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50–396 2010

S. HRG. 110–976 

TURMOIL IN U.S. CREDIT MARKETS: EXAMINING 

PROPOSALS TO MITIGATE FORECLOSURES 

AND RESTORE LIQUIDITY TO THE MORTGAGE 

MARKETS 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING PROPOSALS TO MITIGATE FORECLOSURES AND RESTORE 

LIQUIDITY TO THE MORTGAGE MARKETS 

THURSDAY, APRIL 10, 2008 

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

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 


dcolon on DSK2BSOYB1PROD with HEARING
(II) 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

AMY S. FRIEND, Chief Counsel 

JONATHAN MILLER, Professional Staff 

JULIE Y. CHON, International Economic Policy Adviser 

DIDEM NISANCI, Professional Staff Member 

KARA STEIN, Legislative Assistant 

JAYME ROTH, Professional Staff Member 

MARK POWDEN, Legislative Assistant 

JASON ROSENBERG, Legislative Assistant 

MIKE NIELSEN, Republican Professional Staff Member 

WILLIAM HENDERSON, Republican Legislative Assistant 

COURTNEY GEDULDIG, Republican Legislative Assistant 

JENNIFER C. GALLAGHER, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 


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C O N T E N T S 

THURSDAY, APRIL 10, 2008 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

WITNESSES 

Lawrence H. Summers, Charles W. Eliot University Professor, Harvard University ................................................................................................................... 4 

Prepared statement .......................................................................................... 33 

Response to written questions of: 

Senator Shelby ........................................................................................... 72 

Dean Baker, Co-Director, Center for Economic and Policy Research ................. 6 

Prepared statement .......................................................................................... 35 

Response to written questions of: 

Senator Shelby ........................................................................................... 73 

Senator Bunning ....................................................................................... 74 

Ellen Harnick, Senior Policy Counsel, Center for Responsible Lending ............. 9 

Prepared statement .......................................................................................... 39 

Response to written questions of: 

Senator Shelby ........................................................................................... 77 

Senator Bunning ....................................................................................... 78 

Scott Stern, Chief Executive Officer, Lenders One, Incorporated ....................... 11 

Prepared statement .......................................................................................... 55 

Douglas W. Elmendorf, Senior Fellow, The Brookings Institution ..................... 12 

Prepared statement .......................................................................................... 63 

Response to written questions of: 

Senator Shelby ........................................................................................... 79 

Senator Bunning ....................................................................................... 81 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Letter submitted to Chairman Dodd from William H. Gross and Mohamed 

A. El-Erian, Co-Chief Investment Officers, PIMCO .......................................... 83 


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(1) 

TURMOIL IN U.S. CREDIT MARKETS: EXAMINING PROPOSALS TO MITIGATE FORECLOSURES AND RESTORE LIQUIDITY TO 

THE MORTGAGE MARKETS 

THURSDAY, APRIL 10, 2008 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:05 a.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order. 

Let me thank our witnesses this morning and my colleagues for 

being here. Let me just say on behalf of Senator Shelby, as you all 

might well imagine, there are a number of Committee hearings 

going on this morning, and Senator Shelby is deeply involved in an 

Appropriations Subcommittee which he is the Ranking Member of, 

so he will be moving back and forth here but has urged me to go 

forward and not wait for him to be here this morning. 

I am very grateful to all of you for coming out. I am going to 

make some opening comments, and with the indulgence of Committee members, unless you absolutely feel totally compelled to be 

heard at the outset, I am going to turn to our witnesses, and particularly the former Secretary of the Treasury, Larry Summers, 

who is here. And, Dr. Summers, we deeply appreciate your being 

here, and as well as Mr. Elmendorf. 

They are both hosting a conference later this morning, and so I 

am going to turn to them and urge my colleagues to focus any 

questions they have to these two witnesses. 

I have informed the audience—and our colleagues are aware of 

this—that at roughly 11 o’clock, we have two or three votes on the 

floor of the Senate, so we are going to get as much done as we can 

between now and 11, certainly regarding the two witnesses who 

have other obligations and have graciously agreed to be here this 

morning under the time constraints. And then we will come right 

back again to our other witnesses to complete the hearing this 

morning. A little complicated, but it allows us to get through here 

and have a good discussion this morning. 

Well, today the Senate Committee on Banking, Housing, and 

Urban Affairs is meeting to hold a hearing entitled ‘‘Turmoil in the 


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U.S. Credit Markets: Examining Proposals to Mitigate Foreclosures 

and Restore Liquidity to the Mortgage Market.’’ 

Last week, we had an excellent hearing to look at one result of 

the turmoil we are experiencing in the capital market: the decision 

of the Federal Government to commit $29 billion in taxpayer 

money to rescue Bear Stearns. Today, we are focusing more on the 

other end of the spectrum: the impact of the crisis on homeowners 

themselves. 

This is the second hearing we are holding on this topic. The first 

was held in January. Since then, the crisis only seems to have gotten worse. It has spread from housing to other areas, such as student lending and municipal finance. And I expect that the Committee will examine these other areas in the weeks to come. 

This hearing could not be more timely. Today, after a week of intensive discussions and negotiations, the Senate later this morning 

will pass the Foreclosure Prevention Act of 2008. There are a number of important provisions in the legislation. The bill adds $150 

million to the counseling budget. It includes an expansion and modernization of the FHA program, which will create a real alternative 

to the abusive subprime lending so many working families have 

turned to in the past several years—which has greatly contributed 

to the crisis, by the way. It adds about $10 billion in increased 

mortgage revenue bond authority for the States, which will help to 

provide some lower-cost credit to distressed borrowers. And it includes $4 billion for State and local governments to clean up the 

mess left by historic foreclosure problems we are experiencing. 

There are a number of other provisions in the bill, but those are 

some of the major ones that will be a part of the bill I hope is 

adopted later this morning. 

It falls far short, I would add, this legislation does, of the lofty 

title of the bill. We do not do as much as I would like to have seen 

us do with this legislation. It does not do enough to help families 

facing foreclosure. Nearly 8,000 foreclosure filings occur every day 

in the country—almost 8,000 filings every single day—according to 

RealtyTrac, which follows that information. The most significant 

challenge we now face is helping people tottering on the edge of 

foreclosure to keep them in their homes. It is all well and good to 

provide funds to help pick up the pieces, but we need to do more 

prevention so we have less need for cleanup after the fact. 

To that end, I have been working intensely with colleagues on 

this Committee, have had numerous conversations with members 

of both the Democratic and Republican side, listening to their ideas 

and thoughts about how we could develop such a proposal here to 

deal with these issues. Hope for Homeowners Act of 2008 is sort 

of a compilation of those ideas. It is not the final word on it, but 

it is an opportunity for us to step up and try to move forward as 

a way of dealing with this issue. 

Briefly, the bill would create a new fund at the FHA to insure 

affordable mortgages for distressed borrowers. These FHA mortgages would refinance the old troubled loans at significant discounts. The new loans would be no larger than the borrowers could 

afford to pay and no more than 90 percent of the current value of 

the home. This formula is similar to the one laid out by Federal 

Reserve Chairman Bernanke in a speech several weeks ago when 


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he noted that ‘‘creating new equity for underwater borrowers may 

be a more effective way’’—and I am quoting him here—‘‘to prevent 

foreclosures.’’ Now, apparently the administration has also embraced this concept, and I applaud and welcome their participation 

in this debate and discussion. 

Lenders and investors will have to take a serious haircut to participate in the program, but in return, they will receive more than 

what they would recover through foreclosures, obviously. Borrowers 

get to keep their homes, but they must share the newly created equity and future appreciation with the FHA program to help offset 

possible losses. Only owner occupants would be eligible for this new 

program, and only those who clearly cannot afford their current 

mortgages. There will be no investors in the program. 

In addition to helping homeowners and the communities in 

which they live, this program will help stabilize capital markets, 

put a floor under housing prices, and get capital flowing once 

again. That part of this idea is hardly ever talked about. That may 

be the most important part of this program. I would argue that 

keeping them in their homes is, but the fact that we are establishing a floor and that we get capital flowing again is what is critically missing in all that we are talking about, and that is one of 

the reasons for it. 

The big enemy of smoothly functioning capital markets is uncertainty. Today, nobody knows what the subprime mortgages underlying the alphabet soup of complex securities—CDOs, SIVs, RMBs, 

and the like—are worth. This program would help put a value on 

those mortgages. 

We have another hearing on this proposal next week when we 

will hear from a number of Government witnesses and others. 

After that, I want to work with my colleagues to see if we can move 

this legislation forward. 

As you know, Representative Barney Frank is holding hearings 

as well on this subject matter, and has I think yesterday and 

today, talking about this issue, and we welcome his involvement. 

I understand that some people oppose this kind of program on 

the grounds that we should not reward people who acted irresponsibly. As we have seen from numerous hearings we have held over 

the past 15 months, many people facing foreclosure today were victims of abusive and predatory lending practices. Most were trying 

to act responsibly, but they were led badly astray by unscrupulous 

mortgage brokers and lenders. They were victims of what Mr. 

Stern, one of our witnesses this morning, calls ‘‘mortgage malpractice,’’ and I urge my colleagues to read his testimony in which 

he talks about this phenomenon. This is a lender talking about 

mortgage malpractice that is going on. 

In fact, the Wall Street Journal did a study in which it concluded 

that 61 percent of subprime borrowers it reviewed had high enough 

credit scores to qualify for prime loans. We know that these brokers portray themselves as trusted advisors to unsuspecting borrowers, while steering these borrowers into higher-cost loans in exchange for higher commissions. 

Lenders and brokers gave these borrowers, many on fixed incomes, mortgages with exploding interest rate payments that they 

knew the borrowers could never, ever afford. These are among the 


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homeowners that we seek to help with this legislation. We seek to 

help them because it is the right thing to do. To paraphrase Franklin Roosevelt, when your neighbor’s house is burning, you do not 

charge him for the use of your garden hose. You simply lend it to 

him. We are not acting for their sakes alone. Today, hundreds of 

thousands of our neighbors’ homes are figuratively burning, and 

like any fire, the damage threatens to spread. Every home that 

goes into foreclosure lowers the value of the other homes on that 

block by at least $5,000. It reduces property tax collections, which 

leaves local school revenues struggling. It hurts badly the ability 

of local governments to provide adequate police and fire protection 

and social services just as the need gets more pressing. 

The ripple effects are severe and widespread, so we owe ourselves and our communities, as well as our neighbors, our help in 

a crisis like this. We must act to put this fire out. That is what 

I would hope to do with all of you in the coming weeks. I look forward to hearing from our witnesses this morning and from our colleagues about how to draft this legislation that I have circulated 

a better document, a set of better ideas. We are going to hear from 

witnesses today, those who favor and oppose this ideas, because we 

want to have a balanced view of how we are looking at this as well. 

But my hope is we can put something together here that will accomplish the dual goals of keeping people in their homes as well 

as unleashing capital which is pent up. 

With that, I will turn to Senator Bennett, if you want to make 

any quick opening comments. And I would say to Senator Bunning, 

Jim, we are trying to—because of time constraints and votes this 

morning, if we can move right to witnesses. I apologize. I normally 

like to hear from everybody, but, Bob, any comments you want to 

make. 

Senator BENNETT. Mr. Chairman, I will not presume upon Senator Shelby’s prerogatives, and I will wait my turn. 

Chairman DODD. I thank you very much. 

Witnesses, thank you. Larry, good to have you with us this morning. Welcome back to the Committee. It is an honor to have you 

here with us this morning. 

STATEMENT OF LAWRENCE H. SUMMERS, CHARLES W. ELIOT 

UNIVERSITY PROFESSOR, HARVARD UNIVERSITY 

Mr. SUMMERS. Thank you very much, Mr. Chairman. The honor 

is mine. Let me do two things very briefly: summarize my view of 

where the economy stands, and offer four observations on the policy challenges before you. 

The economy is very likely currently in recession. If it is not a 

recession, it will certainly feel like one to the vast majority of our 

fellow citizens. The likelihood is very high that the downturn will 

continue for some time, certainly the next two quarters, despite the 

many constructive steps that have been taken in recent months. 

Particularly in housing markets, more distress lies ahead. No one 

can forecast where house prices are going, but the available evidence from futures markets, the available evidence on the level of 

inventories of unsold houses suggest that house prices could, on average, fall as much as 15 to 25 percent from current levels. 


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The declines are likely to be concentrated in lower-priced homes 

and in the areas of the country where financing with subprime 

mortgages and low down payments has been especially prevalent. 

These declines in house prices are placing and will place unprecedented burdens on the mortgage finance system. It appears, contrary to some of the discussion, that the dominant determinant of 

how pervasive foreclosures are is the behavior of house prices. 

When house prices rise, people find ways of refinancing as they 

rise, even if they are having personal financial difficulties. When 

house prices fall, foreclosures take off. 

The best estimates suggest, as I read them, that we are likely 

to have as many as 15 million homes with negative equity over the 

next 2 years, and it is very difficult to gauge the number of foreclosures, but they could on the current path exceed 2 million. 

There have been some signs of repair in financial markets since 

the Bear Stearns events of mid-March, but markets remain quite 

fragile. In particular, there is, as your initial comments suggested, 

Mr. Chairman, some reason to believe that as serious as the situation is in the housing markets, because of illiquidity various securities markets are actually pricing in degrees of dislocation that even 

substantially exceed those associated with a serious recession. 

There is, I believe, in the context of these developments, no basis 

for assuming that the housing market will be self-correcting. Indeed, financial markets sometimes—and at times like the 

present—do not follow the ordinary law of supply and demand. In 

economics classes, we teach that when prices fall, demand rises, 

and that tends to stabilize markets. But in leveraged financial markets, when prices fall, with leverage, people have margin calls or 

are unable to meet their debts and are forced to sell their assets, 

and so there is more supply, not more demand. Falling prices leading to reduced demand and increased supply means further falling 

prices, means vicious cycles, and it is interference with that type 

of vicious cycle mechanism that provides the important warrant for 

Government action. 

At the same time, it is appropriate to recognize the policies that 

serve only to delay inevitable adjustments can easily prove counterproductive. 

I would urge that policymakers give serious consideration to four 

areas. 

First, and critically, our policies regarding the Government-sponsored enterprises. The GSEs have a potentially critical role at a 

time of cyclical disturbance. Whatever one thinks about the GSEs 

as a normal matter, they exist to be in a position to be responsive 

at a time like the present. 

For them simply to expand their balance sheets without increased capital would be to expose the taxpayers and ultimately 

the entire financial system to very serious risks. The correct course 

is, therefore, for the Government-sponsored enterprises to raise 

capital on a very substantial scale for both prudential reasons and 

to back expanded lending. This may not be the first choice for their 

shareholders, but it is essential to the national interest. Robust, 

reasonably capitalized, GSEs taking an active role is probably the 

single most important step that the Government can take in bringing more regularity to the housing markets. 


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Second, there is a strong case for Federal support for the writing 

down of mortgages in selected cases along the lines that you, Mr. 

Chairman, and Congressman Frank have suggested. Carefully designed measures to reduce the tremendous externalities associated 

with foreclosures can provide an important contribution in the current context. 

In considering such measures, it will be essential to ponder design issues, including the treatment of second liens, assuring integrity in the appraisals on which the program will inevitably be 

based, possibly adverse selection effects on mortgages offered by 

servicers, and eliminating incentives for opportunistic behavior by 

homeowners. There are also desirable changes in legal rules. 

Third, I support carefully designed bankruptcy reform as a vehicle for encouraging the writing down of mortgages where that is 

appropriate. 

Finally, and respectfully, Mr. Chairman, I would raise serious 

concerns with respect to the tax measures contained in the legislation the Senate is likely to pass this morning as I understand 

them. Providing tax credits conditioned on initiation of the foreclosure process is likely to have perverse effects in two respects: 

foreclosures may be encouraged in order to make the underlying 

sale consistent with the tax credit; and in any event, the benefits 

will flow not to families, but to the financial institutions that have 

taken over the foreclosed property. 

I would also suggest that experience and economic logic suggest 

that tax benefits targeted to corporations with net operating losses 

are unlikely to have major stimulative effects. To the extent that 

stimulus and responding to economic distress are key objectives, 

tax measures targeted at those who suffer foreclosure or at the conversion of foreclosed homes into rental housing would represent a 

substantially more effective public choice. 

I stand ready to respond to your questions. 

Chairman DODD. Thank you very much, Larry. I appreciate your 

testimony immensely, and thank you once again for being here on 

short notice. 

I would say to my colleagues, I called the former Secretary and 

asked if he could be with us today, just in the last few days, and 

I am very grateful to him for making that happen. So I thank you 

for being with us. 

Good morning, Mr. Baker. How are you? Nice to have you with 

us. Are you ready to testify? 

STATEMENT OF DEAN BAKER, CO-DIRECTOR, 

CENTER FOR ECONOMIC AND POLICY RESEARCH 

Mr. BAKER. Thank you very much for inviting me here. What I 

wanted to say is that I would like to recognize first that we have 

a very diverse housing market, and what may be good for some 

portions of the country may not be for other portions. In particular, 

what I am going to do is talk about the loan guarantee program 

and raise three—outline three basic objections to it. 

First, it will lead to many homeowners paying much more in 

housing cost than they would if they were rent a comparable unit. 

Second, we will end up with a situation where many homeowners 

are unlikely to accumulate any equity in their homes and, in fact, 


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we are very likely to end up putting considerable tax dollars at 

risk. 

And, third, I think the effort to stabilize prices in bubble-inflated 

areas will prove unsuccessful and, furthermore, I would argue it is 

undesirable, even if it were successful. And I will very briefly comment on what I would argue is a better alternative to a loan guarantee program, what I call ‘‘own to rent,’’ a temporary change in 

foreclosure rules on moderate-income housing that would guarantee people the option to remain in their house as long-term renters. I think that is a solution that would not cost any taxpayer dollars or require any bureaucracy and potentially lead to much better 

outcomes for homeowners. 

The first point, in talking about the diverse market, it is important to recognize we had an unprecedented housing bubble in the 

United States over the last decade, which led to an overvaluation 

of house prices on average of about 70 percent. We have had house 

prices falling very rapidly in the last year and a half, so the bubble 

is partially deflated, and in large parts of the country I would say 

prices are no longer out of line with fundamentals. Places like 

Cleveland, Detroit, Atlanta, large parts of the Midwest and South, 

prices are pretty much in line with fundamentals. 

On the other hand, in the bubble-inflated areas—primarily areas 

along the coasts, you still have house prices that remain 30, 40 percent above their underlying values. That means that if we were to 

intervene at this point and try and stabilize prices, it would be 

similar to intervening in the collapse of the Nasdaq when it had 

fallen from 5,000 to about 3,500 on its eventual way down to 1,200. 

It is simply not viable and would not be good policy. 

OK. To go through the details, if we look at what we are doing 

for moderate-income homeowners in these bubble areas, we still 

have a situation where the ratio of house price to annual rent is 

far above 20:1. If you do the arithmetic on this, you would find that 

the annual ownership costs in such situations, even getting these 

people good mortgages, a 6-percent mortgage, the annual ownership cost, adding in the mortgage cost, insurance, property tax, 

maintenance costs, that will typically run as high as 10 percent, 

perhaps even higher, as a share of the ownership price. 

So just to take a numerical example, if we are looking at a home 

that would sell for $200,000, this home in this situation might rent 

for $10,000; we would be having a family that stays there as an 

owner paying $20,000 a year in ownership costs. That difference of 

$10,000 a year is a considerable amount of money for a moderateincome family that might be making $40,000, $50,000, $60,000 a 

year. This is money that is not available for child care expenses, 

health care expenses, other necessary expenses for that family. 

That simply does not seem to me good policy to be having moderate-income families pay way more than necessary by way of 

housing costs. 

The second point is, in terms of equity, if prices are falling, if 

they are going to fall 30, 40 percent—as I am quite confident they 

will in many of these bubble-inflated areas—people are not going 

to be accumulating equity even if they get a loan with a substantial 

writedown. Most people, moderate-income homeowners, only stay 

in their home about 4 years. These people are not going to accumuVerDate Nov 24 2008 02:01 Mar 20, 2010 Jkt 050396 PO 00000 Frm 00011 Fmt 6633 Sfmt 6602 E:\HR\OC\A396.XXX A396

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late equity. They are still likely to be underwater at the time they 

leave their home, which means either a loss to them or to taxpayers or to both. So it simply does not seem to me like good policy. 

The third point, in terms of the price support program, I sort of 

think that when we talk about a housing price support program, 

we should think about it the same way we would an agricultural 

price support program, except that instead of talking about a commodity with a market of, say, $20 billion a year, we are talking 

about a commodity—housing—with a value of $20 trillion. It is not 

going to work. We are not going to be able to sustain bubble-markets. 

On the other hand, even if we could do it, it again strikes me as 

rather perverse policy. Why do we want to keep artificially high 

house prices? Do we want to make it impossible for young families 

to be able to afford to buy homes or people moving into an area 

to be able to afford to buy homes? That simply does not seem to 

me like good policy. 

A last point I will just say on that is that we should also keep 

in mind the considerable costs associated with this program in 

terms of implementing—creating new mortgage instruments. Very 

conservatively we would have to imagine it is 1 percent of the cost; 

it might well be 2 percent. If we are talking about a $300 billion 

loan guarantee program, that is $3 to $6 billion in costs that will 

either be borne by the taxpayers or the homeowners. Again, to my 

mind, that is not a good expenditure. 

In terms of the alternative, the own-to-rent alternative, I think 

this is a very simple proposal. It requires no taxpayer money, no 

bureaucracy. We simply have a temporary change in the foreclosure rules that gives moderate-income homeowners facing foreclosure the option to remain in their house as renters for a significant period of time, say 10 years or so. This provides homeowners 

with some security. They know that if they like the home, they like 

the schools, they like the neighborhood, they are not going to be 

thrown out on the street. Perhaps more importantly, it gives the 

mortgage holders a very real incentive to sit down and renegotiate 

terms that will allow the homeowners to remain in their home as 

homeowners since it is a safe bet that banks are not anxious to end 

up as landlords. I would urge Congress to consider this or other alternatives that, you know, perhaps put less taxpayer money at risk 

than some of the guarantee proposals, at least for the bubble-inflated markets. 

In conclusion, I would just say that, to my mind, the big policy 

mistake that we are trying to deal with here is that we allowed for 

a financial bubble, a bubble in the housing market, to grow to very 

dangerous proportions. That was what created the situation that 

led to the crash that led to the recession that Secretary Summers 

was referring to. And I think it is unfortunate that that happened. 

Now that we have seen the crash, I have to say I find it somewhat 

striking that with so many economists that were unable to recognize the inflated prices during the bubble, they are so anxious to 

tell us that now prices are undervalued. 

Thank you. 

Chairman DODD. Thank you very much. 


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Ellen, thank you very much. Ellen Harnick, the Center for Responsible Lending. Thank you for joining us. 

STATEMENT OF ELLEN HARNICK, SENIOR POLICY COUNSEL, 

CENTER FOR RESPONSIBLE LENDING 

Ms. HARNICK. Thank you very much for having me here. 

I think I just want to pick up on the point about the extent of 

the financial crisis we face and just to focus us on the details of 

what this really means. 

Mr. Summers said that 2 million families may end up losing 

their homes in foreclosure. This is consistent with numbers that we 

have seen from a variety of sources. What this means is 2 million 

families will be put out of their homes. Some proportion of those 

families will find themselves homeless. Most of those families will 

suffer financial devastation from which they will never fully recover over the course of their working lives. 

We have talked about the declines in values that their neighbors 

will face, and we should be clear what we are talking about are not 

simply the declines that flow from home prices declining or the deflating of the housing bubble. What we are talking about are additional home price declines that will follow from the foreclosures 

themselves. And in many communities where the number of foreclosures in a particular neighborhood hit a tipping point, what families living in those neighborhoods will face is not merely a loss in 

their wealth and financial stability, but an actual significant decline in their quality of life. 

We all know what boarded-up homes on a block can do, and what 

we will start to see and some parts of the country have already 

started to see are middle-class neighborhoods that are now being 

overrun with criminal activity that makes it uncomfortable for families to have their children walk to and from school for the first 

time in their lives living in those communities. 

I think it is extremely important to take these things into account in deciding what can be done. Congress can avoid a substantial number of these foreclosures. I am not talking about the foreclosures that we will face from families who simply cannot afford 

a sustainable loan. I think that is off the table. But what I am talking about are foreclosures that are needless in the sense that rational economic decisions could prevent the homes from being lost. 

I think that the proposal that you, Mr. Chairman, have made for 

the FHA program is an excellent example of very significant work 

that can be done to avoid needless foreclosures. 

I want to pause for a minute on the moral hazard question. It 

has not been raised, but it sometimes is in other contexts. People 

say, well, we should not help these reckless borrowers, we should 

not support irresponsible lending. And I think—Mr. Chairman, you 

alluded to this in your opening remarks, and I think it is really important to stress that the mortgage malpractice or lending malpractice is an excellent point, and for those who doubt it, you do 

not have to know anything more about the particular borrowers at 

issue other than to know that all of these 228 hybrid ARMs, with 

which I know the Committee is familiar, these are extremely risky 

loans. They are not like your normal adjustable rate mortgages. 

And every single person who received these loans received them in 


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preference to a sustainable 30-year fixed-rate loan, which even in 

the subprime market could have been obtained at a very small increase over the introductory rate on the loan they got. And as Mr. 

Chairman said, many of these borrowers qualified for prime loans. 

The second point on the moral hazard question has to do with 

a point that I think Secretary Paulson made very eloquently immediately following the rescue of Bear Stearns, which was, yes, we 

worry about moral hazard, of course we worry about moral hazard; 

but we worry more, our primary focus at the moment is on stabilizing the market. And I do not think it is too fine a point to note 

that the investment banks and Wall Street have a share of the responsibility for supporting and encouraging the kind of loans that 

led to this crisis. I think helping them should preclude any real 

anxiety about helping the homeowners that we are talking about. 

It is now widely said—Chairman Bernanke said this a few weeks 

ago—that the key is reducing some of these principal balances and 

setting economically rational interest rates. We are not talking 

about propping up home prices unduly. We are talking about putting a floor under the decline. 

I have basically three recommendations to make with respect to 

the Hope for Homeowners Act. 

The first is the 13-percent haircut—the 10-percent reduction over 

current loan value, plus the 3 percent to go to the insurance pool— 

this is essential. It is essential for two reasons: one, to ensure the 

sustainability of the program so that taxpayers are not unduly at 

risk; and, second, from our point of view, it is extremely important 

that while we are going to help put a floor under the problem, we 

are not going to save investors and lenders from the full consequences of their investing decisions. These were sophisticated actors, and it is important that we not take away some of the incentives to behave more responsibly in the future. 

The reason I raise this is that as I read the bill, it leaves open 

the possibility that this requirement could be waived by future administrations of the program, and I think that that would be a mistake. 

The second recommendation is the appreciation sharing so that 

the homeowner is sharing with the FHA some of the benefit of the 

program. We think it is extremely important and appropriate that 

the homeowner should be helping to finance this program. We 

think that extending the appreciation sharing indefinitely, as the 

bill currently does, is not appropriate and also will be unworkable. 

Most homeowners do not stay in their homes more than 5 years. 

But for those who do and who make improvements, for example, 

in the homes, having indefinite appreciation sharing would require 

very complicated calculations about what part of the appreciation 

is a function of the original home and what is a function of subsequent improvements. I think capping it at 5 years with a 3-percent 

payment thereafter, as Mr. Frank’s bill does, is a very good approach. 

Finally, we need a mechanism for dealing with the problem that 

in many cases loan servicers will be unable to take advantage of 

this program, just as they are unable to voluntarily modify the 

loans, even where each of those options is far better for investors 

than foreclosure. And the clearest example of where that will arise 


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is in the case of the loans that carry piggyback second mortgages. 

Without the consent of the second-lien holder, there is no—you cannot modify the loan and save the home. And consent of the secondlien holder has not been forthcoming. The only proposal that I am 

aware of that would address this problem is a mechanism for allowing courts to supervise a modification of those loans so that the 

second-lien holder’s consent is not required. 

Thank you very much. 

Chairman DODD. Thank you very, very much. I appreciate it, and 

I appreciate your testimony. 

Mr. Scott Stern, we thank you very much for being here this 

morning. 

STATEMENT OF SCOTT STERN, CHIEF EXECUTIVE OFFICER, 

LENDERS ONE, INCORPORATED 

Mr. STERN. Thank you, Chairman Dodd. My name is Scott Stern, 

and I am the CEO of Lenders One Mortgage Cooperative in St. 

Louis, Missouri. Since this is our first appearance before the Committee, I would like to say a few words about the unique role that 

Lenders One plays in the mortgage industry. 

As the country’s largest mortgage cooperative, Lenders One represents the Nation’s ‘‘Main Street’’ lenders, like William Raevis 

Mortgage in Shelton, Connecticut, and probably lenders in the 

great States that you all represent. Our 110 shareholder mortgage 

companies have originated over 1 million home loans, almost exclusively prime loans, in the past 5 years, and we make homeownership possible in communities across the United States. 

This Committee, this Congress, and the administration have 

taken important steps to address today’s mortgage crisis. However, 

the mortgage storm is far from over, and the Federal Government’s 

work is not done. More needs to be done to address the root of the 

problem: looming foreclosures caused by defective subprime loans. 

These loans represent a toxin in the mortgage system that has 

spread far beyond the subprime sector to infect liquidity in the 

prime mortgage market, accelerate home price depreciation, and 

cause ripple effects throughout the Nation’s economy. 

As FDIC Chairman Sheila Bair testified recently, negative housing trends are likely to continue at least through this year. The 

bulk of subprime hybrid ARM resets are still ahead of us. Over 1 

million such loans valued in the hundreds of billions of dollars will 

reset in 2008. A similar volume of payment option ARMS and interest-only loans are also on the horizon. Many of these loans are 

foreclosures waiting to happen. 

I would also like to add that, in my expert opinion, these loans 

would not be foreclosure candidates had they been FHA loans in 

the first place. 

Loan modification efforts to date have fallen short of the scale 

necessary to make a significant reduction in foreclosures. The main 

Federal effort, FHASecure, while well intentioned, is simply not 

serving enough borrowers. Credit Suisse has estimated that only 

44,000 delinquent borrowers would be eligible for a refinance under 

the program. And the latest numbers directly from HUD indicate 

that since the inception of the program in September 2007, just 

1,500 FHASecure conversions have been made. 


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We believe that an enhanced federally assisted effort to cleanse 

the market of distressed subprime loans will contribute to stabilizing the mortgage finance system. Chairman Dodd’s bill, the Hope 

for Homeownership Act, is carefully drawn to achieve that goal. 

The concept is simple: lenders and investors would take a loss by 

marking down the loan to market value. Borrowers would refinance 

at a higher yet stable rate than their initial teaser rate. No one 

gets a free ride. 

In my remaining time, I would like to address the three fundamental objections to Government action. 

No. 1, restructuring a troubled loan is not fair to other homeowners who are not in troubled loans. We are not unsympathetic 

to that view. However, the fact is that foreclosures create home equity losses, tighter credit, and a strained tax base for all homeowners, not just the family losing their home. By reducing foreclosures, all homeowners will see the benefits of market stability. 

No. 2, borrowers who take out risky loans deserve what they get. 

As a mortgage practitioner who has personally originated over 

$300 million in home loans, I respectfully disagree. Disclosures 

were often less than adequate, and faced with a bewildering array 

of loan terms, borrowers tended to trust their banker or broker, 

who in turn broke that trust. I liken the situation to that of a doctor and patient dealing with a medical procedure. The patient 

bears some reasonable risk. But they do not bear the risk of malpractice by the doctor. In our industry, we have frankly seen too 

much mortgage malpractice. 

And third, that this creates a burden on the taxpayer. Again, I 

respectfully disagree. The new loans would have positive equity; 

they would be fixed-rate stable mortgages; and the new borrowers 

would qualify under terms that made them safe loans. 

‘‘Curing’’ a loan that had a high risk of failure creates no moral 

hazard. Just the opposite. Modifying a loan which probably should 

not have been made in the first place is the kind of action that can 

help restore integrity in the market. 

Finally, while we support the overall approach for the Hope for 

Homeowners Act, we do have some suggestions for improving the 

proposed legislation which can be found in our written testimony. 

Once again I would like to thank the Committee for today’s opportunity to share the views of the Nation’s independent mortgage 

bankers, and we look forward to continuing to work with this Committee to ensure stability and fairness in the mortgage market. 

Chairman DODD. Mr. Stern, thank you. That was excellent testimony. I appreciate immensely your comments. 

Mr. Elmendorf, welcome. Mr. Elmendorf is a Senior Fellow at 

Brookings, and we appreciate your being back with the Committee. 

STATEMENT OF DOUGLAS W. ELMENDORF, SENIOR FELLOW, 

THE BROOKINGS INSTITUTION 

Mr. ELMENDORF. Thank you, Chairman Dodd and Members of 

the Committee. I appreciate the opportunity to appear before you 

today. 

The American economy, as we all know, now faces serious challenges. The economy is very likely in recession. Neither housing 

construction nor house prices show any sign of reaching bottom. 


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The financial system is reeling, and lending to households and 

businesses is impeded. In the absence of further policy action, several million families will default on their mortgages in the next few 

years and lose their homes to foreclosure. 

Congress, the administration, and the Federal Reserve have responded to the broader problems, with forcible fiscal and monopoly 

actions. But less has been done to tackle the housing and mortgage 

mess directly. It is neither feasible nor appropriate for the Government to ensure that all families, regardless of their mortgages or 

their overall financial situations, can remain in their homes. However, it is both feasible and appropriate for the Government to reduce the number of families that will lose their homes in the next 

few years. Moreover, policy actions in this direction will have favorable effects on the broader economic problems that we confront. 

The first part of my remarks presents the case for greater Government involvement, and the second part turns to specific policies. 

Some have argued that mortgage borrowers and lenders should 

be left to work out their problems themselves. With the sharp deterioration in underwriting standards over the past several years, 

many families have indeed ended up in mortgages that are 

unsustainably large. In addition, the argument goes, it is unfair to 

help homeowners facing foreclosure while not helping people who 

chose to remain renters or who are stretching to meet their mortgage payments. And helping borrowers and lenders will create a 

moral hazard of excessive risk taking in the future. 

These arguments contain some truth, in my view, but they are 

not the whole truth. Despite these reasonable concerns, the Government has a crucial part to play. 

First, the Government has long had an active role in housing finance. With large mortgage lenders suffering massive losses, and 

many mortgage-backed securities viewed especially negatively in financial markets, the private supply of mortgage credit is now severely hampered. 

Second, Government policy never does, nor should, follow free 

market principles absolutely. We are always balancing the need for 

people to bear responsibility for their decisions with the goal of protecting the vulnerable members of our society. 

Third, mortgage problems have consequences that go well beyond 

the families and institutions directly involved. Foreclosures lower 

property values. Gyrations in financial markets pose risks to everyone’s savings. And the weakening of the overall economy hurts 

many, many people. 

Fourth, the legal complexities and coordination challenges created by mortgage securitization imply that fewer loans will be 

modified than would be in the interests of even the lenders. 

The compromise housing bill being debated in the Senate this 

week includes several valuable provisions, as the Chairman has 

noted, including the appropriation of additional funds for mortgage 

counseling and the augmenting of funds for State and local governments. However, the bill falls short of what is needed, in my view. 

The further proposals of Chairman Dodd and Chairman Frank in 

the House to expand eligibility for FHA guaranteed loans would be 

an appropriate and important step forward for several reasons. 


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First, the FHA’s traditional mandate is to assist individuals underserved by the traditional mortgage market. Given the pullback 

in private mortgage lending and securitization, it is natural to increase the FHA’s presence as a counterweight. 

Second, the proposals on the table are appropriately selective in 

the families they help. The proposals recognize the hard truth that 

not every family can afford to stay in its current home, so eligibility 

is limited to owner-occupiers who satisfy underwriting standards 

and represent good credit risks at the new mortgage levels. 

Third, the plans do not simply throw open taxpayers’ wallets. Instead, they keep any cost to taxpayers quite low, again, by limiting 

eligibility to cases where existing principal amounts are written 

down, also by collecting insurance premiums, and by recapturing 

future appreciation. 

Fourth, these proposals encourage servicers to modify existing 

mortgages by providing a safe harbor against legal liability for 

doing so and by facilitating the issuance of new mortgages so that 

the old mortgagors do not need to remain in the market if they 

would prefer to leave it. As other panelists have noted, finding 

ways for the Government to help resubordinate second liens would 

be a valuable further step. 

In conclusion, I would emphasize that all of the policy options 

available to the Congress at this time are unsatisfying in many 

ways, but the cost of inaction is also very high. I urge this Committee and the Congress to go beyond the compromise Senate bill 

by expanding the role of the FHA. Addressing the mortgage mess 

can help families and reduce the scale of our broader economic 

problems, and it can do so with limited effects on future mortgage 

lending and future risk taking, and at fairly low cost to taxpayers. 

Thank you very much. I would be happy to answer any questions 

you may have. 

Chairman DODD. Well, thank you very much, Mr. Elmendorf. I 

think you may be hearing the buzzers going off here, so we will be 

running in and out voting. So let me address, if I can, to both you 

and to Secretary Summers, a question, if I may. And I think, 

Larry, you sort of alluded to this in talking about the negative 

cycle of foreclosures. I think others have called it the ‘‘negative 

feedback loop,’’ and maybe other economists make reference to 

that. Would you expand on that a little bit, because I think it goes 

to the heart of why there is a justification for some intervention 

here. If you get this constant domino effect which drives this problem even further and deeper, creating additional problems, it may 

provide some light as to why this particular fact situation warrants 

something like the suggestion we are making. 

Mr. SUMMERS. You have two different possible vicious cycle 

mechanisms going on. One, which is abundantly clear, is with respect to mortgage-backed securities where, as you put it in your 

opening statement, Mr. Chairman, there was an issue of finding— 

there was an issue of finding a floor and reducing uncertainty. And 

you have the problem that there are leveraged holders of those securities. As those securities decline in value, they get a margin call; 

they have to put up more money. They are either unable or unwilling to put up more money, as a consequence of which they sell 

them, as a consequence of which they go further down in value. 


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And I think it is quite clear that that mechanism is present and 

is pervasively present with respect to mortgages, and anything that 

involves purchasing mortgage-backed securities, as your proposal 

would, or as the involvement of the GSEs does, serves to limit that. 

Second, there is the similar mechanism operative in the market 

for houses. The more house prices fall, the more people walk away; 

the more they walk away, the more house prices fall; and then 

more people walk away, and you have the same kind of vicious 

cycle. There is also a desirability of containing a vicious cycle of 

that kind. 

With respect to the second mechanism, though, I would caution 

that while I do not think I would go quite as far as he did, the 

point that Dean Baker made I thought was right, that one has to 

be very careful in stabilizing markets and preventing overreactions. 

But at the same time, one needs to be very careful of not trying 

to prop up markets at artificially inflated values. And I do not 

think we can say at this point that there are large parts of the 

country where house prices have fallen significantly below fundamentals, and, therefore, by reducing the effective supply of housing, we are making the adjustment process better. 

So while as you know, I am very sympathetic to the broad structures that you have put forward in your legislation, my enthusiasm 

derives from two sources, and quite explicitly does not derive from 

a third. It derives from the sense that this would be constructive 

with respect to the mortgage market in providing stability in that 

financial market. It derives from the sense that it would bring 

about more efficient outcomes that the person who is living in 

many of these houses is the right person to continue to live in that 

house, but needs to be living in that house with the value of the 

house written down. And I believe your legislation will support 

that taking place more efficiently and effectively than it otherwise 

would. 

But I become uncomfortable when—and I also believe related to 

that that in certain neighborhoods preventing an epidemic of foreclosures would avoid a disaster. But I think it is very important to 

be clear that it is not and should not be the objective of public policy to prevent house price deflation as a macro phenomenon. Moreover, in some sense, one of our concerns is that what we have to 

want is that both housing markets and financial markets find a 

level where it is attractive to be a buyer. And the longer the Government—if the Government were to become a dragging anchor, 

slowing the process of adjustment, you would delay the day when 

it was attractive to be a genuine buyer, and in some ways repeat 

the mistakes of what the Japanese did. 

So, yes, but the case is based on the micro of the housing market 

and the macro of the mortgage financial market, and not based on 

a desire to artificially prop up housing prices. And I think it is— 

I am glad you asked the question because I think it is important 

to be clear about, at least for me, where the case lies. 

Chairman DODD. Well, I think that is a very good point, and I— 

other members can speak, obviously, for themselves here. I agree 

with your conclusion; hence, while we are trying to do this carefully, understanding there are hazards in how we craft something 

like this, there is a hazard in not crafting anything at all. And so 


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how you try and manage this intelligently—one of the objectives, 

obviously, is to have a limited timeframe we are talking about for 

exactly the last point you are making, so that this is a very—we 

are talking about a brief period with a sunset provision in a sense, 

so it is not an ongoing program, not setting up a separate bureaucracy, utilizing the platforms that presently exist with FHA, for instance. There is a tendency in this town, obviously, if you establish 

something, it does not go away, and the danger of what that could 

do to your macro point. 

Mr. SUMMERS. I think a danger—If I might? 

Chairman DODD. Yes. 

Mr. SUMMERS. I think a danger which you will need to be attentive to—and I believe it can be addressed—that actually Dean 

Baker’s comments highlighted for me is the following: You are 

going to do one of your transactions where you buy the mortgage 

and then the FHA gives a 90-percent mortgage, and you are going 

to do it hypothetically in some community where there has not 

been a lot of turnover in the housing market, where there are 15 

months of normal demand for houses being supplied. And some appraiser is going to come along and say what the value of the house 

is, and then you are going to write a mortgage for 90 percent of 

that, and that is what the guy holding the mortgage is going to 

have. 

Well, in an illiquid market with a very large inventory, doing 

that appraisal is not an easy thing to do accurately, and everyone 

that appraiser is going to meet is going to tend to have an interest 

in a higher appraisal. And the people who are going to bear the 

burden if there are misappraisals are going to be the taxpayers 

when the appraisal turns out to be wrong and 2 years from now, 

gosh, the house is worth 20 percent less than it was appraised and 

we are seeing this movie again. 

And so I would urge that there be very considerable attention 

given to the incentives in the appraisal process as this takes place, 

and to what I might think of as forward-looking appraisals. It is 

very easy in down markets to do—I mean, I have been misled myself in this on a number of unfortunate occasions, where you are 

told what your house is worth on the basis of somebody who did 

comparables when houses like yours were sold 6 months before, 

and that becomes the basis for the appraisal, and that is not realistic in the context where the market is falling. 

I think one of the things that you will need to give careful 

thought to is the incentives governing the appraisals as this process goes down. 

Chairman DODD. Thank you very much. 

Mr. Elmendorf, do you want to comment on this as well? I know 

you have time constraints. 

Mr. ELMENDORF. I agree with much of what Larry said about not 

trying to prevent an aggregate correction in house prices. I do not 

think your proposed legislation would or could do that. I think our 

goal is to try to avoid an overshooting, and particularly in those 

cases where house prices rose very dramatically and are now coming back down very dramatically. And in those areas, particularly 

those where subprime lending was very prevalent, I think there is 

a risk of an overshooting in a way that would be very damaging 


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to the people in those areas, those in the subprime mortgage 

houses and those in all other houses or rental housing as their 

neighborhoods and communities are hurt. And I think trying to 

avoid that overshooting is a legitimate goal and one that your legislation would help to achieve by providing a way to help people get 

into new mortgages. 

Chairman DODD. Thank you very much. 

Let me turn to Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Welcome all, good testifiers and experts in this field. We have a 

major problem, as you well know, and there are many solutions, 

one of them being on the floor today. I happen to think it is inadequate. But we have an awful lot of other people who are proposing 

changes like Chairman Frank, Chairman Dodd, and others. 

Can anybody answer this question: How many people who are in 

trouble today took second mortgages or refinanced to tap their 

home equity? 

Mr. STERN. I will be happy to answer this question. 

Senator BUNNING. Go ahead, Scott. 

Mr. STERN. Thank you for the question. Our experience is that 

where there were second loans, they were originated as part of a 

single transaction, perhaps an 80-percent first and a 20-percent 

second, not—— 

Senator BUNNING. To get the whole house covered? 

Mr. STERN. To get to 100-percent loan-to-value, most likely on 

the suggestion of a lender. I do not know a lot of mortgage lenders 

who walk into a lender and say, ‘‘I would like an 80:20 piggyback 

loan.’’ These are often at the suggestion of the lender. 

Your question is perhaps to question were these irresponsible 

lenders who just borrowed too much. I would respectfully say I do 

not think so. The majority of the time where these were second 

loans, I think they were part of an overall single transaction of a 

first and second mortgage combined on the recommendation of 

lenders. 

Senator BUNNING. Would that be because of the total overall cost 

not being able to be afforded by a single mortgage so they could 

borrow enough to cover the entire mortgage with a second loan? 

Mr. STERN. Over the past 5 to 7 years, the mortgage industry 

has done a variety of things to expand homeownership opportunities, most of them well intentioned. Some of these involved minimizing documentation, some of them involved lowering credit 

standards, and some of them involved reducing down payment of 

any borrowers who borrowed 100 percent of their home’s value did 

so because they needed to. Many of the borrowers did so because 

they had to. But at the end of the day, there were also competent 

underwriters, typically seasoned underwriters, who looked at these 

transactions and erroneously concluded that the overall risk of the 

loan was accurate. 

What we now know is that there was a significant layering of 

risk that is resulting in the challenges that they have today. They 

do not have enough money. They cannot afford the ARM resets. 

But now, of course, the big challenge is they cannot refinance, even 

if they want to, because their home has negative equity. 


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But in answer to your question, I do think there are cases where 

borrowers put little down because they needed to, but now it is the 

result of the negative equity in their home that is causing the challenges, not the fact that they put no money down to begin with. 

Mr. BAKER. If I could just throw in one more thing. 

Senator BUNNING. Sure. 

Mr. BAKER. A lot of the people that took out additional equity 

when they refinanced, in many cases these were people who wanted to refinance to take advantage of lower interest rates where 

they were subject to resets in 2005–06, and there had been appreciation in the interim, and they were actually encouraged in many 

cases by lenders to take out some of the additional equity to meet 

needs, whatever. So it was very often at the urging of the lenders 

that they would have refinanced for more than the original value 

of their mortgage. 

Senator BUNNING. Can any of you see what incentives there 

would be for second mortgage holders to release their mortgage so 

borrowers can refinance? 

Mr. BAKER. In many of these cases, they have—I mean, as things 

stand now, their second mortgage is going to be almost worthless, 

you know, because the home is underwater. They already—— 

Senator BUNNING. Well, I understand that, but to actually have 

a chance for the first mortgage to get changed, you have got to get 

a release from the second mortgage. So—— 

Mr. BAKER. That is right. You are absolutely right, Senator. I am 

sorry. But, I mean, at this point they essentially are giving up 

nothing except their right to obstruct. 

Mr. ELMENDORF. Can I amend that a bit? I think the problem 

is they are not quite worth nothing because in some cases house 

prices may rise, people may stay in the homes. Second-lien holders 

may get something. It is not very much. It is probably pennies on 

the dollar of what the mortgage—of what they hoped to get in an 

ideal world. But it is not quite zero, and I think that is the complication. It is not just they will not sign the form. They want to 

get a little something out of this, and I think that is the reason 

why coordination in the refinancing is important and why the second-lien holders may need—do need to be brought into this process, 

and they may need to get something out of the deal—not very 

much, I think, but perhaps something. 

Senator BUNNING. Maybe anyone—go ahead, Larry. 

Mr. SUMMERS. I wish I had a clear way forward for you on this 

issue. I think it is a very difficult one. There is what I would call 

a long and undistinguished tradition of hold-up artists in financial 

life. And just as the guy who figures out that somebody wants to 

build a mall in a certain area and he figures out to own half an 

acre, half an acre is not really worth very much to him, but he feels 

himself to have an asset of considerable importance because of his 

blocking right, that is the nature of the problem that one has with 

these second mortgages. 

On the other hand, as I suspect those on your side of the aisle 

will point out, rightly, one does need to be rather careful about 

being cavalier about what, after all, are legal rights that people acquire. 


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Senator BUNNING. Well, especially if we throw it into a bankruptcy court, or something like that. 

Mr. SUMMERS. I personally am of the view—and I know this is 

controversial—that carefully structured bankruptcy reform that 

does it in the context of bankruptcy would be constructive. There 

are others who would go further—and I would not—in allowing as 

part of a comprehensive solution some broad-gauged writing down 

of second mortgages with somebody’s discretion outside of the 

bankruptcy context. I find that to be somewhat—I find that to be 

a problematic approach. But I think the question of how one works 

through the second mortgages is a crucial one. 

I would just add one other thing. I would, if I could be so presumptuous, commend to Committee staff the recent work that has 

been done by the Boston Fed where they have followed every mortgage and every home in Massachusetts over the last 20 years. And 

one finds a variety of quite interesting patterns. Much more common than I would have imagined, for example, is the pattern where 

somebody takes out a prime mortgage and subsequently refinances 

as a subprime mortgage in order to get more out in appreciation. 

And we think of these mortgages that are being restructured all as 

the mortgage that the person used in order to buy the home. And 

it is that in many cases, and most cases probably particularly the 

egregious 2006 and 2007 subprime cases. But there are a variety 

of other phenomena here involving refinancing, and I think there 

is really a great deal of experience that is calibrated in that data 

that could usefully inform the design of this legislation. 

Senator BUNNING. Thank you. 

Chairman DODD. Thank you, Senator. 

Senator Reed. 

Senator REED. Thank you, Mr. Chairman. Thank you for your excellent testimony. 

Secretary Summers, one of the assumptions that everyone is operating under, and I know I am, is that if you adjust the price of 

the property down to a realistic value, then the homeowner will be 

able to carry on. But the question then is the continued viability 

of homeowners given declining wages in some places, stagnant 

wages, unemployment going up, commodity prices going up, and 

family budgets. This is not the best time to try to work out a real 

estate crisis. 

So any thoughts on the other side of the equation, that if this 

continued, price increases in commodities and unemployment 

growth, classic recession, where are we? 

Mr. SUMMERS. I think it is a serious concern, Senator Reed. I am 

inclined to think that the further decline in house prices risk that 

I described is, if anything, slightly greater than the risks you describe, but I do not minimize the risks that you describe. 

The HOLC program in the Depression that the Chairman has 

referenced in designing his legislation has an approximately 20- 

percent foreclosure rate, even though the program was put in at 

the bottom of the Depression, things were getting better, and equity levels were rather higher than what we contemplate today. 

So I think we need to be realistic in recognizing that whatever 

we do with the FHA, there is going to be a significant re-foreclosure rate. On the other hand, there are going to be a very large 


dcolon on DSK2BSOYB1PROD with HEARING
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number of families who are going to have been benefited and who 

are going to have been enabled to stay in their homes. 

Now, some suggest, as Dean Baker did, that, one, cut past all 

that problem by turning the potential victims of foreclosure into 

long-term renters. And I see a merit of that approach in the sense 

that you would avoid some of these problems—not all of these problems. They might not be able at a certain point to afford the rent. 

For me, at the present time, the problematic aspect of that is the 

almost entirely involuntary character of what is happening vis-avis the contract that underlay the mortgage and vis-a-vis the bank. 

So I do not support that and would oppose it fairly vigorously, 

but going in that direction is the direction one goes if the problem 

one is most focused on is the ability of people to continue to stay 

in their homes indefinitely. 

Senator REED. Dean Baker, do you have a comment? 

Mr. BAKER. Yes, just a couple of things. I think any sort of program like the Hope Act would be most successful if we are very 

careful about the prices for reasons Secretary Summers had said 

and I had said earlier. And I think one way in which we could do 

that is if you try to anchor the guarantee price in rents, because 

rents are ongoing in the market, they have not fluctuated in as 

radical a pattern as sale prices. So if we were to set a guarantee 

price of, say, some multiple, 15:1 or something like, of rent, we 

would do two things. One, we would ensure ourselves that we are 

not setting ourselves up, setting up the taxpayers for large losses; 

and, second, we would minimize the subsequent foreclosure because that would be a situation where you would not anticipate 

large subsequent declines in the house price. 

So I would suggest that, you know, when we are looking to appraisals, again, as Secretary Summers said, it is very hard to find 

a reliable appraisal in a very irregular market. We could get a reliable rental appraisal because there is a large amount of rents in 

the market, and that could be a very good anchor. And, again, insofar as we are using money, using some of this guarantee to guarantee overpriced homes in bubble areas, that is money that is not 

going to stabilize markets where it could have a beneficial effect. 

Senator REED. We all make reference back to the experience of 

the 1930s and the Depression, but there seems to be some—there 

are differences, obviously, and one is that—and maybe this is more 

folklore than reality, but it seems to have some currency. It is that 

back then most of the mortgages were owned by a financial institution that could go in and make this deal pretty directly. The 

securitization process, which is very sophisticated, how will that 

complicate or what should we be particularly looking at in terms 

of the obstacles to getting anything done given these very sophisticated securitization products that have been cut up in tranches and 

defy some people’s understanding? Secretary Summers. 

Mr. SUMMERS. I apologize for having lost sight of precisely where 

the legislation Senator Carper has discussed in the past currently 

is. But the proposals to give legal liability—to give relief of legal 

liability from servicers for renegotiate strike me as being close to 

the lowest hanging fruit in this whole area. 

I think there is room for debate as to just how much of the problem they will solve. I think there is no room for—I think there is 


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almost no room for rational debate that they represent a constructive step in the right direction. 

Senator REED. Any other comments? Yes, Ellen. Ms. Harnick. 

Ms. HARNICK. I would add that one other difference that flows 

from the fact that these loans are securitized is that different incentives are at play, so that back in the 1930s, the lender was the 

holder of the note and was the person negotiating. Today, when 

you have the servicer negotiating on behalf of different tranches of 

investors, sometimes the servicer’s own incentives are quite different from what is good for the note holder. So that, for example, 

there has been a lot written about this, but servicers actually earn 

more themselves from foreclosing than they do from some of these 

cost-intensive alternatives like modification. And I assume that 

that would be in play with the FHA proposal as well. They will 

incur costs in going through the process for which they will not be 

reimbursed under their pooling and servicing agreement; whereas, 

if they foreclose, all their costs would be covered. 

So this is a problem that would have to be worked through. 

There would need to be a way to make the rational outcome—realize the rational outcome even where the servicer’s incentive might 

run to the contrary. 

Senator REED. Do you have a proposal? 

Ms. HARNICK. Well, the best proposal I am aware of is the one 

that allows a court to supervise the process and ensure that the rational solution is imposed where the servicer cannot or will not 

agree, and that is the bankruptcy conversation that has been 

raised in other quarters. 

Mr. STERN. If I—— 

Senator REED. Yes, please. 

Mr. STERN. I am happy to just add very, very quickly that the 

No. 1 thing we hear from Wall Street and from securitizers is they 

do not know where the bottom is. And I assure you that when they 

say we do not know where the bottom is, they are not talking about 

credit quality. They are talking about value. 

On a recent call I was on, we discussed the fact that this is the 

best quality of loans—the applications of March of 2008 are the 

best quality of loans many of us have ever seen. They are high 

credit, they are low loan to value, and yet we cannot make the 

loans because simply the properties are not appraising out. 

If we had a bottom of the appraisal market, of the valuation market, these loans could be refinanced. Many of these borrowers need 

to refinance. Their ARMs are resetting. They come to us. We cannot help them because the simple reason is their loans are underwater. Securitizers need a bottom. 

Senator REED. Thank you very much, Mr. Chairman. 

Bob, I think you are next. 

Senator BENNETT. Senator Dodd as he left said he was going to 

have to recess the headquarters because of the votes, and since I 

am the only one who has voted, he said, ‘‘You recess the hearing.’’ 

[Laughter.] 

So I am prepared to do my presentation now—Senator Bayh. 

Senator BAYH. Mr. Chairman, if I could just briefly apologize to 

our panelists for the votes intruding upon this panel. We are all 

grateful for your time. Secretary Summers, it is particularly good 


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to see you, and I could not help but think about the echoes to some 

of the challenges that you dealt with very ably in the 1990s currency crises in East Asia or in Mexico, and the countervailing risks 

of contagion and moral hazard. And it seems to me that there are 

some analogies to this situation where we need to deal with the 

systemic risk of the day, but then look very carefully at how we got 

into this mess and put into place mechanisms to make sure—you 

mentioned the incentives that are misaligned in some cases—to 

make sure we do not get into it again to deal with the moral hazard potentially down the road. 

So I would not help but be struck by that, and, again, thank you 

all. I apologize for having to run, but it is one of the few things 

as Senators, you know, they actually pay us to do here is to vote. 

So thank you all very much. 

Thank you. 

Senator BENNETT. Thank you. 

I want to combine some of the things I would have said in an 

opening statement with my questioning period, and I have found 

this panel to be very, very helpful, not necessarily in terms of the 

solutions you proposed—that might disappoint you—but in terms of 

the problems you have exposed that are helpful to us. 

Secretary Summers, I applaud you and your final statement 

where you say, ‘‘It is essential to recognize that policies that serve 

only to delay inevitable adjustments can easily prove counterproductive.’’ And in our effort to be seen as doing something, the 

Congress inevitably moves in that direction, and I appreciate that 

warning. 

I want to show you a chart—I should have had it blown up, but 

I think it is big enough you can at least see the divergence between 

the two lines, and let me tell you what they are. The blue line is 

estimated price change since January 2006, according to CaseShiller, and it goes from the baseline point, a peak here in price 

appreciation occurring in July of 2006, and then down 10.8 percent 

now. 

The red line is cumulative estimated price change since January 

2006 according to OFHEO’s Monthly Purchase Price Index USA. 

They are dramatically different. OFHEO shows a one-tenth of 1 

percent increase in housing prices over that period, with the peak 

occurring in May 2007. And in May 2007, Case-Shiller had it already underwater. 

And as I have talked to Mr. Lockhart at OFHEO and asked him 

why the discrepancy, the answer is: We went to different places to 

gather data. Case-Shiller gathered the data in the 20 largest cities 

in the United States, and OFHEO tried to gather data over a much 

broader scale. Point one for you, Dr. Baker, that there is a difference between prices in one place and prices in another, which 

makes it more difficult for us to come up with a nationwide system, 

and if we try to do our nationwide system based on the blue line, 

we may very well do damage to people who are living in cities that 

contribute to the red line, because the differential is fairly strong. 

My own observation is that in addition to the differential that 

you talk about, Dr. Baker, where some cities have reached equilibrium and others are in bubble condition, even within the same 

market there are differences, depending on the price band. In my 


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own city of Salt Lake City, I know there is a glut of $400,000 

homes, because my daughter has one that she has been trying to 

sell for over a year and can’t. There is a shortage of homes under 

$200,000. And the law of supply and demand says that we should 

be building homes in that area. Why is there a shortage in that 

price band? Because homeowners in the period when the peak occurred, regardless of where you put it on the chart, could make 

more money building $400,000 homes and so they did not build 

homes in an area where there would be a greater demand because 

they could sell homes in the higher area, because people were buying them with the kinds of practices that you have been talking 

about. And also—let’s not rule this out or turn our backs to it— 

people were buying homes for the purpose of selling them. And the 

homeowners were meeting that demand, and the market was there 

for it. And when that collapsed, everybody involved in it got hurt, 

and I frankly think most of them who were involved in the speculation deserved to get hurt. 

These are not struggling working families who got schnookered 

into something by an improper mortgage activity, Mr. Stern. I fully 

agree that that went on. There is no question that what you have 

described is accurate. But it was not accurate for the whole market, 

and this is my point. Depending on which city you go to, depending 

upon which price band you go to, depending on what kind of buyers 

you go to, you get an entirely different kind of dynamic and an entirely different motive for getting into this, and solving it with a 

single Federal program is extremely difficult. 

Now, Mr. Stern, you said the solution—I wrote down the 

phrase—is you ‘‘mark to market value.’’ Who determine what is 

market value? You have described loans that are good loans that 

fully meet all the needs of the lender, but the market value is not 

there because the appraisal is not there. Is the appraisal—market 

value, the economists tell you, is when a willing buyer and a willing seller sit down and come to a price. And at many parts of the 

there, again, at the lower end, a willing buyer and a willing seller 

could very easily come to a price because there is a shortage. And 

to arbitrarily have some Government agency or someone backed by 

a Government agency try to determine market value is going to be 

very, very difficult. And if all public policy flows from that kind of 

determination, we run the risk of doing what Secretary Summers 

warned us against of delaying an inevitable shake-out here. 

One final comment—well, no, two. This chart is harder for you 

to see at that distance. There is a bottom line that looks flat on 

both charts. It is in dark blue. It is not flat. It is loans in foreclosure, all mortgages. And in 2001, it was at 1 percent, and by 

2008, it is at 2 percent. So it is not flat. It has doubled in that time 

period. 

Now, the swooping red line is subprime adjustable rates in foreclosure. And in 2001, it was at 8 percent. It fell to 3.5 percent in 

2006, and then skyrocketed to 14 percent, and it is still going up. 

The somewhat more complicated chart above it has a third line 

on it in dark maroon. It is between the two. Very interestingly, it 

in 2008 is below where it was in 2001. It is foreclosures of 

subprime fixed-rate mortgages. Subprime fixed-rate mortgages hit 


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their peak in foreclosures in 2002 and have been coming down ever 

since. 

Further underscoring the point that hits me out of all of this testimony is that this is not a monolithic market. And most of the conversation, both by you and by the reporters who have chased me 

as I have walked up and down the halls, is, ‘‘What are you going 

to do about ‘the’ housing crisis?’’ As if it were a single, monolithic 

problem. 

We have differences in—repeat, differences in location, we have 

differences in price band, we have differences in style of mortgages. 

We have all kinds of differences that we are trying to solve by a 

single Federal law. 

My final point, you talk about the resets. I have a mortgage that 

just got reset. It went from 6.25 percent to 5.25 percent. I just got 

the notice yesterday. I ripped it open as I came home from the day 

in the Senate, and I said, ‘‘This is great. I love reset in this market.’’ It just cut one full percentage point, 100 basis points off of 

the amount that I am paying here. We cannot automatically assume that reset means disaster. 

Now, I have gone on too long. That is my opening statement, and 

I am going to have to leave in 2 minutes. But, Secretary Summers, 

you wanted to respond. 

Mr. SUMMERS. Senator, I take your point about heterogeneity, 

but I think is exactly right, but I would qualify—I would at least 

make three points. 

First, I think if you look at the study carefully, the difference between the OFHEO index and the Case-Shiller index, you will discover that different places is part of the story, but another very 

large part of the story is that the OFHEO index covers homes that 

are supported by conforming mortgages, not the homes that are 

supported by the nonconforming mortgages of various kinds, including subprime, where much of the problem lies. 

Second, there is, as you say, heterogeneity, and at least as I understand it, that is why voluntarism is at the center of Senator 

Dodd’s proposal and proposals like it. Homeowners like you and 

mortgage owners of your mortgage will have no motivation whatsoever because of the circumstances—the part of the country you live 

in, the nature of your creditworthiness, and so forth—to bring their 

mortgage forward. The available evidence suggests that foreclosures are vastly disproportionately concentrated in categories of 

homes that have fallen way off in price. 

And so if you make available a universal foreclosure program, 

the people who will take it up will be those who are facing the 

problems of falling house prices and securitization. 

It is an unfair observation, but it is not a completely unfair observation, to suggest that if a proposal were made to help the victims of heart disease that an argument that that was an unwise 

proposal because there was enormous heterogeneity in health and 

many people did not have heart disease and had other diseases 

would probably not be a very strong argument. And while this situation is not—the analogy is not really right, and so what I just said 

is a bit of—— 

Senator BENNETT. I will agree with you that the analogy is 

not—— 


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Mr. SUMMERS. As a bit of a cheap shot, it does capture something 

which I think is important to recognize, which is the place where 

these national programs will have their impact will be in the segments that are caught by the kinds of distress that we have been 

discussing. 

Senator BENNETT. I vastly apologize, but Harry Reid keeps the 

time rule vigorously, and if I do not leave, I will not get there in 

time for the vote. Respond if you want to in writing, anything you 

want to send to my office. And, again, it has been a very valuable 

panel, and I have learned a great deal from it. 

The Committee is adjourned. 

Let me correct that. The Committee is in recess. 

[Recess.] 

Chairman DODD. The Committee will come back to order. My 

apologies. You are very patient. We will have to get you a very 

good mortgage someplace. 

[Laughter.] 

You cannot plan these things. You set up a hearing, and then everything happens at once. Last evening, we spent all day trying to 

resolve some 16, 18 different amendments as a managers’ amendment as part of the housing proposal we just voted on. And I had 

also agreed and accepted a wonderful invitation several weeks ago 

to speak to the midshipmen at the Naval Academy last evening. 

And I wonder who was working against me that all of a sudden the 

final vote on the housing package was going to occur on the very 

night that I was going to address the corps of midshipmen in Annapolis, and then this morning holding this hearing and having the 

votes occur at the same time. 

So to the three of you here, I appreciate immensely your willingness to stay around a little bit and respond more to some Members’ 

questions and some thoughts, and your testimony has been excellent this morning. So I thank you for that as well. 

Given the short time we have, let me turn to Senator Carper. I 

have had a chance already to raise some questions, and he has not, 

and then what we will probably do is leave the record open and 

allow Members to submit additional questions as well for you. 

Senator Carper. 

Senator CARPER. Thank you, Mr. Chairman. Let me just congratulate you and Senator Shelby on the work that culminated 

with the vote on the floor. Do you recall what the final vote was? 

Chairman DODD. 84 to 12. 

Senator CARPER. 84 to 12. It is pretty hard around here to get— 

I could introduce a resolution that says today is Thursday, and I 

would be lucky to get 84 votes for it. So that is pretty impressive. 

[Laughter.] 

I would echo the Chairman’s thoughts. Thank you so much for 

your patience, for waiting for us, and for your testimony and responses. 

One of the things that Secretary Summers mentioned before we 

started our series of votes, he talked a little bit about the safe harbor legislation, and he sort of complimented me on my safe harbor 

legislation, which actually is going to be introduced by Delaware’s 

Congressman, Mike Castle, also a Banking Committee member 

and, like me, a former Governor. People confuse us all the time, inVerDate Nov 24 2008 02:01 Mar 20, 2010 Jkt 050396 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 E:\HR\OC\A396.XXX A396

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cluding in Delaware. But it is an issue that I have some real interest in, and I think the notion is if we are going to have this voluntary program where we get borrowers, lenders, servicers, mortgage servicers to agree to take a haircut, a financial haircut, then 

there may have to be some protection against lawsuits against the 

servicer. 

And what I think Secretary Summers was saying is he agrees 

with that notion, and I just want to ask each of you to comment 

on the value of that proposal by my colleague from Delaware, Congressman Castle, the safe harbor proposal. 

Mr. STERN. I am happy to start. On my way over here today, 

when we were pondering whether Government action was necessary, and we were thinking about medical malpractice, we said, 

well, when something happens to you in the hospital, you sue your 

doctor. You do not ask the Government for help. And why is this 

situation different? And I said, you know what? If I had been the 

victim of a bad loan, I would go sue my lender. And it is very relevant, I think, because I think if I am a servicer, a large servicer, 

and several of these companies have hundreds of billions, if not 

trillions, of dollars of loans, I think they have to be concerned 

about consumer lawsuits—not investor lawsuits, but from the very 

borrowers to whom they made the loans. 

I do think it is an outstanding trade-off or compromise to say 

that in exchange for writing down the loan we will provide a safe 

harbor from a private right of action, because I do think if you are 

a servicer right now, you have to be concerned about lawsuits on 

behalf of borrowers who ended up with loans with the very features 

that are causing the financial pressure. I think it is an excellent 

outcome. 

Senator CARPER. All right. Thank you. 

Others, please. 

Ms. HARNICK. Well, the safe harbor that I think is a really terrific idea and that I think Dr. Summers was supporting is the idea 

of protecting servicers from lawsuits by investors, because I believe 

that that fear is, in fact, one of the significant barriers both to voluntary loan modifications and I would imagine it would be a barrier to accepting a short refinancing under the FHA proposal. So 

I think that that would be really essential. And it is essential in 

part because it would address—there is nothing unfair about it, I 

think, from the point of view of investors, because what it is attempting to do is address the very significant problem that 

servicers are in a position where they often cannot make the economically rational choice. If the economically rational choice is accept a short refinance or modify the loan and thereby recover more 

for the mortgage holder than the inevitable consequence of foreclosure, that is a very good choice. And if servicers—to the extent 

that servicers are—and I have heard repeatedly that they are— 

hampered by the fear that some investors will say, well, the way 

you modified the loan or the way you structured the new refinancing disadvantaged me, even though it was better for the collective. So I do think it is an excellent idea. 

I have to say I would not be supportive of the idea of providing 

a safe harbor from consumer lawsuits, and I do not know if that 

is something that needs to be discussed further. I could expand on 


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it if necessary, but for investor lawsuits, I think it is an excellent 

idea. 

Senator CARPER. Mr. Stern, in your comments were you referring 

to investor lawsuits? 

Mr. STERN. I am suggesting that if a consumer receives a short 

payoff from a servicer, one of the things they should offer in exchange is, yes, to not sue the servicer who provided them the short 

payoff. 

Senator CARPER. OK. Fair enough. Thank you. 

Dr. Baker. 

Mr. BAKER. I do not have too much to add on that. I would agree 

very strongly that I think it is a step in the right direction because, 

you know, you sort of have this asymmetry that, you know, again, 

it may very well be in the investor’s best interest, but from the 

standpoint of the servicer, they want to take the cautious path. I 

do not think any servicer has ever been sued for not doing a short 

sale or a writedown. So, you know, the cautious thing for them is 

just sit there, go ahead with the foreclosure. That is a well-trodden 

path, and that is very safe. 

So I think, you know, giving them symmetry that they do not 

have to fear either way so that they can make what is the best decision, I think that is the good way to go. And, again, I would agree 

with Ellen that I do not—I would not want to give any sort of carte 

blanche. I am not familiar with the legislation, the details of the 

legislation. I would not want to give some carte blanche immunity 

in consumer lawsuits because there were improper actions in cases, 

and, you know, you might want to hold those servicers responsible. 

So I would be hesitant on that. 

Senator CARPER. All right. Thank you. 

The Hope for Homeowners proposal allows a mortgage to be refinanced and insured by FHA, as you know. In return for accepting 

the risk, FHA receives, I think, 50 percent of all future profits. I 

think that is the way it reads. The FHA should, in my opinion, 

share some of the future profit to help pay for the program, and 

the House bill allows FHA to share—I think a lot during the first 

few years, maybe 100 percent in the first year, down to 0 in the 

fifth year of a refinance. But, in any event, it is less over time. 

How much should FHA receive for accepting this risk? 

Mr. STERN. I would be happy to address that, and it might surprise you to know that there are State-run mortgage programs that 

currently allow for the State program to participate in the appreciation of a home. I would be surprised if you did know that. 

In the State of Missouri, there is an organization known as the 

Missouri Housing Development Commission, and specifically they 

supply first-time homebuyer funds for borrowers with a median— 

who have an income below the median level in the area where they 

buy. In exchange for receiving those funds—they are subsidized interest rate and down payment funds. In exchange for receiving 

those funds, the buyer agrees to a concept called a ‘‘recapture tax,’’ 

and that recapture tax agreement says: If you sell your house in 

the future and you make money on the home investment, and your 

income has increased above the median level, you must pay a percentage of those profits back to the Missouri Housing Development 

Commission. And what happens in that case is that money is used 


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to then replenish the system so that future buyers have the benefit 

of the first-time homebuyer system. 

I just thought it would be helpful to you to know that it is not 

unprecedented. It works extremely well in Missouri, so the concept 

is called the ‘‘recapture tax,’’ and they do have the benefit of the 

appreciation of the property in exchange for providing a subsidy. 

Senator CARPER. All right. Thank you. 

Ms. Harnick. 

Ms. HARNICK. Thank you, Senator. I think it is a good idea for 

the homeowner to share some of the appreciation with the program, both for the soundness of the program and because as a fairness issue. 

I think that my recommendation, our recommendation would be 

that we track more closely to what the House bill does. What the 

House bill does is it allows shared appreciation over 5 years, and, 

by the way, it tracks both shared appreciation and also making 

sure that the borrower can’t immediately get the benefit of the 10- 

percent haircut. And the proposal here does the same. I think that 

is an excellent idea. 

At the end of the 5 years under the House bill, the recapture tax, 

as it were, is capped at 3 percent, and I think that that is a more 

appropriate mechanism than having an indefinite 50/50 sharing of 

appreciation. I was saying earlier, quite apart from whether it is 

wise social policy to deprive the homeowner of 50 percent of the 

wealth-building value of a home indefinitely—I think that that is 

a real question. And I also think it is hard to administer. If the 

homeowner invests in a new kitchen, redoes the kitchen, and 15 

years later the home is appraised at a value that exceeds both the 

refinance price and the value of the kitchen, how much of that appreciation is attributable to the work that they did and how much 

is attributable to the refinancing? 

So for that reason, I would say I think it would be better to cut 

it off and cap it. 

Senator CARPER. Well, we all know that when people want to 

raise the value of their home for sale, they improve those kitchens. 

And what do they do next? The bathrooms. At least that is what 

I am told. 

Dean Baker. 

Mr. BAKER. Yes, I would very much agree with that. I think the 

basic point here is that we do not want someone to be able to cash 

in, you know, at the FHA’s expense with the initial 10 percent. So 

something like 100 percent to start and then phasing down close 

to 0 over 5 years, I think that is a reasonable framework we are 

talking about. And once you get further out, again, the value of 

that home is going to reflect, to a large extent, how much people 

have maintained it, what they have put into it, so it does make 

sense that that be, you know, a much lower tax, or however you 

want to put it, at some future point. 

So something like what you have in the House bill I think makes 

a lot of sense. 

Senator CARPER. All right. Great. 

Mr. Chairman, thanks for the chance to ask these questions, and 

again to each of you for—I missed your testimony. I am told it was 

just a terrific panel. I am glad I got to ask you some questions. 


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Chairman DODD. It was very, very good. 

We have a safe harbor provision in our bill, as does the suggestion of the House. The difference is the safe harbor that—in fact, 

the counseling provision is to protect the servicer from investor 

lawsuits. It is not to protect the servicer from consumer lawsuits. 

And there is more of a concern, I think, from that side of the equation. 

In fact, I was curious. I know there are not many examples of 

this, but I was curious as to whether or not if you did not do something—if I am an investor and I discovered that a servicer refused 

to have a workout and the option was losing everything, I would 

be curious if there wasn’t more of an action, a possibility of action 

there, why didn’t you take that 50 cents on the dollar? I would be 

at least 50 percent better off than I am now if I end up losing everything. Again, I do not know if there is any precedent for any of 

this at all or not, but it would seem to me that might be a more 

likely outcome in some ways than the likelihood you are going to 

be sued because I am getting less than 50 cents—or 50 cents less 

than I would have otherwise gotten under the circumstances. 

Mr. STERN. Yes, I would say—Dr. Baker said he has never heard 

of a servicer being sued for not doing a short sale, except I would 

say this is a very unusual time. If you have a chance to do a short 

sale for 50 cents on the dollar and you do not, and you do lose everything, I agree, this is a very unusual time. You could be sued 

for not doing the workout, where they might not have in the past. 

Chairman DODD. Exactly, so it is interesting. Thank you, Senator 

Carper, very much. 

Just going back over—and I am going to—not to keep you, just 

an additional point here. As I mentioned, Larry Summers and 

Doug Elmendorf had to attend a conference they are hosting today, 

and as I said at the outset, the proposal that I have suggested— 

back in January, in fact—raised this idea and then met—it is not 

a new idea, either. These are ideas that have been tried, as you 

point out. There are States that have tried variations of this. I was 

in Pennsylvania with Bob Casey, Senator Casey, the other day for 

a hearing, and I think it is the HEMAP program in the State of 

Pennsylvania, something very similar to what we are talking about 

here. In fact, they go further. They have another program, a HERO 

program, which really does take these underwater—completely underwater programs to try and salvage something out of them as 

well. So, again, people have identified the program in the Depression era, which was a more direct participation, a direct, I guess, 

acquisition and purchasing of these discounted mortgages. 

I am told historically that the Federal Government actually made 

some $14 million. I do not know what that was in today’s dollars, 

what it would be at the end of the day. 

But I want to emphasize the point, I think there are some very, 

very good points. I think, Dean Baker, you raised, along with 

Larry, some cautionary notes, so as you start down this path, understand and think about them. That is why it is very important 

to me. This ought not to be an ideological debate. This ought to be 

a discussion about if we are going to do something, do it well, and 

make sure you are not going to do more harm. I guess to use your 

medical analogy, we ought to apply the Hippocratic oath here as 


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well. The first rule is do no harm. In a sense, while we are talking 

about mortgage malpractice, I want to make sure that we do no 

harm, that as we try to fashion ideas that can limit the number 

of foreclosures that are being filed every day in the country, as I 

mentioned, close to 8,000 a day; 240,000 people went into foreclosure in the month of February. And there is always a normal 

amount of this. I think one of the things that—maybe some people 

would assume we never had any foreclosures, and there are always 

a certain level of them occurring. But this time it is compounded 

in a way because of the liquidity issues that have arisen, and I 

want to underscore Larry Summers’ suggestion. I do not know if 

any of you have any views on this or not, but the notion of the 

GSEs seeking more capital, and while there is a legitimate shareholder interest in all of this, they are called Government-sponsored 

enterprises for a reason, and there is something called a ‘‘Mission 

Statement,’’ and the Mission Statement should reflect circumstances not unlike the ones we are in, as unprecedented as they are 

in many ways, but they exist, in effect, for dealing with moments 

like this. 

And so I support his underlying idea of having them go out and 

raise more capital at this point, and the shareholders certainly 

have to be considered. But they, it would seem to me, have to take 

a secondary position considering what is the rationale for the existence of Fannie and Freddie anyway. 

I do not know if you have—does anybody have any views on 

that? Do you have any view on that, Dean, what Larry talked 

about earlier? 

Mr. BAKER. Yes. I did not quite agree with him on that because 

then we are asking Fannie and Freddie to take on, you know, more 

risk. And if you do not increase the capitalization, then that is putting—it is coming out of the taxpayer’s expense. So the question is: 

How do you balance that, the shareholders versus the taxpayer? As 

they are taking on more risk, that is all going on the taxpayer side. 

It seems reasonable to say, OK, there also ought to be more on the 

shareholder side; therefore, there has to be more capital there. 

So I think that is going in the right direction. How much, you 

know, what is the magic number there, I do not know. But I think 

certainly increasing their capitalization is the right thing to do 

now. 

Chairman DODD. Ellen or Scott, any views on this? 

Mr. STERN. Well, I will share with you that right now there are 

only four reliable sources of capital in the mortgage market today: 

Fannie Mae, Freddie Mac, FHA, and VA. There is no reliable private source of capital from anyplace else, from Wall Street to insurance companies, even to banks lending their own money. And the 

reason for the reliability is the implied guarantee of the GSEs. 

So I would suggest that especially now, the liquidity of the GSEs 

is important. It probably has been never more important. And as 

long as they remain the most reliable source of funding for an average borrower who needs a home for a purchase or refinance, I 

would encourage liquidity of the GSEs. 

Chairman DODD. Ellen. 


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Ms. HARNICK. I do not have anything to add on that point, Mr. 

Chairman, but I did want to come back to a point that was made 

just before the break. May I do that? 

Chairman DODD. Sure. 

Ms. HARNICK. Because it goes to the—— 

Chairman DODD. What was the point? 

Ms. HARNICK. The point is the issue of how difficult—the suggestion is that we have to be careful to make sure that appraisals are 

properly done in figuring out the current value. And I think what 

Larry Summers had said is we need to ensure that appraisers don’t 

have the wrong incentives, that appraisers are not linked to the 

lender in any way or to the servicers, that the lenders do not have 

an incentive to overstate home values. 

But I think what got lost when the conversation got broken off 

is the fact that appraisers do this sort of thing all the time. There 

is nothing unusual about the effort to appraise a property, even in 

markets where sales have been slow, even in illiquid markets. I 

mean, this is something that could be done—Dean Baker suggested 

various mechanisms that could be put in place to ensure that we 

are getting good appraisals. 

So I think that any concern that was raised about that is certainly worth taking into account in shaping the kind of appraisals 

we do. But I think that is as far as the concern needs to go. 

Chairman DODD. OK. Well, again, I wanted to come back and 

just suggest—these ideas and thoughts are very, very valuable to 

us as we try to fashion some good ideas, and I think Doug Elmendorf made a good point. He said, and I am quoting him, ‘‘ . . . we 

must choose between messy policy options and inaction—and the 

cost of inaction is very high.’’ And I agree with him on that. And 

he particularly said, ‘‘. . . a measured expansion in the role of the 

Federal Housing Administration as proposed by [myself] and 

Chairman Frank would contribute importantly to reducing the size 

of the coming foreclosure wave.’’ I do not know if that was raised 

in my absence, this second tranche that we are approaching. 

Larry Summers said careful consideration should be given to the 

type of measures that we are proposing, and I agree with him on 

that. He noted last week that the administration has put together 

programs and policies but have not really come to very much. We 

need a much more activist set of responses to maximize the chance 

that the current crisis is contained. I think he was speaking as well 

about the capitalization issue of Fannie and Freddie, as well as 

possibly the idea we are talking about here. 

I want the Committee to know that I am committed to considering recommendations by our colleagues here, the witnesses. I invite your even further consideration as you look at these proposals, 

unless you just have an underlying total disagreement with the 

thrust altogether. But if you see that at least the thrust may be 

going in the right direction but it needs to be handled in a more 

balanced approach, I would be very interested in hearing your suggestions and thoughts on all of this. As I said, there is no silver 

bullets, but this proposal would provide both lenders and borrowers 

an additional tool to avoid unnecessary foreclosures—in a sense, 

unnecessary foreclosures. 


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You have two constituencies, one that I am sympathetic about. 

I do not want to see anybody lose money. But I feel absolutely no 

obligation whatsoever with the speculator community. I am sorry 

they lost money, but that is the nature of investment here. Those 

things happen. 

The second group of people I feel very sympathetic about, and 

they never should have gotten a mortgage in the first place, and 

there probably is not a structure that we can come up with that 

they are going to be able to meet. Now, we ought to think about 

ways to help people in that category. But I do not see how these 

proposals are necessarily going to work for those people in that situation. I regret deeply the problems they have, but realistically it 

is going to be impossible in some cases to provide help at all. 

And then there is that third group that plays such a critical role 

in all of this, and to the extent we are able to do something about 

that is where my interest is and my focus is, and so I am holding 

this hearing today, and we will have one again next week, and I 

will be in consultations with those of you here. And I really do— 

this is not a gratuitous comment. You are talented, you are knowledgeable, you understand these things very, very well. And it will 

be very, very helpful to share your ideas and thoughts with the 

Committee on how we can do a better job at this. 

I am going to ask as well that we include an editorial from this 

morning—I believe it was this morning—in USA Today, which 

raises legitimate concerns about some of the things in the bill we 

just passed. And I will be the first to admit that there are some 

things in that bill that, had I been writing it alone, would not have 

been in there. There are lot of things that would have been in that 

bill had I had a chance to write it alone. And there are many 

things in there that I think are very good and can be very, very 

helpful. And I am grateful to Senator Shelby and his staff and others for allowing us to work through here, now allowing us to be in 

a position to work with the House of Representatives to fashion a 

more comprehensive set of thoughts on all of this in the coming 

weeks. And we will have markups in this hearing on GSE, on related matters, on the reform ideas that need to be considered as 

well. And I am going to be working with Senator Shelby and his 

staff and other Members of the Committee as we prepare for those 

to see if we cannot reach some strong bipartisan approval of some 

of these ideas. 

But I am very grateful, again, for your testimony today. We will 

leave the record open because I know some other people have some 

questions. But I am very impressed with your testimony and very 

grateful for your presence. 

The Committee will stand adjourned. 

[Whereupon, at 12:49 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM LAWRENCE H. SUMMERS 

WHAT WOULD GOVERNMENT INTERVENTION BUY US?

Mr. Summers, you note that the policy challenge is to mitigate 

market overreactions while not interfering with necessary or inevitable adjustments. At the same time, we hear that government 

intervention in the housing market is needed to essentially set a 

‘‘floor’’ to housing values. 

Q.1. Can government intervention alone set a floor on housing values? Won’t the marketplace still ultimately determine values? 

A.1. Government intervention may not singlehandedly solve the 

turmoil in the housing markets, but the risks of inaction undoubtedly far outweigh the risks of action. Simply because government 

intervention will not be a sufficient solution on its own does not 

mean that it is not one important—and perhaps even necessary— 

part of the solution. 

Q.2. If the government does intervene, are we effectively putting 

all the risk of further price declines on the taxpayer rather than 

leaving it in private hands who benefitted from what we now believe may have been a housing bubble? 

A.2. As I understand the proposals, there is substantial protection 

built in for taxpayers through fees and loan limits, and it would be 

appropriate to design procedures so as to minimize the risk of 

misappraisals. Regardless, in the event that the current economic 

problems prove profound, the costs of current intervention are likely to be the least of the federal budget’s problems. 

Q.3. What is the long-term cost of government intervention into the 

mortgage market to provide stability? Are we encouraging borrowers and lenders to pay even less attention to risk in the future? 

A.3. Any time that the federal government intervenes to protect 

borrowers and lenders, moral hazard is certainly a concern. But in 

a situation where credit problems threaten economic stability at a 

fundamental level, the risk that inaction will cause significant financial distress for American families outweighs moral hazard considerations. The same people who cite moral hazard as a reason 

that government should not act to minimize the threats now facing 

the mortgage market would almost certainly not claim that the 

prospect that people might smoke in bed would be a plausible argument in favor of getting rid of fire departments. 

IMPORTANCE OF DOWN PAYMENTS

A 20 percent down payment to purchase a home became increasingly rare in recent years as home prices accelerated. We now see 

that many of the borrowers who are in trouble made minimal, if 

any, down payment. It is not surprising that we would find a number of homeowners with negative equity, even with modest price 

declines in home values. 

Q.4. As the Congress looks for ways to avoid repeating past mistakes, what should this tell us about down payment requirements, 

particularly with respect to any government-guaranteed mortgage 

programs? 


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A.4. One would hope that any long-term response to a crisis caused 

by excessive hubris and undervaluing risk would place substantial 

value on financial responsibility. Realistic and responsible downpayment requirements would constitute one of many possible measures for restoring stability and credibility to the housing market. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM DEAN BAKER 

IMPORTANCE OF DOWN PAYMENTS

A 20 percent down payment to purchase a home became increasingly rare in recent years as home prices accelerated. We now see 

that many of the borrowers who are in trouble made minimal, if 

any, down payment. It is not surprising that we would find a number of homeowners with negative equity, even with modest price 

declines in home values. 

Q.1. As the Congress looks for ways to avoid repeating past mistakes, what should this tell us about down-payment requirements, 

particularly with respect to any government-guaranteed mortgage 

programs? 

A.1. I would be hesitant to draw conclusions that might be too 

strong about down-payment requirements. Other things equal, it is 

desirable to require that buyers have a reasonable down payment 

so that they have an equity stake in their house from the outset. 

However, I think it is reasonable to lower these requirements to 

more modest levels (3–5 percent) in cases where individuals have 

solid work histories and generally good credit records. It is often 

difficult for moderate-income families to save much money, and 

even a 3 percent down payment can be a burden. 

More than the down payment, I would emphasize the need to ensure that families are not getting into homes that they will not be 

able to afford. If a family has maintained a solid work history and 

generally good credit, then they are likely to act to ensure that 

their mortgage is paid in good faith, barring serious illness or family break-up. 

The housing bubble and the resulting collapse in prices are unusual circumstances which hopefully will not be repeated. When 

house prices fall by 25–30 percent, as we have seen in some areas, 

no reasonable down-payment requirement can prevent homeowners 

from going underwater. I think it would be a mistake to set downpayment requirements based on such an extraordinary event. Rather Congress should try to ensure that comparable housing bubbles 

do not arise in the future. 

DISCREPANCY BETWEEN HOME PRICES AND RENTAL PRICES

Mr. Baker, your testimony notes the large discrepancies between 

home prices and rental prices in much of the country. It would appear that the housing market needs to adjust so that these two 

prices are more aligned, especially if we would like to be able to 

help low and moderate income working families purchase homes in 

the future. 

Q.2. Please explain to the Committee how a program such as Hope 

for Homeowners would stand in the way of such a necessary adVerDate Nov 24 2008 02:01 Mar 20, 2010 Jkt 050396 PO 00000 Frm 00077 Fmt 6633 Sfmt 6602 E:\HR\OC\A396.XXX A396

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justment in home prices and also, what exposure the Federal Government would face if we intervene in this adjustment? 

A.2. The Hope for Homeowners program could interfere with the 

price adjustment process in over-valued markets if it guaranteed 

mortgages at prices that are still above trend levels in these markets. In effect, the program would be providing an artificial source 

of demand that would be propping up prices above their market 

levels. At least for a period of time, this could sustain prices at artificially high levels. 

This would place the Federal Government at risk because it 

would effectively guarantee a price on a mortgage that is above the 

trend market price for the house. If house prices eventually adjust 

to a lower level, homeowners are again likely to find themselves 

owing more than the value of their homes. This means they will 

have a temptation to default on their mortgage. Even if they continue making payments on the mortgage in spite of being underwater, many homeowners could end up selling their homes for less 

than the value of the mortgage. (The median period of homeownership for moderate-income families is just four years.) In both the 

cases of an outright default or a ‘‘short sale,’’ the Federal Government would be obligated to compensate the lender for the difference between the guarantee price and the money the lender actually collects. 

Of course, any time the government sets up a loan guarantee 

program of any type it puts itself at risk in this manner. However, 

I think it is important to distinguish between the type of risks that 

exist in a typical market, and the type that exist in an over-valued 

real estate market. As I said in my testimony, I think that the government can limit this risk if Congress bases the guarantee price 

on a multiple of rent (I suggested 15 to 1). However, if the government were to guarantee prices based on appraisals in a market 

that is still substantially over-valued, it is almost certain to incur 

losses on a large share of its guarantees. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM DEAN BAKER 

Q.1. What do you suggest we do to find the $20 billion this bill 

costs to start up? What should we cut, or what should we raise 

taxes on? 

A.1. Since the economy is currently facing a recession, or at least 

a period of very slow growth, it might be desirable to run a larger 

deficit, at least temporarily. This would provide stimulus to the 

economy, as Congress sought to do with the stimulus package it 

passed in February. 

Obviously any tax increases or spending cuts that Congress puts 

in place would reflect its priorities. I would first and foremost look 

to removing tax breaks which distort the tax code without any obvious rationale. 

The two that come to mind most immediately are the special 

treatment of carried interest which allows hedge and equity fund 

managers to have their compensation taxed at the 15 percent capital gains rate, instead of the 35 percent rate they would otherwise 

pay. This encourages gaming of the system and allows some of the 


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wealthiest people in the country to pay a lower tax rate on their 

earnings than school teachers or firefighters. 

The other tax break that serves no obvious purpose is the mortgage interest tax deduction for expensive homes. While home ownership is often desirable, and it is reasonable to provide assistance 

to moderate- and middle-income homeowners, it is not clear what 

public interest is served by subsidizing the purchase of a multi-million dollar home by a family in the top 1 percent of the income distribution. Congress could substantially lower the caps on the 

amount of a mortgage for which the interest is deductible without 

affecting middle-class families at all. Moving the cap down from 

$900,000 to $500,000 would inflict little pain on anyone. 

Q.2. Do you have any suggestions for making sure someone did not 

lie or not tell the whole truth on their original mortgage application? 

A.2. In the future, it would be appropriate to require that lenders 

make a good faith effort to verify the information that borrowers 

put down on application forms. The Federal Reserve Board has proposed regulations that would require loans be properly documented. I believe that Representative Frank’s mortgage reform bill, 

or at least some version of it, also had such a requirement. There 

may be legitimate reasons why it is not always possible to get full 

documentation of the information used by borrowers to secure a 

mortgage, but such instances should be the exception. 

Clearly, issuers were anxious to issue mortgages in the housing 

boom because they made money on the issuance fees, whether or 

not there was reason to believe that the borrower actually could 

repay the loan. If issuers are made liable for the quality of loan, 

for example by requiring them to hold a 10 percent stake of loans 

sold in the secondary market, then they will have more incentive 

to ensure that the information borrowers provide is accurate. 

Q.3. If home prices continue to fall, lenders would be protected. But 

what protection do the taxpayers have if prices fall 10% more? 

A.3. If home prices continue to decline, and the government issues 

guarantees of mortgages at prices that are near current levels, 

then the government is likely to face a substantial cost associated 

with a high default rate. The most important factor determining 

both the default rate and the cost of each default is the movement 

in house prices. 

If prices continue to fall, then many homeowners will again find 

themselves owing more than the value of their home. This situation 

leads to defaults for two reasons. First, if a homeowner owes more 

than the value of her home, then she does not have the option to 

borrow against equity in order to make her mortgage payments. 

This eliminates an important source of security if job loss or unusual expenses leaves the homeowner temporarily unable to pay 

his or her bills. 

The other reason why this situation increases default rates is 

that homeowners who owe more than the value of their home can 

effectively save themselves money by simply surrendering their 

house to the bank. If a homeowner owes $200,000 on a home that 

is currently worth $180,000, the homeowner can effectively save 

$20,000 by just giving the house back to the bank. While this move 


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will hurt the homeowner’s credit rating, if they don’t have any special attachment to the house, a homeowner may choose this option. 

In addition to increasing the number of defaults and foreclosures, 

falling house prices will also increase the loss on each foreclosure. 

If the house is still valued at close to the amount of the mortgage, 

then the losses on the foreclosure will just be the administrative 

and transactions costs associated with carrying through the foreclosure and reselling the house. However, if the house sells for less 

than the value of the mortgage, then this can be a substantial 

source of additional losses for the government. 

As I argued in my testimony, the government can limit the risk 

that it will set the guarantee price on new mortgages too high by 

using an appraisal of rental price as the basis of the guarantee, 

rather than an appraisal of the sale prices. Since rents never rose 

out of line with fundamentals, an appraisal based on some multiple 

of annual rent (e.g. 15 times annual rent) should ensure that the 

government’s guarantee price is set at a level that is close to the 

price that the home will command after the bubble has deflated. 

Q.4. Should we be encouraging or subsidizing someone staying in 

a house if they would be financially better off if they were renting? 

A.4. Homeownership can be a useful way for families to accumulate 

wealth and to provide good, secure housing. However, if families 

are buying homes at bubble-inflated prices, then they are not likely 

to accumulate any wealth in their home, since the price is likely 

to fall back to its trend level before they sell their home. (The median period of homeownership for moderate-income families is just 

four years.) Furthermore, they are likely to pay far more in housing costs each year, than they would to rent a comparable unit. 

In the case of moderate-income families facing serious budget 

constraints, the additional housing costs associated with owning an 

over-priced home are likely to come at the expense of other necessary items, such as health care and child care. It is difficult to 

see how the government will have helped a family by encouraging 

them to remain in such a situation. The best way to avoid this 

problem would be to have the Hope for Homeowners guarantee 

price grounded in the rental price for the unit. 

Q.5. Should we require financial sacrifices for participation in this 

program, such as selling vacation homes or investment properties, 

selling second vehicles, getting a second job, not taking on other 

debts, or selling non-retirement account investments? 

A.5. I think it would be reasonable to take steps to try to ensure 

that any government aid program helps only low- and moderate-income families. One obvious way to do this would be to limit the size 

of the mortgages that can be financed, which I believe is already 

the case in all of the mortgage-guarantee programs being considered by Congress. It is possible to put additional asset restrictions 

on participants, but my guess is that in the vast majority of cases, 

such restrictions would not affect eligibility. 

For example, there are not many people with vacation homes or 

investment properties who would also be living in a relatively modestly priced home as their primary residence. Furthermore, the few 

people who are in this situation are likely to find ways to hide their 

assets, so that they would still be eligible for the program. 


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The other suggested restrictions also pose problems. For example, a two-worker family may need two cars. Similarly, investment 

accounts can be hidden in the names of relatives. My view is that 

the cost associated with trying to enforce these sorts of restrictions, 

and the additional burden imposed on families who are genuinely 

in need of help and acting in good faith, outweigh the benefits of 

excluding the relatively small number of scam artists that may try 

to take advantage of this sort of program. We will never be able 

to exclude scam artists altogether from such programs and we undermine the purpose of the program if we place too many restrictions on homeowners. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM ELLEN HARNICK 

A 20 percent down payment to purchase a home became increasingly rare in recent years as home prices accelerated. We now see 

that many of the borrowers who are in trouble made minimal, if 

any, down payment. It is not surprising that we would find a number of homeowners with negative equity, even with modest price 

declines in home values. 

Q.1. As the Congress looks for ways to avoid repeating past mistakes, what should this tell us about down-payment requirements, 

particularly with respect to any government-guaranteed mortgage 

programs? 

A.1. Negative equity is a driver of foreclosure, as it deprives borrowers of the ability to sell the home (a particular problem for 

those who need to relocate for jobs or other reasons) or address 

short-term cash crises by tapping into home equity. High loan-tovalue ratios or low down payments, if accompanied by other risk 

factors, can contribute to negative equity or elevate foreclosure 

risk. However, high loan-to-value ratios are not the primary driver 

of foreclosure, and do not create excessive foreclosure risk if the 

loan is properly structured. The most significant driver of foreclosure is the failure to ensure the affordability of the loan beyond 

an introductory period. Appraisal fraud, equity-stripping from successive refinancings, and declining home values are also important 

drivers of negative equity. For these reasons, ensuring affordability, utilizing reasonable debt-to-income ratios and residual income measurements, based on the borrower’s reasonably documented income, are considerably more important than the loan-tovalue ratio. 

The use of high loan-to-value loans expanded homeownership opportunities for individuals who lack sufficient income to sustain 

them. 

With respect to the government backed refinance loan program 

provided by the Hope for Homeowners Act, it is entirely appropriate to allow refinancing for up to 87 percent of the property’s 

current value, and to require the lender to accept this payment in 

full satisfaction of the debt. This both avoids a tax-payer bailout 

and supports the sustainability of the program. For purchase 

money loans, in contrast, it is important to continue to enable government loan programs to serve underserved communities by makVerDate Nov 24 2008 02:01 Mar 20, 2010 Jkt 050396 PO 00000 Frm 00081 Fmt 6633 Sfmt 6602 E:\HR\OC\A396.XXX A396

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ing loans with low down payments, structured as described above 

to ensure sustainability. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM ELLEN HARNICK 

Q.1. What do you suggest we do to find the $20 billion this bill 

costs to start up? What should we cut, or what should we raise 

taxes on? 

A.1. The best way to cover the costs of the HOPE for Homeowners 

FHA program is to make the program self-sustaining, or as close 

as possible. As proposed, the HOPE for Homeowners Act is designed to accomplish this. In this regard, the essential aspects of 

the Act are those that require: (a) a loan-to-value ratio of no more 

than 90%, (b) the creation of an FHA insurance pool to cover losses, 

funded with 3% of the balance of each covered loan, (c) the payment by borrowers of an additional premium of up to 1% per year, 

and (d) the sharing of equity with the FHA. Even if the default 

rate on loans made under the HOPE for Homeowners program 

were twice the FHA’s normal default rate (which would roughly 

correspond to the 20% default rate for loans made by the Depression-era Home Owners’ Loan Corporation (‘‘HOLC’’)), the program 

would have sufficient reserves to cover the losses. (The HOLC covered its losses and even turned a small profit.) 

CBO estimates that the total cost of the program, as revised by 

the Committee, over a ten year period is $729 million in order to 

prevent 400,000 foreclosures. (See http://www.cbo.gov/ftpdocs/ 

94xx/doc9480/RevHR3221Table.pdf.) That is a cost of $1,823 per 

foreclosure prevented. Given the spillover costs to neighbors and 

risks to the economy, not to mention the costs to the family who 

otherwise would face foreclosure, this is a modest expenditure that 

could be offset in a number of different ways, including an assessment on GSE business activities. 

Q.2. Do you have any suggestions for making sure someone did not 

lie or not tell the whole truth on their original mortgage application? 

A.2. It would be difficult, and administratively costly, to conduct a 

fact-finding into the truthfulness, as of loan origination, of data on 

the loan application, and would be harder still to discern whether 

the party responsible for any misstatement was the mortgage 

broker, loan originator, or homeowner. Given the purpose of the 

legislation in part to protect neighbors, municipalities and the 

economy from preventable foreclosures, and the necessity of acting 

promptly so that relief is available in time to accomplish its intended purpose, the benefits of such an exercise seem unlikely to 

outweigh the costs. However, going forward, the FHA needs to ensure that there is reasonable documentation of income and assets 

for any homeowner who refinances under the program. 

Q.3. If home prices continue to fall, lenders would be protected. But 

what protection do the taxpayers have if prices fall 10% more? 

A.3. A further 10% house-price decline beyond the 10% equity 

cushion created by the FHA bill could impact both the risk of foreclosure and loss severities in those markets experiencing such deVerDate Nov 24 2008 02:01 Mar 20, 2010 Jkt 050396 PO 00000 Frm 00082 Fmt 6633 Sfmt 6602 E:\HR\OC\A396.XXX A396

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cline. The factors identified in answer to Question 1 above will play 

an important role in minimizing the impact of these risks on the 

self-sustainability of the program, and we believe are sufficient to 

cover losses that would arise in this scenario. Acting expeditiously 

to avoid further unnecessary foreclosures will help avoid an overdecline in house-prices, and this would benefit the economy as a 

whole, and bolster the sustainability of the program. 

Q.4. Should we be encouraging or subsidizing someone staying in 

a house if they would be financially better off if they were renting? 

A.4. Losing a home to foreclosure has severe consequences for a 

homeowner’s credit rating and financial stability, dramatically limiting the homeowner’s post-foreclosure options, whether the homeowner seeks to buy another home, or rent. For many homeowners 

facing foreclosure the economically rational choice may be to avoid 

foreclosure by refinancing, and remain in the home long enough to 

rebuild their credit and get the benefit of any equity build-up over 

the next several years, than to surrender the home in foreclosure. 

This is so even if, in the same market, people who have not yet 

purchased their first home might deem it economically preferable 

to rent for a year or more, rather than purchase their first home 

now. Making sure that qualified, independent, not-for-profit housing counselors and lawyers are available to homeowners facing 

these hard choices, will assist troubled homeowners in making the 

best decisions given their circumstances. 

Q.5. Should we require financial sacrifices for participation in this 

program, such as selling vacation homes or investment properties, 

selling second vehicles, getting a second job, not taking on other 

debts, or selling non-retirement account investments? 

A.5. As a practical matter, lenders generally will agree to refinance 

on the terms required by HOPE for Homeowners only where this 

is preferable to other legal means of obtaining repayment, and likely will pursue such other means where there are assets available 

to fund the recovery. 

Moreover, some of the specific suggestions could prove more costly than beneficial. For example, determining how many vehicles 

are required to transport a family’s wage-earners to work would 

add administrative burden and cost, and, given the depreciating 

value of used vehicles, the sale of the vehicle might generate less 

cash than the vehicle’s actual value to the family, without materially improving the family’s ability to repay the loan. Nor is it advisable to require families to further deplete their savings to repay a 

loan for which many families over-paid in the first place. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM DOUGLAS W. ELMENDORF 

FURTHER HOUSING PRICE DECLINES

Q.1. Mr. Elmendorf, your testimony notes that ‘‘housing is 

overbuilt and overpriced.’’ You further note that house-price futures 

and analysts’ estimates point to further sizable declines in house 

prices. Assuming that is the case, I am concerned about what a further FHA expansion will mean for taxpayers. 


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If the FHA guarantees a mortgage for 90 percent of a home’s 

market value today and the value declines 10 percent in the next 

year, where will that leave the FHA a year from now? And what 

if there is a further decline the following year? 

A.1. Substantial further declines in house prices certainly pose 

risks for the FHA, and thus for taxpayers, if new mortgages guaranteed under an FHA expansion do not include an adequate financial cushion for the FHA. In my judgment, the cushion built into 

current legislative proposals—involving a combination of principal 

writedowns, premiums, and recovery of a portion of any house-price 

appreciation—is sufficient to limit this risk. 

PROBLEMS WITH SECOND MORTGAGES

Q.2. Mr. Elmendorf, you noted that the prevalence of second liens 

creates an obstacle to refinancing first mortgages into more affordable mortgages. Just to cite one example, data collected under the 

Home Mortgage Disclosure Act suggest that nearly 40 percent of 

higher-priced home-purchase loans in 2006 involved a second mortgage (or ‘‘piggyback’’) loan. 

What would you suggest be done to coordinate the process of 

dealing with the second lien holders? 

A.2. Much of this coordination will need to be undertaken by the 

private lien holders. However, I would also explore whether the 

government could serve as a clearing house for the relevant information—for example, by offering to collect from lienholders the addresses of properties on which they hold liens, and then to share 

that information with any other lienholders who report liens on 

properties at the same addresses. 

Q.3. Won’t there be cases where the interests of the second lien 

holder are not aligned with those of the first mortgage holder? 

A.3. Yes, some second lien holders will likely resist subordinating 

their claims to refinanced first liens. From the perspective of the 

second lien holders, even properties with negative equity on the 

first liens alone might ultimately yield some mortgage payments. 

Moreover, the process of resubordinating the second liens offers 

those lien holders some leverage for extracting money from the first 

lien holders. In some cases, small payoffs from the first lien holders 

to the second lien holders is likely to be part of the refinancing 

process. 

IMPORTANCE OF DOWN PAYMENTS

A 20 percent down payment to purchase a home became increasingly rare in recent years as home prices accelerated. We now see 

that many of the borrowers who are in trouble made minimal, if 

any, down payment. It is not surprising that we would find a number of homeowners with negative equity, even with modest price 

declines in home values. 

Q.4. As the Congress looks for ways to avoid repeating past mistakes, what should this tell us about down-payment requirements, 

particularly with respect to any government-guaranteed mortgage 

programs? 


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A.4. Requiring mortgage borrowers to have some equity in their 

homes—and thus some cushion against potential house-price declines—is a crucial part of responsible lending. Because this point 

is being brought home so forcefully now to many mortgage lenders 

and investors, I do not expect the very high loan-to-value ratios 

seen in some mortgages during the past several years to be repeated in the future. Similarly, government-guaranteed mortgage 

programs need to be ensure a financial ‘‘cushion’’ to protect taxpayers from losses. This cushion depends on loan-to-value ratios, 

the premiums that are charged, and the integrity of the underwriting process. 

RATE RESETS NOT THE ONLY PROBLEM?

Mr. Elmendorf, at times the discussion of the mortgage situation 

has focused on how rate re-sets posed a huge problem as borrowers 

came to realize what was really in the mortgages they took out. 

Some pointed to the so-called 2/28 or 3/27 loans as fueling this crisis. You note in your testimony that declines in short-term interest 

rates since last year have reduced the magnitude of this problem. 

Q.5. If the predicted foreclosure wave isn’t due to rate re-sets, what 

is the underlying cause? 

A.5. Experience suggests that mortgage foreclosures are most closely linked to movements in house prices. When prices decline and 

people lose equity (sometimes all of the equity) in their homes, 

then foreclosures rise. The mechanism is principally that people 

who encounter some obstacle to making their mortgage payments— 

losing their jobs, being hit with high medical bills, or something 

else—can often find a way to keep making those payments when 

they have equity—such as refinancing the mortgage or borrowing 

from relatives—but do not have access to these means when they 

are under water. 

Q.6. Can we draw something from the fact that a large number of 

borrowers went into default only a few months into their mortgages? 

A.6. The high rate of very early defaults on recent mortgage vintages suggests that some borrowers had no intention of making 

mortgage payments but planned instead to re-sell the houses quickly and benefit from the appreciation. Of course, with declining 

rather than rising house prices, this strategy failed. This experience emphasizes the importance of restricting FHA expansion to 

owner-occupied homes and to families who demonstrate in the underwriting process the ability to make payments on restructured 

mortgages. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM DOUGLAS W. ELMENDORF 

Q.1. What do you suggest we do to find the $20 billion this bill 

costs to start up? What should we cut, or what should we raise 

taxes on? 

A.1. To my knowledge, no official cost estimate has been produced 

for the plan put forward by Chairman Dodd. The CBO cost estimate for the similar plan put forward by Chairman Frank of the 


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House Financial Services Committee is less than $3 billion. I agree 

with the spirit of the question that decisions to raise spending or 

cut taxes should be accompanied by decisions about how to pay for 

those actions, because these financing decisions pose the ultimate 

cost-benefit test. As you know, the CBO regularly issues a lengthy 

report on budget options. Among the options in that document that 

I support, ‘‘Eliminate the International Trade Administration’s 

Trade Promotion Activities or Charge the Beneficiaries,’’ ‘‘Impose 

New Limits on Payments to Producers of Certain Agricultural 

Commodities,’’ and ‘‘Reduce Payment Acreage by 1 Percentage 

Point’’ would collectively provide the amount required. 

Q.2. Do you have any suggestions for making sure someone did not 

lie or not tell the whole truth on their original mortgage application? 

A.2. In my judgment, independently verifying the honesty of people’s initial mortgage applications is not worth the administrative 

effort involved. As with other public programs, designing an FHA 

expansion presents tradeoffs between one’s ideal program (here, penalizing people who did not tell the truth) and a program that can 

be administered at reasonable cost. Many people who lied in order 

to buy a bigger house would not meet the underwriting standards 

imposed by the FHA and would not qualify for that reason. The 

retrospective underwriting required to precisely identify the others 

is not worth the cost in my view. 

Q.3. If home prices continue to fall, lenders would be protected. But 

what protection do the taxpayers have if prices fall 10% more? 

A.3. Substantial further declines in house prices pose risks for the 

FHA, and thus for taxpayers, if new mortgages guaranteed under 

an FHA expansion do not include an adequate financial cushion for 

the FHA. In my judgment, the cushion built into current legislative 

proposals—involving a combination of principal writedowns, premiums, and recovery of a portion of any house-price appreciation— 

is sufficient to limit this risk. 

Q.4. Should we be encouraging or subsidizing someone staying in 

a house if they would be financially better off if they were renting? 

A.4. People who would be better off renting than owning are likely 

to give up homeownership even under the proposed FHA expansion. As I mentioned in my testimony, it makes sense to appropriate additional funding for counseling as quickly as counseling 

organizations can build their capacity and use the funds effectively. 

One function that counselors can serve is to help people make informed decisions about whether to be homeowners. 

Q.5. Should we require financial sacrifices for participation in this 

program, such as selling vacation homes or investment properties, 

selling second vehicles, getting a second job, not taking on other 

debts, or selling non-retirement account investments? 

A.5. Again, I see tradeoffs between designing one’s ideal program 

in terms of screening criteria or lending terms and designing a program that can be implemented quickly and administered efficiently. In my judgment, including these various penalties as a cost 

of borrowing would make the program too cumbersome to operate 

effectively. 


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