words. They were being both 

modest and immodest, modest in giving me credit; immodest in 

bragging about what they told me to do. With that, the first panel 

is dismissed, and I will call forth our second panel. 

We will begin with Dr. Alan Blinder, a professor at Princeton, 

and a former Vice Chair of the Board of Governors of the Federal 

Reserve. Dr. Blinder? 

STATEMENT OF ALAN S. BLINDER, PH.D., GORDON S. 

RENTSCHLER MEMORIAL PROFESSOR OF ECONOMICS AND 

PUBLIC AFFAIRS, PRINCETON UNIVERSITY 

Mr. BLINDER. Thank you very much, Mr. Chairman and members of the committee, at least those of you who have had the stamina to last this long. I was thinking, as I was waiting, that I am 

glad I do not have a mortgage; it might have been foreclosed while 

I was waiting. But I have no mortgage on my property. 

This is a very important piece of legislation. I am very glad to 

come here and testify in support of it. 

The credit markets in the United States and around the world, 

and this is broader than the mortgage market, have now been in 

67 

turmoil since last August—at times improving a bit but then deteriorating once again. I would have to say my assessment, indeed 

I think almost everybody’s assessment, is that the overall trend 

since August has been downhill, not uphill, which is most unfortunate. 

Ameliorating the mortgage foreclosure problem, which is the target of this bill, will not cure all the ills that afflict the credit markets, but I think it will help. And for reasons I will elaborate in 

just a second, I furthermore think it is central, that is, it is not the 

only thing that needs to happen, it is not the magic bullet, but I 

think it is central. I will explain why in a second. 

First, I want to note that there is another point of view, one that 

holds, first of all, that housing prices are too high and must be allowed to fall to their market clearing levels, and secondly, that 

homeowners and lenders who made foolish or irresponsible decisions should suffer the consequences of their own actions. There is 

a legitimacy to each of these points. However, the Social Darwinist 

sentiment, to which this often comes down, reminds me of what 

Andrew Mellon said in 1931—and which, by the way, Herbert Hoover had the good sense to reject. It is short and pithy, so I am going 

to quote it. (The quote is right at the top of page two of my testimony.) Mellon said in 1931: ‘‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the 

rottenness out of the system. People will work harder, live a more 

moral life and enterprising people will pick up the wrecks from less 

competent people.’’ Well, I think we outgrew that attitude in the 

1930’s, but it is making a comeback in this decade. 

I want to take that statement as a jumping-off point to address 

the very legitimate question of putting the taxpayer on the hook. 

This bill would, as has been said by several people, leave the taxpayer holding the bag if things go wrong. I want to point out, very 

importantly, that the taxpayers, or if you just broaden it slightly 

the citizens, who are a slightly bigger group, although if you count 

sales tax and every kind of tax, taxpayers include everybody, are 

on the hook if the economy goes into a slump. Indeed, they are on 

the hook already, for the economy is in a slump. If we have a severe slump, or what I fear more, a protracted period when we are 

simply not growing as we should be because of a broken credit 

mechanism, every American is on the hook for that. So it is exactly 

the same people. What this legislation is about, and what I think 

this whole effort should be about, including all the things the Federal Reserve is doing, is to make the bill, in whatever form it 

comes, smaller. And I think there is a good chance that this bill 

can contribute to that. 

The first part of my testimony, which I am going to go over very, 

very quickly in the interest of time, lists six reasons why I think, 

in contradistinction to Andrew Mellon, that the government should 

intervene to try to make this problem smaller. I will really touch 

on only two of them in the time allotted to me here at the witness 

table. 

If I could call your attention to the inverted pyramid that I 

sketched, not that well, on page three; this looked better when it 

came from my secretary, but then I fiddled around with the document and made a mess, so I am sorry. The bottom of this pyramid 

68 

shows homes and then mortgages. The point I am making in this 

diagram is that the problems in the housing market, which of 

course immediately become problems in the mortgage market, sit 

at the bottom, at the apex of this triangle. And lots of financial instruments are then built above mortgages, so the most obvious is 

mortgage-backed securities, MBS. Then you have the notorious 

CDOs and an entire alphabet soup of all kinds of other things. And 

then at the top of this diagram, it shows in large letters the entire 

credit market, which has by now been infected by the contagion. So 

the problem spiraled up from the bottom in this diagram, from falling housing prices to more actual and feared defaults on mortgages, to lower values for MBS, to decimated values for a variety 

of derivatives built on them, and hence to the whole credit market. 

The basis of the Federal Reserve’s much applauded, although in 

some quarters criticized, intervention in the Bear Stearn’s, J.P. 

Morgan matter was exactly stopping contagion. The Federal Reserve really did not care about Bear Stearns per se, but it cared 

a great deal about contagion to the rest of the financial system and 

thus to the entire economy. That is what this effort is about, as I 

see it. There has been tremendous contagion already from the bottom of this pyramid filtering up and that is why it is appropriate, 

I believe, to start at the bottom to reverse this cycle and turn it 

into a cycle where the foreclosure problem starts looking smaller 

rather than larger, the mortgage-backed securities start gaining 

value rather than losing value, and so on up the pyramid. Then 

you start creating more confidence in the entire credit system. 

The second point I want to make, which is very much related to 

that, is that all modern economies run on credit and when the 

credit system malfunctions, the whole economy malfunctions. That 

takes us back to the question I raised earlier about who is on the 

hook for all this? Every single American is on the hook for this, 

and the worse the economy gets, the worse it is for all of us, Andrew Mellon notwithstanding. While the moral hazard problem is 

perfectly valid, this could be a very expensive moral hazard problem to solve if we just let laissez-faire do it. Laissez-faire will do 

it in rough but reliable ways, and, by the way, it seems to be taking a long time. That is why I emphasized that this crisis started 

in August, and here we are in April and the credit markets are 

looking worse, not better—which to me was a huge surprise. I 

would not have thought in August that we would still be in crisis 

in April. 

So I just want to pick out a few points in the legislation and 

mention them. How many minutes do I have left? 

The CHAIRMAN. About 2 or 3 minutes. 

Mr. BLINDER. Two or three, alright, I will be very selective. First 

of all, one of the keys to the moral hazard problem is the haircuts 

that both borrowers and lenders will have to take. Borrowers in 

this bill give up certain privileges of price appreciation. I would actually like to see them give up more privileges in terms, for example, of the ability to take out a second mortgage, which includes a 

home equity loan, on the property. Ordinary homeowners have that 

privilege as long as the bank will give them the money. For these 

special mortgages, I think it would be appropriate to take that 

69 

privilege away as another way of controlling the moral hazard and 

controlling the demand for the program, as well. 

When it comes to the lenders, the right thing to do, of course, is 

to mark the mortgages down to market. The problem, the catch 

here, and it is a gigantic catch, is that the market for re-selling 

these mortgages has practically evaporated. I would like to see the 

bill—and I think it is the intent, it is your intent, Mr. Chairman 

and the intent of other people who have input into this bill—to try 

to mimic something like what the market would do if the market 

was functioning. My idea on this was a little bit different. It was 

to have the FHA post buying prices for mortgages of various qualities, based on the best guess it could make of what the market 

price would be, and then watch. If it gets flooded with servicers trying to sell mortgages, it has set the prices too high. If nobody 

shows up, that will show it has made the prices too low and try 

to iterate in that way towards market prices. But, really, the point 

I want to make is that in this respect, trying to mimic what the 

market would do if there was a market is an important way to 

think about framing the legislation. 

I had a number of things in here about eligibility criteria, which 

is going to go to determine the size of the pool of mortgages that 

get refinanced this way, but let me skip most of that and just make 

two points. One is that nobody knows how many mortgages will 

need this treatment, so to speak, so nobody can sit here and say, 

well, this will be 1 million mortgages or 1.5 million mortgages, and 

I think the Congress needs to allow in the legislation flexibility and 

just understand in Members’ own minds and in citizens’ minds that 

nobody really knows what the scale of this operation must be, and 

once we embark on it, it would be foolish to cut it short before it 

has done what it was supposed to do. 

The other point I wanted to make, because it came up in the previous panel more than once, I think, is that we ought to be pretty 

tough about fraud, that is, people who committed fraud and misrepresentation to get their original mortgages ought not to be eligible for this program. I would like to see this program administered 

as a high-document one, in contradistinction to the low-document 

or no-document mortgages, including such things as proof of residency and a whole variety of other things. 

[Gavel] 

Mr. BLINDER. Am I out of time? 

The CHAIRMAN. Yes. 

Mr. BLINDER. Then I will stop, thank you. 

[The prepared statement of Dr. Blinder can be found on page 114 

of the appendix.] 

The CHAIRMAN. We will get to some of this in the questions. I 

gave you a little extra time because these three witnesses were 

very forbearing for a long morning and into the afternoon. 

Mr. Brian Wesbury, the chief economist at First Trust Advisors. 

Mr. Wesbury? 

STATEMENT OF BRIAN WESBURY, CHIEF ECONOMIST, FIRST 

TRUST ADVISORS L.P. 

Mr. WESBURY. Thank you, Mr. Chairman. Thank you, members. 

It is good to be here. Thank you for inviting me. I will try to be 

70 

brief but if I could put my entire testimony into the record, that 

would be great. 

The CHAIRMAN. Yes. 

Mr. WESBURY. It is interesting that Dr. Blinder brings up Andrew Mellon’s quote to ‘‘liquidate, liquidate, liquidate’’ because we 

have heard a lot of talk about the Great Depression in recent 

weeks and Herbert Hoover and a lot of it has been about how he 

sat idly by while the economy crashed, and we use his image as 

a kind of a dart board, I suppose, these days politically about what 

is going on, and I think this is just false in two ways: Number one, 

Herbert Hoover was extremely active in the late 1929, early 1930 

period; and number two, we have done unprecedented things in the 

last 7 months as well, and I think there are great parallels. One 

of the reasons that a recession turned into the Great Depression 

in the 1930’s, in my opinion, is because the government overdid 

things; they became too active. Herbert Hoover signed a tax increase in 1932, signed the Smoot Hawley Tariff Act, which raised 

tariffs on exports and imports, and literally shut down world trade. 

He increased— 

The CHAIRMAN. Mr. Wesbury, we do have time, but the economic 

history part, if we could get to the more current stuff, that would 

be helpful. 

Mr. WESBURY. Okay. My feeling is that the history is relevant 

here. 

The CHAIRMAN. Alright, but it comes out of your time if that is 

how you want to use it. 

Mr. WESBURY. And I have 5 minutes, I was going to use it in a 

way— 

The CHAIRMAN. Go ahead. 

Mr. WESBURY. Just to skip to today, we have been extremely active. The Federal Reserve has cut interest rates by 57 percent in 

the last 7 months; that is the fastest rate cutting we have had in 

60 years. There have been hundreds of billions of dollars lent to financial institutions to help them through this period of time. FHA, 

Fannie Mae, Freddie Mac, and the Federal Home Loan Banks all 

have had rules changes to allow not the FHA yet but to allow more 

lending to take place. The HOPE NOW Program has by most accounts helped almost a million homeowners restructure the terms 

on their loans. This is a very, very active government, and I think 

with a matter of time, we are going to see the impact pick up and 

the economy pick up as well. 

Now, let me go to my next point and that is this: How did we 

get in this mess? Was it really about fear and greed, greed of homebuyers, greed of lenders, people taking advantage of each other, or 

was it about something else? And my belief is that people, human 

beings, do not change from spendthrifts to misers overnight. They 

do not go from not wanting to buy homes to wanting to buy everything in sight that has a two-by-four in it overnight. Something has 

to happen to create a change in their behavior, and I think what 

changed was that the Federal Reserve drove interest rates to 1 percent back in 2003 and held them there for too long. What this did 

is it drove up home prices and it made mortgages extremely cheap. 

Everyone thought interest rates were going to stay down low forever and, as a result, we saw a surge in activity. In fact, if you look 

71 

at almost any measure of housing activity between 2003 and 2006, 

it surged well above its trend, and I believe that is how we got 

here. 

The interesting thing is that this kind of mirage in the marketplace has happened before. In the 1970’s, the Federal Reserve was 

also too easy, it drove up oil prices, Penn Square Bank made too 

many oil loans, and sold participation in those loans to Continental 

Bank and Seafirst Bank, and all three of these banks went under. 

In other words, we have seen financial problems caused by this 

occur before and in the 1980’s, we continued to grow, the economy 

was fine, and one of the reasons that we did continue to grow is 

that the government was not too active in the 1980’s like it was 

the 1970’s or in the Great Depression. 

So what I would come back to, Mr. Chairman, is that I would encourage the committee to think twice and be very, very patient 

with the economy before interfering with the marketplace. Interfering with the marketplace, as we did in the 1930’s, can often lead 

to even worse economic problems in the future and make our issues 

less tolerable. 

Thank you. 

[The prepared statement of Mr. Wesbury can be found on page 

198 of the appendix.] 

The CHAIRMAN. If you need more time, we did give Mr. Blinder 

more time, if you want a couple more minutes, please. 

Mr. WESBURY. That is okay. Five minutes is what you gave me. 

The CHAIRMAN. Finally, Allen Sinai, who is the chief global economist and president of Decision Economics, Incorporated. 

STATEMENT OF ALLEN SINAI, CHIEF GLOBAL ECONOMIST, 

STRATEGIST AND PRESIDENT, DECISION ECONOMICS, INC. 

Mr. SINAI. Thank you, Mr. Chairman. Let me summarize some 

major points and the context in which the proposed draft legislation fits in an array of public policy measures that need to be taken 

to deal with the current situation. No one measure will do it, but 

many will. 

The U.S. economy is in recession as we speak. It has been in recession since around the turn of the year. The recession is intensifying and widening as indicated by an increasing array of monthly key economic and financial indicators. The recession, already I 

believe in its 4th month, cannot be short. The average length of 

U.S. recessions has been about 101⁄2 months. The last two in 2001, 

1990 and 1991 were 8 months each and before 1980 to 1982 and 

1973 to 1975, we had 16-month recessions. This one cannot be 

mild. Forget GDP has the measure. It is misleading as to what is 

really going on where it counts, in jobs, for the consumer, in housing, and for small businesses on Main Street. The downturn is also 

this time, in the eyes of Wall Street, a holy terror. This is what 

one sees in the end and in an unwinding of a boom and asset price 

bubble, often in business cycles occurring in real estate, the stock 

market or both and not just in the United States. 

Now, the pinnacles of the bust in housing—declines in housing 

prices and effects on credit have attached to consumption spending, 

currently growing at a sharply lower pace, more than 3 percentage 

points below its historical trend and itself now touching and causVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00075 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
72 

ing reductions in business sales and earnings so that business cutbacks, more firing than hiring, decreased production and lower inventories and reduced capital spending are adding to the economy’s 

downward thrust. 

As for housing, where a huge overhang of inventories of unsold 

single multi-family homes exist relative to sales, as the recession 

intensifies and widens and the unemployment rate rises, the demand for housing will weaken further and the overhang of supply 

raised by more foreclosures in the absence of legislation like the 

one suggested by this committee will probably remain and home 

prices will keep declining. The end to the declines in housing prices 

cannot yet be seen therefore. The U.S. recession not only cannot be 

short, it could also be quite severe. 

The anatomy and process of the downturn suggests that we are 

still its early stages, much is familiar but what is new is an overlay 

of a financial crunch and crisis that will prolong it. What is old is 

an inflationary shock of higher food, energy inflation, and that will 

prolong it. Sticky high inflation from also high health care inflation 

and a lower dollar will prevent all the stimulus that is needed and/ 

or the rising purchasing power that typically is an automatic selfcorrecting mechanism in a recession to bring about their recovery. 

The temporary tax cut stimulus will probably provide only transient help. 

The process of the downturn started in housing and a decline of 

activity in the aftermath of an incredible boom. The housing downturn turned into a collapse, and now I think it is a bust. And the 

unprecedented fall in housing prices, now down 10 percent to 16 

percent from previous peaks, we are not through yet, in published 

measures took down the value of housing as asset collateral, upon 

which has been built and leveraged so much credit, debt, spending, 

businesses, new financial instruments and the business of financial 

intermediaries, bank and non-bank. The ongoing credit and balance 

sheet crunch has cracked the U.S. financial system and made financial intermediaries the lever risk in a hurry, unwilling to lend 

much within and outside of the financial system. All Americans are 

adversely effected by this. 

Housing is in crisis. There is also a financial crisis. And so one 

should ask, what is the role of public policy in this situation? Well, 

since housing is at the very heart of this episode, a place to start 

is with policies that seek to reduce the excess overhang of the housing stock relative to housing demand and the excess bad collateral 

built on the now collapsed housing sector and falling housing prices 

and excess supply of mortgage debt and mortgage-based, a derivative securities and structured finance built on that. 

What are the policy choices? Certainly, one that has been taken 

and is absolutely necessary is low interest rates. These must be 

maintained and reduced even more. In some fundamental sense, 

low interest rates under normal circumstances can stop the declines of housing prices that are taking down the value of housing 

as collateral and as a source of ultimate value in so many derivative financial instruments and for those financial institutions 

whose balance sheets and businesses are tied to it and where those 

businesses are declining. But with the negative price dynamic of a 

bursting asset price bubble, the psychology associated with declinVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00076 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
73 

ing house price expectations could well overwhelm the fundamental 

health that lower interest rates provide; they may not work. 

The second choice line of defense is an aggregated fiscal policy 

measure, such as tax cuts or increased government spending. The 

fiscal policy stimulus recently passed provides one time tax reductions to households and businesses that may cushion the overall 

economy from the consequences of the housing downturn for a 

time, but they cannot get at the root cause of the housing and financial crises: too much available housing, too little demand, too 

large a supply of mortgage debt, mortgage-derivative securities and 

structured investment vehicles relative to the demand. And, unfortunately, these tax reductions, since they are only temporary, on 

our work are not going to make a big difference for a very long 

time in the economy. 

Third, there are measures in public policy that can be taken. The 

Federal bank central bank have done a number of these. And, of 

course, the fourth choice is to do nothing. Politically this is virtually impossible in the current situation. For many Americans, 

owning a home is a lifetime dream and the value of their house is 

much, if not all, the family net worth and what is needed for retirement. With so many abuses and so much laxity in supervision over 

what went on in housing, housing finance subprime lending and 

borrowing and the huge payouts to executives and workers in many 

financial intermediaries, the taxpaying public is justifiably enraged 

and concerned about what we call moral hazard. 

The CHAIRMAN. Mr. Sinai, we have to move to a close. 

Mr. SINAI. Doing nothing, however, would be too little and that 

is part of the 1930’s history, public policy is here and free markets 

can solve many problems but there is a legitimate role for government intervention when there are market failures and casualties of 

capitalism. 

The public policy measure being considered here is a good one. 

This potential legislation that would enhance the FHA to help stabilize housing, and facilitate homeownership would work through 

the forces of demand and supply and help to arrest the decline in 

housing prices. It makes lenders better off by not having to deal 

with foreclosure costs or the refusal or failure of borrowers to make 

monthly payments. It saves a lot of litigation and legal costs. Many 

homeowners would keep their homes; the FHA-approved lender 

would take the loan, reconfigure it, restructure it, and refinance it 

in a reasonable fashion, and it would be insured or guaranteed at 

little risk to the government. This enhanced program provides benefits to all, some penalties to all, retires some of the supply of mortgage debt that needs to be taken off books or mortgage-backed securities relative to demand, and should strengthen the demand for 

housing relative to supply. 

In conclusion, as one approach of Federal Government action to 

intervene and cushion in this particular situation where housing 

has been a big source of our problems, my conclusion is Congress 

should move this proposal ahead, integrate Administration comments and other ideas into it, fine tune it and get it passed in a 

hurry, quickly, quickly, quickly. Time is of the essence. 

[The prepared statement of Dr. Sinai can be found on page 185 

of the appendix.] 

74 

The CHAIRMAN. Thank you, Mr. Sinai. Let me begin by saying 

that obviously, I am in agreement, and I appreciate two of our 

economist members of this panel stressing that we are dealing here 

with the macroeconomic problem, not just the specific problem of 

mortgages. I understand a lot of the criticisms, and if it were not 

for the fact that we have lost 230,000 jobs this year, that we are 

in a recession that I believe was exacerbated, there was no factor 

that was more of a cause of this problem than the subprime crisis 

reverberations. The argument for moving here is the broader economic effect. The foreclosure damage occurs in concentric circles. 

The main burden falls on the person whose house is lost and in 

some cases, they made mistakes. In an ideal world, we would let 

those individuals bear the burden of their own mistakes, but the 

other people who own houses on the block are hurt, the city is hurt, 

and the whole economy is hurt, so that is the justification. 

One other issue I just wanted to note, the President issued a 

statement today about, and of course Commissioner Montgomery’s 

testimony made clear, we have moved closer in some ways here. 

There was one statement in which the President says, ‘‘The Administration opposes legislation that would allow lenders or services to 

sell bad loans to the taxpayers through an auction process, clearinghouse, or other wholesale mechanism.’’ That is a straw man; no 

such legislation is before us. The proposal today, at the encouragement of the Federal Reserve, does include an auction process but 

at no point will the FHA be compelled to accept any of those loans. 

The FHA screening procedures will remain in effect and an auction 

process we believe will help set a price, but before any guarantee 

is attached to any loan, the FHA will do an individual analysis and 

we will accept it or reject it, so we agree with that. 

Mr. Wesbury, I was just interested that you questioned a number 

of things that the government has already done, and I appreciate 

that, but as I read your testimony, it sounds like you wish they had 

not, or we had not. The last page of your testimony, ‘‘Government 

action,’’ talking about the contemporary situation, ‘‘Government action has compounded problems faced by the U.S. economy,’’ and 

particularly you note for instance that the Federal Reserve recently, the Fed’s sharp cuts in interest rates over the past 7 

months have probably prolonged the recovery process. And specifically, for example, Fed rate cuts are the most likely cause of a 

spike in oil prices from $70 in August to a recent all-time high, so 

you believe that in this past year, the Federal Reserve has done a 

lot more harm than good. You also mentioned the HOPE NOW Program. Is that also one that has done more harm than good in your 

judgment? 

Mr. WESBURY. No, actually I think the HOPE NOW Program, because it is voluntary between borrowers and lenders, I think borrowers and lenders would have come together even without HOPE 

NOW to restructure many of these mortgages or restructure. 

The CHAIRMAN. So it was not harmful; it was just not effective? 

Mr. WESBURY. No, I am not saying it harmed but what I am getting at there is that Federal Reserve rate cuts, especially if I am 

a potential homebuyer today, and I think the Fed may cut interest 

rates again next month, why would I buy a home today, why would 

I do that? 

75 

The CHAIRMAN. I understand that but— 

Mr. WESBURY. That is what I am talking about. And also when 

the Federal Reserve cut interest rates in August dramatically, 

starting in September and cut them dramatically, we saw a surge 

in gold and silver and corn and wheat and oil prices. Oil prices 

went from $70 to $100, and today $111 or $110 a barrel, four airlines have gone bankrupt in the last week, partly because of high 

energy prices. My belief is the inflation— 

The CHAIRMAN. I appreciate that, the President, for example has 

said that it was not anything we were doing domestically that was 

causing oil prices to go up, that this was worldwide factors, etc., 

but you disagree with that. You believe that the Federal Reserve’s 

interest rate cuts are, as you say, the most likely cause of the spike 

in oil prices? 

Mr. WESBURY. Absolutely. 

The CHAIRMAN. The other issue, I was struck by this because I 

must say I have also felt that the emphasis on homeownership has 

been overdone and there has been a lot of pride taken in increased 

homeownership and it has been the goal, you say in your next to 

last paragraph, ‘‘A widespread effort by the Federal Government to 

create more homeowners is one of the key causes of today’s financial market problems.’’ Would you in the last minute or so elaborate on that? 

Mr. WESBURY. Sure, and I am not saying anything that Ned 

Gramlich, the late Ned Gramlich, the Federal Reserve Board Governor— 

The CHAIRMAN. Sadly, not available, so we will have to have you 

say it. 

Mr. WESBURY. Right or Larry Lindsey has also said the same 

thing, and they both chaired the Community Reinvestment Act 

panel or—I’m not sure of the name of it internally at the Fed, but 

that subcommittee of the Federal Reserve Board that enforced the 

Community Reinvestment Act. They both have highlighted the fact 

that this forced many banks and cities to issue subprime loans in 

lower income— 

The CHAIRMAN. Oh, no, I would disagree. Larry Lindsey has said 

no such thing and neither did Ned Gramlich. What they were concerned about was the failure of the Federal Reserve, Mr. Gramlich 

was, to use the authority granted under the Homeowners’ Equity 

Protection Act. Without objection, I will put into the record the letter from Mr. Lindsey—which he sent a couple of years ago when 

he had that position—in which he said, ‘‘No, the CRA caused none 

of these problems.’’ He was a strong supporter of the CRA and of 

expanding it and said it did not lead to any unsafe or unsound 

practices. And Mr. Graham specifically was critical, Mr. Blinder 

was there, of the failure to use the Homeowners Equity Protection 

Act. Neither one of them blames CRA. If you have any evidence to 

the contrary— 

Mr. WESBURY. I do. 

The CHAIRMAN. —we will take it to the record, but I have Larry 

Lindsey’s repudiation of that argument. 

Mr. WESBURY. I have somewhere with me, I did not bring all this 

stuff with me, but Ned Gramlich gave a speech, he didn’t actually 

give it, someone gave it in his stead in Wyoming last year for the 

76 

Kansas City Fed in 2007 and Larry Lindsey wrote an editorial for 

the Wall Street Journal, both of which said the Community Reinvestment Act was part of the problem with subprime loans. 

The CHAIRMAN. Well, again, Mr. Lindsey contradicted that earlier when he was on the Board. And the problem also, Mr. 

Gramlich was talking very much about was the Homeowner’s Equity Protection Act and the insufficient regulation. I will be glad 

to have that testimony. I will put in Mr. Lindsey’s letter that he 

submitted to this committee specifically on that issue. 

The gentleman from Texas? 

Mr. HENSARLING. Thank you, Mr. Chairman. Again, we have 

many important policy decisions to make here. It is always useful 

to have the facts. I believe that Dr. Sinai, in your testimony, you 

spoke of the unprecedented fall in the value of real estate that we 

have seen recently. But preceding that, have we not seen an unprecedented increase in the value of real estate in, at least at the 

moment taking a snapshot, aren’t home values on a nationwide 

basis roughly where they were 3 years ago? 

Mr. SINAI. The answer is yes. The unprecedented decline is in 

the published indices from 10 to 16 percent, depending on the 

index, relative to the previous peak. And in Table 1 at the back of 

my testimony, the price increases are shown and they were much, 

much higher than that. So, there are two ways to look at that. I 

think we are going to lose a lot of those extraordinary boom and 

bubble price increases that we had, and at the moment, we are in 

the process of the declines and that is really what we have to deal 

with unfortunately. 

Mr. HENSARLING. Listening to the debate surrounding these 

issues, I suppose there are two compelling reasons to have Federal 

Government intervention, particularly taxpayer exposure to the 

housing market. One is we have a lot of innocent victims out there 

and it is the fair and right thing to do to give them Federal assistance, which ultimately is taxpayer exposure. 

The other argument is we have such a precarious macroeconomic 

mess that even though these people may not be deserving of help, 

that we have to do it for the greater good of the economy. Let me 

first explore what is typically called the fairness argument, one we 

hear frequently in Congress. Again, as I look at the universe of 

people who may be helped by legislation, either what the chairman 

has put forth or similar pieces of legislation, I do not, one, conceptually believe you can help borrowers without simultaneously helping the lenders. 

I fundamentally think it is an impossible task, so therefore I am 

sitting here wondering, we have a lot of smart people on Wall 

Street who supposedly knew a lot about real estate, and maybe 

they didn’t know a whole lot about real estate. And so, at least 

under this piece of legislation as I understand it, potentially we are 

allowing those people to unload their worst performing assets for 

15 percent haircuts so it is kind of a stop loss. 

When I look at the borrowers’ side, there is no doubt in my mind 

that some people were taken advantage of. Some people were victimized by what is often called predatory lending. I think it is probably basic fraud. But for every utterance we hear of the phrase 

77 

‘‘predatory lending,’’ we rarely hear the phrase ‘‘predatory borrowing.’’ 

In an earlier panel, I don’t have it with me now, I had a copy 

of a FinCEN report, which I think comes about as close to an expert in Federal Government in financial crimes, that talks about a 

huge spike in the last 4 years of mortgage fraud, much of that 

being borrowers. Apparently my reading of the report is well over 

half of the borrowers who have either given false asset statements, 

liability statements, income statements, occupancy statements. So 

we have a whole group of these people who don’t seemingly make 

a very sympathetic poster child for taxpayer exposure and help. 

I also cited a Boston Fed report that came across my desk a few 

days ago that seemingly makes the case that the real reason for 

default on subprime mortgages isn’t necessarily the inability of people to make the reset payment. Instead, it has to do with the devaluation of the asset. In other words, these were people seemingly 

arguably counting on the appreciation of the real estate so they 

could flip it or they could refinance with the additional equity, or 

they use the additional equity to trade out of the 6-year old station 

wagon into the Lexus, or get the big screen television. They also 

don’t seem to be a very sympathetic figure. 

So, again, if I am sitting here thinking am I going to reward all 

these people, again, it suggests to me the moral hazard issue, and 

ultimately, I guess I am mixing metaphors here, kicking the housing bubble down the road. And I see I am almost out of time, so 

that is the only question I have, starting with you, Mr. Wesbury, 

if you would comment. 

Mr. WESBURY. Sure. I believe that one of the things that happened in that 2003 to 2006 period is that extremely easy Federal 

Reserve policy caused borrowers, lenders, and everyone involved in 

the whole process of making mortgages and packaging them up to 

believe that interest rates would stay low forever and that housing 

prices would rise forever. 

By the way, Penn Square Bank believed this about oil back in 

the late 1970’s, early 1980’s; they thought oil was never going to 

go down so they made loans like crazy and then sold off their participations. This has happened before. And the way that these markets correct is when prices fall and the loans go bad, people pay 

for their bad decisions. 

What is interesting is that in the last few years of this process, 

a lot of these loans were made with no money down. So you can 

sort of kind of think of a bank not as a mortgage holder but as a 

landlord because the homeowner had no skin in the game. With no 

money down, there was no skin in the game, and therefore what 

everybody hoped was that the price of the home would appreciate, 

then the homeowner would accumulate in the skin in the game. 

But what happens is, if prices don’t keep going up, then no, 

there’s no skin in the game and people walk away from their mortgages. I think trying to lock people into those mortgages is a moral 

hazard situation that could actually make this problem worse down 

the road. 

Mr. BLINDER. Did you want each of us to answer that? 

The CHAIRMAN. Very quickly. We only have time for one more. 

78 

Mr. BLINDER. Yes, I think that there isn’t any doubt that if you 

try to classify people as to who is morally deserving and who is not 

morally deserving, first of all, it is virtually impossible to do. There 

are certainly cases of the sort that you are talking about—no 

doubt. There were huge numbers who were duped into mortgage 

contracts that they didn’t understand. That is plain. And my view 

is that when you come in with a fixed, generically and certainly in 

this case as well, when you come in with some kind of fix-up after 

a mess occurs, which is where we are right now, some people are 

going to be helped who ought not to be helped. I view that as the 

collateral damage that you pay in order to pull the economy out of 

the soup. That is the big picture here. There will be some of those 

cases. 

The CHAIRMAN. Let me just ask to take 15 seconds on the CRA 

point. I just want to make this point. I think it is fairly clear. The 

disproportionate share of the mortgages that should not have been 

made in the subprime area were made by people not covered by 

CRA. Mortgage brokers are not covered by CRA. In fact, if you look 

at the banks, which were covered, they did a relatively better job. 

So the other point is that the worst records were by the mortgage 

brokers not covered by CRA. The gentlelady from California. 

Ms. WATERS. Thank you very much. Mr. Chairman, members, 

and panelists, the discussion about macroeconomics is an interesting one, but I am so focused on the foreclosures all over America 

and the fact that I have been in several cities, including Cleveland, 

Ohio, and parts of California, such as the San Bernardino, Riverside area, and in Detroit, Michigan, where I have seen entire 

blocks boarded-up that I am singularly focused on helping American citizens who are in trouble. Those people that we can save 

from foreclosure, we need to do it and we need to do it quickly. And 

for those people who have been harmed by foreclosure, we need to 

find ways by which we can help them also. 

You mentioned government’s involvement and you talked about 

the HOPE NOW Alliance, Mr. Wesbury, and you mentioned how 

many modifications or workouts they have done. How do you know 

how many they have done? 

Mr. WESBURY. It was in the testimony of Mr. Montgomery in the 

panel before us. He talked about it, and this has fallen pretty much 

in the public record. 

Ms. WATERS. Well, let me just say this. One of the problems I 

have with trying to do oversight is the fact that we have to depend 

on information from regulators and those who are managing some 

of our agencies that should know information when they come before us. There is nobody that I have talked to who can document 

the number of workouts that have been done by the HOPE NOW 

Alliance. 

As a matter of fact, there are those who have information to say 

they haven’t done very well at all. It is indicated that HOPE NOW 

states that it helped 545,000 homeowners in the last half of 2007, 

but 33 percent more homeowners actually lost their homes to foreclosure during the same time period. In addition, through January 

of this year, HOPE NOW servicers have been allowed to reduce interest rates or to otherwise modify loans that are unaffordable. Instead, 72 percent of the homeowners being helped by HOPE NOW 

79 

are only receiving repayment plans. I share that information with 

you because the industry has had time to show what it could do. 

But is the HOPE NOW Alliance or Wall Street or servicers that 

had time to show that they could straighten out this situation; that 

they could do loan modifications; that they could do voluntary 

things. It has not worked. It has not been done. The people do have 

some reasonable expectation that their government is supposed to 

have regulation and regulators who at least watch closely enough 

to know when citizens are being ripped off; when products are 

being invented that are misleading; and when citizens will be 

harmed. And, thus, when the regulators are not doing their job, 

and we are not doing our jobs, and the people are harmed, I think 

it is reasonable for them to expect some government intervention. 

Don’t you? 

Mr. WESBURY. Well, I think that there are always unintended 

consequences to government intervention and that is what I try to 

remind people of all the time, and that is if we are to bail out people today who made bad decisions, who thought housing prices 

were going to go up forever, what is next? Are we going to help out 

because their stock portfolios fall? Are we going to do this the next 

time, the next time housing prices are running, are we going to— 

Ms. WATERS. My question— 

Mr. WESBURY. —tell me people, no, don’t buy a house because if 

you get in trouble— 

Ms. WATERS. —my question is, we have a problem; we have a crisis; we have a subprime meltdown. Do you think people should 

have reasonable expectations that their government will do something to help them now? 

Mr. WESBURY. I listed all of these things. We can go back and 

talk about them. The Federal Reserve has cut interest rates dramatically. 

Ms. WATERS. Do you think that— 

Mr. WESBURY. We have a rebate check coming starting in May. 

The Federal Government has been extremely active. I mean, this 

has been amazing. Hundreds of billions of dollars, the Federal Reserve doing unprecedented things to shore up the mortgage market. 

I mean, I think the Federal Government has done something. 

Ms. WATERS. Do you think that there is a crisis that still remains? 

Mr. WESBURY. I mean, are we out of the woods in terms of the 

economy? 

Ms. WATERS. No, I mean, you can claim it any way you want. My 

question is, do you think we still have a subprime crisis? 

Mr. WESBURY. I’m not sure what—I don’t even—I am not trying 

to be— 

Ms. WATERS. Okay, that is okay. 

Mr. WESBURY. —combative. 

Ms. WATERS. If you don’t know what it is, I will understand that. 

If you don’t know what a subprime crisis is, if you don’t think that 

what we are confronted with now is a crisis, okay, that is fine. And 

if you don’t think that the government should intervene, would you 

tell me again what the citizens of this country who depended on 

the regulators that are paid for by the people to give them some 

measure of protection, what do you think they should do? Should 

80 

they just suffer until, I think as you described, there is a natural 

turn and a change of things that will straighten this out; is that 

what you are saying? 

Mr. WESBURY. No, I guess what I am saying, Congresswoman, is 

this, and that is that is that I believe a lot of people went into the 

housing market with their eyes wide open. In many cases, in these 

no-document loans, people were lying about their income. They 

knew they were lying. 

Ms. WATERS. So you think that if they—do you think the regulators should have vetted no-doc loans and do you think there 

should have been some regulation and oversight on no-doc loans? 

Mr. WESBURY. Yes, there should and there is regulation on that. 

One of the interesting things that the chairman said about CRA 

was that it did not cover the mortgage lenders. That is true, but 

subprime loans, when they were packaged into pools and then purchased by banks, counted towards CRA rules. So, in fact, even the 

mortgage lenders were influenced by the CRA program. 

Ms. WATERS. Well, I think there is just a difference of opinion 

about who caused this mess, and if you are trying to lay off a significant responsibility to CRA for the mess, we don’t believe that, 

most of us on this side of the aisle, just don’t believe that. All right. 

My time is up so I would like to engage with you, but it would not 

be fair so I am going to go on to the gentlelady from New York. 

Thank you. 

Mrs. MALONEY. I thank the gentlelady for yielding. Dr. Blinder, 

you say that the most urgent problem before us is the potential 

tsunami of home foreclosures, as you put it. I agree with you, and 

I am pleased to see that you support Chairman Frank’s proposal 

to provide $300 billion in FHA home loan guarantees. Fed Chairman Bernanke testified before the Joint Economic Committee last 

week, and when we asked his opinion of this approach, he said, ‘‘I 

am still focused on the loan by loan approach where servicers 

would voluntarily modify loans to make them eligible for FHA refinancing.’’ Given that the evidence is that this is not working, don’t 

we need a new, large scale-strategy like the Frank proposal for this 

new large-scale challenge that we confront? Dr. Blinder. 

Mr. BLINDER. Well, I obviously think that we do need that. The 

numbers here are tremendous, and as I said, and as you just said, 

they are in some sense at the apex of our broader credit and economic problem. What I would say, however, is that those pieces of 

Chairman Bernanke’s testimony that you just cited seem to me 

quite consistent with the approach in this bill. It is voluntary. Nobody is going to be dragged into this against their will. And in 

large measure, it is loan by loan. There is this title, too. But in substantial measure it is, in fact, loan by loan. It is not saying that 

we are going to take this entire category of loans and apply a cookie-cutter treatment in which all loans are going to be treated exactly the same. So at bedrock, this is a loan-by-loan approach, although one that has enough financing behind it and enough scale 

behind it that you could start getting into the millions of loan 

refinancings. 

Mrs. MALONEY. In February, Dr. Blinder, in your writings, you 

argued that we should bring back the Home Owners Loan Corporation, the Depression-era entity that functioned as a big bank and 

81 

bought up old mortgages and issued new more affordable mortgages. But the Frank proposal, which you now support, is for the 

government to be an insurer of new mortgages instead of being a 

bank like the old HOLC. 

Since the effects would be much the same, doesn’t it seem more 

prudent to limit government liability by being the insurer rather 

than the bank? And further, some have argued that we should not 

be putting taxpayers’ dollars at risk this way, however, the Fed put 

taxpayers’ dollars at risk to rescue Wall Street with the Bear 

Stearns deal, arguing that it was too big to fail. Isn’t the prospect 

of letting millions of main street homeowners fail also too risky for 

our economy, Dr. Blinder? 

Mr. BLINDER. Yes, let me take them backwards, starting with the 

one you just asked, and the answer is absolutely yes. I mean, we 

are looking at a very serious economic situation here. The center 

of the problem, as I said, is with housing, and the center of that 

is with foreclosures. I don’t think we can afford the risk of saying, 

well, it may be another 2, 3, or 4 million houses that are foreclosed, 

but let’s just let it happen because there is a bigger economy at 

stake. If it gets to 4 million houses, that is 4 million families. There 

are over 100 million families in America, and everybody has a 

stake in the overall economy. 

On your question about the HOLC versus the insurance approach, as I say in the testimony, and as you just said, you get to 

a similar place by either having the government come in as a big 

banker or having the government come in as a big insurer. You get 

a lot of mortgages refinanced to more affordable mortgages, and ultimately, the taxpayers are holding the bag. 

Mrs. MALONEY. One way the Frank plan seeks to recoup some 

of the cost of this program is for homeowners to relinquish some 

of the price appreciation of their homes as long as they have an 

FHA guaranteed mortgage. You would go a step further and limit 

beneficiaries. Beneficiaries should have to forfeit second mortgages 

and home equity loans. Are there other measure we should be considering that will help recoup the Federal costs? 

Mr. BLINDER. To help recoup the costs—one thing I was going to 

say takes me back to your previous question. One reason I actually 

preferred the HOLC approach, which is not going to happen and 

therefore I am very happy to support this approach, but one reason 

I did is there was a considerable up-side potential for the taxpayer 

in return for taking the risk. The HOLC in the 1930’s, under pretty 

adverse circumstances, actually turned a profit. No one could guarantee that would happen again, but it did have that aspect. 

So I think the prospects, you know, the up-side participation of 

the government is quite limited. I think it could be bigger, by the 

way. I mean, it phases down and I don’t think it would be a bad 

thing if it was greater. It is, after all, a legitimate question being 

asked by a lot of Americans and it came up in this hearing, especially in the previous panel, why should we be paying for this; and 

the more that we can explain to the people who didn’t do the wrong 

thing, shall I say worked hard and played by the rules, that we are 

not making such an attractive proposition for the people in trouble. 

We are just trying to keep them above water and that they have 

82 

to pay for this privilege, I think the more saleable the proposal becomes. 

Mrs. MALONEY. I understand. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. I just want to ask one 

question that I hope never happens, but I guess we have to consider the potential that it could. I am looking at a chart that was 

prepared by OFHEO and I actually started to pay attention to this 

yesterday when I watched the news and they ran a chart that was 

similar to this that suggested that home prices from 1975 up 

through 2007 increased double, more than double, but that most of 

that increase in value or prices was between 2000 and 2007, in 

fact, probably 90 percent of it. Suppose—since Mr. Frank’s proposal 

talks about the FHA insuring this program applying to loans to 

new mortgages based on 90 percent of the current appraised value, 

you have some play in there because you have 90 percent, but you 

are talking about doing it on the basis of current appraised value— 

suppose housing prices keep going down. 

What would be the—first of all, what is your assessment of the 

likelihood of that, and what would be the consequences of it, Mr. 

Blinder and Dr. Sinai? I will start will Dr. Sinai, since he raised 

his hand first. 

Mr. SINAI. I think from my comments, you can tell that I think 

housing prices are going down a lot more. It is an asset price bubble that is bursting. And what we have seen when that happens 

is a small part of where we eventually go, point number one. 

Point number two, the new mortgages would, over time, end up 

underwater and then it would cost the government money because 

of the insured nature of the draft legislation. 

Number three, how much money will it cost the government compared with the lost tax receipts if nothing is done in a macroeconomy that gets worse because nothing was done? And, indeed, 

how much is the cost actually of this draft legislation now? It is 

simply the risk of the insurance. So I think you would have to 

think about the ultimate magnitude of a negative scenario to get 

comfortable with the scenario that you are talking about. 

Mr. WATT. So you are saying my reference point should be not 

this chart that I am looking at but the prospect that nothing is 

done and housing prices continue to go down. 

Mr. SINAI. You know, taxpayer monies are already out. The economy is a lot worse. Tax receipts are down at the Federal, State, 

and local government by a lot. Taxpayers are paying now. The cost 

of this draft legislation administratively, I think it was what, $350 

million? 

Mr. WATT. Let me let Dr. Blinder, and I want to get Mr. 

Wesbury’s—I don’t want him to feel left out because I would like 

to get his opinion on it, too. 

Mr. BLINDER. The straightforward answer to your question is 

yes. So I took the question to be, is there residual risk to the FHA, 

or whatever the institution is called, if home prices continue to 

plummet, and the answer is yes. Now I want to qualify that with 

two things in addition to everything Dr. Sinai just said. First of all, 

it is not the case that every mortgage that goes underwater in that 

sense defaults. Most people want to stay in their homes and, as 

83 

long as they can keep current on the mortgage payment, they will. 

So it is not like, even if housing prices fall another 10 percent we 

shouldn’t think that these mortgages— 

Mr. WATT. Right, okay. 

Mr. BLINDER. —new mortgages are going start defaulting in massive amounts. But maybe the more important point is how much 

housing prices will eventually fall and I don’t know the answer to 

that. It will depend on a lot of things, but among those things are 

the actions that either Congress does take or does not take. And 

one of the subtexts of this legislation and other things that are 

going on, what the Federal Reserve is doing for example, is to try 

to put some sort of cushion under this decline so that we don’t just 

fall right off a cliff. 

Mr. WATT. Mr. Wesbury, quickly. 

Mr. WESBURY. Sure. I look at the Case-Shiller home price index. 

In 1996, it was 80. It had risen to 190 in 2007, so more than a doubling in home prices. Sixty percent of that move— 

Mr. WATT. You are describing the same thing I described. I am 

trying to get a response to— 

Mr. WESBURY. —right, and I promise you I am getting to that. 

Sixty percent of that move was between 2001 and 2005 and 2006 

when housing prices peaked. And that is when we had most of the 

subprime loans. We have fallen back to 2005, which means that the 

homes that are underwater today are the most recent mortgages, 

which many of them are subprime, which many of them have very 

low downpayments; in fact, many have no downpayments at all. 

Those are the kinds of mortgages that would be refinanced in this 

FHA proposal, I believe, and they are very vulnerable to further 

declines in home prices, especially because many of those are in 

high price appreciation areas like, let’s say, Las Vegas or Florida 

or Southern California where we had very rapid price appreciation, 

lots of new home buying, and lots of exotic mortgages. I think that 

is where you are going to see most of the problem and that is 

where you are going to see most of the price decline as well. So I 

do think that the government becomes more vulnerable to price declines under this program because of that very reason. 

Mr. WATT. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from Missouri. 

Mr. CLEAVER. Thank you, Mr. Chairman. I just have one question for all three of you. I watched with great interest last evening 

an interview with Jesse Ventura about the state of affairs in America, and while I don’t equate his responses with those of Ben 

Bernanke, I was interested in the fact that he spoke, I think very 

powerfully, about how in this crisis it appears as if the corporate 

interests are dealt with first and the people are considered secondarily. His comments struck home with me because that is what I 

hear at home, whether fact or fiction, that is a growing belief out 

in the world. And it is based on a number of things, the Bear 

Stearns bailout being one. And so when you add in the fact that 

in the President’s budget, he either zeroed out or, in some instances, underfunded programs to aid the poor in housing, Section 

8, for example, it does appear that Jesse Ventura makes a point 

that is being made elsewhere. 

84 

My question: Does not the chairman’s proposal equal out, or at 

least reduce, the way in which government appears to be leaning 

in this crisis? 

Mr. SINAI. The answer is yes. What happened is outrageous from 

the point of view of America and the sleepiness of the regulators 

that Congresswoman Waters referred to is obvious to anybody with 

any common sense and it is the job of government to fix those 

things when they happen and I think you are on the right track 

and you are up to doing that, and that proposal is in that spirit. 

Mr. BLINDER. I also think the answer is yes. I was advocating a 

proposal something like this, the HOLC proposal that Congresswoman Maloney mentioned before, before the Bear Stearns, J.P. 

Morgan transaction, but I didn’t think it would get anywhere. But 

the asymmetry thereby created exactly what you are referring to, 

I think changes things in a very fundamental way. So I think it 

did change. I think it is unbalanced if you leave it the way it now 

is and I think it is both good politics, if I may say that, but also 

good economics to look on the other side, to the household side, 

which is what this bill does. 

Mr. CLEAVER. Thank you. Mr. Wesbury. 

Mr. WESBURY. Sure, and I would agree with Dr. Blinder that it 

is good politics, or at least it looks that way, but I think it is lousy 

economics. And one of the reasons that I say that is that imagine 

if the whole financial system failed, just went away; very, very few 

people could ever afford a home because they would have to put 

cash down. They couldn’t borrow money to buy it. They couldn’t get 

insurance on the home. They couldn’t get mortgage insurance, not 

fire insurance, not any kind of insurance because it is the financial 

system that provides all of that and it allows people to buy little 

pieces of it over time and it makes a great big thing. And then it 

is easy to attack this great, big thing but, in fact, we couldn’t live 

our lives as we do today without the financial system in place. 

Mr. CLEAVER. But if you are sitting here in Kansas City, Missouri, and you are out here watching this huge bailout and you 

have just been ripped off and you are going to get a $300 check as 

a stimulus, don’t you think you would feel like the government always leans towards the corporate level? And are you saying that 

is what it should do, lean toward the corporate because if the corporate folk are healthy and happy it always rains down on the less 

fortunate? I mean, your comment just now reminded me of the 

statement—I am going to try to remember the statement from Mr. 

Mellon—I mean, that is kind of what you just said and paraphrased. 

Mr. WESBURY. It is not what I said. 

Mr. CLEAVER. Okay. 

Mr. WESBURY. What I said is, sure, I can see why people might 

think that. But what I am saying is that you could not get mortgage without the financial sector there, and so if the Federal Reserve is not—I am not saying that I agree with the bailout of Bear 

Stearns and what they did with J.P. Morgan, etc., etc, but in general, helping the financial sector survive a hiccup like this, or a 

mess like this, or a crisis like this, is absolutely essential to keep 

society going like it was. You can’t get a mortgage without the financial sector. So the Federal Reserve’s attempt to save the finanVerDate Aug 31 2005 16:22 Jul 16, 2008 Jkt 042715 PO 00000 Frm 00088 Fmt 6633 Sfmt 6633 K:\DOCS\42715.TXT TERRIE
85 

cial sector, if that is the way you want to put it, you can phrase 

it any way you want, is actually an attempt to make sure that people can continue to get mortgages down the road. So in essence, I 

can understand why people feel that way, but what it tells me is 

they are not thinking very deeply about the issues. 

Mr. CLEAVER. Well, I would like to invite you to my town hall 

meeting Saturday and you tell them that they are not thinking 

deeply. 

Mr. BLINDER. Congressman, could I just say one sentence? I 

think this bill would do a world of good for the financial system as 

well. 

Mr. SINAI. Congressman, what you said I have to say something. 

I am a citizen of this country, not just an economist or somebody 

who comes here to testify. What you just described is what is 

wrong with America. The instincts of your people tell me that if 

you all do something about it we will get back in the track of doing 

what is right for America. What went on is absolutely egregious in 

the financial system and all the things that happened. There is no 

other way in a commonsense way to put it that way, and the way 

that your constituents are seeing is the way most Americans are 

seeing it. The polls say that very clearly. 

The CHAIRMAN. Thank you. The gentleman from Colorado— 

Mr. PERLMUTTER. Thank you, Mr. Chairman. And I appreciate 

the testimony— 

The CHAIRMAN. —whose questioning will be greeted with great 

joy, since he is the last questioner. 

Mr. PERLMUTTER. I appreciate the testimony from all three of 

you because there are parts of things that you have all said that 

I agree with. Mr. Wesbury, I agree with you wholeheartedly. I 

mean, my belief is every 20 years we go through something similar 

to this because people forget the lessons of the past. They believe— 

they get greedy. They get stupid. They believe the prices are always going up and, you know, the 1980’s, you talked about Penn 

Square, M Bank, Continental Illinois, Silverado, with the belief 

that everything was going to go up. And in Colorado it was real estate, not just oil. So it isn’t just the homeowners and it isn’t just 

the lenders. It isn’t just the regulators. I mean, Congress—one of 

the things I am angry about is the loosening of laws that kept investment banks separate from traditional banks, I mean, a lesson 

we learned in the Depression for goodness sakes; all based on 

greed. 

And I would ask you three as some of the top scholars on the 

subject, this Nation is borrowing a lot of money as individuals and 

as a nation. How does that play into everything we are doing here? 

Let me go back to the chairman’s bill before I get to waxing eloquently. Mr. Wesbury, under his bill, it is voluntary by the lender 

to take advantage of a carrot, which would be the FHA guarantee 

at 90 percent of the written down-amount. So what is wrong with 

that? 

Mr. WESBURY. I think as long as it stays voluntary, we are okay 

with it. I think if we allow the FHA—it does get the government 

more involved, which can always— 

Mr. PERLMUTTER. But we are going to get involved if we have to 

start helping the FDIC and we have already gotten involved when 

86 

we gave $30 billion to underwrite Bear Stearns because of these 

lousy mortgages. We are already in this deal; big. 

Mr. WESBURY. I understand that. One thing I go back to is that 

I heard the chairman say that if the servicers don’t voluntarily do 

something, then we are going to make them do something. And I 

am paraphrasing him. We can go back and look at the record. So 

I hear you when you say voluntary, but very often once we do get 

involved with these things, it quickly becomes involuntary. 

Mr. PERLMUTTER. Okay. So then my question is this: Listening 

to Dr. Sinai and Dr. Blinder, you, too, have recognized we are on 

sort of a precipice here. My question is, if we don’t do anything, if 

we let the market sort of work itself out, how many foreclosures 

are we going have, and how long is this going to take? 

Mr. WESBURY. No one knows for sure, but I think the worst estimates that I have seen in foreclosures is about 2 million foreclosures and that is out of 108 million homeowners, occupied 

homes. I am sorry, renters or homeowners. And so that is less than 

2 percent. Now that’s—anybody who has their home foreclosed on 

them, if they actually have resources in it, skin in the game, that 

is a sad thing. 

Mr. PERLMUTTER. And I recognize that. I have come as a bankruptcy lawyer to this, representing lenders. I have been there for 

that. But something 2 or 3 weeks ago ago triggered a very dramatic 

effort by the Federal Reserve to move over to the investment banking side because of fear that we were in trouble on these mortgagebacked securities. 

Mr. WESBURY. This is very, very similar to Continental Bank, 

which was too big to fail. Bear Stearns had its tentacles and 

counterparty risks throughout the system and the Federal Reserve 

was worried that that would cause systemic problems. I don’t know 

whether they were right or not. We won’t ever know because it is 

over now. It was similar to Continental Bank. 

What I will say is that we survived, the economy survived, the 

2000 to 2002 stock market crash where the NASDAQ alone lost 

$4.5 trillion of value. No one is talking about losses even close to 

that, maybe 10 percent of that in the housing market over the next 

couple of years. So our economy can absorb these kinds of hits 

much more readily than many people seem to fear today. I think 

we are much more resilient than people believe. And that is what 

I would hope is that we would believe in our economy more, that 

it can withstand these shocks, that the bankruptcy— 

Mr. PERLMUTTER. Well, and I would have agreed with you but for 

the dramatic action that was taken 3 weeks ago. Over a weekend, 

we are not in session, boom. There was a real fear that there was 

going to be a domino effect on Wall Street and here we are doing 

a voluntary effort to help some homeowners and provide lenders a 

guarantee. I just don’t see—compared to what we did and the dramatic step that was taken 2 or 3 weeks ago, this is helpful. It is 

nothing like that. 

Mr. WESBURY. As long as it stays voluntary, I think it is a very 

good thing. 

Mr. PERLMUTTER. Thank you, Mr. Chairman. 

The CHAIRMAN. And let me just add that it is voluntary in two 

ways, and there is an error in the Administration talking about 

87 

being forced to take bad loans. It is entirely voluntary on the part 

of the holders of the mortgages. No one is going to be coercing them 

at all. The one coercion that might have happened, and I was going 

to vote for it but it is now a dead issue, is a bankruptcy bill. The 

fear of bankruptcy in the primary residence might have been suppressed. I was a sponsor of it. It is now clearly dead. So this now 

entirely voluntary. 

On the other side, nothing we are doing statutorily will compel 

the FHA to accept any loan. We have talked about changing the 

standards. The FHA has beat us to the punch as the Commissioner 

acknowledged. The FHA yesterday announced that they are going 

to waive this requirement of no default. But they are doing away 

with arbitrary restrictions to go to case-by-case and the FHA will 

remain committed to doing a study of each loan and not accepting 

a loan if they don’t think it can be repaid. That one is possible. 

They may misjudge it and under their plan if housing prices drop 

more precipitously than expected, yes, there is some liability there. 

We would hope that wouldn’t be happening. But that is it. It is voluntary on the part of the servicers. The FHA has the right to say 

yes or no. 

We do believe, and I think it is probably, as I said, the economic 

problem, if I remember my economics class correctly, is mainly that 

there are things that an individual might not do himself or herself 

that he or she would do if you knew that other people were doing 

them as well. And that may be encouraging this together could be 

helpful. That is what this is and, again, I want to stress on the 

auction, which the Federal Reserve suggested to us. The auction— 

there will be a Federal mechanism that will accept bundles of loans 

for the FHA guarantee but the FHA will then have the independent authority to examine that pool and kick out any that don’t 

meet its standards. So there will be no coercion of the FHA on that 

end. I thank the panel, particularly these three panelists for staying all day, and adding a kind of perspective that was very helpful 

to us, and the hearing is mercifully adjourned. 

[Whereupon, at 3:32 p.m., the hearing was adjourned.] 

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