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74–982 PDF 2013

S. HRG. 112–468 

STATE OF THE HOUSING MARKET: REMOVING 

BARRIERS TO ECONOMIC RECOVERY 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE STATE OF THE HOUSING MARKET 

FEBRUARY 9 AND FEBRUARY 28, 2012 

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

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

CHARLES YI, Chief Counsel 

BETH COOPER, Professional Staff Member 

GLEN SEARS, Senior Policy Advisor 

WILLIAM FIELDS, Legislative Assistant 

ANDREW OLMEM, Republican Chief Counsel 

CHAD DAVIS, Republican Professional Staff Member 

DANA WADE, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

THURSDAY, FEBRUARY 9, 2012 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

WITNESSES 

Mark Zandi, Chief Economist and Co-Founder, Moody’s Analytics .................... 3 

Prepared statement .......................................................................................... 30 

Christopher J. Mayer, Paul Milstein Professor of Real Estate, Finance, and 

Economics, Columbia Business School ............................................................... 5 

Prepared statement .......................................................................................... 49 

The Honorable Phillip L. Swagel, Professor of International Economic Policy, 

University of Maryland School of Public Policy ................................................. 6 

Prepared statement .......................................................................................... 59 

Responses to written questions of: 

Senator Toomey ......................................................................................... 67 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement of the National Association of Realtors® ............................................. 69 

Statement submitted by Tim C. Flynn, CEO, National Value Assurance, 

LLC ........................................................................................................................ 71 

TUESDAY, FEBRUARY 28, 2012 

Page 

Opening statement of Chairman Johnson ............................................................. 73 

Prepared statement .......................................................................................... 118 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 74 

Senator Menendez ............................................................................................ 76 

WITNESSES 

Shaun Donovan, Secretary, Department of Housing and Urban Development . 76 

Prepared statement .......................................................................................... 118 

Responses to written questions of: 

Senator Shelby ........................................................................................... 183 

Elizabeth A. Duke, Governor, Board of Governors of the Federal Reserve 

System ................................................................................................................... 98 

Prepared statement .......................................................................................... 128 

Edward J. DeMarco, Acting Director, Federal Housing Finance Agency ........... 100 

Prepared statement .......................................................................................... 157 

(III)

(1) 

STATE OF THE HOUSING MARKET: REMOVING 

BARRIERS TO ECONOMIC RECOVERY—PART I 

THURSDAY, FEBRUARY 9, 2012 

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

The Committee met at 10:03 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I call this hearing to order. I thank our witnesses for joining us. 

Today’s hearing is a continuation of our in-depth look at housing 

finance reform that we just started last year in a bipartisan fashion. Many of the previous hearings have examined the long-term 

structure of the Nation’s housing finance system. In this hearing, 

we will focus on the current state of the housing market and its 

effect on the larger economy. 

In January, the Board of Governors of the Federal Reserve System released a white paper entitled ‘‘The U.S. Housing Market: 

Current Conditions and Policy Considerations.’’ In this paper, the 

Board stated that continued weakness in the housing market poses 

a significant barrier to a more vigorous economic recovery. 

The white paper documents the problems that so many families 

and communities are facing, such as: declining home prices and the 

loss of $7 trillion in home equity since 2006; millions of responsible 

homeowners are underwater on their homes through no fault of 

their own; excess supply of homes for sale at the same time that 

rents are rising; obstacles to refinancing at today’s record low mortgage rates. 

The paper also discussed policy options for addressing what it 

identified as impediments to a housing—and ultimately economic— 

recovery. Such impediments include: the excess supply of homes for 

sale, tightened mortgage credit, and the flow of additional homes 

entering the foreclosure pipeline under current conditions. Many 

potential solutions are being offered by a wide range of interested 

parties. In recent weeks, the Administration has outlined administrative steps and legislative proposals for overcoming barriers to 

housing market recovery. An interagency group led by the Federal 

Housing Finance Agency has begun taking steps to address the 

large volume of real estate-owned properties held by the Government-sponsored enterprises and Federal agencies, including pilot 

projects converting some of these properties to rentals. I look forVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
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ward to hearing more from the Administration and FHFA about 

their proposals. 

Finally, this morning, we are expecting an announcement in the 

long-anticipated mortgage servicing settlement. I look forward to 

carefully reviewing the details of these agreements as part of the 

Banking Committee’s continued oversight efforts to hold servicers 

accountable for their failures and protect homeowners from abuse. 

I agree with the Fed’s assessment. Without an improvement in the 

housing market, the economic recovery will also continue to drag. 

We must do everything we can to help with economic recovery. 

This is important to me and my constituents. This means we must 

find ways to improve the housing market. 

Today, we explore potential solutions with three highly respected 

economists. I have invited our witnesses to share their insights on 

barriers to and solutions for housing market recovery. These witnesses have extensive experience analyzing the housing market 

and broader economy. I hope to learn from them practical solutions 

to improve the housing market, the economy, and the lives of millions of Americans. 

With that, I would turn to Senator Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Unfortunately, as we sit here today, I believe the only realistic 

assessment of the state of our housing market is that it is weak 

and has faced continued decline. Home prices declined nearly 5 

percent in 2011. This was the fifth straight year of declines. Worse 

yet, some States saw declines of more than twice that rate. In Illinois, prices declined over 11 percent; in Nevada, prices declined 

more than 10 percent. 

The troubled state of our housing market should be a call for 

Congress to take action. Traditionally, this Committee has acted in 

a bipartisan fashion to address pressing problems facing the Nation, and during my tenure on the Committee, which is 26 years, 

we have worked across party lines to pass important legislation to 

reform the GSEs and resolve the savings and loan crisis. But there 

is a lot of work to do. I believe we can and we should return to 

that practice. 

Some have speculated that Congress will fall into gridlock during 

the rest of the year. However, that does not have to be the path 

of this Committee. Given strong bipartisan support for helping 

homeowners, I believe that it is unfortunate that Congress has yet 

to devise a thoughtful and effective program to revive the housing 

market. 

As early as 2008, right here I warned that, to be effective, we 

needed to address the underlying fundamentals driving the housing market and the mortgage foreclosures. We have not done that. 

I warned that if we did not adopt such an approach, we would risk 

wasting a lot of taxpayer money. And perhaps we have. Unfortunately, the Administration has rolled out one ineffective homeowner assistance program after another. 

The Administration’s latest proposal, as I understand it, reveals 

its unwillingness to provide the leadership necessary to make the 

tough choices required to really revive the housing market. This 

3 

appears to be today now an ideal time for the Members of this 

Committee to step into the leadership vacuum. I have no illusions 

that this will be easy. However, we will never solve the problems 

with the housing market if we do not start working together to find 

a reasonable solution here. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Shelby. 

Are there any other Members who wish to make a brief opening 

statement? 

[No response.] 

Chairman JOHNSON. If not, thank you all. I want to remind my 

colleagues that the record will be open for the next 7 days for opening statements and other materials you would like to submit. Now 

I would like to introduce our witnesses here today. 

Dr. Mark Zandi is the chief economist at Moody’s Analytics. 

Dr. Christopher Mayer is the Paul Milstein Professor of Real Estate, Finance, and Economics at the Columbia Business School. 

And the Honorable Phillip Swagel is a professor at the University of Maryland’s School of Public Policy and the former Assistant 

Secretary for Economic Policy at the Treasury Department from 

December 2006 to January 2009. 

Dr. Zandi, you may proceed with your testimony. 

STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND COFOUNDER, MOODY’S ANALYTICS 

Mr. ZANDI. Thank you, Mr. Chairman, Mr. Vice Chairman, and 

Members of the Committee. I am the chief economist at Moody’s 

Analytics. My remarks, though, are not those of the Moody’s Corporation. They are my own views. You should also know that I am 

on the Board of Directors of mortgage insurer MGIC. You should 

know that. 

I will make five points in my remarks. 

Point number one is that the housing crash is not over. Home 

sales and housing construction have hit bottom. They have stabilized. There are even some signs of life there. But house prices 

continue to decline. Since prices began declining 6 years ago, they 

have fallen by about a third, and I expect more price declines in 

coming months. 

The key problem is the still large number of properties that are 

in the foreclosure process. Just to give you a number, there are 3.6 

million loans that are in foreclosure or pretty close, 90 days and 

over delinquent. They are unlikely to cure, and they will likely go 

to foreclosure. So the share of home sales that are distressed, that 

are foreclosure and short, will likely rise later this year, and that 

means more house price declines. 

Point number two is that when house prices are falling, it is hard 

to be entirely enthusiastic about the economic recovery. The home 

is still the most important asset that most households own, most 

middle-income households. Many small business people use their 

home as collateral to get a loan. So, for example, when I started 

my company 20 years ago, I had to go get a loan, and I put my 

home up as collateral. I doubt I could do that in today’s environment. Many local governments obviously rely on property tax revVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
4 

enue, which has been falling because of the decline in housing values. 

Most significantly, though, is the risk that we fall back into a vicious cycle that prevailed back in the recession; that is, price declines result in more homeowners that are underwater. By my calculation, there are 14.6 million homeowners that are in negative 

equity positions, half of which are underwater by more than 30 

percent, and the average amount of negative equity per homeowner 

is about $50,000. So that is the fodder for more default; more default means more distressed sales and more price declines. 

This leads to point number three, and that is, I do think the policy response to the housing crash has been helpful and did, in fact, 

break that vicious cycle back in late 2008 and early 2009. There 

were a myriad of policy steps taken to break the cycle, everything 

from the Federal Reserve’s quantitative easing efforts, buying 

mortgage securities to bring down mortgage rates, which has 

brought fixed mortgage rates to record lows, to temporarily raising 

conforming loan limits, to three rounds of housing tax credits; and, 

of course, the FHA, a yeoman effort to fill the void in mortgage 

lending left by the collapse of private mortgage lenders. So, in my 

view the policy response, while obviously not perfect and we can 

take umbrage with any individual aspect of the response, reasonable criticism, I think the totality of the response was pretty good. 

Point number four is at this point I think policy makers should 

remain supportive of the housing market and continue to provide 

temporary, modest support to housing so that we do not reignite 

that vicious cycle. We cannot allow that to occur because if it does, 

there will not be any good policy response and our economy will 

pay a price for it. 

The proposals put forward by the Federal Reserve Board and the 

Administration I think are pretty good. They focus on three things, 

and I think this is where you should focus. 

First is facilitating more marriage refinancing. I think that is a 

slam-dunk idea in the context of record low fixed mortgage rates. 

That is an immediate boost to these very stressed homeowners. 

The second thing is facilitating more loan modifications, particularly principal write-down mods that are very well targeted, and I 

think that dovetails very nicely with the mortgage settlement that 

we are going to be getting, hopefully today. I think facilitating that 

effort would be very helpful. 

And then third is promoting REO to rental. The GSEs, obviously—FHA has a lot of properties sitting in REO. We want to get 

that into rental before it hits the market and drives house prices 

lower. So anything that could be done—and there are lots of things 

that can be done—to address those—to facilitate those three policy 

steps. 

Finally, my fifth point is that this should not cost taxpayers 

money. These are things that can be done, I think, without any 

cost to the taxpayer. Some of the things will require some cost, particularly the principal reduction, if we juice up HAMP and increase 

the incentives there. But we have TARP money that has been 

budgeted for these purposes, and I think they should be used. 

Finally, let me say I think it is very important for Congress, the 

Administration, the FHFA, and other regulators to remain aggresVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
5 

sive and vigilant, make sure that this housing crash definitively 

comes to an end, because until it does the recovery will not gain 

traction. 

Thank you. 

Chairman JOHNSON. Thank you, Dr. Zandi. 

Dr. Mayer, you may proceed. 

STATEMENT OF CHRISTOPHER J. MAYER, PAUL MILSTEIN 

PROFESSOR OF REAL ESTATE, FINANCE, AND ECONOMICS, 

COLUMBIA BUSINESS SCHOOL 

Mr. MAYER. Good morning, Chairman Johnson, Ranking Member 

Shelby, and Members of the Committee. My name is Chris Mayer. 

I am the Paul Milstein Professor of Real Estate at Columbia Business School. 

Despite record low interest rates, some signs of economic recovery, mortgage activity and house prices continue fall. Purchased 

mortgages last year were at the same level as in 1992, according 

to data from the Mortgage Bankers Association, and refinancings 

were at the second lowest level since 2001. By comparison, new 

consumer lending for items like autos and credit cards is up 11 percent. 

In its recent white paper, the Federal Reserve observes, ‘‘Obstacles limit access to mortgage credit among creditworthy borrowers, 

barriers to refinancing blunt the transmission of monetary policy.’’ 

Unfortunately for taxpayers, homeowners, and the economy, 3 

years into the FHFA’s conservatorship of the GSEs, Fannie Mae 

and Freddie Mac continue to act as profit-maximizing private firms 

determined to remain in the game for long-term profits through 

their near monopoly power in the mortgage market rather than 

making the market more efficient. The FHFA has taken a narrow, 

ineffective, and harmful approach to managing GSE activities. 

Conservatorship has failed to adequately address critical conflicts 

of interest between the two principal GSE businesses: providing 

mortgage guarantees and managing a large retained portfolio of 

mortgages and MBS. Examples abound of GSE actions that padded 

their portfolio profits even while restricting refinancing. Fannie 

Mae imposed new origination fees called LLPAs that could be 3 

percent or more of the mortgage balance only weeks after the Federal Reserve announced its intention to purchase what would eventually be $1.25 trillion of GSE MBS. Freddie Mac followed suit 2 

months later. 

LLPAs were applied to those refinancing existing mortgages even 

though lowering the payments for those borrowers would save 

Fannie Mae and Freddie Mac and the taxpayers money by lowering 

defaults. Existing borrowers with high loan-to-value ratios, those at 

the greatest risk of default, were locked out of refinancing altogether. 

The GSEs made it harder to refinance with another servicer despite borrowers’ many complaints about poor service from their existing servicers. Consumers now pay three-quarters of a percent 

more per year for their mortgage to originators than they did before conservatorship due to limited competition to originate mortgages. 

6 

The GSEs failed to address critical problems in mortgage insurance. The only seemingly plausible reason for policies that unduly 

restrict credit and, thus, raise defaults by existing borrowers is to 

protect high interest payments on assets held in the GSEs’ portfolio. 

Reports by National Public Radio and ProPublica highlighted 

these conflicts of interest and how they may have influenced portfolio decisions at Freddie Mac. Instead of selling off its MBS, 

Freddie Mac created and help complex, highly leveraged, risky 

mortgage derivatives that had no value as a hedge. More recently, 

Freddie Mac created new and complex long-term financing for its 

mortgage-backed security positions called MLANs. Both types of 

transactions were structured so that the enterprise lost valuable 

interest payments if borrowers with very high interest rates refinance their mortgages, a policy that is substantially under the control of Freddie Mac. These transactions also make it harder to unwind Freddie Mac and its portfolio in the future, something all of 

us should be concerned about. 

While seemingly consistent with conserving and preserving assets, these policies appear to violate a number of the GSEs’ other 

mandates under HERA to foster liquid, efficient, competitive housing finance markets and to operate in a manner consistent with the 

public interest. 

Finally, the GSEs need to reform their loss mitigation practices. 

Private portfolio lenders were the first to adopt widespread mortgage modification programs and principal reduction plans with 

their own loans and have also much lower redefault rates than the 

GSEs. The GSEs need to follow practices that portfolio lenders use 

for their own defaulted mortgages and work to attract private capital to purchase and manage nonperforming loans and REO. 

We must change the mandate of conservatorship. Legislation 

should mandate that an independent trustee wind down the GSEs’ 

retained portfolio of MBS and require other steps to attract private 

capital. The GSEs should finally remove all of the obstacles limiting access to refinancing for existing GSE borrowers and address 

constraints on mortgage credit as identified by the Federal Reserve. Conservatorship as it stands now is laden with conflict of interest and is going to be incredibly difficult to unwind these institutions. 

I appreciate the opportunity to address you today and look forward to answering any questions you may have. 

Chairman JOHNSON. Thank you, Dr. Mayer. 

Professor Swagel, you may now proceed. 

STATEMENT OF THE HONORABLE PHILLIP L. SWAGEL, PROFESSOR OF INTERNATIONAL ECONOMIC POLICY, UNIVERSITY OF MARYLAND SCHOOL OF PUBLIC POLICY 

Mr. SWAGEL. Thank you, Chairman Johnson, Ranking Member 

Shelby, and Members of the Committee. The housing market remains weak even as the job market improves. The latest housing 

proposals we are considering today largely expand on previous actions. 

My concern is that the proposals share a common feature of the 

previous actions, and that is their moderate impact, an impact that 

7 

is in every case less than was advertised when the various policies 

were launched. 

It is useful to consider a specific example of why the new proposals will share this unfortunate feature. One proposal is a broad 

refinance for loans to be refinanced by the FHA, the Federal Housing Administration. The Administration’s fact sheet—and that is 

all we have is a fact sheet—says there will be no red tape, no 

delays, no tax forms, no appraisals. The policy applies to owner-occupied homes and not to investors. 

Now, the problem is that the lenders have to verify that a home 

is owner-occupied. This is the case even if a lender is refinancing 

its own home because now it will be getting a Government guarantee. Without access to tax forms, without appraisals, it is not 

clear how the lender is supposed to do this. Are they supposed to 

send someone to the house and look in the window? So these implementation details matter greatly. And, again, we have no text for 

the legislative proposal. We just have a fact sheet, when these details are really crucial. It is 2 weeks after the proposal has been 

announced. I have serious doubts about whether it can actually be 

implemented in practice, and there is really no way to know. 

In general, what we have learned over the last 3 years is that 

the one-at-a-time nature of the transactions involved in dealing 

with the housing weakness is a considerable hindrance to implementing these proposals. 

Now, on their impact, I think it is clear that credit was too loose 

before the crisis during the housing bubble, and I think a good case 

can be made that now credit is too tight, and access to mortgage 

financing is too difficult for many homeowners. 

To me, the lessons is to get the standards right, not to have the 

standards be set by unelected and unconfirmed Government administrators, but to think about what are the right standards and 

let the private market decide how to deploy capital and what risks 

to take on that capital. 

I worry that there will be a modest impact from the new proposals in terms of avoiding incremental foreclosures. Many of these 

proposals might have made more sense in early 2009, but at that 

time the measures were considered not prudent, not a good ratio 

of benefits to costs. So here we are in 2012. If anything, as my 

written testimony explains in detail, the ratio of cost to benefits 

has gone up. There are fewer incremental foreclosures avoided for 

each dollar of taxpayer resources used. 

If these proposals work, to the extent they do, it will be mainly 

as economic stimulus, as writing checks from taxpayers to particular homeowners. I think it is fine if someone wants to make a 

case that we should have more fiscal stimulus. I think that will 

have a limited impact and is probably not needed in light of the 

improving economic data. But that debate should be made openly 

as stimulus and not as a housing policy or as pressure on a Government administrator. 

Another point, related, is that Government aid should probably 

be better focused. Rather than having the FHA refinance anyone’s 

mortgage, it might be useful to look at which homeowners and 

which income levels. As I mentioned in my testimony, the White 

House has recently defined the middle class as topping out at 

8 

$80,000 a year or $100,000 a year, and it might be useful to limit 

FHA to homeowners of that income level. 

There are actions that can be taken that will be useful to speed 

the housing adjustment. The REO initiative to move empty houses 

into rentals I think will be very useful, and that really should be 

the focus of policy, a focus on speeding the adjustment. We want 

a recovery in housing. We need the housing market to lift off the 

bottom. But, unfortunately, that does mean the housing market 

has to hit bottom so that it can lift off of it, and we want that to 

happen as quickly as possible. We want to end the legal and regulatory uncertainties that are now waiting on the market. Moving 

forward with housing finance reform, reform of the GSEs in particular, will be helpful for bringing private capital back to the market and moving the housing market forward. 

Thank you very much. 

Chairman JOHNSON. Thank you, Professor Swagel. 

As you mentioned at the outset, the long-anticipated mortgage 

servicing settlement has been reached. Although we may not have 

all of the details, I am interested to hear each of your thoughts on 

the impact of this settlement on the housing market. Dr. Zandi, we 

will start with you and go down with the panel in turn. 

Mr. ZANDI. I think it will have a meaningfully positive impact on 

the housing market and the broader economy for three reasons: 

First, it provides a substantive amount of resources for more loan 

modifications, and it sounds like a fair number of those will be 

principal reduction modifications, which the servicers are already 

engaged in quite successfully. According to OCC data, roughly 20 

to 25 percent of their current mods are principal reduction mods, 

so I think this will be helpful in that regard. 

And, by the way, the Administration proposal to triple the benefits to principal reduction mods in HAMP I think would dovetail 

beautifully with that settlement. And I think that is meaningful. 

I think you will get a half a million to a million homeowners that 

get substantive help here, and that will make a big difference in 

terms of that share of home sales that are distressed, and that will 

help to keep any future house price declines limited. 

The second reason is that I think this does help the banking system. One of the reasons the banking system has been slow to provide credit is the cloud hanging over it with regard to various legal, 

regulatory issues. There are still many, and there are still many 

clouds. But this was one significant cloud, and I think lifting it will 

be helpful, and it will allow the banking system to gain confidence 

and become more aggressive in extending credit, which is very key 

to the economic recovery. 

Third, I do think this is consistent with Professor Swagel’s point 

about facilitating the foreclosure process. This will allow the foreclosure process to reaccelerate for us to move through the mountain 

of foreclosed property that is still plaguing the housing market. 

Many of these foreclosed properties are vacant. They are investor 

properties. They are blighting communities. We need to work 

through these properties; otherwise, we are not going to find a bottom. So I am hopeful that this leads to a clearer path toward more 

foreclosure—resolving more of these foreclosure issues and coming 

9 

to the day when we find the bottom of the housing market. So I 

think this is a very encouraging development. 

Chairman JOHNSON. Dr. Mayer. 

Mr. MAYER. Yes, I agree with Dr. Zandi on many of these points. 

I think it does continue a practice which private lenders are doing 

with their own portfolios, which are principal modifications. 

What is unclear is how well we have bifurcated past actions 

versus future results. One of the problems has been there are many 

people who are not making their payments for 2 years or longer 

and are remaining in their properties, and we are starting to see 

in the data that people in judicial States where that is happening 

are defaulting relatively more relative to people in nonjudicial 

States. And so we should start to worry about that moral hazard, 

and if this presents a path for either modifying or foreclosing a 

home, we really need that. We cannot have people who stay, you 

know, years in homes without payments and without really having 

an ownership stake in where they are. 

The third is something that I think really highlights what Senator Shelby said at the beginning of this hearing, which is we are 

going to have a lot of stuff coming on the market, and given the 

current structure of both the GSEs and the lending market, we are 

not going to have the credit or the capacity to absorb this stuff. If 

we end up with a couple million homes that come on the market 

next year with the sale rate of, you know, under 5 million today, 

a third of those home sales are already cash sales; a third are home 

sales under contract; a third, brokers report that their sales fall 

apart because of credit problems. So it is critical for this Committee 

and for policy makers to address the issue of restoring a more normal credit standard in the market; otherwise, this flood of housing 

may well push prices down a lot more and push us into a situation 

where we have other problems. 

So I think this is a wonderful proposal. Lots of people, including 

myself, are talking about refinancing. But we also need to open up 

a reasonable standard for new mortgages, whether they be for people who are owner occupants, whether they be investors buying in 

bulk. And the GSEs at the moment are not accomplishing that 

goal, and I think that needs to change. 

Chairman JOHNSON. Professor Swagel. 

Mr. SWAGEL. I also welcome the settlement on the robo-signing. 

Obviously, the robo-signing was outrageous, and illegal behavior 

should be—illegal actions should be punished. 

I think the positive impacts will be twofold: One is there will be 

some assistance for individual homeowners. I think the bigger impact on the overall economy and on the housing market is removing the uncertainty that is preventing banks from operating and 

from lending going forward. We have to remove that uncertainty to 

start origination going forward. 

We have to be realistic about the impacts, 17 or 37 billion, somewhere in that range, in terms of principal writedowns. Those are 

big numbers, but there is $700 billion or more of underwater borrowers, negative equity. So the impact will be pretty modest relative to the scale of the problem. 

10 

The original HAMP proposal was supposed to help 3 or 4 million, 

and it has helped less than a million. It is just an indication that 

we should all be wary of these promises. 

The last thing to mention is that the market is moving. Lenders 

are paying homeowners to avoid foreclosure, and it makes sense, 

right? If it takes 24 to 36 months to actually foreclose on someone 

who is not even making their payments, it makes sense for lenders 

to pay that person to move out, and there is much greater dignity 

in that solution than in a foreclosure. 

So these adjustments are useful, and we want them to keep happening, but, again, I think the biggest impact, positive impact of 

the AG settlement is the certainty about market conditions going 

forward. 

Chairman JOHNSON. Dr. Zandi, we have heard arguments that 

the market should be left to hit bottom. I would like to hear your 

analysis of this issue. Do you see any barriers to the market healing itself? Are there any risks with remaining housing prices to fall 

further? 

Mr. ZANDI. Well, I would make two points. First, I think house 

prices have fallen sufficiently to be consistently now with household incomes and effective rents, so effectively house prices are at 

bottom. They are at equilibrium. Affordability is very high, and you 

have fairly strong investor demand because rents have risen so 

considerably. So I think any further house price declines would be 

what you might call overshooting. 

Second—and this is more important, and this goes to my point 

about the vicious cycle—what concerns me or makes me nervous is 

that once house prices start falling, it is very difficult to see where 

that ends. We can get back into a very vicious cycle. Prices decline. 

You have 14.6 million homeowners underwater. When prices are 

falling, people think prices are going to fall in the future, that gives 

them less incentive to hold on. They default. The defaults lead to 

more foreclosures, short sales, more price declines, more negative 

equity homeowners, and you can see this dark vicious cycle taking 

hold. And we had to throw enormous resources at this vicious cycle 

in the recession to break it. And we did. If you look at prices, they 

have basically—they are soft, but they have basically stabilized 

since early 2009. 

So I do not think it is worth taking the chance to allow that possibility to occur. The tail risks, as you would say, are very enormous. 

So I think policy makers can do some things that are modest, do 

not cost taxpayers significant dollars, and mitigate that risk, and 

I think that is entirely appropriate. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

Dr. Zandi, you estimated earlier in your testimony that an additional 6 million homeowners will lose their homes before the housing market recovers, and you also said that foreclosures will not return to normal levels until 2015. 

How could you rationalize—I know you are an economist. Sometimes economists are right, sometimes they are wrong. 

[Laughter.] 

11 

Senator SHELBY. How do you rationalize the housing market has 

bottomed out and so forth if you are going to have 6 million more 

foreclosures and so forth? You know, I hope you are right, but I am 

not sure. Tell us why. 

Mr. ZANDI. Yes, very good question. 

Senator SHELBY. In other words, you are saying that the price of 

housing is not going to continue to decline, but that seems counterproductive to what we see. 

Mr. ZANDI. Yes, it is a very good question. First, let me say there 

are three broad measures of the housing market: 

Home sales—that is, housing demand. That has hit bottom. It is 

actually starting to improve. 

Senator SHELBY. How do you determine that has hit bottom? We 

hope it has hit bottom. What is your data? 

Mr. ZANDI. Existing home sales from the National Association of 

Realtors, new home sales from the Census Bureau. If you take a 

look, they have basically been moving along the bottom for 3 years 

and are now starting to trend up a little bit. 

Housing construction, single-family, multi-family starts, also 

Census data, that is starting to rise—admittedly, at very low—— 

Senator SHELBY. But not everywhere, right? 

Mr. ZANDI. No, of course not. I am talking nationally. 

Senator SHELBY. OK. 

Mr. ZANDI. But house prices, you are right, they are continuing 

to be weak, and I do expect more house price declines in the immediate future. But this is a very important point, and it refers to 

something Dr. Swagel said. The key to house prices is the change 

in the share of home sales that are distressed, foreclosure and 

short. You can still have a very high level of distressed sales, and 

we are because we have a lot of property in foreclosure, and it is 

going to take many years to work through that. But if you can 

start moving that share downward, you are going to get house price 

growth. And lots of good things will happen as soon as house prices 

are moving north. 

All I am arguing to you, sir, is that we are very close. We do not 

need to solve the $700 billion, by my calculation $750 billion negative equity hole. We just need to get another half million or a million homeowners on solid footing, get that share of home sales that 

are distressed moving south, and we will start making progress on 

house prices. 

Senator SHELBY. Do you have that same feeling in areas like 

Florida, Nevada, California, you know, some distressed areas 

where so many properties are underwater or is your language, your 

testimony, basically across the Nation? 

Mr. ZANDI. Well, also a very good question. I so far have been 

speaking nationally, but obviously there is a great deal of variability across the country. Places like Florida, Atlanta, Arizona, Nevada, Central Valley of California, parts of Rhode Island, parts of 

the Midwest are encumbered with a great deal of foreclosed property, so price declines there are going to be more deep and longer. 

It is going to be harder to get that share of distressed properties 

moving south in those areas because the foreclosure problem is a 

bigger problem. 

Senator SHELBY. Dr. Mayer, do you have a comment on this? 

12 

Mr. MAYER. Sure. I am actually in the camp of prices have fallen 

further than equilibrium. In many parts of the country, house 

prices are below construction costs of comparable homes. And given 

where interest rates are—— 

Senator SHELBY. Is this an area where it is like Florida, California, Nevada, Arizona, where—— 

Mr. MAYER. Yes, and Atlanta and Phoenix. You know, this is 

true in many parts—— 

Senator SHELBY. Where housing was overbuilt and oversold perhaps. 

Mr. MAYER. Yes, that is true. But the sort of question is where— 

if you sort of think about where we should be in equilibrium, that 

is the sort of analysis. Now, I think it—— 

Senator SHELBY. That is the ideal way. If demand and supply are 

in equilibrium, things are fine, right? 

Mr. MAYER. Right. The problem with that is that, on the other 

side of the coin, what is not working is access to credit, which is 

part of what is contributing to prices hanging below the market. 

One of the things I would point out is that I pay a lot of attention not necessarily to foreclosures but as well to sort of vacant 

houses, because if you take a family who leaves a home, they are 

going to go somewhere else, and someone else is going to move into 

the home that they have. And the question is, is there somebody— 

what determines house prices is, is there somebody who can sort 

of buy that home and either provide a rental or someone else who 

is going to occupy the property? And that sort of transition is a 

place that I think policy makers can and should be focusing on, 

which is: How do we make sure that when people leave these 

homes, whether through short sales, as Dr. Swagel talked about, 

or foreclosures, that there is somebody else who can acquire that 

property without a huge amount of distress and make it available 

for families to live in so it does not become vacant and get destroyed? 

The really big overbuilding is in a small number of parts of the 

country, and in many other parts of the country house prices are 

below construction costs, but we are not seeing it because of this 

transition challenge. 

Senator SHELBY. Professor Swagel. 

Mr. SWAGEL. Yes, I also worry about the impact of the delayed 

foreclosures on house prices going forward. There is a sense in 

which we have put a bunch of foreclosures on hold, meaning millions of foreclosures on hold, but we have not prevented them, especially with the economy having been relatively weak over the last 

3 years. 

Senator SHELBY. Is one of the problems of delayed foreclosures 

that each State has a different law regarding foreclosures and the 

speed of them and so forth? 

Mr. SWAGEL. That is right, and judicial States take a lot longer. 

That is right. We have started to see lenders essentially paying 

homeowners considerable amounts to move out of their home and 

avoid foreclosure. It seems like the market then is finally starting 

to adjust. 

Senator SHELBY. Professor Swagel and Dr. Mayer, I will refer 

this to you. In both of your testimonies, you cite the lack of GSE 

13 

reform, Freddie and Fannie, as impeding the recovery of the housing market. So what will be the consequences to the housing market if Congress continues to neglect and push down the road GSE 

reform? Professor Swagel. 

Mr. SWAGEL. I would say it is very much an impediment to having the housing market recover, and it is an impediment to the policy debate today. We see everyone pounding on poor Ed DeMarco 

to adjust the refinancing standards. That should not be his line of 

business. It should be the market. But we need GSE reform for 

that to happen. It would be hard for private market participants 

to lend someone money for 30 years when the Government could 

change the rules entirely in a few years. 

So that is what I would want. Move forward with GSE reform 

and have private capital come in and take the risks. 

Senator SHELBY. Dr. Mayer. 

Mr. MAYER. I am not as sanguine on the actions of the conservator in this regard. I think there—— 

Senator SHELBY. That we have now? 

Mr. MAYER. Yes, the current conservator of the FHFA. As I made 

comments, I think the conflicts of interest have been material. The 

GSEs under conservatorship have imposed new fees, new restrictions, and new things that never existed before conservatorship 

and are enormous impediments to the recovery of the mortgage 

market and can only be explained by the retained portfolio. And 

these are things that, in principle, the conservative could within 

his power adjust, but he has chosen not to. So the conservator 

could hand, without legislation, an independent trustee to manage 

and wind down the portfolio, but the conservator has chosen not to 

do that. The conservator could take many other steps that would 

reduce the losses and foreclosures and open up credit but has chosen not to do it. So while it does not require legislation—— 

Senator SHELBY. Isn’t that going to make it worse in long run 

and harder to do and more costly? 

Mr. MAYER. Actually, it is counterintuitive, and, you know, this 

is based on work I have done with Dean Hubbard at Columbia 

Business School, Alan Boyce, and James Witkin. What the GSEs 

are doing is actually making it harder for them to be unwound. So 

the way they are managing their portfolio with issuing—they just 

put out 10-year debt. They have created these complex derivatives. 

These are not transactions that are sort of making it easier to unwind. They are actually making it harder to unwind. And the frictions in the market that they are creating are also making it harder to unwind them because nobody will sort of—this is not a market anybody wants to be in. When you sue your originator, same 

problem. The litigation creates a harder space for private capital 

to—— 

Senator SHELBY. Is this a philosophical design by the conservator? 

Mr. MAYER. I have had different views—— 

Senator SHELBY. It is not an unknown. 

Mr. MAYER. I would not want to speculate as to why the conservator has taken the actions that he has. I just look at the results 

of those actions. And I think as the manager of any institution, one 

of the critical things, you know, that CEOs have to deal with are 

14 

conflicts of interest in an organization, and not managing those 

conflicts of interest effectively is something that a CEO should be 

held responsible for if they are not doing that. And so to my mind, 

that is the sort of critical question, and I do not want to—I cannot 

speculate. I do not know why these have or have not been—— 

Senator SHELBY. You might not speculate, but you can evaluate 

the real data. 

Mr. MAYER. Our report clearly—you know, I have done a lot of 

writing on this, some of which is in my testimony, more of which 

is written on a Web site that we have been maintaining. We have 

been arguing this, Dr. Hubbard and I, since September of 2008 

when we saw the mortgage spreads go crazy and, you know, conservatorship not fixing things. 

Senator SHELBY. Dr. Zandi, I know the time has eaten away, but 

in fairness, what is your view here? 

Mr. ZANDI. Thank you. Yes, I think it is very important for Congress to resolve Fannie and Freddie, that as long as they remain 

in conservatorship, nothing good happens. Of course, you have 

many other moving parts that you need to nail down before you 

can actually resolve Fannie and Freddie. The private residential 

mortgage securities market is, as you know, dead in the water, and 

that needs to be revived before we can resolve Fannie and Freddie. 

But I agree with you. You know, the longer they are in this noman’s-land, it is a problem for everybody. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, gentlemen, for your 

excellent testimony. 

Dr. Zandi, longer term we have to do lots of things, but in the 

short term, I think that both you and to a degree Dr. Mayer are 

saying there are steps that the conservator could and should be 

taking right now. In fact, one of the recent Presidential proposals 

through HAMP, as you have noted, Dr. Zandi, for principal 

writedown modifications has given additional resources potentially 

to FHFA and the Fannie and Freddie to do that. And the question, 

I think, is why is it—it should be increasingly difficult for FHFA 

to argue that they cannot do it because of their obligation to preserve the portfolio, et cetera, et cetera, et cetera, when, in fact, there 

are resources available that will make the calculation positive. 

Just a final point, too. One of the themes that I sense out is that, 

first of all, this settlement today I think is very encouraging, but 

that essentially goes to the paper owned by the banking institutions. 

Mr. ZANDI. Correct. 

Senator REED. And as many have noted, banking institutions, 

good businessmen and women are making decisions about principal 

writedown mortgage modification not because they want to help 

the homeowner, but they are looking at their shareholders’ bottom 

line. So the business logic here is to get FHFA to do what business 

is doing and use resources that have been recently made available 

to start principal writedown modifications and add further momentum. And that can be done instantaneously. They do not have to 

wait for new statutory authority. Is that accurate? 

15 

Mr. ZANDI. Yes, I think first I would like to say the principal goal 

of the conservator should be to preserve taxpayer money, right? I 

mean, we have ante’d up $160 billion for Fannie and Freddie, and 

this is getting to be very costly, and I think it is prudent that the 

regulator focus on that. 

But in that context, I think there are many things that can and 

should be done. I think, for example, mortgage refinancing, facilitating more mortgage refinancing—it perplexes me why FHFA is 

not being more aggressive here in trying to promote that activity. 

Now, we had HARP II, the juiced-up HARP, and that is progress. 

But even to this day, for example, I think HARP II rules—and we 

can describe what they are, but it facilitates more refinancing— 

should be extended to all Fannie and Freddie borrowers. But 

Freddie has different rules than Fannie, and it is just mucking up 

the process. This makes no sense and should be resolved, as an example. 

Moreover, REO to rental I think everyone agrees makes—you 

know, it is a slam-dunk thing, I think. And I know it is a hard 

process and we need to have pilot projects, and we are not sure exactly—and we do not want to give too much away to investors. I 

am on board with that. But it feels to me that this should be moving at a much greater pace. 

Moreover, the third point, to your point, I am perplexed. I have 

my models, and I look at this data very carefully—with the argument that Fannie and Freddie do not believe in principal 

writedown, they believe in principal forbearance. Well, under some 

circumstances, under reasonable assumptions, principal writedown 

works better than principal forbearance. Just to completely say we 

are not going to have any principal writedown in a targeted way 

so we do not have moral hazard issues, I mean, I understand that. 

I think that is just a step too far. 

So, as you can tell from my voice, I am frustrated. I am frustrated by it. 

Senator REED. You are not alone because, you know, I have been 

arguing in REO, for example, for 2-plus, 3-plus years to move on 

that. That seems to be sort of something that is obvious. And I 

think, Dr. Mayer, you, too, feel that the REO issue is something 

that should be moved aggressively. 

Mr. MAYER. Yes. 

Senator REED. It should have been done. 

Mr. MAYER. Right. I should say one thing, which is I do advise 

a group of a startup company that is working in the space of trying 

to acquire homes on the rental market. I should say that straight 

off. They are not actually deploying capital at the moment, but I 

do believe in this as a really, really important step to move the 

market forward. 

I would respond to your question and also that of Senator Shelby 

at the end about data and how to account for this. We have posted 

an incredibly detailed model that goes through the profitability of 

a mass refinancing program to all the various parties. This model 

is, I think, a state-of-the-art model and probably better than anything that we have seen out there in terms of analyzing the costs 

and benefits, because I agree with Dr. Zandi and Dr. Swagel, and 

16 

I think the Members of this Committee, that, you know, conserving 

and preserving assets is an incredibly important goal. 

If the GSEs were to do a refinancing program where they added 

a modest increase in the G-fee—because many of the old G-fees 

were as low as 12 to 15 basis points. If they were to raise that Gfee on refinanced mortgages to 25 to 35 basis points, which would 

still leave enormous benefit for homeowners, a mass refinancing 

program would be enormously profitable for taxpayers and for the 

GSEs and would actually help wind down the process by reducing 

credit losses in the future. 

The problem is that that analysis is hard to do without also considering the portfolio. We have done very careful work, and if you 

sort of tell me that, gee, the portfolio has X, Y, Z bonds in it—and, 

of course, the conservator has never made public what kinds of 

bonds are sitting inside the portfolio. But if you did that and you 

told me, gee, you know, 25 basis points was not enough but 35 

basis points would do it, given that many of these borrowers have 

a 6-percent mortgage and they could be refinancing in something 

below 4, there are 200 basis points of spread there. There has got 

to be a place that that is profitable for the GSEs, even considering 

their portfolio, profitable for taxpayers. In fact, we even go through 

and calculate the opportunity costs for the Federal Reserve because 

we also believe that we should look at this in a very holistic sense 

of the Government to include all the mortgages that the Federal 

Government holds. 

The other thing I would sort of say is I completely agree on the 

mortgage modification. If you look, for example, in 2008, GSE 

modifications were about 40 percent less effective than private 

lenders in their own portfolio. In 2009, same thing. In 2010, the 

GSEs caught up, and their modifications started to have similar effectiveness to private portfolio lenders. In 2011, we are back to the 

GSEs’ modifications being about 40 percent less effective; that is, 

the redefault rates are about 40 percent higher than what the private sector is doing with their own loan modifications. 

I think that is the best place to look, is when somebody owns a 

loan outright, what do they do with it? Well, oftentimes they sell 

it to special servicers whose job is to write down the loan, modify 

it, get the people out, pay them, do whatever they need to do to 

work forward. And the GSEs have consistently lagged behind the 

private market, which sort of tells me that what they are doing is 

not what is the state-of-the-art. And if they cannot do that themselves, they should be selling off some of those NPLs into the market and letting the private sector do the kinds of things the private 

sector would do well, which I suspect would get some of the principal modifications that many people hope for, but would also sort 

of, I think, get us out of the bureaucracy that we are in at the moment. 

Senator REED. Well, thank you. 

Dr. Swagel, I must apologize because my time has long been exceeded, and my colleagues are waiting, and they have brilliant 

questions to ask, much more so than I. But just one point is everything you have talked about I think can be accomplished with the 

current authority of the conservator right now. In fact, my sense 

is you are arguing that this is really what he should be doing beVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
17 

cause of his obligations under the present law to, you know, stabilize and to recover as much assets and be as businesslike as possible. You are nodding your heads. I will take that as unanimous. 

Mr. ZANDI. Yes. 

Mr. MAYER. Yes. 

Mr. SWAGEL. I would just make a very small point, if it is OK. 

Senator REED. Can I just—go ahead, please. 

Mr. SWAGEL. It ultimately comes down to numbers and the costs. 

The Federal Reserve is a substantial owner of mortgage-backed securities and would be affected by this. Mr. Garrett asked Chairman 

Bernanke last week, ‘‘You are in favor of this. What is the impact 

on you?’’ And the Fed has not done the calculation. It is just puzzling that they are affected and have not done the calculation. I 

wonder if there is a message there. 

Senator REED. Hopefully they will do the calculation, and it will 

be the right calculation. 

Chairman JOHNSON. Senator Corker. 

Senator REED. Thank you. 

Senator CORKER. Thank you, Mr. Chairman, and I thank each of 

you for your testimony, and I appreciate your being here. 

I think that all three of you have said that Fannie and Freddie 

staying in their present state in perpetuity is probably not a very 

good thing, and in order for them to wind down from their dominant position, what we have to do is really bring the private sector 

back. They are on strike for lots of reasons, and what we have to 

do is build a mechanism to bring them back in and have a real 

TBA market on the private side and make sure that reps and warranties are actually there and there is actually the types of underwriting that they can expect to take place. And if we can figure out 

a way to do that, then we can really begin to diminish the amount 

of reliance we have on Fannie and Freddie. Is there general agreement on that? And that the longer they stay like they are, actually 

more mischief kind of comes into play. 

I would love to have your responses very briefly to Congress, for 

instance, for 2-month payroll tax adding a G-fee, if you will, to all 

Fannie and Freddie loans over the next 10 years to pay for that. 

Is that something that is good for our housing industry? I think I 

get three noes. 

So I hope there is a way that—we have a bill out there that is 

just a marker for discussion. We want to attract one of our great 

friends on the other side of the aisle and know that changes have 

to be made to cause that to happen, and we only did that to begin 

conversation. We never offer a piece of real legislation until we 

have a Democratic cosponsor, but I sure hope you will weigh in on 

that. 

But let me move to another question. You know, we have this 

chart of underwater loans, and it is pretty interesting how they are 

concentrated more fully in a handful of States. Dr. Zandi, what is 

the reason for that? I mean California and Nevada and Arizona 

and Florida, why is the concentration so heavy there? 

Mr. ZANDI. Well, as you know, that is where the housing bubble 

was its most significant. 

Senator CORKER. Well, I know that, but why was that housing 

bubble predominantly in those States? 

18 

Mr. ZANDI. Well, a number of reasons. One key reason is that 

these markets generally are supply constrained. It is hard to build. 

So if you get any pick-up in demand for housing, because of the 

supply constraints house prices start rising very quickly. And once 

house prices start rising quickly, like any asset market, people 

start forecasting with a ruler, and they speculate. 

Senator CORKER. Speculation, yes. 

Mr. ZANDI. And then adding fuel to this fire was, of course, very 

easy credit, so private label, subprime lending, Alt-A lending, Option ARM lending provided the credit, the juice to speculate, and 

you saw this surge in prices. 

Senator CORKER. I knew you were going to say that, and I thank 

you. So—— 

[Laughter.] 

Mr. ZANDI. Uh-oh, that sounds scary. 

Senator CORKER. I enjoy so much working with you on the auto 

deal. 

Mr. ZANDI. I got in some kind of trap. 

[Laughter.] 

Senator CORKER. I say this to my friends from Colorado and Oregon and Virginia and Alabama and Rhode Island and South Dakota. I guess as I start looking at the principal reductions, I have 

supported what Dr. Mayer said from the very beginning 3 years 

ago, that if Fannie and Freddie—if there were spreads there and 

there was an opportunity for people to refinance at lower rates, let 

us have at it within those institutions. It made them strong, it 

made the homeowner stronger. 

You start getting into principal reductions, and whether using 

existing TARP money, which, you know, our country still owns, or 

whether you are doing it through other mechanisms, in essence 

what we are doing is really creating a transference of wealth from 

Tennesseeans and Alabamans and Virginians and Oregonians and 

people from Colorado, a transference of wealth from their taxpayers 

to people in these States that speculated. Now, why would we do 

that? It just makes no sense to me that everybody has gotten on 

this bandwagon of principal reduction when the creation of this 

bubble was exactly what you said. 

Now, I want you to tell me how I go back home to Tennessee and 

say that this is a great policy for you to send a check up each year 

to the Treasury and let them write a check to Fannie and Freddie 

for losses because we are going to do principal writedowns. 

Now, explain to me how that makes sense and why maybe it 

would not be better just to say in California or Florida, in places 

where people did a lot of speculation—which, by the way, drove a 

lot of revenues for those States, I might add. Wouldn’t it be better 

if those States themselves put up the money for those principal 

writedowns? I mean, it is a geographic issue. It is not a national 

issue. I do not understand why people have not thought about it 

in that way. 

I would love for you to respond to that. 

Mr. ZANDI. Yes, you make very good points. This is a very difficult problem, and fairness is, you know, at the heart of it. You 

know, there are moral hazard issues. How do you do this so you 

do not set off a firestorm? 

19 

Senator CORKER. Right. 

Mr. ZANDI. I hear what you’re saying, and I understand what you 

are saying. This is not something that I would—— 

Senator CORKER. Well, tell the farmer in west Tennessee the answer to that question. 

Mr. ZANDI. OK. I would say a couple things. 

The first thing I would say is that I would disagree a bit with 

your characterization that this is only a California and Florida—— 

Senator CORKER. No, it is not ‘‘only.’’ All of our States have those 

issues, but it is hugely disproportionate. 

Mr. ZANDI. It is by my calculation, 14.6 million—and I can provide it for your State of Tennessee. It is not insignificant. There are 

a lot of homeowners in your own State that are underwater. 

Senator CORKER. But most folks in other States played by the 

rules. They were not going and specking a housing bubble with almost no money down. 

Mr. ZANDI. I am not so sure. Subprime lending was pretty widespread. 

Senator CORKER. Well, tell me the answer for the west Tennessee 

farmer. 

Mr. ZANDI. Let me get to the more fundamental point. 

Senator CORKER. All right. 

Mr. ZANDI. The more fundamental point is that I think we are 

very close to solving this problem, to putting an end to it, and getting house prices moving north. And if it requires a half million to 

a million principal reduction mods that are very well targeted and 

done by the banking system and some hopefully by the GSEs, then 

I think that is a reasonable cost to make a reasonable thing to do 

to get the housing market on solid footing, moving north, and our 

recovery engaging. And this will benefit all Americans, not just Floridians but people in Tennessee who are unemployed. 

You have to think about this—it is almost—you know, sort of the 

metaphor is if someone else’s house is on fire and you are in the 

same block, you have to put that fire out because it is going to save 

your block. Same deal. I know that does not resonate particularly 

with the farmer in Tennessee, but the reality is, I think—it is my 

judgment—that that is—— 

Senator CORKER. Let me ask you another question. You know, I 

have really enjoyed working with you on numbers of things, and 

I always appreciate the input of all three of you. The other thing 

we are looking at doing, we are going to take—I understand about 

refinancing Fannie inside Fannie and Freddie inside Freddie. But 

the fact that we are now going to take private loans and banks and 

if they are going to be—let us say they are 5.5, 6 percent rate and 

they want to refinance, we are going to transfer those over to FHA, 

and the ones that are going to be transferred obviously are the 

ones that are problematic. 

Do you think that is a good idea, to take from private lending 

institutions, transfer them on to the Government’s balance sheet? 

Do you think that is a good idea? I am just stunned by that. 

Mr. ZANDI. Well, I would put that at the bottom of the list of 

things that I would be focused on. I think the most important thing 

is to facilitate more Fannie/Freddie refinancings and more FHA 

20 

refinancings. If at the end of the day there is a long list of things 

that have been proposed here, I would put that near the bottom. 

Senator CORKER. Well, now, that is one of the top-list things that 

is being proposed. I would love to have the input—— 

Mr. ZANDI. Well, can I say, by my calculation, if you look at the 

benefit of these various refinancing proposals, the biggest benefit 

is to refinancing more Fannie, Freddie, and FHA loans. That is 

where—— 

Senator CORKER. Within Fannie, Freddie, and FHA. 

Mr. ZANDI. Exactly. 

Senator CORKER. I agree with that. And I do not know why we 

would not do that. I agree that is an absolute no-brainer. 

Is it OK if the other two respond to taking private lending institutions and transferring them over to the FHA books as thinking 

that is good public policy? 

Chairman JOHNSON. Would you please make it brief? 

Mr. SWAGEL. I will be very short, yes. FHA is already about $50 

billion under—is going to need a $50 billion or maybe a $100 billion bailout. I think it would be difficult to countenance transferring over more risk. A year ago the Treasury report on GSE reform 

said we should shrink the FHA from its 30-percent share back to 

10 to 15 percent. And now they are going in the opposite direction. 

So it is puzzling. 

Mr. MAYER. Any such program that involved taking on the risk 

of loans from private lenders I think should be predominantly funded through the owners of those mortgages. There might be ways to 

do that, but I think that would be an important thing to look at 

in this regard. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman, and I appreciate 

the comments of my friend from Tennessee. I have enjoyed working 

with him, and I want to go back to his kind of somewhat similarly 

answering I think a really legitimate issue that you raised. As 

somebody on the principal reduction—and Lord knows as somebody 

who spent more time on the business side than I have on this kind 

of job, I absolutely start with the same premise that you start with. 

But I do kind of think it is more than just certain States’ problems. 

We do have now $160 billion worth of taxpayer exposure. The notion that one of the tools in the toolbox, as long as it was narrowly 

defined that we would exclude that tool from being used, particularly when we see the private sector—and I think I go back to Dr. 

Mayer’s comments, that the private sector is using that tool and 

has a more—is it a 40-percent lower redefault rate than the 

GSEs?—to me argues—as hard as I would say if somebody would 

match my capitalist credentials with you, you know, that we are 

in such a hole here, and this has such a potential effect on the 

overall national economy that I would not take that tool out of the 

toolbox. But, you know, you make a great—I think you make a very 

strong, strong case on the other side. 

I guess one of the things I want to start with here is that Senator Reed made mention a number of times about the fact that the 

conservator can go ahead and take more actions than he has taken 

at this point. It seemed to me, Dr. Mayer, that you were saying— 

and I also agree with, I think, Senator Shelby and Senator Corker 

21 

that we need to move on fuller GSE reform. But one of the things 

that I think, Dr. Mayer, you were saying, I just want to make clear 

that you were saying perhaps as an interim step that we need to 

legislatively make clearer to the Administrator that you ought to 

not put these further impediments in terms of unwinding the portfolio, that they need to be—he needs to move more aggressively on 

the refinancing opportunities. Did I hear that in your testimony? 

Mr. MAYER. Yes, I think I fully appreciate the challenges we all 

have with trying to figure out what the future of the U.S. mortgage 

finance system is going to look like. That is an enormously challenging problem, and, you know, I am an economist, not a political 

scientist, but I know we have an election coming, and, you know, 

there are a lot of issues going on here. 

That said, I think there are a number of areas which should be 

in common ground across the parties that, unfortunately, would require legislation because of the existing impasse in the institutions. 

I liken it to the responsibility of a board of directors when the CEO 

does not step in on his or her own to manage an existing conflict 

of interest. That means that the board of directors, unfortunately, 

has to step in and manage that conflict of interest. And so I 

think—— 

Senator WARNER. The conflict, again, to be clear, you are saying 

implicitly, is the conflict between preserving taxpayer dollars at the 

end of the day and the macro goal of one trying to refinance and 

also trying to have overall economic health? Is that—— 

Mr. MAYER. No, no. Actually, the conflict of interest is more 

mundane than that, so to speak, which is the conflict of interest 

is they are managing a portfolio of mortgages, of hundreds of thousands of dollars—— 

Senator WARNER. In Freddie’s circumstance that was exposed recently by NPR. 

Mr. MAYER. Right. You know, but long before NPR, many people 

had been talking about these issues, and, you know, the conservator’s comments were not to actually deny that there was a conflict 

of interest, only to sort of say that he instructed the GSEs in November of 2011 that they should not consider their portfolio. But 

that conflict of interest has existed for years, and I think it is still 

the only plausible explanation for some of the comments that Dr. 

Zandi made about restrictions on refinancing that exist today. And 

so I think, unfortunately, that requires legislation. 

Senator WARNER. I would like to—again, I do not want to take 

beyond my time, but I would like to get Dr. Swagel and Dr. Zandi. 

It does seem to be that there is this common agreement that we 

would all agree, whether some of the Administration’s new proposals merit or not, that the refinance opportunity, at least within 

the GSE portfolio, we ought to be moving more aggressively on it, 

and what else should we do—do you believe that it requires legislation? Or what else should we do to urge those actions to place? Dr. 

Swagel and Dr. Zandi. 

Mr. ZANDI. Go ahead. 

Mr. SWAGEL. The refinance issue is a tough one. There are people 

who are paying a higher interest rate than it seems like they 

should. On the other hand, someone who has lost a job over the 

22 

last 3 years of the weak job market, it is not clear that taxpayers 

should take on the additional risk. 

One other note is that the proposal from the Administration specifically is limited to people who have been essentially current on 

their mortgage for a year. So in terms of preventing incremental 

foreclosures, the impact will be modest because the proposal is restricted to people who look like they are doing OK. 

So that is what I mean, it is really a stimulus, it is writing people a check. That might be the right thing to do, but it is not foreclosure avoidance, mainly. It is mainly—— 

Senator WARNER. Wouldn’t it be by definition, if they are current, then their chances of default would actually be less as well? 

Mr. SWAGEL. Absolutely. Absolutely. 

Mr. ZANDI. Yes, I would disagree with Dr. Swagel. I think this 

is a slam-dunk. You should work very hard to facilitate more refinancing through Fannie, Freddie, and FHA loans. And I think the 

Administration’s proposal to extend HARP 2.0 rules to all Fannie, 

Freddie, and FHA borrowers is a good one. It is not only—and I 

should say this means a lot to a lot of people. Just simple calculations, I think at least 5 million homeowners at current mortgage 

rates, say fixed mortgage rates stay around 4 percent, about 5 million homeowners could refinance over the next couple of years. And 

I think that makes a tremendous difference to those households. 

Senator WARNER. How do we make that urgent? And then I will 

stop now, but just do you think we just need to continue to make 

that point, or do you think, as Dr. Mayer said, you actually need 

legislative direction? 

Mr. ZANDI. I think at this point I would go down the path of writing legislation and hopefully the FHFA, you know, engages. So, for 

example, there is a piece of legislation I have seen floating 

around—Senator Franken, I believe—trying to require that Freddie 

adopt the rules that Fannie has adopted with respect to refinancing. Something along those lines. That is getting really into 

the weeds, and you would hope that, you know, this would be done 

administratively, not legislatively, because once you do legislation, 

things get complicated, right? You do not want to do that. But I 

think I would start moving down that path, and hopefully that 

lights a fire. 

Chairman JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you all for 

your presentations. 

The perspective that folks bring to my town hall is that the Government intervened with enormous support for our major financial 

institutions, and as we know, a few months ago that included additional support from the Fed—and I am including the Fed as part 

of the definition of ‘‘Government’’ here—of trillions of dollars of 

loans, more than $1 trillion. It rolled over several times, which is 

what led us to that $7.7 trillion figure. And folks say, you know, 

if the Government can intervene with so much help and such low 

interest rate money to help our major financial institutions, why 

can’t they intervene in that manner to help ordinary citizens wrestling with a housing market that was put into a bubble by policies 

that allowed predatory loans and teaser rates and steering payVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
23 

ments, if you will, kickbacks, an enormous set of Government policies that drove that bubble? 

I raise this because I think it is important to return to that 

framework, and as we think about this question of refinancing, it 

is helpful to have that citizen’s voice in our mind. It is easy for us 

to talk about those loans that are currently guaranteed by the Government by chance; that is, when someone comes into our casework 

team and says, ‘‘Would I qualify for what is going on?’’ do you have 

a Fannie or Freddie mortgage? Because if you do, then you may be 

able to get refinanced. But they have no idea where their loan has 

been sold until we help them find out. 

So you have so many families out there at higher interest rates 

who are wondering, well, why should it just be a matter of the lottery, that if my loan happened to be acquired by Fannie and 

Freddie, I qualify for this improved HARP program, but otherwise 

not? And given we have been so generous in helping financial institutions—I mean, let us not just look at the economy from the top. 

Let us look at it through the success of families. And certainly the 

economy in Oregon depends upon a successful home ownership 

market. 

We sell grass seed, which is down the tubes without people buying homes. We sell nursery stock. We sell lumber. We sell insulated 

doors and windows. And that is true for virtually every State. A 

piece of their economy is driven by the housing market. 

I have listened to the conversation about let us focus on those 

loans that happen to be with Fannie and Freddie, but the rest, 

well, maybe we just leave those people adrift, I feel a little bit of 

pushback that I wanted to share with you. 

I do feel indeed like the conversation about the conflict of interest, Mr. Mayer, that you have been pointing out with Fannie and 

Freddie, where they have resisted financing because they have 

high-interest loans. Well, this is an argument that one can also 

make on the other side of the non-Fannie/Freddie world and part 

of why exactly home modifications have been so difficult to achieve. 

Maybe you would just like to share a little bit about that. 

Mr. MAYER. So, first, I share your concern about the seeming unfairness of how the mortgage market and the economy have worked 

at the moment, and I think that that is a very, very deep concern, 

and I hear it a lot because I, you know, do talk shows and NPR 

and other kinds of things, you know, and I talk to a lot of people— 

not as many as you do, certainly, or as any of the Committee Members do, but I share that, and I have relatives who are locked into 

these situations as well. So I feel that very deeply. The challenge 

is how to do that within the existing structure. 

I think there are ways that we could think more creatively that 

fund something a little bit like the Home Owner Loan Corporation, 

for example, or some other sort of structure where the funding does 

not necessarily have to come from taxpayers, but may also come 

from mortgage holders or other kinds of—you know, I think there 

are some creative structures that one could build to do this in a 

way that would encompass more people but at the same time be 

respectful of taxpayers’ obligations as well. And I do think we have 

an obligation to think harder about those things, so I think the Administration bringing this up is important. I am not sure about a 

24 

bank tax—how I would fund it. I would like the incidence of this 

to be on the holders of the mortgages so they understand their cost 

to that. 

I would also sort of say that I think there are other—we could 

help those people also by doing other kinds of reforms in the market that help stabilize housing and that bring private capital in as 

well. There is no single tool that is going to fix this. It is going to 

be a variety of things. But I do think that there are going to be 

ways, if there is bipartisan support, to move this forward in a way 

that is respectful of taxpayers but is inclusive of a broader group 

of people, and I think those are both important concerns. 

Senator MERKLEY. The 5 minutes disappears magically, so quickly. So thank you. The HOLC model, there are many, many variants 

of it. The President has put out one variant of it. There are many 

other ways to tackle this, but I feel like time is passing; that is, 

efforts that should have been concluded and put in place very 

quickly 2 to 3 years ago, we still have a window now, and we 

should get it done. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. And let me 

thank several of you who have appeared before our housing Subcommittee and given a lot of great insights, and I appreciate it, as 

do the Members. 

You know, I have, as the Subcommittee Chair, been listening to 

a lot of our colleagues, and there seems to be a pretty strong universe of those for the refinancing camp. And, you know, I fully appreciate the question of the conservator’s challenge in conserving 

and preserving assets. The question is whether you do that for a 

foreclosure or refinancing to a large degree, because it is, you 

know, very well if it is a default option, it is going to be one of 

those, too. 

And so I do not get it when you could create a large base of continuing responsible borrowers at the end of the day and, therefore, 

solidify a significant part of the housing market and have an economic stimulus, because if I have been patching the roof because 

I cannot afford to, you know, get a new one and now my mortgage 

rate is down and I have some extra money I am going to go ahead 

and get the new roof, and that means that there is going to be a 

stimulus in the economy as well as a foundation for the housing 

base. 

So that makes me wonder, then, and I would like to ask you, Dr. 

Mayer, when I hear about Freddie Mac having investments—some 

call it ‘‘bets’’—against the homeowners that are contrary to the interests of homeowners, is that one of our challenges here? Because 

I do not think people make investments to then go against their 

investments. 

Mr. MAYER. Right. I do agree that this is a very serious concern. 

In my written testimony, I go through in fairly good detail, particularly in the conclusion, how it is that that ended up in a situation 

where well-meaning people ended up doing things that present an 

enormous appearance of, you know, a significant conflict of interest 

and a bet against homeowners. And I think you do not have to 

have—you know, you could believe, as I think was reported in that 

story, that paying $2.5 million salaries to the people that created 

25 

those instruments might well have been involved in the process. I 

know many Members of Congress have been very critical of the salaries paid to, you know, some of the executives in those organizations. 

But I think there are—the conflict of interest of an organization 

that controls an outcome and also holds securities that are dependent on that control make it very, very difficult to manage the portfolio, because if you try and sell those bonds, people in the market 

look and say, ‘‘But I do not want to buy them because the only reason you are selling them is you are about to refinance them 10 

minutes later.’’ And history says that Fannie Mae and Freddie 

Mac—particularly Freddie Mac—actually did that. 

Senator MENENDEZ. So do you think these investments that influence Freddie’s policies may very well have discouraged homeowners with high-interest mortgages from refinancing? 

Mr. MAYER. Yes, I think they have to do, and I go through the 

logic in my written report. I would not follow the conservator’s argument that this is $5 billion in a $600 billion portfolio so who 

cares, this cannot really have driven anything. I think that argument is not right because, one, these are derivatives that are based 

on probably, you know, $26 to $30 billion of mortgages, not $5 billion. You never value derivatives based on the value of the derivative. You value it based on the value of the underlying. 

But the second is that almost surely many of the other mortgages in their portfolio look exactly—MBS—look exactly like these. 

And so without disclosure of what the whole portfolio looks like, I 

really think it is—we cannot conclude that that conflict of interest 

is—— 

Senator MENENDEZ. Do we know if Fannie or Freddie have other 

investments or financing arrangements that are contrary to the interests of homeowners? 

Mr. MAYER. I think the mortgage-linked amortization notes that 

I talked about earlier give Freddie Mac the same economic interest, 

which is they finance over a 10-year period holdings of high-interest rate mortgages, leaving them with a strip or a spread which is 

3.96 percent that lasts only as long as the refinancing does not 

occur or default does not occur. 

Senator MENENDEZ. Well, this is a real concern to me because I 

do not understand why you make a bet that you can largely control 

the outcome of and want your bet to lose. I think that is against 

human nature. So I am not quite sure these firewalls exist in a 

way that are not affecting policies, and that is a problem. Let me ask any one of you, do you think the $25 billion StateFederal foreclosure settlement is a good deal? Do you think that 

that is the right amount? There is a lot of angst out there in the 

country that says $25 billion fell short of the mark. 

Mr. ZANDI. Well, I do not know what is appropriate in the context of the misdeeds that were done. I do think $25 billion is substantive and can make a difference in terms of responding to the 

housing crisis. I think if $15, $20 billion go to modifications and 

some additional refinancing, I think that is substantive, particularly if it is executed over the next 12 to 18 months. So is $25 billion the right number? I do not know. But it is a substantive number. 

26 

Senator MENENDEZ. Do any of you have a view on that? 

Mr. SWAGEL. I would just say we should expect a modest impact 

and it will help some people. The biggest value is removing the uncertainty and having the housing market move forward and origination restart. 

Senator MENENDEZ. One last question. We talked a lot about refinancing. I have been pursuing and am introducing legislation 

today that creates a pilot program at the FHA and the FHFA that 

would reduce principal writedowns to 95 percent loan to value in 

exchange for the bank or the investor getting a share of the profits 

when the home is sold or refinanced down the line, generally 

known as ‘‘shared appreciation mortgages.’’ I think it takes away 

some of the concerns that Senator Corker was talking about. It is 

not a complete question that we raise very often here about the 

moral line. You are getting a writedown, but you are also giving 

up the possibility of appreciation in return for the writedown. 

What do you think of that as a concept? 

Mr. ZANDI. I think that is an excellent idea. I wish I had thought 

of that in my response to Senator Corker. But I do think that that 

is appropriate, that there should be shared appreciation of any 

principal writedown, and perhaps clawback provisions, too, if 

homeowners do not execute in the way that they are contracted to 

do in the principal reduction modification. So, I think there are a 

lot of moving parts here, and I am sure you know this may not 

work out as you would hope for because there are just so many 

things going on. But I think given that we have got this issue for 

the next 3, 5, 7 years, I think this is entirely appropriate to do. 

Hopefully we will learn from this and this will become part of the 

toolkit going forward. 

Mr. MAYER. I would support the idea of trying to look for ways 

that—as you pointed out, the private sector are already managing 

these mortgages, and we know some of them are using shared appreciation mortgages. And I think in legislation, as I note in the 

written comments, we should actively call for such pilot programs 

modeled off of private sector initiatives. 

The other thing I would sort of just point to in that process is 

one thing that might help in this legislation would be taxpayers 

could, in fact, have a clawback over a longer period of time, which 

is to say homeowners could promise a share of not only the appreciation of the existing home but future homes to help pay for that. 

That could be done through the existing Tax Code which has a deferral of certain capital gains on homes and would be a way of 

making such a proposal even more profitable or break even for taxpayers as well. 

Mr. SWAGEL. I would just say that the shared appreciation mortgage might be useful for some people. Again, I would worry about 

a limited impact. People just do not like to share their home with 

the bank or the taxpayer. We have some experience with the socalled Hope for Homeowners program that was in the 2008 legislation, and there are more people in this room than were helped by 

that program. So it is just a limited—— 

Senator MENENDEZ. I appreciate it. Ocwen is doing this as one 

servicer who is doing this pretty successfully, and we think it can 

27 

be, as referred to, a tool within a larger—thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Hagan. 

Senator HAGAN. Thank you, Mr. Chairman. And thanks for your 

testimony today. 

I know the President recently released his plan to help responsible homeowners and heal the housing market, and one pillar of 

this plan is to establish a broad-based refinancing plan for responsible homeowners. I understand that in both public and private refinance plans there has been a problem with take-up and lenders 

will present borrowers with refinancing plans that would lower 

their interest rates and monthly payments, but that some borrowers are simply not choosing to sign up. 

Can you shed any light, any of you, on this problem and provide 

your thoughts on what might be done to remedy it? 

Mr. ZANDI. Well, you are absolutely right, I think there is a problem with take-up, even when it ostensibly makes sense from a financial perspective for the homeowner to engage in the refinancing. 

I do think that part of the problem in the take-up is that people 

are just very nervous that if they come forward, they are not sure 

what else in their financial lives is going to be uncovered and what 

other kind of damage could be done to their finances as a result. 

So I think it is very important, when servicers go to try to execute 

on these refinancings, that they make it very clear that, you know, 

they just want to make sure you have a job and that is it. So you 

have to be very, very clear that there are no other strings attached. 

All we want to do is make sure you have got a job, you are getting 

paid. If that is the case and you are current and you meet these 

other very limited restrictions, then you are good; we are going to 

refinance you. 

The other thing is I think financial literacy obviously is a very 

significant problem. People are just confused. They do not know, 

they do not understand. And so I think anything that could be done 

to really educate people as to, this is really going to help you and 

make it very clear on one piece of paper, this is your mortgage, this 

is your monthly payment, this is exactly what is going to happen, 

you email it to them or you put it in their mailbox, then, you know, 

hopefully that will increase the take-up. 

So I think it is a matter of communication and transparency with 

respect to—— 

Senator HAGAN. And how would you go about doing that? 

Mr. ZANDI. Well, I think when Fannie and Freddie and the FHA 

sit down with the mortgage servicers and talk about how they are 

going to execute on this plan, if, in fact, we move forward on it, 

then these are the kinds of things that they discuss. How are we 

going to do this so that we do get more take-up? 

Mr. MAYER. I agree that take-up is an issue, but I actually think 

that the right approach is one word: competition. We did not ever 

have to sort of push people to take mortgages. You know, in 2002 

and 2003, there were 35 million new mortgages originated in this 

country. Those were predominantly not subprime loans. Some of 

them involved cash-out refinancing. But what drove that was competition among servicers for the businesses, and I think one of the 

28 

most significant barriers to the take-up and one of the reasons that 

HARP in all its incarnations, including potentially this one, do not 

work is because you lock the existing servicer and you give them 

a big advantage relative to other servicers. 

So what you need is not only the servicers who are in that room, 

but people who want to start a business as servicers who are not 

sitting in that room should have the opportunity to enter and take 

the business of the existing parties if they do not serve their customers well, of which there is some evidence is not happening. 

They are going to find lots of ways to reach people that is not just 

by mail. They are going to advertise on the Internet. They are 

going to be on late-night TV. They are going to figure out ways to 

do it because it is in their financial interest to do it, and that competition is also going to drive down these incredibly high spreads 

between retail and wholesale mortgage rates. 

So my view is that we should be doing everything we can to open 

this up to competition. We should put out a list protecting privacy 

of borrowers who have Fannie and Freddie loans. Your mortgage 

is already a public record in virtually every State in the country. 

That should be available to any servicer, existing or not, who wants 

to come and say, ‘‘These are people who are eligible for this program, and I will jump in.’’ My bet is that somehow those existing 

servicers will really quickly discover how to refinance their existing 

people if they think they are going to lose that servicing business. 

Senator HAGAN. Thank you. 

Mr. SWAGEL. I would just add very briefly, it is a tough issue. 

A borrower in trouble is being pounded by the bank, you know, 

‘‘Pay up, pay up,’’ and then gets a call, ‘‘OK, now we want to help 

you,’’ and it is hard to know. So nonprofit counselors have been a 

big success story, a big part of the solution. 

Just the other small thought is that it is a difficult issue just because of the screening, trying to get the right people to help, the 

more kind of screening you do to get just the right people limits 

the effectiveness, and that is in my written testimony as a concern 

I express about the White House fact sheet, the announcement, is 

that they are trying to say, OK, we want this to be no red tape, 

no hassles, but also no tax forms, but only owner occupied, and 

those things do not go together. You cannot make sure it is owner 

occupied if you do not have tax forms and you do not have an appraisal. 

So I just worry about the ability to implement the proposal that 

the White House has proposed. 

Mr. ZANDI. Senator, could I say one other thing? Just one other 

plug for the Administration’s proposal, which is very similar to the 

Federal Reserve’s proposal, and this dovetails with what Dr. Mayer 

is saying. The way this is designed is that it is going to relax some 

of the reps and warranty features of the refinancings, also the 

mortgage insurance companies, most of them have given up rescission rights. This is very important to the mortgage lenders, the 

servicers, and it is a reason to believe that they are going to engage 

in a lot more competition and do the kinds of things that Dr. Mayer 

has suggested. 

So in the design of the proposal, there are a lot of good reasons 

to believe that you will get more take-up because you will have 

29 

more competition. So just another reason why I think you would 

want to execute on this. 

Senator HAGAN. Thank you. And, Mr. Zandi, your comment on financial literacy is near and dear to my heart. When I was in the 

State Senate, I mandated that financial literacy be taught, at least 

a portion, in civics and education class in high school, and it is certainly something that I am adamantly in support, that you look at 

the financial crisis that hit, I think we have got to do a better job 

educating our young people in particular on financial literacy and 

the skills. You cannot get by in the country today without understanding debt. You really need to work on that. 

Mr. ZANDI. In my high school education, I learned how to make 

a really good omelet. I had no idea what a mortgage was. 

[Laughter.] 

Mr. ZANDI. I am not sure that makes any sense at all—although 

I really make a good omelet. 

Mr. MAYER. In my high school, the omelets were on the ceiling. 

[Laughter.] 

Senator HAGAN. Then I had one other question, Mr. Chairman. 

Mr. Zandi, in your testimony you mentioned that Fannie and 

Freddie have historically not engaged in bulk foreclosure sales to 

investors or entered into agreements with property managers. Do 

you believe that a properly constructed—any of you—REO to rental 

program would reduce taxpayer exposure to Fannie and Freddie? 

Mr. ZANDI. Yes, I think this is also a very fruitful area for addressing the housing crash. I think that if you look at property in 

REO, more than half now, and rising quickly, is at Fannie, Freddie, 

and the FHA, and increasingly the share of REO that is going to 

be Fannie, Freddie, and FHA is going to rise. So anything that 

they can do to facilitate moving that REO to rental as opposed to 

moving it through to a distressed sale is really very positive for the 

economy. 

The one problem is they have no experience with it and, thus, 

it is taking them time to really get going. But Congress, I think, 

should really be pushing this and asking FHFA to really engage 

because this could reap enormous benefit. 

And one other quick point. Again, this is a problem that is going 

to be with us for a number of years, 5, 6, 7 years. So I think we 

should—even if it does not reap benefit 6 months from now or a 

year from now, this is something that should be pursued very aggressively. 

Senator HAGAN. Thank you, Mr. Chairman. 

Chairman JOHNSON. I would like to thank all of our witnesses 

for your this and for being here with us today. A strong, robust 

housing sector recovery is not just vital to our country’s homeowners; it is vital to our country’s economic strength. This Committee will continue to search for consensus solutions to help responsible borrowers in these difficult times. 

This hearing is adjourned. 

[Whereupon, at 11:37 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

30 

PREPARED STATEMENT OF MARK ZANDI 

CHIEF ECONOMIST AND CO-FOUNDER, MOODY’S ANALYTICS

FEBRUARY 9, 2012 


20912001.eps
31 


20912002.eps

Six lean yeal'S 

The housing crash is six years old and counting. Sales of existing homes- a gauge of 

demand- languish near an arumal rate of 4.5 million, of which about a third are 

foreclosures and short sales. Sales of new homes are even bleaker, running at a record 

low rate close to 300,000 units per year. In a well-functioning housing market, about a 

million more new and existing homes would change hands per year, and fewer than a 

tenth would be distress sales. II 

Housing construction- the marker for supply- is also depressed. Single- and multifamily 

housing starts run close to 650,000 units annualized, and manufactured home placements 

barely reach 50,000 per year (see Chart I). This is nearly the weakest pace for residential 

construction since World War II. A well-functioning housing market would produce 

closer to 1.75 million units annually. iii 

Chart 1: An Epic Housing Crash 

2,400 

2,000 

1,000 

1,200 

BOO 

400 -GS®Home Price It'dex, 00Cl1=100 (R) 

0 

75 BO 85 9J 95 00 05 10 

Sources: Fiserv. SEA, Mood)IsAna/)4ics 

Nationwide, house prices remain fragile. The Fiserv Case-Shiller national house price 

index has dropped by a third since peaking in the first quarter of2006, and prices are still 

falling in many parts of the country as a result of the pressure created by the large number 

of distressed property sales. In a well-functioning market, prices should rise around 3% 

per year. iv 

Economic fallout 

Although housing is no longer the drag it was during the worst of the Great Recession, it 

remains a significant weight on economic growth. This is particularly disappointing since 

housing is often a major source of growth early in an economic recovery (see Chart 2). 

Falling house prices and the resulting hit to household wealth remain seriolLs problems. 

Some $7.4 trillion in homeowners' equity was lost in the housing crash, with close to 

$500 billion of that occulTing in 2011. Given the impact on consumer spending from lost 

housing wealth, this shaved about 0.2 percentage point from real GOP growth last year. v 
32 


20912003.eps

TIle loss was particularly hard on middle-income households, who benefited less from 

rising stock prices than did their higher-income neighbors. 

Chart 2: Housing Weighs on the Economy 

Contribution to real GCP grCMrth, % 

1.' ,----------------, 

1.0 

a.' 

0.0 +-- "-r''-r''..--..... "_t\h_+._T...,,.j 

.(), 

-1.0 

·1.5 

_ Housing wealth effect 

_ Residential investment 

- Total 

-2.0 "----------------' 

96 98 00 02 04 06 08 10 

Source: MoodIs,o,,~cs 

Shaky house prices also make it difficult for small-business owners to use their homes as 

collateral. Bank lending to small businesses picked up over the past year, but it is hard to 

see how credit will flow freely until house prices rise again. Since small businesses are a 

key part of job creation, this is a significant impediment to a stronger job market. 

Strapped local governments are also struggling with the impact of falling house prices on 

property tax revenues. Despite rising millage rates in many parts of the country, tax 

revenue is growing at nearly its slowest pace on record. Given the lag between market 

price changes and tax assessments, revenues are likely to slow even more in the coming 

year. Local governments will thus have little choice but to continue cutting budgets and 

laying off workers. Local government payrolls are off by more than 500,000 from their 

peak and shrinking by about 10,000 jobs per month. 

Other effects of falling house prices are serious but harder to quantify, such as a reduction 

in labor mobility- an important way for the economy to adjust to shocks- and the 

erosion of retirement savings for low- and middle-income homeowners. 

While the worst of the crash appears to be over, housing continues to grapple with big 

problems, including a glut of vacant homes and a mountain of properties in or 

approaching foreclosure. With so many home loans deeply under water, risks remain 

uncomfortably high that the vicious cycle offoreclosures and price declines that ravaged 

the economy during the Great Recession will be reignited. Aside from the European 

sovereign debt crisis, there is arguably no more serious threat to the current economic 

recovery than the troubled housing market. 
33 


20912004.eps

Excess unentory 

The rampant overbuilding that occurred during the bubble years remains a significant 

impediment to a housing rebound. While builders have slashed construction and have 

made progress working down inventory, the market still struggles with excess vacant 

homes; we estimate just over 900,000 are either for sale, for rent, or being held off the 

market (see Chart 3). This is the difference between the 9.4 million vacant homes 

measured by the Census Bureau's Housing Vacancy Survey and the number of 

vacancies- around 8.5 million- that would be consistent with a well-functioning 

housing market. At current levels of supply and demand for new houses, it would take 

until mid-20B to work ofT this excess inventory. 

Chart 3: Glut of Vacant Homes 

Vacant homes for sale, for rent and held off market, ths 

11 ,500 

10,500 

9,500 

8,500 

7,500 

6,500 

5,500 

Houslnl Supply 

Sln8Ie·l.mUy 

Mullil. ",UV 

M.nulK\u,td HOUSing 

Houslnl Demlnd 

Kouwhoi<! form'llons 

Ob-K>lf"f""f 

SfCorlC!Homfs 

..,.,. 

~2~.000 

4l~.000 

l~,ooo 

".~ .r"V-. 1,4.00.000 JI ~.~ 

A j --- , ~.~ 

~.~ Trend 

"'''''Y 

00 ~ ~ % ~ 00 00 ~ 00 00 10 

Sources: Census. Moo~sh1aMics 

There is some evidence that the situation may not be quite as bad as these munbers 

suggest. It is unclear how well many vacant properties are being maintained, especially in 

heavily overbuilt markets such as Florida and California's Central Valley. Such houses 

may be unusable without significant renovation. Moreover, the excess-inventory problem 

is regionally concentrated. Atlanta, Florida, Nevada, Arizona, and the Central Valley are 

awash in vacancies; elsewhere the inventory problem is much less pronounced and will 

thus be resolved sooner. vi 

Demand and supply will not improve simultaneously, moreover. It is likely that demand 

for vacant homes will pick up more quickly than will new construction. The principal 

component of demand is household fonnation, which has been depressed recently 

because of the weak job market. With fewer job opportunities, young people have been 

staying in school; labor force participation has plunged anlOng those between 16 and 29 

years old. While the data here are sketchy, it appears that at its low point, household 

fonnation slowed to an annualized pace close to 300,000 in early 2010. It has picked up 

over the past year to closer to 750,000 per year; this has fueled a surge in rental 

absorption but is still well below the 1.25 million households expected to be fonned each 

year in a well-fwlctioning economy. 
34 


20912005.eps

As the job market comes back to life and young people return go to work, household 

fonnation should accelerate. Many young people have stayed in their parents' homes 

longer than in nonnal times, suppressing household fonnation; this should be reversed in 

the next year or two. FOfll1ations in 201 3 and 2014 could be well over the 1.25 million 

expected in a typical year. 

Still, it will take a number of years for housing constmction to really get going. Even as 

demand revives and the inventory of vacant homes is worked down, it will take time for 

builders to obtain construction and land development loans from banks, many of which 

are still processing the poor loans they made during the bubble. It also will take time for 

builders to ramp up new-home construction, a process that includes acquiring land, 

obtaining permits, and getting equipment on site. Multifamily construction will come 

back first- it already is reviving thanks to stronger absorption, falling vacancy rates, 

improving rents, and more ample credit- but even under the best of circumstances, 

single-family home construction will not be back to full strength lmtil the middle of the 

decade. 

Foreclosure crisis 

A more serious threat is the huge munber of first mortgage loans stuck in foreclosure or 

more than 90 days delinquent and thus headed for eventual foreclosure. At the end of 

20 11 , 3.6 million loans (out of 49.9 million loans outstanding) were in this predicament 

(see Chart 4). Most will end up in foreclosure, short sale or distress sale over the ne)"112 

to 24 months, pushing house prices lower. 

Chart 4: A Mountain of Distressed Property 

First rrortgage loans, ths 

5,000 

4,500 

4,000 

3,500 

3,000 

2,500 

2,000 

1,500 

1,000 

500 

o 

. 90 days delirquent 

_ 120 days delinquent 

_I n foreclosure 

,. : ..... 

06 07 08 09 10 11 
35 


20912006.eps

TIle key to house prices in the current environment is th e change in the share of home 

sales that involve distressed properties. Prices fall when the share rises, stabilize when the 

distressed share peaks, and rise when the share declines (see Chart 5). It is important to 

note that house prices will rise if the share of distress sales declines, even if the share 

remains elevated, as it will for a number of years given the large number of troubled 

properties. 

Chart 5: Higher Distress Share .. LoVloef House Prices 

NSA 

5 15 

4 10 

3 5 

2 0 

0 

-5 

-1 -10 

-2 -15 

-3 -20 

-4 -25 

06 07 08 10 11 

Sources: Fise~ zjllo.v, Moody'sAna/lfljcs 

The share of distress sales is likely to rise and house prices to fall further after the 

nation's largest mortgage servicers and state attorneys general resolve legal issues arising 

from the robo-signing scandal and other foreclosure process issues. These issues have 

significantly slowed the pace of foreclosures and distress sales over the past year or so. 

Little progress has thus been made in reducing the number of troubled loans. Once the 

pending lawsuit is settled, which should be soon, the foreclosure process is likely to gear 

up again, resulting in more distress sales and more house price declines. 

House prices are expected to fall only modestly, no more than 5% from current levels. 

Sturdy investor demand for distressed properties will limit the declines, particularly in the 

hardest-hit markets. Prices have already fallen so sharply in Atlanta, much of Florida, 

Nevada, and Arizona that investors can purchase distressed properties and profitably rent 

them out. Many of these markets actually appear undervalued when current prices are 

compared with household incomes and effective rents. Unlike the house flippers who 

sought quick profits during the bubble, today's distressed-property investors seem willing 

to hold on. TIley include both individuals and institutions with investment horizons of 

more than a few years. 

Prices for nondistressed homes are also holding up better than they did earlier in the 

foreclosure crisis, according to CoreLogic and FNC. Many distressed properties may be 

in less desirable areas and no longer in direct competition with nondistressed properties. 

nlis suggests that damage to homeowners' wealth will be less severe, with less economic 

fallout. 
36 


20912007.eps

TIle flow of mortgage loans entering foreclosure should also begin to slow soon, since 

fewer troubled loans are in early stages of delinquency. TIle number of first mortgage 

loans between 30 and 90 days delinquent is falling quickly (see Chart 6). This reflects a 

better job market and improvements in lUlderwriting standards since the recession. 

Mortgage loans originated during the past three years are of excell ent quality. 

Vicious cycle 

Chart 6: Early-Stage Mortgage Delinquency Is Falling Fast 

First rrortgage loans 30-90 days delinquen~ ths, SA 

2,400 ,----------------, 

2,200 . 60 days 

2,000 . 30 days 

1,800 t------;-: 

1,600 +---

1,400 

1,200 

1,000 

800 

800 

06 07 08 09 10 11 

Notwithstanding our optimism that future house price declines will be modest, risks are 

too high that they will be more severe than anticipated. With so many underwater 

homeowners, it would not take much to reignite the vicious cycle that roiled the housing 

market and economy during the Great Recession: Falling prices pushed more 

homeowners lUlder water, prompting more mortgage defaults and more distress sales and 

thus more price declines. 

With an estimated 14.6 millioll homeowners under water, half by more than 30%, this is a 

real possibility (see Chart 7).Vll Adding to the concern, the average underwater 

homeowner's debt exceeds the market value of her hOllle by nearly $50,000. It would not 

take much to induce many in this situation to mail their keys back to lenders; a leaky roof 

or broken air conditioner might be sufficient, particularly if rental housing is available 

nearby for less than the cost of the mortgage. Studies based on credit file data suggest the 

share of strategic defaults- involving homeowners who are current on other debt 

obligations-has risen and now accounts for approximately one-fourth of all defaults. 

Decisions to default depend critically on expectations about future house prices. If 

homeowners think prices will rise, they are more likely to hold on; if they believe more 

price declines are coming, they are more likely to give up. 111is can quickly become a 

vicious cycle, as occurred during the depths of the recession. 
37 


20912008.eps

Chart 7: Millions of Homeowners Sink Underwater 

f-bmeOWlers' equity distribution, mil of homecwners, 201103 

5,--------------------------, 

3 

2 

o 

Nearty 15 mi oomeo't'l'l'lers are underwater 

and 6.5 mil are underwater by more than 

30% 

>-5O'lb -5O%.30% -3Q%.20% ·20",(,.10% -10%-0'lb 

Sources: Eq.lifaJ:, Mooc¥sMal~cs 

Only a massive policy effort broke that vicious cycle. The federal govemment put Falmie 

r."Iae and Freddie Mac into conservatorship and the FHA aggressively expanded its 

lending. Today the federal govenUllent originates more than 90% of all new mortgages. 

In addition, conforming loan limits were increased and three rounds of housing tax 

credits were enacted as part of the federal fiscal stimulus. The Federal Reserve purchased 

$1.25 trillion in mortgage securities to bring mortgage rales down as part of its 

quantitative easing initiative. TIle govenuuent also took part in the mortgage-loan 

modification effort via the Home Affordable Mortgage Program and encouraged 

mortgage refinancing via the Home Affordabl e Refinancing Program. 

Although various elements of this policy response may warrant criticism, it is important 

to remember that the effort was devised and implemented quickly, under e}"ireme 

circumstances. Moreover, in its totality, the policy response worked; the housing market 

stabilized beginning in 2009. Yet if housing were to begin another dark cycle, the policy 

response would not be nearly as aggressive. There is little political appetit e for another 

big-government intervention in the economy, particularly given Washington's precarious 

fiscal situation. 

With housing and the economy still facing significant threats, and with poli cymakers 

unlikely to respond aggressively in another crisis, it is sensible to consider a number of 

modest additional steps now to make sure housing does not backtrack. These should 

include facilitating more mortgage refinancing, supporting increased mortgage loan 

modifications, and aggressively pursuing efforts to convert more ,distressed properties to 

rental use before they are sold and further depress house prices. Vlll 

More mortgage refmancing 

Policymakers should move to substantially increase the amount of mortgage 

refinancing.

ix 111is is a particularly propitious time for homeowners to refinance, as 

mortgage rates have fallen to record lows. The 30-year fixed mortgage rate for prime 
38 


20912009.eps

borrowers is well below 4%, and likely to remain very low for some time given the 

Federal Reserve's stated resolve to keep interest rat es low for the ne;...1 several years. 

Monetary authorities are also keeping open the possibility of more quantitative easing 

that would likely include purchasing more mortgage-backed securities. 

Given record low borrowing costs, refinancing has been disappointingly slow. In 2003, 

when fixed mortgage rates were between 5.5% and 6%, home loans were being 

refinanced at an annualized rate above $4 trillion. The current level of activity is about 

one-fourth of that (see Chart 8). The 2003 boom was fueled by the large number of 

mortgages that had been originated when rates were much higher, making a sub-6% rate 

very attractive. Yet even today, some two-thirds of all outstanding mortgages carry 

coupons above 5%. Millions more U.S . homeowners should be refinancing, significantly 

cutting their monthly payments. TIlis would be a boost both for individual household 

finances and for the ailing economic recovery. 

Chart 8: Rates Plunge, Refis Putter 

3,&10 11 

3,000 -Freddie Mac fixed rate (R) 10 

2,&10 9 

2,000 8 

1,500 

1,000 6 

500 5 

0 

90 95 00 05 10 

Sources: MBA, FreddeMac, MooOjshla¥ics 

TIle Obama administration has worked since the introduction of HARP in mid-2009 to 

encourage homeowners with little or negative equity, and whose loans are insured or 

owned by Fannie Mae and Freddie Mac, to refinance. Originally, the administration said 

HARP would allow between 4 million and 5 million homeowners to reduce their interest 

rates to market levels. But so far, only about 1 million homeowners have refinanced using 

HARP, and fewer than 100,000 underwater homeowners have refinanced. 

TIle disappointing results prompted the administration to unveil a number of important 

changes to the HARP program late last year. These included relaxed eligibility 

requirements, allowing borrowers with loan-to-value ratios (LTV) of above 80% to 

participate, streamlining the appraisal and underwriting process, getting most mortgage 

insurers to drop their recession rights, and requiring Fannie and Freddie to relax their reps 

and warranties. It has taken a few months for mortgage servicers and insurers to 

implement the new HARP mles, but the benefits of the new mles should become evident 

in coming months.x Servicers appear to be particularly enthusiastic about the possibility 

of reducing their put-back risk. xi 
39 


20912010.eps

As recently as early February, the administration proposed even more aggressive steps to 

support refinancing, affecting all mortgage loans including those insured by Fannie, 

Freddie, the FHA, and nongovernment lenders.

xii If implemented quickly, this proposal 

should boost refinancing, speeding the recovery in housing and beyond. 

For Farmie and Freddie loans, the Obama administration proposes that the new HARP 

rules apply to all loans, not just those with LTVs over 80% as is now the case. For 

FHAIV A loans, the administration is proposing that the FHA drop refinanced loans from 

the "Compare Ratio" process by which the perfonnance oflenders is assessed (analogous 

to Fannie and Freddi e's reps and warranties). For nongovernment loans, the 

administration is proposing that the FHA refinance the mortgage. The administration is 

also proposing that taxpayers pay closing costs when homeowners agree to loans of 20 

years or less, with monthly payments equal to those on their current loan. TIlis would 

allow homeowners to build equity more quickly. 

TIle administration's proposal substantially increases the pool of homeowners eligible to 

refinance and helps remove impediments to more refinancing. Significantly reducing the 

put-back risk faced by lenders on refinanced loans will encourage lenders to aggressively 

compete for refinancing business. Lowering borrowers' closing costs increases the 

incentive for them to participate as welL 

Fully implemented, the administration's proposals \vould increase the munber of 

homeowners eligible to refinance to nearly 28 million, covering more than half of all 

loans outstanding.

xii1 1l1e plan would affect all mortgage loans on owner-occupied singl efamily homes for which the current mortgage rate is above 5%, and that have been 

current over the past six months. To qualify, borrowers would have to be no more than 

one month past due in the prior 12 months, be within the confomling loan limits, and 

have a credit score of more than 580 (see Chart 9). There would be no restriction on when 

the loans were originated, unlike the current HARP, which is limited to loans originated 

before mid-2009. 

Chart 9: Mortgage Loans Eligible for Refinancing 

First mortgage loans, ths 

2,500 

~2 000 

"500 

1,000 

500 

o 

-FHAIVA 

- - FannielFreddie 

A -Nongovernment 

1\, V V 

IN l.~ v\. 

A. ./':l NV V' I.LU. ~ 

2 2.5 3 M 4 ~ 5 5.5 6 6.5 7 75 8 

Current Coup::m 

Sources: McO~sh.lPS 
40 


20912011.eps

For all this, many homeowners would still not refinance. Yet under reasonable 

assumptions- including mortgage rates remaining near their current 4o/o-we estimate 

that the administration's proposal would result in 6.8 million more refinancings by the 

end of2013.

xiv That number includes 3 million FannielFreddie borrowers, 2.5 million 

FHAIV A borrowers, and 1.3 million nongovernment borrowers. 

There should be no cost to taxpayers for the additional Fannie, Freddie, and FHAIV A 

refinancings. As the FHA refinances loans of nongovernment borrowers it will take on 

added credit risk, the cost of which would be borne by the financial industry under the 

administration's plan. Since the industry will likely oppose this, jeopardizing the overall 

effort, Congress could instead use some of the remaining $20 billion in TARP money set 

aside to pay for policies targeted at addressing the housing crisis. 

For the administration's efforts to be effective, the FHFA-Fannie and Freddie's 

regulator- will need to support the plan, and the FHA refinance plan for nongovernment 

borrowers will require legislation. The FHF A has been reluctant to engage in such efforts, 

ostensibly because it fears they will require more taxpayer support for the agencies.xv 

This argument seems increasingly specious. While the agencies would lose some interest 

income on their $1.2 trillion in mortgage securiti es and whole mortgage loans, under 

reasonable assumptions the cost would be offset by lower default rates on loans that are 

refinanced. Borrowers are more likely to stay current if their monthly payments drop by 

$100 or $200. hldeed, under reasonable assumptions, Fannie and Freddie would break 

even if the probability of default on the loans and securities they own and insure falls by 

about 25 basis points.

xvi 

The benefit to borrowers is meaningful. Assluning the average homeowner can refinance 

into a 4% fixed-rate loan, the gross saving from lower mortgage payments would come 

close to $18 billion a year (6.8 million borrowers x $140,000 average mortgage balance x 

1.8% average rate reduction). 111is would provide a quick cash boost for mostly middleincome homeowners. Some would be used to repay other debt, but the bulk would likely 

be spent on home improvements or other needs. Assuming about three-fourths of the 

eA1ra cash is spent during the year, real GOP will see a small but meaningful boost, 

adding 0.1 percentage point to growth this year. xvii The fragile U.S. recovery can clearly 

use all the help it can get. 

More refinancing would also further the Federal Reserve's short-tenn goals. Monetary 

policymakers are considering a new round of quantitative easing-a process in which the 

Fed purchases long-tenn securities in an effort to bring down interest rates, including 

fi xed mortgage rates. Indeed, the recent decline in mortgage rates is due in part to 

expectations that the Fed will resume quantitative easing. If it does, arguably the most 

significant benefit would involve increasing the pace of home-loan refinancing. Anything 

fiscal policymakers can do to support the Fed's efforts would be a plus. 
41 


20912012.eps

While homeowners would clearly benefit from more refinancing and taxpayers would be 

largely lmaffected, global investors in agency mortgage-backed securities would be hurt 

financiall y. As more loans are refinanced, higher-yielding MBS would be retired and 

replaced with lower-yielding MBS. To be precise, if a more effective HARP resulted in 

6.8 million more refinancings, private investors would receive approximately $11 billion 

less in aJIDual interest income. xviii 

MBS investments are held by a wide array of institutions. Through its credit easing 

efforts last year, the Fed quickly became the largest owner of agency MBS, amassing 

$1.25 trillion or about a fourth of the total outstanding. The nation's central bank can 

easily absorb the lost interest income from increased prepayments, but this may put 

pressure on the Fed to be more aggressive in its quantitative easing efforts to forestall a 

counterproductive rise in mortgage rates. TIle interest rate spread between MBS and 

Treasury yields will increase regardless, but MBS yields need not rise if the Fed buys a 

sufficient amount of Treasury bonds. 

While other private MBS investors will not be happy to get their money back when 

interest rates are low, they were aware of this prepayment risk when they purchased their 

securities. hldeed, investors are likely surprised that their securities have not been retired 

already, as they would have been in a more normally flIDctioning mortgage market. The 

updated HARP can thus be seen as a way to correct a serious market failure. It is also 

important to note that MBS investors have been significant beneficiaries ofthe monetary 

and fiscal policy response to the financial panic and Great Recession. The Fed's massive 

purchases of agency MBS during a previous rOlmd of quantitative easing was a windfall. 

Myriad federal housing and foreclosure poli cies aiming to stem foreclosures have also 

significantly benefited investors through reduced prepayments. 

Policymakers may be nervolLs that overseas investors, who constitute a sizable and 

growing source of capital for the u.s. Treasury, will be annoyed by faster prepayments. 

Policymakers may also worry about implications for the financial health ofthe nation's 

depository institutions and pension funds, who also are big investors in agency MBS. 

While not unreasonable, these seem marginal concems given the magnitude of the losses 

that will be widely distributed anlOng investors. 

Another potentially unwelcome side effect of boosting refinancing activity today could 

be less labor mobility in the future. Borrowers who lock in record low mortgage rates 

today will be less willing to move when rates start to climb. Given that homeowners tend 

to be more skilled than renters, this impediment to labor mobility could aggravate the U.S. 

economy's current skills mismatch. However, it is difficult to know the scale ofthis 

consideration; it seems small against the sizable near-tenn benefits of a refinancing 

program. It is also worth noting that homeowners who switch from adjustable-rate to 

fixed-rate mortgages will be protected when interest rates ultimately rise. 
42 


20912013.eps

Principal reduction modifications 

A more dramatic and costly policy step, but one with the best odds of ending the housing 

crash more quickly and definitively, would be to encourage more mortgage modifications, 

particularly those involving substantial principal write-downs. Principal reduction has 

economi c positives and negatives, but is a positive on net if it is well-designed. TIle main 

concerns are moral hazard and fairness. To deal with these, modifications must be welltargeted, Witil clearly articulated eligibility requirements. A long vesting period and some 

type of clawback provision for future capital gains to guard against potential fraud would 

also be helpful. 

HAMP was reworked in late 2010 to promote principal reduction modifications, but the 

change has accomplished little so far. To date, there have been fewer than 1 million 

permanent HAMP modifications, and very few of these have involved principal reduction. 

When HAMP was unveiled in mid-2009, President Obama was hoping for between 2 

million and 3 million HAMP modifications. xix (see Chart 10) 

Chart 10: Modification Efforts Flag 

Permanent m:xIifications, ths, annualized 

2,000 ,--------------------, 

1,750 

1,500 

1,250 

1,000 

'''' 

500 

'''' 

_ Private mods _ HAMP mods 

~-L L-~~~~~ 

07 08 09 10 11 ytd 

Sources: Hope N!JW, Mo»js Alla¥ics 

Responding to this shortfall, the Obama administration proposes more changes to HAMP 

to increase eligibility and extend the program through 2013. More importantly, the new 

program will significantly increase incentives for mortgage servicers who modify 

mortgages by reducing principal. For every dollar that a servicer writes down a loan, the 

Treasury will pay the servicer up to 63 cents. The president proposes paying for this out 

ofthe remaining $20 billion in TARP money slated for housing. 

11lis expansion of HAMP could be particularly effective given the impending settlement 

between state attorneys generals and mortgage servicers over robo-signing and other 

foreclosure process issues. This deal is reported to include a monetary settlement of up to 

$25 billion, a significant share of which will be allocated to modifications, including 

principal reduction, ofloans on the servicers' balance sheets. 
43 


20912014.eps

For scale, suppose a total of $20 billion is allocated to principal reduction modifi cations, 

including those done via the new HAMP and the mortgage settlement. If the average 

amount of principal reduction per homeowner is $30,000, more than 650,000 

homeo\vners would benefit. This is approximately equal to the number who currently 

satisfy the following eligibility requirements: 

• Homes are owner·occupied. 

• Homes were bought before December 31, 200K 

• The homeowner took no cash out in past refinancings. 

• First mortgages are below cOllfonning loan limits. 

• Loan principal is reduced by no more than $40,000. 

Moreover, the modification would have to result in the following conditions: 

• The loan could be no more than 10% above the home's market value (to limit the 

probability of redefault). 

• The "front·end" debt-to-income ratio (counting only housing costs) could not 

exceed 31 %, and the "back-end" DTI ratio (counting all obligations) could not 

exceed 50%. 

Assuming a redefault rate of 25%, this would result in almost 500,000 sustainable 

modifications.

xx Along with those that would take place in any event, this is about the 

number needed to forestall anticipated hOLlSe price declines. Without such a plan, the 

share of distress sales is expected to rise from more than a third to just under 40% by late 

2012 (see Chart II). House prices will decline as the share of distress sales rises. But if a 

modification progranl is implemented soon, the share of distress sales will level off and 

house prices will stabilize. 

Chart 11 : Distressed Share of Sales Are High and Rising 

Share of home sales 

40 

35 

30 

25 

20 

15 

10 

5 

o 

I- • Short sale share 

I- • Foreclosure share 

... 

11.11.11.1.1.1. 

06 07 08 

Sources:zjllow, Reatt , Moodjshla~C'i 

09 10 11 
44 


20912015.eps

REO to rental 

Policymakers are also rightly focused on converting more distressed property to rentals. 

Reducing the munber of distressed properties that go up for sale will reduce the share of 

such sales and thus support house prices. The number of properties classified by banks as 

"other real estate owned" or REO-the last stage of the foreclosure process before a 

distress sale-has declined over the past year, hut only because the robo-signing scandals 

have slowed foreclosures (see Chart 12). Once a settlement is reached between the state 

AGs and mortgage servicers, foreclosures and thus REO properties and the distressed 

share of home sales will pick up again. Converting more REO property rentals will 

mitigate this increase and thus slow further house price declines. 

Chart 12: REO Inventory Remains High 

REO inventory 

700,0:::0 

600,"" 

500,"" 

400,0:::0 

300,0:::0 

200,"" 

100,0:::0 

o 

---=-

- • 

_BankS 

_Fannie 

_Securitized 

08 

II 

iI 

II 

FHA _ Freddie 

09 10 

Sources: Fannie, Freckie, FHA, FDIC, M~5Al1a¥iCS 

~ -=-

11 

A key to doing this is getting private investors and property managers involved. Investors 

show healthy interest in buying distressed property for rental, fueled by the fall in house 

prices alongside a sharp increase in rents. Given strong rental absorption and very weak 

construction of rental space, rents are rising at a sturdy mid-single-digit pace and are at 

levels that can cover investors' costs while they wait for properties to appreciate. Most 

investors are not flippers looking for quick profits- given the state of the housing market 

this would not be a winning strategy- but have investment horizons of three to seven 

years. Such investors would likely be willing to rent properties purchased from Fannie, 

Freddie and the FHA for at least several years, selling them after house prices begin to 

nse aga1ll. 

It is important to note that many investors are local, living in the neighborhoods where 

they are buying. Many have also bought with cash, given the dearth of mortgage 

financing. Institutional investors are also participating, but at least so far have been 

cautious and selective in their purchases. 

The Obama administration recognizes that converting REO properties to rentals is a 

potentially productive way to help the housing market. Last summer they asked various 

housing market participants how to design an REO-to-rental program. As part of the 
45 


20912016.eps

president's recent housing initiative, the FHFA announced it would pre-qualify investors 

to bid on Fannie and Freddie REO-to-rental transactions. Hopefully more initiatives will 

soon come to fruition. 

It is also important for the FHF A to fully embrace this process. Fannie and Freddie have 

historically not engaged in bulk foreclosure sales to in vestors or entered into agreements 

with property managers. To successfully engage in these kinds of activities will require 

the blessing of the FHFA and significant investment. Even then, Fannie's and Freddie's 

lack of experience in this area is among the most significant impediments to success. 

One way to significantly increase investor interest in purchasing REO properties is to 

allow buyers to expense their investments for tax purposes up front. 11Iis is the same 

benefit received last year by businesses for investments in equipment and software. 

Giving investors a small tax break should boost demand, supporting prices for distressed 

homes and the housing market in general. It would cost taxpayers little, since the tax 

liabilities of investors will be greater once they have exhausted their depreciation benefits. 

Conclusions 

The housing crash and foreclosure crisis are not over. Home sales and housing 

construction are stable but depressed, and house prices remain weak. With millions of 

foreclosures and short sales set to hit the housing market over the ne).1 two years, house 

prices are set to fall further. 

While house prices are declining, th e recovery will have difficulty gaining traction. For 

most Americans, the home is still the most important asset, and consumers will be 

reluctant to spend while their wealth erodes. Many small-business owners use their 

homes as collateral to grow, and local governments rely on property taxes tied to house 

pnces. 

11Iere are some reasons to be optimistic that the crash is winding down. House prices 

have fallen far enough that singie-fanlily housing is affordable and increasingly attractive 

compared with renting. Investors are putting up cash to purchase distressed properties. 

Overbuilding remains a problem, but a decreasing one given a record-low pace of new 

construction and increased household formation. 

But this optimism will be easily overwhelmed if house price declines reignite a vicious 

cycle, putting more homeowners under water, accelerating foreclosures and distress sales 

and driving prices even lower. Only an unprecedented monetary and fiscal policy 

response short-circuited that cycle during the recession. 

Given the balance of risks, policymakers should thus consider providing additional 

temporary help to the housing and mortgage markets. Reinvigorating mortgage 

refinancing would provide a substantial boost with no memlingful cost to taxpayers. More 

refinancing will mean fewer borrower defaults and more money in the pockets of 

homeowners, supporting the recovery through a quick and sizable cash infusion. 
46 


20912017.eps

Facilitating more well-targeted principal reduction loan modifications would be a much 

larger and costli er step but would bring the housing downturn to a quicker and more 

definite end. The number of modifications and the amount of principal reduction 

necessary to stabilize house prices can be reasonably financed with funds from the 

impending settlement between state attorneys general and mortgage servicers, and the 

president's proposals to expand RAMP. 

Moving more property out of the foreclosure pipeline before it goes to a distress sale 

would also be a big plus, reducing the pressure on housing values. Given the sharp 

decline in house prices and the recent increase in effective rents, the returns to private 

investors participating in such efforts are increasingly attractive. 

Each of these policy steps has their problems, but they are worth carefully considering 

given that the housing downturn remains among the most serious threats to the stillfragile economic recovery. 
47 


20912018.eps

I We estimate that nearly 6.5 million homeowners have lost homes through foreclosure, short sale, or deeds 

m heu smce the housing crash began in 2006. An addltional 6 million homeowners are expected to lose 

homes before foreclosures return to levels consistent with a well-functioning housing market, expected in 

2015 

i, A well-functioning housing market is defined as one consistent with an economy operating at full 

employment and growing at its potential rate 

III The pace of new construction is supported by the annual formation of 125 million households, the 

obsolescence of 300,000 housing units, and the purchase of 200,000 vacation homes 

iv House prices should increase at a pace between the annual rate of growth in household income (4%) and 

overall annual price intlation (2%). House prices are ultimately determined by replacement costs, which 

equal the cost of land plus the cost of construction, The cost of land is determined by its opporttmity cost, 

or GDP per developable acre. The growth in GDP per acre is equal to the growth in household income 

(assuming that the profit share of GDP remains constant). Construction costs will grow at the rate of overall 

mflation In the long run, although matenal and labor costs can tluctuate substantially in the short run. Since 

the share of land costs in overall house prices varies considerably from place to place (very high in San 

Francisco, for example, much lower in Des Moines) growth in house prices will vary considerably among 

regions. For the past quarter century or so (the recent boom and bust aside), house prices have grown at a 

rate closer to household income. As financia l and other incentives for homeownership increased, 

households spent as much on housing as their incomes would allow. These incentives have likely peaked 

and may well declme; therefore households WIll devote less of their income to housing, and pnces are 

likely to increase at rates closer to intlation. 

v There is a long literature with regard to the wealth effect. For a description of my estimates and how they 

are incorporated into the Moody's Analytics model of the U.S. economy, see "The Wealth Effect," Mustafa 

Akcay. Regional Financial Review, November 26,2008. 

"The Housing Vacancy Survey may also overstate the problem, Recent data from the 2010 census suggest 

there are fewer rental vacancies than the survey implies The Census Bureau's Housing Vacancy Survey is 

based on a sample that, given the 2010 census data, appears to be biased 

vii CoreLogic estimates there are closer to 11 million underwater homeowners, The Moody's Analytics data 

are based on actual mortgage debt outstanding from Equifax credit files. while CoreLogic's estimate is 

based on debt outstanding at origination The Moody's estimate of negative equity is nearly the same as 

CoreLoglc's in California, much lower in Flonda, and higher most everywhere else, CoreLogic may have 

some difficulty measuring debt outstanding in rural or exurban areas where homeowners generally have 

little equity even in good times (since house prices there do not rise much) and go into small negativeequity positions in difficult times. The Moody's estimate is much higher in Texas, for example. CoreLogic 

data are also unavailable for a half-dozen states. 

,m The Federal Reserve's recent white paper on housing advocates similar steps. See "The U.S Housing 

Market: Current ConditIOns and Policy Considerations," January 4,201 2 

http://federalreserve,gov Ipubl ica ion~ other -reJ?Orts/fileslhousing -white-paper -20120 I 04. txlf 

IX Calls for policymakers to enable mortgage refinancing have steadily increased since late 2010. See 

"Restringing HARP: The Case For More Refinancing Now," MarkZandi and Cris DeRitis. Moody's 

Analytics Special Report, October 7, 2010. http://www.economy.comimarkzandi/documentslHARP 10071 O,pdf 

x See "Improved HARP Will Expand Refinancing and Boos! Recovery," Mark Zandi and Cris DeRitis 

Moody's Analytlcs Special Report, October 31 , 2011, http://www.economy.com/markzandi/documentsf20 11 -1 0-26-Zandi-Improv ed-HARP-W ill-Expand-Refinancing -Boost -Recovety.pdf 

xi Put-back risk is the chance that Fannie and Freddie will require the servicer to take back a loan that was 

improperly originated. There is also a risk that mortgage insurers will rescind insurance on a poorly 

underwritten loan. The cost to servicers of having loans put back has been considerable. 

xu A fact sheet describing the president's housmg plan can be found at http://www.whitehousegovithepress-officeI2012i02l01 /fact-sheet-president-obama-s-plan-help-resoonsible-homeowners-and-heal-h . 

• i,i This is based on an analysis conducted by LPS using the McDash servicing database and the LPS-AA 

HPL 

.iv This is a very conservative estimate of the number of homeowners who will refinance, excluding all 

eligible FannielFreddielFHAlVA borrowers with LTVs of less than 100% and nongovernment borrowers 
48 


20912019.eps

with L TVs of less than 80010 The working assumption is that these borrowers have already had the 

opportl.mity to refmance and are thus unhkely to use the new programs 

<V Taxpayers have already put more than $150 billion into Fannie Mae and Freddie Mac since they were put 

into conservatorship in September 2008 

1\' The break-even change in the default rate equals the lost interest income divided by the product of the 

mortgage debt ovmed and insured and the loss from default, which is assumed to be 50010 of the mortgage 

balance 

Hi; This assumes the proposed changes to HARP are implemented by early next year. The assumed 

spendout rate is consistent with that of the 2001 tax rebate and the refmancing wave early in the last decade. 

See Johnson, et. I'll. "Household Expenditure and the Income Tax Rebates of2001," American Economic 

Review, vol. 96, no 5. pp. 1589-1610. The spendout would likely be greater given that homeowners will 

view lower mortgage payments as a more pennanent increase in real incomes . 

..,;, This excludes the interest income that would be lost by Fannie, Freddie, and the Federal Reserve 

xiI There have been nearly 5 million total modIfications, includmg those done under HAMP, by the FHA 

and in the private sector since the modification effort began in earnest in 2007. RAMP has arguably 

facilitated more private modifications by requiring private servicers to invest in their own modification 

efforts. Hope Now provides the most comprehensive accounting of the modification effort. See: 

http://www.hooenow.com/industry -data/20 12-0 1-13-HOPENOW%20Data%20Reoort-

(November)%20DraftV3.pdf 

n The redefault rate could be even lower gIven that tlus IS comparable to the redefault rate on HAMP 

modIfications. 
49 

1See, H.R. 3221-11. I have abbreviated the rules to focus on the relevant parts of the legislation for this testimony. This is not a complete list of all legislative requirements. 

PREPARED STATEMENT OF CHRISTOPHER J. MAYER 

PAUL MILSTEIN PROFESSOR OF REAL ESTATE, FINANCE, AND ECONOMICS, COLUMBIA

BUSINESS SCHOOL

FEBRUARY 9, 2012 

Good afternoon Chairman Johnson, Ranking Member Shelby, and Members of the 

Committee. Thank you for inviting me to speak today. My name is Christopher J. 

Mayer. I am the Paul Milstein Professor of Real Estate at Columbia Business 

School. I have spent the last 18 years studying housing markets and credit while 

working at the Federal Reserve Bank of Boston and serving on the faculties of Columbia Business School, the University of Michigan Business School, and the Wharton School of the University of Pennsylvania. I also serve as Visiting Scholar at the 

Federal Reserve Bank of New York. 

The Federal Reserve recently issued a white paper documenting many of the frictions in the housing finance system and suggesting how such frictions have had a 

negative impact on the housing market and the economic recovery. The Federal Reserve points out that ‘‘Obstacles limiting access to mortgage credit even among creditworthy borrowers contribute to weakness in housing demand, and barriers to refinancing blunt the transmission of monetary policy to the household sector.’’ 

Despite record low interest rates, mortgage activity has fallen precipitously. According to the Mortgage Bankers Association, the dollar volume of mortgages originated to purchase homes in 2010 (the last full year of data) has fallen to the same 

level as in 1992 (see, Figure 1, at the end of this testimony). Although one might 

have expected large numbers of refinancings because of low rates, refinancing activity in 2010 was, in fact, at the second lowest annual level since 2001 (Figure 2). 

So far, through the 3rd quarter of 2011, mortgage lending is down almost 19 percent 

from the same period in 2010. By comparison, according to Equifax Origination 

Credit Trends, new consumer lending is up 11.1 percent on a year-to-date basis in 

November 2011 from the previous year, showing increases in nearly every category 

including auto lending, credit cards, consumer finance, and student loans. 

Other housing data released since the white paper was published continue to 

highlight the negative picture of the housing market that the Federal Reserve discusses relative to the rest of the economy. S&P/Case-Shiller indexes for 20 cities in 

November fell 1.3 percent from October and 3.7 percent for the full year, both larger 

decreases than anticipated and stoking fears that home prices might start falling 

again if foreclosures pick up, as they inevitably must. Lender Processing Services 

reports that 8.15 percent of mortgages are delinquent and 4.12 percent of mortgages 

are in some stage of foreclosure; both numbers that are nearly identical to June 

2011. The share of mortgages that were current 6 months earlier but seriously delinquent now is higher than it was in June 2011. In other words, even as the labor 

market has started to improve, the housing market remains mired in difficulties. 

Stepping back, it is important to understand the role of Government interventions 

in the housing market and the unintended consequences. After housing prices went 

into a free fall in 2007, private mortgage credit collapsed shortly afterwards. Newly 

issued private first mortgage securitizations, which once were nearly a trillion dollars per year, fell to almost zero. Government sponsored entities Fannie Mae and 

Freddie Mac (the GSEs) along with the Federal Housing Administration (FHA) 

quickly came to dominate the market. Yet soon the bond market became leery of 

lending to the GSEs, which did not have an explicit guarantee on their debt. With 

their solvency in doubt, the Federal Government backstopped the GSEs by putting 

them in conservatorship in September 2008. The Federal Housing Finance Agency 

(FHFA), an independent Government agency and previously the GSE’s regulator, 

became the conservator, taking over management of the GSEs. As well, the Government provided an explicit guarantee on their debt. The Government began further 

backing the GSEs when the Federal Reserve announced at the end of 2008 that it 

was beginning the purchase of what eventually became nearly $1.25 trillion of GSE 

securities. 

Fannie Mae and Freddie Mac Under Conservatorship 

In 2008, Congress passed the Housing and Economic Recovery Act (HERA). Under 

HERA, which tasked the Director of the FHFA to ensure the GSEs meet a number 

of conditions, including: 1

1. ‘‘each regulated entity operates in a safe and sound manner . . . ’’ 

50 

2FHFA Strategic plan, 2009–2014. 

3See the recent story from National Public Radio and ProPublica, http:// 

www.propublica.org/article/freddy-mac-mortgage-eisinger-arnold. 4 In response to recent allegations of conflicts of interest, the FHFA has pointed out that refinancing represents a large portion of the GSEs overall business. As I discuss below, this fact 

is not inconsistent with the allegations of a conflict of interest. Many of the restrictions on refinancing did not impact all borrowers, but instead reduced refinancing by borrowers with high 

mortgage rates that may also be held in GSE portfolios. 

2. ‘‘the operations and activities of each regulated entity foster liquid, efficient, 

competitive, and resilient national housing finance markets . . . ’’ 

3. ‘‘the activities of each regulated entity and the manner in which such regulated 

entity is operated are consistent with the public interest.’’ 

Soon after taking over conservatorship of the GSEs, Director James Lockhart restated the agency’s mission: 2

Provide effective supervision, regulation and housing mission oversight of 

Fannie Mae, Freddie Mac, and the Federal Home Loan Banks to promote 

their safety and soundness, support housing finance and affordable housing, 

and support a stable and liquid mortgage market. 

As well, GSEs were required to start to reduce the size of their retained portfolio 

of mortgages and mortgage-backed securities (MBS). While many critics and observers also expected or hoped that FHFA conservatorship would set the stage for the 

eventual wind down and replacement of the GSEs, no such mandate was given to 

the FHFA. In fact, Director Lockhart noted the strategic goal under conservatorship, 

‘‘FHFA preserves and conserves the assets and property of the Enterprises, ensures 

focus on their housing mission, and facilitates their financial stability and emergence from conservatorship.’’ Nowhere was there a goal to eliminate the GSEs. 

Unfortunately for taxpayers, homeowners, and the economy, in the more than 3 

years since FHFA has taken over conservatorship of the GSEs, the enterprises have 

continued to act as profit maximizing private firms, taking advantage of their market power in the mortgage market to earn profits rather than working to make the 

market more efficient. In doing so, the GSEs have taken a very narrow, and arguably, ineffective and harmful approach to managing their activities. These actions 

have resulted in enterprises that are arguably no easier to wind down today than 

they were 3 years ago. This is despite the fact that almost all commentators and 

policy makers have suggested that the GSEs as currently constructed do not represent an attractive way to finance U.S. housing in the future. 

Maybe the single biggest problem with the ongoing operation of the GSEs has 

been to failure to adequately address critical conflicts of interest in their operations. 

The evidence suggests that the conflict of interest between the businesses of providing mortgage guarantees and managing a large retained portfolio of mortgages 

and MBS have led to the obstacles to normal credit conditions. This conflict of interest was raised in recent reporting by National Public Radio and ProPublica. 3 In its 

white paper, the Federal Reserve noted that ‘‘ . . . easing some of these obstacles 

could contribute to the gradual recovery in housing markets . . . ’’ Even without 

considering the overall economy, GSEs should be concerned with the health of the 

housing market, since they now hold the risk for more than one-half of all outstanding mortgages. Thus, absent a conflict of interest, it would appear to directly 

benefit the GSEs to remove some of the obstacles the Federal Reserve discusses. 

There are plenty of examples of how this conflict of interest might have led the 

GSEs to take actions that padded their portfolio profits, even while harming the 

mortgage market and the larger economy. Many credit market decisions by the 

GSEs seem to be driven by a desire to block refinancing. 4 Fannie Mae raised upfront fees on all new loans just weeks after the Federal Reserve announced its MBS 

purchase program, with Freddie Mac following suit two months later. These new 

fees applied even in cases where borrowers’ mortgages were already guaranteed and 

their refinancing not impose any additional risk. The GSEs have taken steps to reduce competition between servicers, despite borrowers’ many complaints about poor 

service by their existing servicers. Shrinking lending, increasing legal liability, and 

other GSE policies appear to have contributed to a lack of competition to originate 

mortgages, leading to retail spreads on mortgages that remain near at all-time 

highs. The GSEs have failed to address critical problems in the mortgage insurance 

industry, leaving many consumers locked into high interest rate mortgages and 

making mortgage modification more challenging and less effective. Since refinancing 

and mortgage modification as well as lower retail spreads on mortgages reduce the 

cost of mortgage guarantees by reducing defaults, the only seemingly plausible reaVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00054 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
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5http://www.businessweek.com/news/2012-01-17/freddie-mac-sees-selling-40-billion-of-debttracking-mortgages.html 6Downing, Chris, Dwight Jaffee, and Nancy Wallace. 2009. ‘‘Is the Market for MortgageBacked Securities a Market for Lemons?’’ Review of Financial Studies, 22(7):2457–2494. 

son for such policies is to protect high interest payments on mortgages and MBS 

held in the GSE’s portfolio. 

The reports by National Public Radio and ProPublica highlighted how these conflicts of interest may also have influenced portfolio decisions at Freddie Mac. Instead of selling off the MBS that it inherited when it entered conservatorship, 

Freddie Mac appears to have created and held complex, highly leveraged mortgage 

derivatives that are risky and nearly impossible to sell. In addition, Freddie Mac 

created new and complex long-term financing for its MBS positions (called Mortgage-Linked Amortization Notes, or MLANs) rather than choosing to sell these securities into the open market and reduce the size of its portfolio business. 5 These 

transactions highlighted the appearance of a conflict of interest since the transactions were structured so that the enterprise lost valuable interest payments if borrowers with very high interest rates were able to refinance their mortgages, a policy 

that is substantially under the control of Freddie Mac. Whether intended or not, 

these transactions also make it harder to unwind Freddie Mac and its portfolio in 

the future. 

While seemingly consistent with the strategic goal listed above of conserving and 

preserving assets to emerge as an ongoing entity, the policies described above appear to violate a number of the GSE’s other mandates, which are to ‘‘foster liquid, 

efficient, competitive, and resilient national housing finance markets’’ and to operate 

in a manner ‘‘consistent with the public interest.’’ From the first quarter of 2008 

to the first quarter of 2011, the market share of the top five mortgage originators 

has grown from 56 percent to 65 percent. As well, according to Bloomberg (Figure 

3) the spread between retail and wholesale mortgage rates has widened by at least 

0.75 percent (75 basis points) between its average from 2000 to 2007 and its level 

at the end of 2011. These facts suggest that conservatorship has resulted in less 

competitive and less efficient mortgage markets. 

The Dueling Business Interests of the GSEs: A Conflict of Interest? 

To better understand these issues, it is important to look at the historical context 

in which the enterprises arrived into conservatorship. When the FHFA took over the 

management of Fannie Mae and Freddie Mac (GSEs), the enterprises had two principal businesses: mortgage guarantees and portfolio management. The mortgage 

guarantee business involves collecting premiums and insuring bondholders against 

credit losses. When a borrower defaults on a mortgage, the GSEs must buy the 

mortgage out of a pool at par, so bondholders are made whole. The portfolio business involves owning and managing a large balance sheet made up of mortgagebacked securities (MBS) and mortgages. Both businesses were considered to be in 

serious financial trouble when the GSEs entered conservatorship. 

The guarantee and portfolio businesses have always involved an inherent conflict 

of interest—the GSEs know more about the mortgages in the MBS than other parties. One study by researchers at the University of California at Berkeley and 

Barclays argued that the mortgage-backed securities market was a market for lemons. 6 The article showed that securities that Freddie Mac sold to the market were 

of lower quality than those it didn’t sell. Traders have always recognized that the 

GSEs were more informed than they were and market prices reflected this friction. 

Financial economists would note that the existence of some traders using nonpublic 

information inherently leads to less liquid and efficient markets, as other traders 

must account for adverse selection when bidding on securities. 

Most public policy concern about the growth of the GSEs portfolio was not about 

conflicts of interest, however, but risk. During the 2000s, the retained bond portfolio 

grew rapidly, taking advantage of their implicit guarantee by taking on additional 

risk on behalf of taxpayers. The GSEs even began to purchase securities with risky 

subprime mortgages that were specially designed for them to acquire. 

In 2008, the FHFA inherited the management of firms with $1.1 trillion of MBS, 

hundreds of billions in mostly failed mortgages, and a bankrupt guarantee business. 

As well, with the demise of private securitization and the fragile state of the financial services sector, the GSEs and the FHA were guaranteeing more than 90 percent 

of new mortgages, a condition that continues today. Without competition in new 

mortgage origination, the conflict of interest between mortgage guarantees and portfolio management once again rose to the forefront. After all, actions that might lead 

to even a small percentage change in the value of the portfolio would have a material impact on profits of these formerly semi-private companies. 

52 

7See a history of our research on widespread refinancing along with our current proposals 

on our Web site: http://www4.gsb.columbia.edu/realestate/research/housingcrisis. 8http://libertystreeteconomics.newyorkfed.org/2012/01/why-mortgage-refinancing-is-not-azero-sum-game.html 

Soon after conservatorship, in December 2008, Fannie Mae announced LLPAs 

(loan level pricing adjustments), up front fees that would be paid by all borrowers 

on newly originated mortgages. These fees, when combined with adverse market delivery charges, could equal more than three percent of the mortgage amount, to be 

paid up front. Freddie Mac soon followed with its own fees, although it never posted 

its fees online the way Fannie Mae did. 

While such fees have sometimes been defended as an attempt to add risk based 

pricing to mortgage originations, they were also applied on an equal basis to borrowers who were refinancing mortgages that the GSEs already guaranteed. The 

Federal Reserve white paper referred to such fees as ‘‘hard to justify’’ when applied 

to refinancing their own mortgages. As well, imposing new, large up-front fees in 

the middle of a serious recession and stock market decline when down payments 

were scarce had the practical effect of reducing demand for mortgages among affected borrowers. A seemingly preferable alternative would have been to increase 

the annual guarantee fee (so-called ‘‘g-fee’’) on mortgages for new purchases, which 

would likely have had a smaller negative impact on demand. A fee structure that 

decreased demand for new mortgages also would have cut the demand to purchase 

homes, helping to contribute to a further decline in home prices. Falling home prices 

materially increased losses in the GSE’s mortgage guarantee business. However, 

from the perspective of the portfolio, an equivalent increase in the g-fee rather than 

a higher up-front borrowing cost (LLPAs) might have allowed a much larger wave 

of refinancings, possibly leading to portfolio losses. These large up-front fees were 

not a market outcome nor were they mandated in any way by conservatorship, but 

were a barrier imposed by the GSEs themselves, seemingly designed to protect their 

own portfolios from prepayments, the very outcome that the Federal Reserve’s MBS 

purchase program sought to create. 

The high up-front fees when applied to mortgages they already guaranteed was 

just one of many steps the FHFA and the GSEs have taken since conservatorship 

that have had the effect of preventing refinancing of many mortgages. As early as 

September 2008, Glenn Hubbard and I have argued for the Government to facilitate 

widespread refinancing to reduce defaults, help stabilize the housing market, and 

stimulate the economy. 7 In our own analysis, Alan Boyce, Glenn Hubbard, James 

Witkin and I have shown how a slightly higher g-fee on refinancings would create 

a structure whereby the GSEs could more than recoup any portfolio losses. David 

Greenlaw (Morgan Stanley), Mark Zandi (Moody’s Analytics), Bill Gross (Pimco), 

and many economists made similar arguments in the intervening years, but with 

little success. 

In March 2009, the President announced the HARP (Home Affordable Refinance 

Program). The program was an attempt to streamline refinancings, but eventually 

resulted in fewer than one million refinancings over a period of nearly 3 years. 

While HARP officially applied to borrowers with a loan-to-value ratio (LTV) of up 

to 125 percent, technical barriers prevented take-up by all but a few borrowers with 

LTVs above 105 percent. And up-front GSE fees (LLPAs) still applied to HARP 

mortgages. As well, under HARP, only the borrower’s existing servicer could effectively pursue a new refinancing. Even today under the new so-called HARP 2.0, existing servicers have a large advantage over new servicers in pursuing a HARP refinancing for a given borrower. 

HARP also excluded borrowers with LTVs of less than 80 percent. While some 

such borrowers might have had an easier time pursuing a refinancing, many of 

these borrowers were still subject to up-front fees and other barriers. LLPAs were 

charged for borrowers with LTVs in excess of 60 percent and FICO scores below 760. 

Reps and warranties liabilities likely prevented many such borrowers from getting 

attractive quotes from other lenders. Also, many borrowers with seemingly low 

LTVs had second liens, so that these borrowers would likely have an elevated risk 

of default and thus could benefit from lower mortgage payments. 

Finally, all of the exclusions from HARP had an additional negative effect on taxpayers and the overall economy. For example, Joseph Tracy and Joshua Wright of 

the Federal Reserve Bank of New York point out that refinancings are not simply 

a zero sum game and might instead ‘‘ . . . stabilize the housing market and support 

economic growth.’’ 8

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9 Early research on the HAMP program showed the mortgage modifications that lowered 

mortgage payments had a strong impact on reducing defaults. See, Federal Reserve Bank of 

New York Staff Report #417, originally published in December 2009, for example. 10http://www.cbo.gov/ftpdocs/124xx/doc12405/09-07-2011-LargeScalelRefinancinglProgram.pdf 

gages would almost surely reduce defaults. 9 In fact, from the perspective of the 

mortgage guarantee business, one might have expected the GSEs to go out of their 

way to refinance the riskiest borrowers, who would otherwise be at greatest risk of 

default. Yet the barriers imposed by the GSEs had exactly the opposite effect, severely limiting refinancing by the riskiest borrowers. The fees on refinancing were 

highest on mortgages where the borrower had a low FICO score or high LTV. Mortgages with high loan-to-value ratios were locked out of refinancing altogether. 

Looking back, the costs of these actions have become clear. According to my own 

calculations using data from Lender Processing Services, about one-sixth of all GSE 

guaranteed mortgages with a mortgage rate above 6 percent in 2009 defaulted, compared to defaults by about one in fifty mortgages with rates below 5 percent. Almost 

surely a program to refinance high mortgage rate borrowers would have lowered 

this default rate for this population, saving the GSEs from some large losses from 

their mortgage guarantee business and reducing the number of foreclosures and 

short sales that have contributed to falling house prices and thus even larger future 

costs from mortgage guarantees. In fact, the Congressional Budget Office’s recent 

paper on found that about for every 1,000refinancings that took place, 38 defaults 

would be prevented. 10 According to the CBO, such a program would have saved the 

GSEs billions of dollars in lower guarantee costs. A program that facilitated millions 

of refinancings might have prevented hundreds of thousands of defaults. 

It appears only possible to understand this behavior by looking at the GSEs’ portfolio management business. In fact, the CBO pointed to possible portfolio losses 

when considering the costs and benefits of a widespread refinancing program. While 

the GSEs have never disclosed much detail about their portfolio holdings, many of 

their purchases of mortgage-backed securities seem to have taken place in the mid2000s. The mortgages in these mid-2000s pools have mortgage rates that are 5.5 

percent or above. These loans have much lower mortgage balances, which indicate 

lower income households, and may be more likely to be under financial stress. In 

other words, many of the mortgages inside the securities held in GSE portfolios may 

also have been those at the greatest risk of default. Refinancing mortgages for responsible borrowers who were current on their mortgages, but also at great risk of 

default, might well have imposed losses on the GSE portfolios while saving significantly more for their credit guarantee businesses. 

Let me put the hypothesis directly. The possibility of protecting their portfolios 

explains why the GSEs have been so resistant to refinancing certain mortgages. If 

not for the conflict of interest between the portfolio and mortgage guarantee businesses, why else would the GSEs have imposed so many barriers to refinancing? 

Did Freddie Mac ‘‘Bet Against Refinancing?’’ 

Last week, National Public Radio and ProPublica reported that Freddie Mac created risky securities called Inverse IO Floaters that had the appearance of betting 

against household refinancing. These securities involve creating a concentrated risk 

position that pays off only as long as the underlying mortgages continue making 

payments. If the mortgages refinance, the payments stop and the securities lose significant value. 

The FHFA responded with a statement arguing against the premise of the story. 

It claimed that ‘‘Freddie Mac’s retained portfolio investment in inverse floaters did 

not have any impact on the recent changes to the Home Affordable Refinance Program (HARP). In evaluating changes to HARP, FHFA specifically directed both Enterprises not to consider changes in their own investment income as part of the 

HARP evaluation process.’’ As well, it argued ‘‘Of Freddie Mac’s $650 billion retained portfolio, only $5 billion is held as inverse floaters.’’ As well, FHFA points 

out that about 80 percent of its recent business is refinancing mortgages. 

It is important to understand what the statement says and what it does not. This 

statement does not imply that Freddie Mac’s credit decisions prior to HARP 2.0 in 

November 2011 were unaffected by its portfolio. In other words, the statement does 

not deny that the conflict of interest between lending and portfolio management 

might have impacted Freddie Mac’s past practices. In fact, as argued above, the retained portfolio appears to be the only plausible reason to impose many of the lending restrictions that the GSEs have imposed over time. What remains puzzling, as 

well, is why Freddie Mac and not Fannie Mae imposed new and harsher restrictions 

54 

11http://www.zerohedge.com/contributed/qa-alan-boyce-freddie-mac-and-inverse-floaters 12http://www.occ.gov/publications/publications-by-type/other-publications-reports/mortgagemetrics-2011/mortgage-metrics-q3-2011.pdf 13See, for example, Tomasz Piskorski, Amit Seru, and Vikrant Vig. 2010. ‘‘Securitization and 

Distressed Loan Renegotiation: Evidence From the Subprime Mortgage Crisis’’, Journal of Financial Economics 97, 369–397. 

on refinancing some mortgages under HARP 2.0. If not for the portfolio, why would 

Freddie Mac impose new restrictions on HARP 2.0 refinancings? 

A recent posting by Alan Boyce on the Web site www.zerohedge.com helps explain 

why FHFA’s statement might be true but that the conflict of interest might still 

have materially impacted lending. 11 For example, Mr. Boyce shows how the Freddie 

Mac might have simultaneously been refinancing some borrowers while also protecting its portfolio. The highest rates of refinancing have been for borrowers with 

relatively low mortgage rates, large loan balances, high FICO scores and low LTVs 

originated between 2009 and 2011. These loans were made after conservatorship 

and at a time that Freddie Mac was reducing it’s MBS holdings. Refinancing such 

mortgages may be good business, but it does not change the GSE risk profile much, 

because these mortgages are already unlikely to default. But, of course, Freddie Mac 

may not own many securities that contain recently originated mortgages. 

NPR/ProPublica identified $3.4 billion of inverse IOs, which were backed by the 

interest payments on about $19.5 billion of mortgages. FHFA said that these risky 

derivatives were in fact larger, amount to $5 billion in size, which could have been 

backed by $26 to $30 billion of loans. The FHFA notes that inverse IO floaters represent only a small portion of Freddie Mac’s portfolio, implicitly suggesting that 

such a small stake cannot possibly drive their lending restrictions. These trades 

took place in a 6 month time period and had the effect of reducing the total balance 

sheet of Freddie Mac by almost exactly the amount required by Congress, not an 

insignificant sum. In addition, FHFA does not describe the characteristics of the 

rest of Freddie Mac’s $224 billion holdings in its own MBS. Is the remainder of 

Freddie Mac’s portfolio also composed of high interest rate mortgages that Freddie 

Mac has spent more than 3 years imposing restrictions and prohibitions on refinancing? The entire Agency MBS market is trading at a premium, which means 

that every bond is well above par. It cannot be the case that taking an illiquid and 

highly levered position in inverse IOs can provide any hedge value for the rest of 

their portfolio. In fact, such a position would represent additional risk, in the same 

direction as its other holdings. Portfolio holdings may also explain why Fannie Mae 

has pursued refinancing restrictions that are nearly as strict as Freddie Mac. 

Fannie Mae owns nearly as much MBS as Freddie Mac. 

Mortgage Modifications Under Conservatorship 

Rather than pursue a widespread refinancing program to help reduce credit 

losses, the GSEs have attempted to manage the defaults of risky mortgages once 

they occur. The problem has been that the GSEs have also been slow and less effective at adopting loss mitigation practices that the private sector has identified. 

Private lenders, at least those who service mortgages in their own portfolio, were 

first to adopt widespread mortgage modification programs and have much lower redefault rates than the GSEs. (This is not to say that the industry responded quickly; 

only that the industry responded more quickly than the GSEs.) Consider data from 

the latest OCC Mortgage Metrics Report. 12 In 2008 and 2009, the redefault rate on 

mortgage modifications by the GSEs was almost 50 percent higher than mortgage 

modifications pursued by lenders on their own mortgages. In 2008, for example, the 

12-month redefault rate was about 58 percent for GSE modifications versus 40 percent for private lender modifications on their own portfolio loans. In 2009, the GSEs 

performed even worse on a percentage basis for the same measure (42 percent 

versus 25 percent for portfolio loans). By 2010, the GSEs 12 month redefault rate 

had caught up to that of portfolio loans. But in 2011, redefault rates for GSE modification are once again much higher than modifications of portfolio loans. 

In looking at the recent data, one striking feature stands out. Many portfolio lenders, as well as private servicers, have turned to principal reductions to better manage defaults. Understanding what private investors and lenders do with their own 

loans is very instructive because it helps set a benchmark for behavior that is unaffected by the many conflicts of interest in securitization. 13 According to the OCC 

data, portfolio lenders pursue principal reductions for more than 18 percent of mortgage modifications on their own portfolios. The FHFA still refuses to allow any principal reductions based on its calculations that more progressive modification and 

principal reduction programs will cost taxpayers money. 

55 

14http://www.newyorkfed.org/research/stafflreports/sr417.pdf 15 Amherst Mortgage Insight, 12/01/2011. 16 Chris Mayer serves as an advisor to Pathway, a start-up firm in the business of purchasing 

houses for long-term rental. 

In addition to the fact that private lenders often pursue principal write-downs 

with their own funds at risk, other studies also support the value of principal write 

downs that reduce LTVs as a tool for modifying mortgages. A 2009 study by the 

Federal Reserve Bank of New York concluded ‘‘The data indicate that the redefault 

rate declines with the magnitude of the reduction in the monthly payment, but also 

that the redefault rate declines relatively more when the payment reduction is 

achieved through principal forgiveness as opposed to lower interest rates. 14 As well, 

a recent study by Laurie Goodman supports the same conclusion, noting ‘‘Controlling for payment relief, we find that principal reduction modifications are more effective than either rate modifications or capitalization modifications. These differences by modification type are larger for modifications on prime/Alt A/option 

ARM loans than for subprime loans.’’ 15

Another problem with all of these studies, and an issue that does not appear to 

be explicitly modeled by the FHFA analysis, is the risk of moral hazard. Private 

portfolio lenders are certainly be aware of this risk and have developed ways of 

minimizing moral hazard. Nonetheless, Government backed lenders like the GSEs 

may face a higher risk of moral hazard than private lenders would. This would be 

a place, once again, where the GSEs might benefit from examining the practices of 

private portfolio lenders. 

For some GSE mortgages, the existence of mortgage insurance (MI) appears to be 

a barrier to principal write-downs. However, the value of such MI is likely dubious. 

The GSEs have as much as $150 billion of insurance from various MI companies, 

but more than 80 percent of those potential claims are underwritten by MI companies that are either insolvent or have a credit rating of BB- or worse. The suspect 

nature of these receivables gives the GSEs incentives to delay loss resolutions as 

much as possible and may impact the extent to which the GSEs efficiently manage 

losses and foreclosures. 

Why Not More Private Capital and Expertise for the GSEs? 

Another concern about the current process of how the GSEs have managed the 

housing crisis has been the lack of steps to bring in private capital and expertise 

in their businesses. It is important to note that the existing mandates for conservatorship do not require or even suggest that the GSEs bring private capital into 

their businesses. Of course there is a mandate to reduce risk, but that could be done 

without sharing the risks with private firms. 

Nonetheless, the GSEs have not taken advantage of places where private capital 

and expertise might be valuable in reducing losses or helping to stabilize housing 

markets. For example, the fact that private portfolio lenders appear to have much 

lower redefault rates on mortgage modifications of nonperforming loans (NPLs) suggest that the GSEs might profitably sell NPLs to specialized servicers. Private portfolio lenders sell certain NPLs to such specialized servicers. One might have expected the GSEs to do the same. 

It is critically important to examine new ideas to help attract private capital and 

ideas to address the housing crisis. In my testimony before the Senate Subcommittee on Housing, Transportation, and Community Development of this Committee I detailed a number of such proposals, including how to sell non performing 

mortgages and why sales of REO to long-term businesses dedicated to building a 

business in renting single family homes. 16 I also discussed the potential for shared 

appreciation mortgages to help resolve the current glut of seriously delinquent mortgages. 

Conclusion 

I believe that the largest failure of conservatorship has been the unwillingness of 

the FHFA to adequately address the conflicts of interest it inherited when it took 

over management of the GSEs. 

Consider the problem of how the GSEs would have managed a portfolio of MBS 

with above-market interest rates—securities that might sell at a price above the par 

value of the securities. For example, a pool of MBS with a 6 percent coupon might 

sell for $1.10 for each $1 of principal with such a high coupon. Given that the GSEs 

had more information than buyers about their own intentions with regard to refinancing, as well as greater information about the underlying mortgages and their 

expected performance, buyers might be quite wary of purchasing MBS at market 

prices from the GSEs. Buyers could be concerned about the potential that the GSEs 

56 

17Some might argue that it is necessary to have an investment portfolio to ensure the solvency of the guarantee business. However, since the GSEs are insolvent, the U.S. Treasury already serves the role of liquidity provider under conservatorship. As the GSEs return to solvency, they may want to acquire assets that help meet capital and liquidity needs. However, 

there is no reason for the GSEs to make such investments in their own MBS, which only amplifies the GSEs exposure to various mortgage market risks. The trustee would use the proceeds 

from the sale of the assets of the GSEs (MBS) to pay down the GSE’s liabilities. 18 Any loans made available on portfolios of single-family homes might have a sunset provision so that lending is reduced over time as the private lending market recovers. 

might then turn around and take action that would result in widespread refinancing. Buyers might also be worried that mortgages inside the MBS were at imminent risk of default. In either case, the securities would pay off at par ($1.00), 

leaving the buyer with an appreciable loss ($0.10). Aware of the conflict of interest, 

buyers might appropriately diminish their bids for agency MBS sold by the GSEs 

above par. 

Under conservatorship, the FHFA could have appointed an independent trustee 

to manage the sale of the MBS over time, with the explicit mandate to maximize 

the returns for taxpayers. If the trustee were truly independent, this plan would 

have mitigated the conflict of interest and maximized the sale proceeds from the 

pool of MBS. Put differently, taxpayers likely would have received higher proceeds 

from the sale of MBS had the GSEs turned over management of their portfolio to 

an independent, third party because buyers would have paid more for the MBS absent a potential conflict of interest. 17

Of course, the GSEs might have instead tried to earn even higher profits by keeping their portfolio and imposing frictions on refinancing. Even if imposing mortgage 

market frictions were to have maximized short-run profits on their portfolio, effectively conserving and preserving assets, it would have had other consequences in 

making a less efficient, less competitive, and more illiquid mortgage market and 

working against the public interest. 

Nonetheless, such a policy would have ignored another option—widespread mortgage refinancing—that can and should have been a profitable business. My own 

analysis, conducted with Alan Boyce, Glenn Hubbard, and James Witkin, shows 

that refinancing should be profitable for the GSEs. By charging a slightly higher 

guarantee fee and creating a small fund to cover any possible losses from reps and 

warranties relief, refinancing could have been a way to help recapitalize the GSEs 

and help minimize taxpayer losses. Combining mortgage refinancing with an independent trustee would result in a win-win for taxpayers, mortgage borrowers, homeowners, and the larger economy. 

It is not too late to achieve that win-win scenario. The FHFA still has the authority to follow such a prescription. However, current policies do not make such a policy 

shift appear likely. 

Instead, Congress should consider changing the mandate of conservatorship to address its flaws. Legislation should mandate that an independent trustee be appointed to wind down the GSE’s retained portfolio of MBS. The GSEs could continue 

to retain nonperforming loans that they have bought back from securitizations as 

is necessary to perform their mortgage guarantee business. Independent management of the retained portfolio will make the eventual privatization or replacement 

of the GSEs considerably easier. Legislation should also mandate other steps to 

move towards attracting private capital into the mortgage market, including ideas 

such as trial programs for the sale of NPLs to third party servicers, the sale of REO 

to private investors, and provisions that allow the GSEs to provide responsible 

amounts of leverage for owners of single-family home portfolios in the rental business on a temporary basis. 18 Legislation should also ensure that the GSEs remove 

all of the obstacles limiting access to mortgage credit as identified in the Federal 

Reserve white paper. All borrowers should have access to refinancing without restrictions or qualifications other than being current on their mortgage and any refinancing programs should be available to be offered by any qualified originator to 

any qualified borrower. 

Until we fix the housing market, it will be hard for the economy to fully recover. 

In this testimony, I have addressed a number of reasons that the lack of GSE reform continues to hold back the housing market and the economic recovery. I believe 

that immediate action is necessary to address fundamental flaws in the structure 

of the GSEs. Conservatorship as it now stands is laden with conflicts of interest between lending and portfolio management and holds back the reintroduction of private capital. These steps can occur now, even without a consensus on what the future of the U.S. housing finance system will look like. 

I appreciate the opportunity to address you today and look forward to answering 

any questions that you might have. 

57 


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59 

1See the appendix of the January 2012 HUD-Treasury Housing Scorecard: http://portal.hud.gov/hudportal/documents/huddoc?id=JanNat2012lScorecard.pdf. 

PREPARED STATEMENT OF THE HONORABLE PHILLIP L. SWAGEL 

PROFESSOR OF INTERNATIONAL ECONOMIC POLICY, UNIVERSITY OF MARYLAND

SCHOOL OF PUBLIC POLICY

FEBRUARY 9, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for the opportunity to testify on housing policy and the state of the housing market. I am a professor at the University of Maryland’s School of Public Policy 

and a faculty affiliate of the Center for Financial Policy at the Robert H. Smith 

School of Business at the University of Maryland. I am also a visiting scholar at 

the American Enterprise Institute and a senior fellow with the Milken Institute’s 

Center for Financial Markets. I was previously Assistant Secretary for Economic 

Policy at the Treasury Department from December 2006 to January 2009. 

The continued weak state of the housing market and the toll of millions of foreclosures already, millions more families still at risk of losing their home, and trillions of dollars of lost wealth all reflect the lingering impact of the collapse of the 

housing bubble and ensuing financial crisis. A range of policies have been undertaken over the past several years aimed at the housing market—a recent summary 

from the Department of Housing and Urban Development lists 10 separate policy 

actions. 1 These can be grouped into two broad categories. What might be seen as 

‘‘backward-looking’’ policies seek to avoid foreclosures on past home purchases 

through actions such as incentives for mortgage modifications and refinancing. By 

avoiding foreclosures, these policies both assist individual families and help reduce 

the supply of homes for sale (and in the overhang of the so-called ‘‘shadow inventory’’) and thus reduce downward pressures on home prices that in turn affect 

household wealth and the broad economy. In contrast, ‘‘forward-looking’’ policies 

seek to boost demand for home purchases, such as with the first time homebuyer 

tax credit and the Federal Reserve’s purchases of mortgage-backed securities (MBS). 

The common feature of these housing policies is their limited effectiveness. To be 

sure, these policies have done something: MBS purchases resulted in lower interest 

rates for families buying a home or refinancing a mortgage; some 930,000 homeowners have benefited from permanent mortgage modifications through the HAMP 

program; and so on. But relative to the scale of the weakness in home prices and 

housing market demand, and especially compared to the tragically huge number of 

foreclosures, the set of housing market policies to date appears to have underperformed compared to expectation set at each policy unveiling. Moreover, these programs have involved considerable costs for taxpayers, with the benefits accruing 

mainly to a relatively small group of recipients. And on top of the millions of foreclosures not prevented by the policies of the past several years, there is likely another huge wave of foreclosures set to take place in the next year or two, with many 

of these representing foreclosures that were delayed but not ultimately prevented 

by policies to date. 

This experience is important to keep in mind as the Congress contemplates a 

range of new and expanded housing policy proposals from the Administration, along 

with a white paper from the Federal Reserve that covers similar ground. Broadly 

speaking, the proposed actions look to provide homeowners with reduced monthly 

payments through Government-assisted refinances; to lower principal mortgage balances; and to speed the pace at which vacant homes become rentals. The goal, as 

with all policies throughout the crisis, is to have fewer foreclosures and stronger 

consumer spending. These policies are well-intentioned. 

Unfortunately, there is every reason to believe that the new policy proposals for 

streamlined refinancing and principal reduction are likely to have the same modest 

impact—and at an even worse tradeoff in terms of cost to taxpayers for each foreclosure avoided than for the policies to date. Simply put, we have learned that mortgage modification programs are difficult to implement and execute because of the 

intrinsically one-at-a-time nature of the transactions involved. And the expansions 

of some programs, such as considerably increased payments from the Government 

to motivate reductions in mortgage principal, face less promising conditions now for 

being effective than was the case when many of these policies were launched in 

early 2009. Three years of a weak job market have forced many of the borrowers 

who might have been helped by reduced payments or a lower mortgage balance into 

foreclosure. 

There are other approaches that can be taken to help heal the housing market 

and speed the recovery of home prices and construction while reducing the pain for 

60 

2This is in some ways reminiscent of the 2008 Hope for Homeowners program that likewise 

had only modest impact in reducing foreclosures. 

American families. This testimony first provides a critical analysis of recent policy 

proposals and then discusses alternative steps that the Congress might consider. 

The goal of these policies is for the housing sector to once again contribute positively 

to the U.S. economy and to American society—to have a housing system that works 

for families looking to buy homes, for investors with funds to lend, and for taxpayers 

who deserve a stable financial system and protection from another expensive bailout. 

Mass Refinancing Proposals 

It is useful to consider a specific example that raises the question of whether the 

latest policy proposals from the Administration will perform differently than previous initiatives. The White House fact sheet for the Administration’s refinancing 

proposal for a single family, owner-occupied principal residence promises that there 

will be ‘‘no barriers and no excuses’’ (top of page 3) and no new appraisal or tax 

forms involved in enabling eligible homeowners to refinance their mortgages into an 

FHA-guaranteed loan with lower monthly payments. Without access to tax forms, 

however, it is not clear how lenders are meant to verify that a home is indeed 

owner-occupied—the natural mechanism would be to look at the address on the 

homeowner’s 1040 tax form. Indeed, the lender could even just examine the address 

on the IRS form 4506 by which the borrower requests that a copy of the tax return 

be sent to the lender; this would be less intrusive than having the lender examine 

the 1040 itself but is again off-limits in the new proposal. A lesson of the past several years is that unverified mortgage applications (so called ‘‘no doc loans’’) are convenient but do not end well for either lender or borrower. 

The alternative of having the lender send someone out to the home also runs 

counter to the stated policy proposal—there are to be no appraisals, and the need 

for possibly repeated site visits to confirm the owner-occupied status seems to be 

exactly the barriers and red tape that are not allowed (not to mention the intrusiveness of having someone peek through the windows to figure out who is living inside). 

On the other hand, lenders clearly will not be willing to allow borrowers to simply 

attest that they are refinancing an owner-occupied property. After all, this was a 

common misrepresentation during the housing bubble and it would be outrageous 

for lenders not to check carefully for loans receiving a Government-backed guarantee such as with the new refinancing proposal involving the Federal Housing Administration (FHA). Moreover, the Administration has launched an investigation 

into possible abusive behavior in mortgage origination and servicing; presumably 

this investigation and the similar effort launched in 2009 will deter lenders from 

allowing potential fraud. But this leaves the problem of how to comply with the contradictions between the proposed policy and the rhetoric by which it has been introduced. 

This is just one type of hurdle that implementation of the latest proposal for refinancing of non-GSE loans is likely to face—the desired ease of the refinancing is 

defeated by the conditions of the proposal itself. Perhaps there is some workaround 

in the offing for this and the other inevitable problems of implementation that have 

plagued past efforts, but it is now more than 2 weeks since the proposals were 

launched by the President in his State of the Union address and there is no legislative text to consider these important details. Similarly, the Fed’s white paper on 

housing proposals includes a broad discussion of the possible beneficial impacts of 

widespread refinancing, but does not get into the operational details that are crucial 

to achieve actual policy outcomes. 2

The lower monthly payments for homeowners that would result from the proposed 

FHA-based refinancing scheme for non-GSE loans and the expansion of the previous 

HARP (Home Affordable Refinance Program) for GSE loans announced in October 

2011 are meant to both reduce foreclosures by improving affordability and to boost 

the economy through increased spending by families with greater free cash flow as 

a result of lower mortgage payments. That is, refinancing would be a sort of stimulus analogous to sending a monthly check to qualifying households. It is clear that 

mortgage credit was too easily available in the run-up to the crisis, and a good argument can be made that the pendulum has swing too far in the other direction now 

so that some creditworthy borrowers do not have access to mortgages for home purchases or refinancing. An important lesson of the current situation, however, is to 

highlight the problem of having the Government so intricately involved in setting 

mortgage standards. It would be preferable for private suppliers of capital to fund 

housing and to take on the risks and rewards of credit decisions. This provides an 

61 

3See, http://www.whitehouse.gov/sites/default/files/ 

kruegerlcaplspeechlfinallremarks.pdf. 4See, http://portal.hud.gov/hudportal/documents/huddoc?id=housingfinmarketreform.pdf. 

important motivation for moving forward with housing finance reform. With Fannie 

Mae and Freddie Mac in Government control under conservatorship at present, it 

is inevitable that public officials will be involved in the choice of credit standards. 

The driving force for these decisions should be to find the appropriate balance between protection for taxpayers against overly risky loans while maintaining access 

to credit for homebuyers and rebuilding a responsible private mortgage market— 

and not to have these decisions motivated by a desire to implement a backdoor fiscal 

stimulus. 

Indeed, stimulus is likely the best way to view the impact of the two mass refinancing proposals involving HARP 2.0 for GSE-backed mortgages and the FHA for 

non-GSE loans. Both refinancing proposals would benefit borrowers with high loanto-value (LTV) mortgages, including underwater borrowers whose mortgage balances are greater than the value of their home and who thus have an incentive to 

walk away from their home and allow a foreclosure. The current proposals, however, 

are restricted to borrowers who have been in their homes since at least mid-2009 

and have been nearly current on their payments for a year (6 months with no late 

payments and no more than one 30-day late payment in the preceding 6 months). 

In other words, the refinancing assistance would go to borrowers who have shown 

that they want to stay in their home and have done so for several years in the face 

of declining home prices and a weak job market. To be sure, these borrowers will 

benefit from the lower mortgage payments. But the targeted population for the refinancing has already shown that they are resistant to foreclosure, meaning that the 

program will avoid relatively few incremental foreclosures per dollar of taxpayer expense. This leaves stimulus as the main motivator for mass refinancing. 

As noted in the Fed’s white paper and in recent analysis provided by the FHFA 

in a letter to Representative Elijah Cummings, both refinancing proposals involve 

costs to taxpayers because the U.S. Government is a beneficial owner of mortgages 

through MBS holdings of both the Federal Reserve and the GSEs. This is not to 

say that U.S. Government asset holdings should come before homeowners—not by 

any means. The point is that the costs of the refinancing proposal must be weighed 

against the benefits, keeping in mind that the principal benefit is through a relatively targeted fiscal stimulus going to particular homeowners (and not to renters, 

who tend to have lower incomes than homeowners). One could imagine policy makers calling for another round of taxpayer-funded fiscal stimulus such as through providing checks or other tax benefits, but this should be debated openly. It is hard 

to imagine that a new stimulus would involve the relatively narrow targeting of the 

population of homeowners with high LTV’s who bought homes at a particular time 

period and who have been able to afford their monthly payments. 

In a time of tight fiscal constraints, one could also imagine seeking to focus costly 

Government programs on homeowners who could be seen as most in need of assistance and for whom refinancing programs might be most effective. The refinancing 

proposals are limited by the amount of the mortgage but one could further restrict 

this Government assistance to people with desired income ranges. The White House 

has recently defined the middle class as households with the median income plus 

or minus 50 percent. 3 With median household income around $52,000, this would 

imply limiting the refinancing program to households with incomes of no more than 

around $78,000—the top of the White House definition of middle class. Alternately, 

one could use the approximately $64,000 median income of family households (that 

is, leaving out individuals, who tend to have lower incomes). This would give a maximum income for the middle class as defined by the White House as $96,000— 

rounding up would then give $100,000 as the maximum income limit for eligibility 

for the Administration’s FHA refinancing proposal. One could imagine applying this 

income limit to all FHA programs in order to best focus the taxpayer-provided subsidy implicit in FHA activities to households most in need. 

It should be noted as well that the February 2011 report to Congress on ‘‘Reforming America’s Housing Finance Market’’ by the Treasury Department and HUD 

stated that the ‘‘FHA should return to its precrisis role as a targeted provider of 

mortgage credit access for low- and moderate-income Americans and first-time 

homebuyers.’’ 4 The report notes that the FHA market share (around 30 percent in 

early 2011) is already substantially above what Treasury and HUD see as the historical norm of 10 to 15 percent. The Administration’s refinancing proposal thus represents a policy reversal that both goes in the wrong direction for housing finance 

reform and increases the taxpayer exposure to losses by the FHA when recent analVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00065 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
62 

5See, Joseph Gyourko, ‘‘Is FHA the Next Housing Bailout?’’ November 11, 2011. http:// 

www.aei.org/papers/economics/financial-services/housing-finance/is-fha-the-next-housingbailout/ 6See, Joseph Tracy and Joshua Wright, ‘‘Why Mortgage Refinancing Is Not a Zero-Sum 

Game’’, January 11, 2012. http://libertystreeteconomics.newyorkfed.org/2012/01/why-mortgagerefinancing-is-not-a-zero-sum-game.html 

yses indicate that the agency is likely to require a taxpayer bailout of $50 billion 

or more as a result of its existing obligations. 5

The Administration proposes to offset the costs of the FHA refinancing proposal 

with a tax on large banks. As Treasury Secretary Geithner noted at a press conference last week, ‘‘there are pockets where credit is tighter than it needs to be, including mortgage finance and small business.’’ The bank tax would expand these 

pockets, with costs of the tax passed through to borrowers in the form of higher interest rates and reduced availability of credit. 

It is the case, as noted in a recent analysis from the Federal Reserve Bank of New 

York, that foreigners have meaningful holdings of U.S. mortgages in the form of 

mortgage-backed securities and would bear some of the cost of the refinancing proposals. 6 Given the U.S. fiscal imbalance and ongoing current account deficit, it is 

likely that the United States will rely on inflows of foreign capital for the foreseeable future. Policies that are seen as unexpected or unfair to foreign investors might 

then result in reduced demand for Treasury securities and other dollar assets and 

thus higher financing costs for American borrowers including the United States 

Government. This is not a reason to avoid a refinancing proposal, but the potential 

impact on future interest rates should be taken into account in evaluating the costs 

and benefits. 

Similar considerations apply to domestic suppliers of capital for housing finance. 

Buyers of mortgages and mortgage-backed securities plainly take on refinancing 

risk—the compensation demanded for this risk accounts for part of the spread between yields on GSE-backed MBS and Treasury securities. Continued expansions of 

refinancing proposals, however, could give rise to the belief that mortgages going 

forward have embedded in them a new feature that gives borrowers easier access 

to a downward adjustment of interest rates than was believed to be the case in the 

past. This regime change would then translate into market demands for higher 

yields on mortgage-related securities and thus higher interest rates going forward. 

In other words, current homeowners would benefit from refinancing but future ones 

would pay more. This is akin to the impact of so-called ‘‘cramdown’’ proposals that 

would change the bankruptcy code to allow reductions in the principal balance of 

mortgages: current homeowners would benefit from having reduced debt but future 

homeowners would face higher interest rates and reduced availability of credit. Relatively risky future borrowers, who tend to have lower incomes, would be most adversely affected. 

As noted above, there are reasons for concern about the impact and cost-benefit 

calculus of mass refinancing programs. Nonetheless, it is possible for the Administration to move forward with some aspects without Congressional action. The expanded HARP refinancing is moving forward though financial firms’ computer systems are reportedly not yet fully ready for the new program. Some FHA guidelines 

could be adjusted as well to streamline the appraisal process and include some additional mortgages (though the expansion to underwater loans would require Congressional action). In other words, there are steps that could be taken without waiting 

for the inevitable rejection of the proposed bank tax. 

Expansion of the Home Affordable Modification Program (HAMP) 

The HAMP program involves Government payments to incentive mortgage modifications that lower homeowner payments and thus seek to prevent foreclosures. 

Lenders (typically servicers acting on the behalf of the beneficial owners of mortgages) have an incentive to make such modifications to avoid the considerable costs 

involved with foreclosure, but many institutional features slowed the modification 

process—to widespread frustration, including at the Treasury Department when I 

served as Assistant Secretary. The difficulty with a modification is to find the right 

targeting, amount, and structure of the modification that balances effectiveness with 

cost. A lender will not want to modify a loan for a borrower who can afford their 

original payments or for a borrower who could not afford the lower payments resulting from a modification that has an economic value equal to the cost of foreclosure. 

The presence of underwater borrowers is an important consideration, since an underwater borrower has an incentive to walk away from a home even if the payments 

are affordable and the lender will not recover the full value of the loan in a foreclosure. But a modification involving principal reduction is especially costly for the 

63 

7For more discussion, see, Phillip Swagel, April 2009, ‘‘The Financial Crisis: An Inside View’’, 

http://www.brookings.edu/economics/bpea//media/Files/Programs/ES/BPEA/ 

2009lspringlbpealpapers/2009lspringlbpealswagel.pdf. 

lender and gives rise to important concerns about strategic behavior and spillover 

effects such as having other homeowners seek unnecessary principal reductions. A 

further complication is that the weak economy of the past several years has meant 

that some homeowners who could initially afford the lower payments of a modified 

loan might suffer an income decline such as from a job loss and then ‘‘redefault’’ 

on the modified loan (that is, default). It has been said that this combination of factors leaves a potentially narrow aperture through which to make a successful modification. 

HAMP uses taxpayer dollars to tip the balance toward increased modifications. 

Under certain conditions, the Treasury puts in money to pay for part of the cost 

of the modification. The selection criteria are crucial to the outcome of the policy 

and involve profound challenges. It is natural to focus taxpayer dollars as tightly 

as possible on incentivizing incremental modifications rather than providing a windfall for ones that lenders would have done on their own and to avoid as much as 

possible providing an incentive for homeowners to stop paying their mortgages in 

order to qualify for assistance. At the same time, implementing a tighter screening 

to focus on the right set of borrowers translates into fewer incremental modifications. 7 These considerations presumably went into the cost-benefit calculations that 

were done with the original HAMP program, which was initially predicted to lead 

to three to four million modifications by the end of 2012 but had chalked up somewhat less than one million permanent modifications through December 2011. 

A key feature of the Administration’s recent HAMP proposal is to substantially 

increase the taxpayer-provided payments to lenders that reduce principal as part of 

a modification for underwater borrowers. This is a relatively costly way of reducing 

monthly mortgage payments compared to reducing a borrower’s interest rate. If the 

focus of modifications is on affordability, it would be more effective to extend the 

term of a loan and reduce interest payments rather than writing down principal. 

Still, one could justify a focus on principal reduction if the goal is to avoid foreclosures by homeowners who can pay their mortgage but choose not to because they 

are underwater. The key issue is whether this is a cost-effective approach. 

A concern about the expanded HAMP incentives recently announced by the Administration is that this is a policy that would have been much more cost-effective 

in terms of a lower cost to taxpayers for each foreclosure avoided in early 2009. 

Three years later, underwater borrowers who are still in their homes have demonstrated their attachment to it. To be sure, a principal reduction will benefit homeowners. But the cost to taxpayers will be much larger with the expansion of HAMP 

payments, and the impact in terms of foreclosures avoided is likely to be much modest than in 2009 given that the target population has made it this far. This leaves 

a high cost-benefit ratio from the HAMP expansion—presumably a much higher 

cost-benefit ratio than was judged to be prudent when the program was designed 

in 2009. 

A natural question then is to consider what is different today than in 2009 that 

results in the apparent imperative to reduce foreclosures in 2012 regardless of the 

cost effectiveness of the policy tools involved. This is a worrisome approach to policymaking and to the stewardship of taxpayer resources. 

Pilot Program to Transition Real Estate Owned (REO) Property to Rental 

Housing 

The aftermath of the bubble has left the U.S. economy with too many homes for 

sale or in the so-called ‘‘shadow inventory’’ of homes that will be for sale once prices 

firm. The announcement by the FHFA of a pilot program to transition REO properties to rentals is a welcome step to speed up the adjustment of the housing market 

to post-bubble conditions. Facilitating purchases of vacant homes by firms that can 

manage them as rentals will help speed up the market adjustment, at least modestly. This program will not be helpful in all parts of the country, but it will be most 

useful in areas in which foreclosures and vacant homes are especially acute. The 

inventory of REO properties held by Fannie Mae and Freddie Mac has been declining as properties are sold while inflows of new REO dwellings have slowed as the 

result of legal uncertainties surrounding the foreclosure process. But there is likely 

to be a wave of foreclosures in the pipeline and having this program ready will be 

useful. At the same time, it will be important to ensure that buyers of REO properties bring capital to the table rather than relying heavily on the GSEs for financing. With Fannie and Freddie under taxpayer control, this would constitute yet anVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00067 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
64 

8For longer discussions from which this is drawn, see, ‘‘The Housing Bottom Is Here’’ on 

http://www.calculatedriskblog.com/2012/02/housing-bottom-is-here.html and Prashant Gopal, 

February 7, 2012, ‘‘Banks Paying Homeowners To Avoid Foreclosures’’, Bloomberg News. http:// 

www.bloomberg.com/news/2012-02-07/banks-paying-homeowners-a-bonus-to-avoid-foreclosuresmortgages.html. 9See, Gopal, op cit. http://www.bloomberg.com/news/2012-02-07/banks-paying-homeownersa-bonus-to-avoid-foreclosures-mortgages.html 

other Government involvement in the housing sector. GSE financing of institutional 

buyers would increase the firms’ balance sheets and thus taxpayer exposure to risk. 

The importance of putting vacant homes to use can been seen in the combination 

of rising rental costs and declining prices for home sold under ‘‘distress’’ such as following a foreclosure. 8 Overall indices of home prices such as the S&P/Case-Shiller 

index declined to post-bubble lows in the most recent data for November 2011, while 

the FHFA purchase-only price index rose in November and has moved slightly above 

the low point of March 2011. Downward price pressures involved in distressed sales 

likely contribute to differences between these price indicators. This conclusion is bolstered by recent press reports citing RealtyTrac as calculating that bank-owned foreclosures and short sales sold at a discount of 34 percent to nondistressed properties 

in the third quarter of 2011. 

As discussed in the Fed white paper, the use of short sales and deeds-in-lieu of 

foreclosure can reduce losses for lenders and provide a better financial outcome for 

borrowers (and with greater dignity than a foreclosure). Recent press reports indicate that use of these tools is growing, along with payments by lenders to homeowners willing to move out rather than go through the foreclosure process. With the 

foreclosure process taking 24 to 36 months in States with a judicial foreclosure process, quite large payments could be rational on the part of lenders. 9 The Treasury’s 

Home Affordable Foreclosure Alternatives (HAFA) program similarly provides modest payments to market participants (servicers, homeowners, and investors) to 

choose short sales over foreclosure. Given the substantial private incentives for 

these short sales to take place it is not clear that the HAFA program is needed. 

Housing Market Adjustment and Alternative Policy Approaches 

Housing markets naturally adjust slowly because the typical homebuyer must sell 

their existing home at the same time that they buy a new one, while the stock of 

homes evolves slowly given that homes tend to last for 50 years or more. The adjustment has been especially slow in the wake of the crisis and recession as the result 

of reduced household formation that has diminished the natural growth in demand 

for housing. 

The goal of policy moving forward should be to facilitate the ongoing adjustment 

and quicken the recovery of both housing prices and construction. By definition, a 

recovery commences only after the market hits bottom. It is desirable to lift off the 

bottom quickly. Fostering a stronger overall economy is perhaps the most important 

element of this, since a stronger economy will boost housing demand, including 

through increased household formation. Other policies could be useful as well, notably actions that facilitate a more rapid market adjustment and that strengthen demand. 

Rhetoric about not wanting the market to hit bottom is a combination of empty 

and factually incorrect—after all, a housing market recovery by definition will start 

only after the market hits bottom. What is desirable is for the recovery to start immediately—that is, for the bottom to have been reached already. 

In considering housing policy going forward, it is important both to avoid policies 

that will prolong the housing downturn or lengthen the time at which the market 

rests on the bottom. This implies that it would be valuable to resolve legal and regulatory uncertainty facing mortgage servicers and originators as quickly as possible. 

To be sure, past wrongdoing should be punished, notably including inappropriate 

foreclosures on servicemen and servicewomen. On the other hand, a lengthy period 

of uncertainty will affect the willingness of banks to take on housing-related risks. 

This concern has practical relevance for the Administration’s recent proposals. Bank 

A, for example, will naturally hesitate to refinance a loan originally made by Bank 

B even with an FHA guarantee if there is a concern about the possibility of future 

litigation. The same applies to concerns about the ability of banks to foreclose on 

borrowers in default—if a mortgage is no longer a securely collateralized asset, then 

there would be widespread ramifications to the detriment of future homebuyers. 

Imagine the cost of financing a home purchase with an unsecured loan facility such 

as credit cards. 

There are important institutional and legal overhangs slowing the housing recovery, including lawsuits and regulatory actions involving the MERS title system, settlement discussions related to so-called robosigning, putbacks of bad loans to origiVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00068 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
65 

10See, Phillip Swagel, ‘‘The Future of Housing Finance Reform’’, October 2011 paper for the 

Boston Fed Annual Research conference, http://www.bos.frb.org/economic/conf/LTE2011/papers/Swagel.pdf, and Phillip Swagel, ‘‘Reform of the GSEs and Housing Finance’’, Milken Institute White Paper, July 2011. http://www.milkeninstitute.org/pdf/HousingFinanceReform.pdf 11For more discussion, see, Chris Papagianis and Phillip Swagel, ‘‘Put Fannie and Freddie 

on Federal Books’’, Bloomberg View oped, January 22, 2012. http://www.bloomberg.com/news/ 

2012-01-23/put-fannie-and-freddie-on-federal-books-papagianis-and-swagel.html 

nators by the GSE, and perhaps others. Again, there should be appropriate consequences for past wrongdoing and steps to avoid repetition. But there is also a 

value in a rapid resolution of these uncertainties so that the mortgage financing system can once again operate effectively to the benefit of U.S. homebuyers and homeowners. A desire to punish the financial industry sits awkwardly with the desire for 

a housing recovery. It is important to keep in mind as well that some foreclosures 

are unavoidable—just as hundreds of thousands of foreclosures took place in years 

with a strong housing market before the recession. It is important to have a foreclosure process that is accurate and fair and that can move forward responsibly but 

without unnecessary delays. Foreclosures are difficult and tragic events for households. Yet some foreclosures are inevitable. A housing rebound ultimately requires 

that adjustments including unavoidable foreclosures take place. 

Government policies could also play a positive role in improving industry weaknesses that have been highlighted in the various judicial actions. The MERS titling 

system, for example, arose in part to compensate for the varying information systems by which property title information is kept, generally at the county level. A 

useful initiative would be to develop standard formats for these data. This would 

preserve local control over intrinsically local decisions and information, but facilitate 

nationwide transmittal and analysis of information. Similarly, better coordination of 

information regarding second liens would facilitate some additional modifications 

based on bargaining between owners of the primary mortgage and second lien. 

Finally, moving forward with housing finance reform remains vital for a sustained 

housing market recovery. It is now a year since the Treasury Department and HUD 

released a report on housing finance reform and concrete action is long overdue. Uncertainty about the future of the housing finance system, notably the role of the 

Government, will make private providers of capital hesitate to fund mortgages. This 

leaves Government officials to make crucial decisions regarding credit availability 

that are better left to market participants with incentives based on having their 

own capital at risk. 

I have written at length elsewhere about steps for housing finance reform, including the future of Fannie Mae and Freddie Mac. 10 The steps involved in moving forward with reform involve a combination of several policy levers: bringing in private 

capital to takes losses ahead of taxpayers; reducing the scope of any guarantee; and 

increasing the price or reducing the quantity offered of the guarantee. Moving forward in these dimensions would help increase the role of the private sector in housing finance and reduce Government involvement and taxpayer exposure. Importantly, these steps could be taken without a firm conclusion about whether there 

will be a Government guarantee on housing at the end. Enough progress in utilizing 

these policy levers would eventually lead to a housing finance system that is entirely private, but the path to a private system would involve a mix of private capital and incentives backstopped by a secondary Government guarantee. This means 

that starting with reform that involves a secondary Government guarantee does not 

rule out ending up with a fully private housing finance system. The key is to move 

forward expeditiously in order to provide increased certainty about future market 

conditions and thereby bring private capital back into housing finance. A useful additional step would be to make transparent the budgetary impact of GSE activities. 

The use of the TARP to compensate the GSEs for costs related to the Administration’s housing proposals, for example, obscures the underlying reality that the financial consequences of activities of both the TARP and the GSEs show up on the public balance sheet. H.R. 3581, the Budget and Accounting Transparency Act that 

passed in the House of Representatives earlier this week, provides a step forward 

in ensuring desirable clarity in budget treatment. 11 It would useful as well for the 

GSEs to make available loan-level data that facilitates analysis of market conditions 

and helps private participants to enter the housing finance market. 

Recent news reports indicate that Freddie Mac is developing a pilot program 

under which private owners of capital would purchase a security that absorbs losses 

on a pool of loans ahead of Freddie Mac itself. This would have Freddie in a senior 

position and outside investors in a first-loss position. Such a structure would have 

the GSEs lay off housing risk on private market participants while obtaining a market-based indication of the return market participants require to take on housing 

66 

credit risk. Such a pilot program would thus test the appetite of the private market 

for first-loss risk on housing assets in exchange (presumably) for higher returns, indicate the market’s assessment of the value of the Government guaranteed on mortgages, and illuminate the path leading to a reduced role of the Government in housing finance. We have learned that it is difficult for the Government to price its guarantee for taking on risk, making it extremely useful to have a market-based indication. One could imagine applying such a framework to FHA loans as well to reduce 

Government exposure and protect taxpayers compared to the current model under 

which the FHA does not share risk. 

Conclusion 

A revitalized housing sector and an end to the sadly elevated number of foreclosures would mark salient progress in moving past the consequences of the housing bubble and financial crisis. Government policies can usefully contribute to the 

needed adjustment. But it is essential to be clear about the costs associated with 

proposals such as those from the Administration that would expand efforts to use 

taxpayer funds to avoid foreclosures. It is far from clear that these efforts will be 

effective and even less apparent that they will have a positive impact commensurate 

with the taxpayer resources involved. It would be better instead for Congress to consider steps that would hasten the housing market adjustment, facilitate the return 

of private capital into housing finance, and bring the housing sector more quickly 

to the point at which home prices and construction activity lift off the bottom into 

recovery. 

67 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM PHILLIP L. SWAGEL 

Q.1. Last November, Congress passed legislation making loan limits for FHA-insured loans higher than the loan limits for privately 

insured loans purchased by the GSEs for the first time in history. 

In December, Congress increased the GSE guarantee fee by 10 

basis points, which has the effect of making privately insured loans 

bought by Fannie and Freddie more expensive than loans insured 

by the FHA. 

Aren’t these actions going to further move the FHA far beyond 

its core mandate of serving low to moderate income borrowers who 

otherwise would not have access to home ownership? 

A.1. Yes, higher loan limits for FHA and higher fees on GSEbacked loans both make FHA lending relatively more attractive. 

This is in addition to the lower downpayments required for FHAbacked loans than for GSE-backed mortgages. Having FHA provide 

a guarantee for people buying homes with mortgages of up to 

$729,750 is far beyond its core mandate to serve low to moderate 

income borrowers. It is hard to understand why helping people buy 

homes with a mortgage of $729,750 is an appropriate use of Government resources. 

Q.2. And in so doing, don’t these moves supplant privately insured 

loans with FHA-backed loans, thereby driving private capital away 

from the housing market and putting taxpayers at risk for losses 

that otherwise would be borne by the private sector? 

A.2. FHA guarantees mean risk for taxpayers; indeed, one of six 

FHA-backed loans is delinquent. Were it not for the increased FHA 

loan limits, the private sector would handle mortgages larger than 

the conforming loan limit for Fannie Mae and Freddie Mac. FHA 

activities thus displace private sector risk-taking and private capital. 

Q.3. Given that the FHA is severely undercapitalized and teetering 

on the edge of a massive bailout, shouldn’t the FHA be focused on 

managing and containing its significant risk exposure, and not on 

increasing its market share and financial exposure? 

A.3. As documented by Joseph Gyourko and Edward Pinto in research released by the American Enterprise Institute (AEI), FHA 

is in severe financial difficulty. As Pinto notes, the agency is on 

track to end 2012 with only $3 billion in reserves, considerably 

worse than the $11.5 billion in reserves projected in November 

2011 (http://www.aei.org/files/2012/08/20/-fha-watch-no-8-august-2012l142920761624.pdf). The agency is likely insolvent if 

measured by private sector standards rather than governmental accounting methods. The FHA should focus on managing and containing its risk, since FHA losses ultimately would require a costly 

bailout by taxpayers. 

Q.4. What actions should Congress take to mitigate these risks and 

level the playing field? 

A.4. Congress should refocus FHA on a core mission of assisting 

homebuyers with low- and moderate-incomes. This could be done 

by reducing the limit for mortgages to qualify for an FHA guarantee and by imposing income tests on borrowers receiving FHA 

68 

assistance. These steps would help reduce the FHA market presence back to the roughly 10–15 percent historical market share. It 

would be useful as well to require FHA to provide more realistic 

measures of its financial condition so that Congress and the public 

have a full understanding of the agency’s financial condition and 

the risks borne by taxpayers. 

69 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

STATEMENT OF THE NATIONAL ASSOCIATION OF REALTORS®

Introduction 

On behalf of more than 1.1 million REALTORS® who are involved in residential 

and commercial real estate as brokers, sales people, property managers, appraisers, 

counselors, and others engaged in all aspects of the real estate industry, thank you 

for giving us an opportunity to share our thoughts on improving the housing sector, 

and thus spurring an economic recovery. 

It’s no secret our Nation’s housing markets remain depressed and continue to suffer. While no one thought the crisis would carry on so long, markets are slowly recovering, but remain in need of immediate policy solutions to address the myriad 

challenges in order to stabilize housing and support an economic recovery. REALTORS® have long maintained that the key to the Nation’s economic strength is a 

robust housing industry. And, we remain steadfast in our belief that swift action 

is needed to directly stimulate a housing recovery. 

REALTORS® Plan To Improve Housing 

REALTORS® are eager to work with Congress and the Administration to put a 

plan into action that helps significantly reduce monthly mortgage payments by reducing the barriers to low-cost, streamlined refinancing for millions of homeowners 

as an alternative to defaulting on their mortgage loans. Moreover, improving access 

to simple, low-cost refinancing and streamlining the process will help hardworking 

families who have also stayed current on their mortgage payments, which also goes 

a long way to helping keep more families in their homes. 

With the mantra of helping the Nation’s homeowners maintain their homes, in 

late 2011, NAR worked with two well-respected policy think tanks—the Progressive 

Policy Institute (PPI) and the Economic Policies for the 21st Century (e21)—to organize and conduct a housing solutions policy. ‘‘New Solutions for America’s Housing 

Crisis’’ brought together policy leaders, industry representatives, Members of Congress, thought leaders and the media to present ideas and make actionable recommendations intended to stimulate the growth necessary for a sustained recovery 

in housing and extend an ensuing positive effect on job creation and the broader 

economy. 

Crafted from the conference’s discussions are recommendations that REALTORS®

respectfully submit as examples of relatively easy solutions that can help the housing sector recover. In recent weeks, some of these ideas have been suggested as solutions by the Administration and Federal Reserve. REALTORS® appreciate their 

thoughtfulness in identifying a plethora of fixes that we believe will make an immediate, positive impact. 

Do Not Risk Weakening Our Nation’s Housing Markets Any Further 

There are a number of proposed rules and recent congressional actions that actively thwart the housing recovery. Rectifying these issues will offer confidence and 

reassurance to investors and consumers, and bring them back into the marketplace. 

1. Re-craft the Qualified Residential Mortgage rule mandated by the Dodd-Frank 

Act to include a wide variety of traditionally safe, well documented and properly underwritten products. Requiring a 20 percent down payment coupled 

with stringent debt-to-income ratios and rigid credit standards—as defined 

under the proposed rule by six Federal regulators—would be detrimental to 

prospective home buyers, especially first-time and middle-income buyers. 

2. Restore higher loan limits supported by the GSEs to provide additional liquidity in housing markets and to assure mortgage financing options while stabilizing local housing markets. 

3. Resist proposals that call for changing the tax rules that apply to home ownership now or in the future. Without a doubt, now is not the time to change the 

mortgage interest deduction or any other housing incentives. Making gradual 

or targeted changes would send the wrong signal further undermining confidence and further depressing home values. 

4. Reject further g-fee increases as a means to offset the costs of a payroll tax 

extension. Additionally, we urge you to reject measures that would increase 

Ginnie Mae’s g-fees or FHA mortgage premiums (both single- and multi-family) 

that will disproportionately harm low- and moderate-income borrowers, firsttime homebuyers, renters with modest incomes, and others when those funds 

are diverted to the Treasury and used as an offset to pay for a 10-month extension of the current law. Diverting these fees away from their intended purpose 

70 

is a de facto tax increase on homebuyers and raises costs on the very same 

Americans the underlying bill sought to help. 

Restore Vitality to Our Communities and Neighborhoods by Reducing the Foreclosure 

Inventory 

REALTORS® are more than business owners within local communities—we are 

residents. As foreclosures mount, REALTORS® are not just impacted by reduced 

sales, we are also impacted by depressed home values that reduce Government services and further deteriorate communities. Therefore, efforts to mitigate foreclosures 

and restore communities are paramount to our members. 

1. Support S.170, The Helping Responsible Homeowners Act, sponsored by Senators Barbara Boxer (D-CA) and Johnny Isakson (R-GA). Their bill would remove refinancing limits on underwater properties for borrowers that have been 

paying on time, and would eliminate risk-based refinancing fees charged by 

Fannie Mae and Freddie Mac. 

2. Support bipartisan Senate efforts calling for improvements to the Home Affordable Refinance Program (HARP). Led by Senators Barbara Boxer (D-CA), Johnny Isakson (R-GA) and Robert Menendez (D-NJ), the time is appropriate to enhance HARP and provide refinancing opportunities to at-risk borrowers as an 

alternative to defaulting on their mortgage loans. 

3. Direct Fannie Mae, Freddie Mac and servicers to prioritize short sales above 

foreclosures. 

4. Support all necessary foreclosure/loss mitigation efforts to keep American families in their homes. Realogy Corporation’s President and CEO, Richard Smith, 

has proposed a debt for equity approach to help underwater borrowers in trouble keep their homes and lower their monthly payments while lenders take a 

smaller hit than they would have with a default and foreclosure. Realogy Corporation is a leading provider of real estate and relocation services representing world-renowned brands and business units that include Better 

Homes and Gardens® Real Estate, CENTURY 21® , Coldwell Banker® , 

Coldwell Banker Commercial® , The Corcoran Group® , ERA® , Sotheby’s 

International Realty® , NRT LLC, Cartus and Title Resource Group. 

5. Ensure that any plans by Government agencies to sell foreclosed properties in 

bulk are done on a limited scale, are carefully tailored and appropriate for the 

markets in which they occur, and provide flexibility should market conditions 

not ultimately favor rental conversion of properties. 

Open Opportunities for Private Capital To Return to the Mortgage Marketplace To 

Foster New Demand Among Responsible Homebuyers 

Reforming the secondary mortgage market is essential to ensuring a reliable 

source of mortgage lending for consumers in all types of markets and is integral to 

the Nation’s economic and housing recovery. NAR supports efforts to increase private capital in the housing finance market and reduce the size of the Government’s 

involvement. Below are two quick fixes that we believe will immediately encourage 

the return of private capital. 

1. Open up the FHA Section 203(k) rehabilitation loan program to investors to 

encourage purchasing of foreclosed property. This will facilitate the rehabilitation of the existing housing stock and help reduce the inventory of foreclosed 

homes. 

2. Require the GSEs to temporarily suspend investor financing limitations, especially the limit on the number of mortgage loans allowed for any one investor/ 

borrower (currently 4 for Freddie Mac and 10 for Fannie Mae). This will give 

small, private investors the opportunity to absorb some of the excess inventory, 

resulting in the stabilization of prices for existing real estate-owned (REO) 

properties. 

Support a Secondary Mortgage Market Model That Includes Some Level of Government Participation 

Though REALTORS® agree that a properly functioning housing finance market 

requires reducing the Government’s participation and increasing private capital, full 

privatization is not an effective option. 

REALTORS® oppose proposals that call for full privatization of Fannie Mae and 

Freddie Mac. This is not an effective option because private firm’s business strategies will focus on optimizing their revenue/profit generation. This model would foster mortgage products that are more aligned with the businesses goals than in the 

best interest of the Nation’s housing policy or the consumer. 

71 

Conclusion 

Home ownership matters. It represents the single largest expenditure for most 

American families and the single largest source of wealth for most homeowners. The 

development of home ownership has a major impact on the national economy and 

the economic growth and health of regions and communities. Home ownership is inextricably linked to job access and healthy communities and the social behavior of 

the families who occupy it. We recognize the serious public debate as to which tax 

and spending policies will best support the sound fiscal management that our Nation requires. However, we urge caution against dismantling or eliminating vital resources for housing that provide important economic, social, and societal benefits. 

The National Association of REALTORS® sees a bright future for the housing 

market and the overall economy. However, our members are well aware that the 

future we see rests on the industry’s and the economy’s ability to successfully navigate some significant obstacles. Congress and the housing industry must maintain 

a positive, aggressive, forward looking partnership if we are to ensure that housing 

and national economic recoveries are sustained. 

I thank you for this opportunity to present our view on improving the housing 

market. As always, The National Association of REALTORS® is at the call of Congress, our industry partners, and other housing stakeholders to help facilitate a sustainable housing and national economic recovery. 

STATEMENT SUBMITTED BY TIM C. FLYNN, CEO, NATIONAL VALUE 

ASSURANCE, LLC 

A Unique Strategy for Addressing the Enterprise REO Inventory Imbalance 

A solution designed to be immediately deployable and without cost to taxpayers! 

The purpose of this submission is to present a new and compelling strategy that 

will significantly reduce, or even eliminate the excess REO inventory that is owned 

by the Enterprises. This strategy is best described as the ability to provide qualified 

homebuyers, who intend to be owner occupants, with the contractual assurance that 

their home purchase will not be subject to the value degradation that has been experienced by almost all homebuyers in America over the past 6 years. In a phrase, 

we are referring to the strategy as ‘‘homebuyer’s price (value) protection.’’ 

Over the past 2 years, the inability of the American housing economy to absorb 

it’s excess housing inventory and install a solid bottom to the downward spiral in 

home prices has been a great disappointment. This is especially true in the case of 

the Federal Reserve, which through various policy initiatives, has facilitated the 

lowest costs for mortgage financing in the Nation’s history. Most regulators and policy makers believed that home affordability was the key to resolving the Nation’s 

housing problem. This strategy proved ineffective, and the need to find a solution 

continued with increasing intensity. Policy makers and the Fed are now defaulting 

to one of the only remaining options: a bulk sales strategy discussed in the January 

4 white paper. 

The principal contention of this document is that the Enterprises, neighborhoods, 

and taxpayers would be better served by occupying these REO’s with qualified buyers rather than ‘‘bulk purchase owners.’’ We contend that this can be accomplished 

quickly and efficiently with a ‘‘homebuyer’s price (value) protection’’ program. We 

disagree with the conclusion that if the most favorable home affordability metrics 

in history couldn’t attract buyers, then individual qualified buyers were not present 

in sufficient numbers to significantly impact REO inventory. In our opinion, the 

major barrier to attracting qualified home buyers in this market is crowd psychology. It’s about fear—the fear of losing principle value on the largest investment 

most families will ever make. 

Our strategy represents a substantial departure from traditional thinking. The 

January 4, 2012, Fed white paper, entitled ‘‘The U.S. Housing Market: Current Conditions and Policy Considerations’’, did not include the concept of homebuyer’s price 

protection in its analysis and subsequent recommendation to Congress. It is our contention that the implementation of this strategy into the Enterprises REO marketing plan will result in a dramatic reduction of inventory and an optimum return 

of capital to the taxpayer. It will also foster a rapid, if not immediate, perceived bottom to the downward spiral in home prices. 

We have created a model utilizing homebuyer’s price protection that projects a 

present value benefit in excess of $42 billion dollars, or in our estimate, 36 percent 

in excess of the reasonable financial returns from any ‘‘bulk sales’’ tactic that is 

being considered and seems to be gaining momentum. 

72 

Certainly the financial implications are an important consideration, but as suggested in both the August 15th RFI issued by the Enterprises and the Fed white 

paper, another critical consideration is to protect the value and integrity of affected 

neighborhoods. On this point, there is universal agreement that the most desirable 

occupants for the REO inventory are qualified owner occupants. 

Our model that generated the above result assumed a 100 percent utilization of 

one strategy versus another. We clearly understand that the characteristics of the 

Enterprise REO inventory require multiple approaches to attain a satisfactory result for taxpayers. However, it is clear and financially irrefutable that the most beneficial solution for all related parties is to install owner occupants into as many 

REOs as possible and the only way to accomplish this is to use a form of homebuyer’s price protection. 

Thank you. 

(73) 

STATE OF THE HOUSING MARKET: REMOVING 

BARRIERS TO ECONOMIC RECOVERY—PART 

II 

TUESDAY, FEBRUARY 28, 2012 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:07 a.m., in room SD–38, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I will call this hearing to order. 

I thank our witnesses for joining us. Today’s hearing is part two 

of our examination of the state of the housing market and steps 

that can be taken in the near term to remove housing market barriers to economic recovery. 

This Committee has undertaken a bipartisan, in-depth look at 

long-term housing finance reform. I hope to continue this effort 

with additional hearings and by working with Ranking Member 

Shelby and Committee Members to seek bipartisan consensus. In 

today’s hearing, we will focus on the immediate problems confronting the housing market and the larger economy, which is a 

critical first step in finding a long-term solution. 

In January, the Federal Reserve released a white paper entitled, 

‘‘The U.S. Housing Market: Current Conditions and Policy Considerations.’’ In this paper, the Fed stated that continued weakness in 

the housing market poses a significant barrier to a more vigorous 

economic recovery. 

As I stated during our February 9 hearing on this topic, I share 

the concern that ongoing challenges in the housing market are acting as a drag on the economic recovery. I want to find practical solutions to help overcome them. 

Today’s hearing provides a good opportunity to discuss the current housing market environment with regulators and the Administration’s top housing official. I would like to hear from our witnesses about potential solutions, both legislative and administrative. 

In addition to the Federal Reserve’s recent white paper, other analysts, regulators, and the Administration have offered up options 

and proposals to address barriers to housing and economic recovery. Earlier this month, the Administration outlined a new housing 

plan to give more families the opportunity to refinance at today’s 

74 

low rates. Just yesterday, the Federal Housing Finance Agency announced its first pilot sale in an initiative to address the large volume of real estate-owned properties held by the Government Sponsored Enterprises. 

At our February 9 hearing, the witnesses and a number of Committee Members on both side of the aisle cited helping families refinance at today’s low interest rates as a powerful example of an action that would help bolster the housing market and stabilize housing prices. This is particularly true for mortgages held by the 

GSEs. I would like to see the FHFA take additional steps to facilitate refinancing for families currently stuck in higher-interest 

mortgages held by Fannie and Freddie. I look forward to hearing 

more from Acting Director DeMarco on steps that FHFA is planning to take to speed up these refinancings. 

Without a robust housing market recovery, our economy will continue to drag and millions of Americans will continue to struggle 

to make ends meet. I look forward to continuing to work with our 

witnesses and Members of the Committee to find workable solutions to improve the housing market and lead us further down the 

road to prosperity. 

With that, I turn to Senator Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Welcome, again, Mr. Secretary. 

Mr. DONOVAN. Good morning. 

Senator SHELBY. This is the second hearing this Committee has 

held this year to examine the Nation’s weak housing market. Each 

witness before us today has a proposal to revive the housing market and help struggling homeowners. Some of these proposals 

would require Congressional action. 

As I stated during our last hearing, I believe that this Committee 

should come together and craft common sense legislation to address 

the serious problems weighing on the housing market today. Hopefully, today’s witnesses will identify some potential solutions to 

these problems and give the Committee some options for its consideration. 

Our first panel will be HUD Secretary Shaun Donovan, who will 

discuss the President’s most recent housing proposal. The centerpiece of that plan, as I understand it, would allow underwater borrowers with loans held in the private sector to refinance with an 

FHA loan. To subsidize the additional risk placed on the FHA fund, 

the President has proposed using money from a bank tax. As we 

have not yet received many of the details or any analysis of this 

plan, I look forward to hearing more from the Secretary as to who 

this plan may help and the Administration’s estimate of its impact 

on the housing market as a whole. 

Because the President has proposed a new use for the FHA, I 

would like Secretary Donovan to update us on the status of the 

FHA fund. The President’s budget predicted that FHA would require a taxpayer bailout this year were it not for the funds it would 

receive from the recent mortgage settlement. And given the repeated assurances from the Secretary and multiple FHA Commissioners as to the strength of the fund, this revelation is troubling, 

75 

although not unexpected for those of us here who have predicted 

insolvency for the FHA for quite some time. Hence, today’s discussion should also include what changes should be made, Mr. Secretary, I hope, to FHA to ensure that the taxpayer is not on the 

hook for FHA losses. 

We also, I believe, we need to learn more about the settlement 

that is providing these funds to the FHA. To date, Congress and 

the public have been given only broad outlines of the terms of the 

settlement, and as a result, there are many unanswered questions 

about how the settlement was reached and how it will operate. The 

most important question, I believe, is how will this money be distributed, Mr. Secretary. In particular, is there a connection between how much harm a homeowner suffered and the amount of 

compensation a homeowner receives? 

Although having the settlement compensate as many people as 

possible may make sense politically, settlement funds, I believe, 

should compensate homeowners who suffered actual harm and 

deter future violations of the law. The settlement, however, appears to come up short on both counts, but we will wait and see. 

For example, the Administration’s press release indicates that 

homeowners who were improperly foreclosed upon will receive only 

about $2,000, and as a result, homeowners who were wrongfully 

foreclosed upon will still likely have to pursue the remainder of 

their claims in court or through financial regulators. In contrast, 

many homeowners who suffered no legal harm appear to be eligible 

for compensation under the settlement, as well. I hope Secretary 

Donovan today can provide more clarity on how the Administration 

will determine who will be compensated under the settlement and 

for what. 

Our second panel today, Mr. Chairman, as you pointed out, will 

discuss two recent papers by the Federal regulators on reforming 

the housing market. Federal Reserve Governor Duke will be discussing the white paper that was recently sent to Congress by 

Chairman Bernanke. This paper reviewed numerous proposals but 

concentrated on measures to convert bank-owned real estate to 

rental property. 

FHFA Director DeMarco will be discussing the new strategic 

plan he recently released outlining the future of the 

conservatorships of Fannie Mae and Freddie Mac. The conservatorship has already lasted over 3 years. The longer it continues, the 

greater the risk is, I believe, that taxpayers will suffer additional 

losses as Fannie and Freddie’s uncertain future erodes their ability 

to retain high-quality personnel and make essential infrastructure 

investments. 

But given the FHFA’s limited legal authority as conservator, only 

Congress, I believe, can determine the future of Fannie and 

Freddie. I regret that Congress did not take action with regard to 

these companies years ago. I look forward to learning more about 

what FHFA intends to do until Congress does act and what additional steps Congress should take to end the conservatorships of 

Fannie and Freddie. 

I believe the testimony of all three of today’s witnesses reveals 

that there is a great deal to be done to both revive the housing 

market and reform the GSEs. It is always my hope that this ComVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00079 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
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mittee does not delay any further in moving bipartisan legislation 

to help struggling homeowners and to reform our housing market. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Shelby. 

Are there any other Members who wish to make a brief opening 

statement? Senator Menendez. 

STATEMENT OF SENATOR ROBERT MENENDEZ 

Senator MENENDEZ. Thank you, Mr. Chairman. I appreciate you 

holding this hearing. I think it is incredibly important. It has long 

been our top priority in the Housing Subcommittee that I am privileged to chair to restore the housing market to full health so that 

we can get the broader economy moving more quickly. And we have 

made some progress in knocking down barriers that are slowing 

the housing market rebound, but there is a lot more to do. 

So I welcome the Secretary. I am looking forward to hearing 

more about the Administration’s plan. Many of those items are 

items that the Subcommittee has proposed. That includes helping 

homeowners refinance more easily, which I am currently working 

on a bill to implement. It also creates national servicing standards 

so that banks are held accountable for following foreclosure laws 

and fixing the vacant homes that are blighting our neighborhoods 

and turning some of them into affordable rentals in those places 

that make sense. 

But last, I am really concerned, and I look forward to Mr. 

DeMarco’s appearance, Mr. Chairman. The FHFA has shown a dismal lack of initiative in the housing crisis and needs to be far more 

aggressive in taking steps that could both help homeowners and 

taxpayers, particularly on the question of refinancing and principal 

reduction. We can either achieve that through foreclosure or we 

can achieve it through refinancing and principal reduction. It 

seems to me that there are greater benefits for both the housing 

market and American families through that—via that process than 

what we have seen today, and I think that we can do that without 

sacrificing taxpayers’ interest, because Fannie and Freddie’s financial health is directly tied to how quickly the housing market recovers. So I look forward to the opportunity to hear from Mr. DeMarco 

as well as the Secretary. 

Chairman JOHNSON. Any other Members? 

[No response.] 

Chairman JOHNSON. Thank you. 

I want to remind my colleagues that the record will be open for 

the next 7 days for opening statements and any other materials 

you would like to submit. 

Now, I would like to briefly introduce our first panel witness. 

Secretary Shaun Donovan is the 15th Secretary of the Department 

of Housing and Urban Development. Secretary Donovan has served 

in this capacity since January 2009. Secretary Donovan, you may 

proceed with your testimony. 

STATEMENT OF SHAUN DONOVAN, SECRETARY, DEPARTMENT 

OF HOUSING AND URBAN DEVELOPMENT 

Mr. DONOVAN. Thank you, Chairman Johnson, Ranking Member 

Shelby, Members of the Committee. Thank you for this opportunity 

77 

to testify about how the Administration’s housing initiatives are 

helping remove barriers to economic recovery. 

Thanks in part to the partnership of this Committee, this is a 

very different environment than the one we faced when President 

Obama took office. Back in January 2009, America lost 818,000 

jobs. Housing prices had fallen for 30 straight months and foreclosures were surging to record levels month after month. 

Today, more than 13 million homeowners have refinanced their mortgages since April 2009, putting nearly $22 billion a year in 

real savings into the hands of families and into our economy. Because we provided responsible families opportunities to stay in 

their homes, more than 5.6 million mortgage modifications have 

been started in the last 3 years and foreclosure notices are down 

about 50 percent since early 2009. Because we helped communities 

struggling with concentrated foreclosures, today, vacancy rates are 

down and property values are up in areas where we focused Neighborhood Stabilization dollars. Most important of all, our economy 

has added private sector jobs for 23 straight months, totaling 3.7 

million jobs. 

Mr. Chairman, this represents important progress, but there is 

more to be done. Three key barriers hold back the recovery of our 

housing market, which is key to our broader economic recovery. 

The first is keeping more families in their homes. While the number of homeowners at risk of losing their home is down significantly, there are still too many families that face hardships and are 

underwater, and their unaffordable monthly payments put them at 

an increased risk of default, dragging down markets, reducing 

labor mobility and consumer spending. 

Indeed, as economist Mark Zandi said, there is no better way to 

quickly buoy hard-pressed homeowners than helping them take advantage of the currently record low fixed mortgage rates and significantly reduce their monthly mortgage payments. That is why 

last fall, the President announced critical changes that would help 

more families with loans backed by Fannie Mae and Freddie Mac 

to refinance. Thanks to this work, another 300,000 families have 

already filed applications for refinancing and stand to save an average of $2,500 per year, the equivalent of a good-sized tax cut. 

Similarly, we have also been taking steps to make FHFA streamlined refinance available to more borrowers with loans insured by 

the FHA, allowing them to refinance into a new FHA insured loan 

at today’s low interest rates without any additional underwriting. 

This not only reduces homeowners’ monthly mortgage payments, 

but also risk to FHA. 

Still, there is no reason why families with FHA loans or loans 

backed by the GSEs should be the only ones who get help. Millions 

of homeowners who have done the right thing and paid their bills 

cannot refinance because they are underwater and owe more than 

their homes are worth, leaving them stuck paying higher interest 

rates that cost them thousands of dollars more a year and putting 

them unnecessarily at risk. 

That is why in his State of the Union Address President Obama 

announced a plan that will give every responsible homeowner in 

America the chance to take advantage of today’s record low interest 

rates. Any borrower with a loan that is not currently guaranteed 

78 

by the GSEs or insured by FHA can qualify if they are current on 

their mortgage, meet a minimum credit score, have a loan that is 

within FHA’s conforming loan limits, and are currently employed. 

While this program would be run by FHA, it would be financed 

from a completely separate account from FHA’s MMI Fund. Indeed, 

by financing this proposal through a dedicated funding source, it 

will have no impact on FHA’s MMI Fund. We look forward to working with Members of this Committee to craft legislation to accomplish these goals and establish a broad-based refinancing program. 

At the same time we provide relief to responsible homeowners 

and keep families in their homes, we also need to attack the second 

barrier to our housing recovery, the overhang of properties that are 

at risk of or already in foreclosure. While targeted support to markets struggling with foreclosures, blight, and abandonment has reduced vacancy rates, increased home prices, and shrunk the inventory of homes for sale, an overhang of properties at risk of or in 

foreclosure continues to drag down property values and harm the 

hardest-hit communities. With the rental market recovering faster, 

we need to think creatively about ways we can dispose of this shadow inventory. 

With about a quarter-of-a-million foreclosed properties owned by 

HUD and the GSEs, this August, HUD joined with FHFA and 

Treasury to seek new and innovative ideas for absorbing excess inventory and stabilizing prices. Yesterday, the FHFA in conjunction 

with Treasury and HUD announced the first major pilot sale of 

foreclosed properties to be repurposed into rental housing. This 

marks the first of a series of steps that the FHFA and the Administration will take to develop a smart national program to help manage REO properties and ease the pressure of these distressed properties on communities and the housing market. 

While expanding REO to rental is a critical tool, in the hardesthit markets where prices have dropped the most and the most vacant and abandoned buildings are found, more needs to be done to 

jump-start construction and reduce vacancy rates. That is why 

President Obama has proposed Project Rebuild. Building on the 

Neighborhood Stabilization Program, Project Rebuild would allow 

commercial redevelopment essential to neighborhood revitalization 

to be funded directly and expand the ability of the private sector 

to participate with localities, ensuring there is the expertise and 

capacity to bring these neighborhoods back in a targeted way. Most 

important of all, it would create 200,000 jobs in the places that 

need the most. 

The third barrier to recovery, Mr. Chairman, is access to credit. 

While we stabilize the market and put an end to the worst abuses 

that caused this crisis, uncertainty over making loans has made it 

too difficult to get a mortgage today. Reducing this uncertainty is 

why we recently published our indemnification rule to clarify 

standards in FHA’s Lender Insurance Program and continue to 

work with Congress to ensure FHA direct endorsement lenders are 

subject to the same rules and regulations. And it is why we believe 

it is important for the Federal Housing Finance Agency to make 

clear the rules of the road for GSE lenders with well defined, 

straightforward reps and warranties that will further reduce uncertainty around repurchase risk. 

79 

And, Mr. Chairman, a clear example of our efforts to clear away 

all of these barriers to recovery is the historic $25 billion mortgage 

servicing settlement reached by the Obama administration and an 

unprecedented coalition of 49 State Attorneys General that 

spanned partisan and geographic lines. The product of 16 months 

of intensive negotiations, the settlement addresses the harm mortgage servicing abuses have done to homeowners and the housing 

market more broadly. It keeps more families in their homes by providing tens of billions of dollars in relief for struggling homeowners, much of which will come in the form of principal reduction 

for distressed homeowners. 

Keeping these families in their homes not only improves their 

prospects, but also those of their neighborhoods who have watched 

their own property values plummet by $5,000 to $10,000 each time 

a foreclosure sign goes up on their block. Indeed, that is why we 

recently tripled the incentives for cost effective mortgage modifications through the HAMP program that include a write-down of the 

borrower’s principal balance and, for the first time, made these incentives available to Fannie Mae and Freddie Mac. We believe this 

is good for taxpayers and families alike. 

The settlement attacks the shadow inventory by reducing the 

number of homes that will need to go to foreclosure and by establishing a clear foreclosure process, helping families who are waiting 

to buy vacant homes and lifting neighborhood home prices as a result. And it reduces uncertainty that impedes access to credit by 

providing clear and fair servicing standards that build upon the 

new protections in our Homeowner Bill of Rights. 

That means at the same time the new Consumer Financial Protection Bureau is putting in place a single, straightforward set of 

common sense rules that families can count on when they are buying a home, the standards in this settlement will give people the 

confidence that lenders and servicers are adhering to a specific set 

of rights should they ever lose a job or have a medical emergency 

that puts their home at risk. No more lost paperwork. No more 

runaround. No more excuses. And by forcing banks that service a 

majority of all mortgages in the country to fix the types of problems 

we uncovered during our investigations, these new protections set 

the stage for servicing standards reform more broadly. 

And so, Mr. Chairman, as you can see, we have made very important progress in recent months to get our housing market back 

on track, putting in place the most significant principal reduction 

effort in history and establishing critical consumer protections that 

hold powerful institutions accountable for their actions, helping our 

housing market recover and giving every homeowner the dignity, 

respect, and fair treatment they deserve. 

But for all this progress, we still need Congress to act to ensure 

that every responsible family in America, regardless of who owns 

their loan, has the opportunity to refinance. We still need to continue our work together to create a robust private housing system 

of housing finance and protect the FHA fund for the future. And 

we still need a balanced National Housing Policy that ensures 

Americans have choices in housing that make sense for them and 

their families. That is the goal of all of this work and it is fundaVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00083 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
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mental to creating an economy that is built to last. I look forward 

to working with Congress to make it possible. 

And with that, I look forward to taking your questions. Thank 

you. 

Chairman JOHNSON. Thank you for your testimony. 

As we begin questions, I will ask the Clerk to put 5 minutes on 

the clock for each Member. 

Secretary Donovan, some have stated concern about the potential 

risk to taxpayers from the President’s proposal to refinance nonGovernment-backed loans through a new FHA program. What policy do you believe FHA can adopt to ensure that any risk to the 

FHA and taxpayers is paid for? 

Mr. DONOVAN. Mr. Chairman, a very important question. First 

and foremost, I think the focus of this program, this proposal, is 

on borrowers who are paying, who have come through this entire 

crisis even though they are underwater and continue to be responsible and make their payments. Those are already low-risk loans, 

and by lowering their payments further, on average, about $3,000 

a year, we would make them even less risky. So that is the first 

important focus. 

Second, as I mentioned in my testimony, we would set up an entirely separate fund to—that would not affect FHA’s finances in its 

MMI or other funds and would identify a dedicated source of funding to offset risk in those loans. 

Third, we would also impose and look forward to discussing with 

Congress a set of standards around what loans could refinance. For 

example, we have proposed a cap of 140 percent loan-to-value so 

that whoever owns the loans currently is required to do principal 

reduction and reduce the risk on those loans even further as they 

are refinanced. 

But the last thing I would say, and this is perhaps the most important, is the single most important thing we can do to protect the 

taxpayer is to ensure that existing investments of FHA, Fannie 

Mae, Freddie Mac, any Government-backed entity, that those investments improve in value. And by stabilizing the housing market 

more broadly, by putting billions of dollars into the pockets of 

homeowners that can help to boost the economy more broadly, we 

believe that these steps on refinancing can lift the overall housing 

market and, therefore, lower losses on legacy books of loans in the 

FHA and at the GSEs. 

Chairman JOHNSON. Mr. Secretary, a key component of the 

multi-State Federal servicer settlement is that a uniform set of 

servicer standards will be put in place for the five largest banks. 

In your opinion, how will this part of the settlement affect the foreclosure and loss mitigation process that servicers engage in, and 

what benefits will be provided to the housing finance sector as a 

whole? What is the time line for implementation of these standards? 

Mr. DONOVAN. A very important piece of the settlement, as you 

recognize, is establishing these standards, and one of the things I 

would point out, we worked very closely with the FHFA, and I 

want to compliment them on their work on that, to make sure that 

these standards did not just cover FHA and non-GSE loans, but 

also would cover GSE loans. So it is comprehensive in terms of the 

81 

types of loans that it covers. And just the five servicers that have 

signed on at this point—there are others that we continue to negotiate with—but just the five represent a majority of all loans serviced in the country. So it is very important just to have those five 

signed on. 

The three key benefits that I would identify in terms of the servicing standards, one is that homeowners will be able to depend on 

getting real help to stay in their homes, as required by FHA standards and, frankly, in a way that will benefit the investors in those 

loans, as well. We found in our investigations significant noncompliance with our requirements for FHA in terms of loss mitigation and other standards, and so protections like, for example, not 

being foreclosed on while your application for assistance is being 

evaluated by the bank is one of the standards. Having a single 

point of contact at the banks so that you are not shuffled from person to person, your paperwork lost, et cetera. So those are important consistent standards that are there that will help homeowners. 

Second of all, by establishing these standards, we expect to speed 

up not just the process of getting help to homeowners, having fewer 

families falling into foreclosure, but right now, the foreclosure process itself is dragging on across many, many States and is hurting 

neighbors where homes are sitting vacant in those communities. 

And so clarifying and having a single foreclosure process across the 

country is a very important step in terms of getting relief to housing markets, as well. 

And then, finally, I would point out that investors in these loans 

will also now have a more consistent set of what they can expect 

in the way that loans are serviced and the kinds of steps that will 

be taken to protect their investment, just as they will the taxpayers’ interest in the FHA. 

Chairman JOHNSON. Secretary Donovan, can you provide additional detail on how the elements of the servicing settlement coordinate with the Administration’s housing plan. 

Mr. DONOVAN. I would be very happy to do that. I think two specific points that I would make beyond the servicing standards that 

we just spoke about. These servicing standards, I think, are a good 

starting point for the broader work that we are doing across all the 

regulatory agencies to create uniform servicing standards by regulation, and so that is a first important step. But two other points 

are very critical here. One is that the settlement would make available to non-GSE, non-FHA borrowers some amount of refinancing 

for current borrowers. So it is, if you will, a downpayment, so to 

speak, on the broader proposal that the President laid out in the 

State of the Union Address. So that refinancing piece is important. 

Second, it is, as I said in my testimony, the most important step 

that we have taken thus far of the crisis, to get real significant 

principal reduction started. But by combining that with increasing 

our incentives for principal reduction through the HAMP program, 

making those incentives available to Fannie Mae and Freddie Mac, 

we think that the settlement could have a catalytic effect in really 

showing, demonstrating that principal reduction is positive, not 

just for homeowners and communities, but is also positive for investors. When it is done in a net present value positive way, in a 

82 

way that increases returns to investors, we think it could set a new 

standard along with these other steps that we have taken to make 

principal reduction more widespread as a solution to our housing 

challenges. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you. 

Secretary Donovan, in 2009, right here, you told this Committee, 

and I will quote, ‘‘Based on current projections and absent any catastrophic home price decline, FHA will not need to ask Congress 

and the American taxpayer for extraordinary assistance. There is 

no need for any bailout.’’ Those are your words. 

Despite this reassurance, OMB predicted that were it not for the 

funds that FHA is to receive in the mortgage settlement, FHA likely would have required a taxpayer bailout this year. As Secretary 

of HUD, you are ultimately responsible for ensuring the solvency 

of FHA regardless of unexpected events or erroneous projections. 

Without any caveats or qualifiers, can you assure this Committee 

that the American taxpayer will not need to bail out the FHA 

fund? 

Mr. DONOVAN. Senator, I wish I had a crystal ball—— 

Senator SHELBY. I know that. 

Mr. DONOVAN. ——of exactly how the housing market would perform the rest of this year and beyond. The fact is that I am confident, and I remain confident, that we are taking responsible steps 

to protect the FHA fund and, at the same time, to ensure that our 

housing market continues to recover. 

And specifically to your question about the numbers in our budget, as OMB made clear, those numbers were outdated at the time 

that they were published. We did not include in our budget additional premium increases that were announced yesterday because 

we were waiting to see the outcome of the servicing settlement and 

the recoveries that we would make there from our increased enforcement activities. 

Senator SHELBY. What will the additional fees do for you? How 

much money will it bring in, roughly? 

Mr. DONOVAN. If you include both the—actually, not including 

the premium increases that were included in our budget, the additional changes that we announced yesterday will net us over a billion dollars more between fiscal year 2012 and 2013. 

Senator SHELBY. OK. Secretary Donovan, there has been very little information provided to the public regarding how the Administration determined that the settlement compensates fairly homeowners who have legal claims. In your review, how many borrowers 

did you find that had been improperly foreclosed upon? 

Mr. DONOVAN. Senator, I think this is a very important point 

about the investigations that we did. One piece of it was on improper foreclosures. 

Senator SHELBY. OK. 

Mr. DONOVAN. But we also—we began our investigation at FHA 

in the summer of 2010 looking at, more broadly, at servicing problems, not just in the foreclosure process but more broadly in the 

servicing problems. And before even the word ‘‘robo-signing’’ became a publicly used term, we were more than a year into those 

investigations. 

83 

Senator SHELBY. OK. 

Mr. DONOVAN. And so, to be clear, what we found in the case of 

some institutions, as high as 60 percent error rates in servicing 

FHA loans, a whole range of different types of errors. And then 

equally high rates of problems in foreclosures with certain institutions. 

We will be actually making public a number of those investigations, redacting sensitive information that may be there, but we 

will be making those available publicly this week—— 

Senator SHELBY. Would you furnish that—— 

Mr. DONOVAN. ——and that we would be happy to share more 

detail on the—— 

Senator SHELBY. With the Committee. 

Mr. DONOVAN. ——specifics of those reports with the Committee. 

Senator SHELBY. With this Committee. 

Mr. DONOVAN. Yes. 

Senator SHELBY. Does a borrower under the settlement need to 

have suffered any legal harm to be eligible for a refinanced mortgage or principal reduction under the settlement? 

Mr. DONOVAN. There are different pieces of assistance that come 

from the settlement. There is direct compensation that is available 

that really coordinates with assistance that is made available by 

the OCC and the Fed through their process which came out of the 

very same investigations. So there is direct assistance there. 

But one of the things that we found, Senator, as we went 

through and investigated this is that there were many, many 

harms to those who had FHA loans, for example, who, because 

their paperwork was lost, did not get help or did not get help as 

quickly. And in that case, it is very difficult to say precisely what 

would have happened had they gotten help on time. And so without 

the ability to say exactly what the amount of harm is in each of 

those cases, we had to set some standards for those who were 

harmed to help those homeowners. So, honestly, there is no precise 

way to measure exact harm in all of these processes that we had. 

The other thing, frankly, that we found, as I said in my testimony, is that if you live next door to a foreclosure, if there was 

somebody wrongly foreclosed on, that harms your neighbor who has 

done absolutely nothing wrong. And so we felt having a settlement 

that provided broader help to those housing markets that have 

been hardest hit through, for example, refinancing for borrowers 

who are current, was a—had a real connection to the type of harm 

that we saw as we went through these investigations. 

Senator SHELBY. But should not compensation as a principle be 

based on harm, in other words, somebody suffering harm? 

Mr. DONOVAN. I could not agree more—— 

Senator SHELBY. OK. 

Mr. DONOVAN. and again, the number of families that I have 

seen who have done everything right, who have paid their mortgages, and because there was a wrongful foreclosure next door, because somebody lost their home that should not next door, their 

own house prices have been harmed as a result. 

Senator SHELBY. Mr. Secretary, shifting around a little bit, about 

a month ago, President Obama told the American people that he 

was sending this Congress a plan to address the troubled housing 

84 

market. Subsequently, he has given speeches urging Congress to, 

quote, ‘‘pass his plan.’’ Today, it is my knowledge, as of this morning, Congress has not received that plan. We have not received it 

here. It has not been supplied to the Committee. When will the Administration’s housing plan be sent up for us to consider? 

Mr. DONOVAN. Senator, I think it is fair to say that we have 

shared a plan of the program that we would like to see enacted. 

We have had a series of meetings with your team, with others on 

the Committee—— 

Senator SHELBY. ——no more than—— 

Mr. DONOVAN. We do not at this point have specific legislative 

language—— 

Senator SHELBY. OK. 

Mr. DONOVAN. ——but we want to make sure that we get the 

input of Members of this Committee and others in Congress before 

we settle on a final legislative proposal. 

Senator SHELBY. Thank you. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Tester. 

Senator TESTER. Yes. Thank you, Mr. Chairman, and I want to 

thank you for bringing the folks together at this hearing to determine what is happening in our housing market. I think we heard 

some good news, recent data, and I think you have presented some 

good news, Secretary Donovan, on the housing market, but I think 

we all realize we have got a ways to go. 

One important step toward a healthy market is resolving and addressing the missed contact, which you addressed, that hurt homeowners, that pushed them into foreclosure. And while I appreciate 

the efforts of the State Attorney Generals and HUD and the Department of Justice to hold mortgage servicers accountable through 

this settlement, I still have questions how this settlement is going 

to help Montana or rural America specifically. 

I understand that Montana is going to receive a portion of the 

funds, and I know that Attorney General Bullock will put those to 

good use with that flat payment, but it is not going to be nearly 

enough to compensate, but it is a step. The bulk of the settlement 

is targeted toward struggling homeowners through refinancing as 

well as a menu of options, including principal reduction, forbearance, and short sales. Each of the parties of the settlement were 

required to meet dollar targets through these options and receive 

varying amounts of credit based on what sort of assistance is provided to original homeowners. I am getting there. 

As I understand it, the servicers the servicers are the party 

which will have complete discretion in determining which loans are 

modified, provided that they meet dollar obligations. So the question is, is what guarantee—since the servicers are making the call, 

what guarantee is there that any of the troubled homeowners in 

Montana will see a benefit from this settlement? 

Mr. DONOVAN. Senator, we would be happy to share with you 

specifics on what our estimates are of that help to Montana homeowners. But I think you asked a very important question, particularly given the experience we have had with past settlements 

where what was promised was not delivered. And there are three 

specific ways that we have built into this settlement to make sure 

that what has been promised will actually be delivered. 

85 

First of all, there are substantial financial penalties for not 

reaching those specific numeric goals. Again, this is not, like in 

some past settlements, a promise to knock on a door, to send a solicitation to offer something to a homeowner. There are very specific targets of what they actually have to deliver in each of these 

categories, and if they do not, any amount that they do not provide 

is converted to a cash penalty with a 25 percent or a 40 percent 

penalty on top of that amount. 

Senator TESTER. OK. 

Mr. DONOVAN. Second of all, there is a very strong monitoring 

system that has been put into place that will include a State Monitoring Committee. They have the ability to go into court, and both 

the monitor can levy fines up to $5 million for any violations and, 

beyond that, can go back into court for other remedies. 

Finally, and I think this is one of the most important aspects, we 

have built into the settlement a requirement that any principal reduction or any other help to homeowners has to be successfully 

working for 90 days to be able to count. In other words, it is not 

just that you have reduced principal, but that you have done it in 

such a way that we can assure that that homeowner has actually 

benefited and will continue to be able to stay in the home, and 

that, I think, is very important in terms of creating sustainable 

modifications for these families. 

Senator TESTER. OK. And just correct me if I am wrong. Is 

there—I mean, there are bigger incentives where there are a lot of 

foreclosures, especially compared to rural areas of this country, 

Montana being one of them, where we have had our share of foreclosures, too, but not nearly as many from a numeric standpoint. 

Is there anything that will require the servicers to go into rural 

areas, or will they just focus on—or could they just focus on the 

urban areas? 

Mr. DONOVAN. So this was a—this is an important question as 

we went through the settlement negotiations. Had we established 

individual targets for every State around the country—— 

Senator TESTER. Right. 

Mr. DONOVAN. ——we could have ended up—if you multiply 15 

States by 14 servicers, we could have ended up with 700 different 

targets—— 

Senator TESTER. Understand—— 

Mr. DONOVAN. ——which was not practical. What we did put in, 

though, is a specific requirement that there can be no actions that 

any of the servicers take that harm any particular geography. So 

the monitor does have the ability to go and say, wait a second. You 

are not reaching out to rural borrowers. You are not treating rural 

borrowers in the same way that gives them access to the same benefits. And we think that that protection will be strong enough to 

make sure that, whether it is Montana borrowers or other rural 

borrowers, do not get treated in a different way than anyone else 

around—— 

Senator TESTER. OK, and that monitoring system is the State 

Monitoring Committee that you had talked about in a previous 

question? 

Mr. DONOVAN. There is a full-time monitor who has been appointed who has very broad authorities to oversee. There is a MoniVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00089 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
86 

toring Committee, including Federal and State officials, that will 

have an ability to oversee the monitor. And then there is the Federal District Court in D.C. that will oversee the settlement. Should 

there be any disputes with the monitor, they can be resolved in the 

Federal District Court. 

Senator TESTER. And so—not to put words in your mouth, and 

my time has run out—but you feel confident that there are protections in place—and it can go either way, by the way. They could 

all focus on rural America. That has not traditionally been the way 

it has been. So you feel confident that there are entities in place 

that can force the settlement to go into rural America. 

Mr. DONOVAN. I do feel strongly that that is true. But I would 

also say, Senator, do not take my word for it. Forty-nine different 

State AGs, including yours, signed on—— 

Senator TESTER. Yes. 

Mr. DONOVAN. ——and many, many other rural States felt confident that this would benefit their States. 

Senator TESTER. And there is no doubt that the payment that 

those AGs are going to get is going to go to those States. I am talking about—— 

Mr. DONOVAN. Absolutely. 

Senator TESTER. OK. Thank you, Mr. Chairman. 

Mr. DONOVAN. Thank you. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. Thank you, Mr. Secretary, for being here. 

With the AG settlement, what is the differentiation that is being 

made between second lien holders and first lien holders? It is my 

understanding that it appears that first lien holders are going to 

be taking hits while second lien holders are not, which is incredibly 

perverse. I would like for you to enlighten us—— 

Mr. DONOVAN. Yes. 

Senator CORKER. ——if that is the case. 

Mr. DONOVAN. A very important question, and there have been 

some mistaken reports about this, so I am glad you asked the question. There are two different ways that we are making sure that 

lien priority is respected. 

First of all, the credit for the write-offs of second liens is different 

from the write-off for first liens. We are recognizing—— 

Senator CORKER. Let me just ask it a different way. 

Mr. DONOVAN. Yes. 

Senator CORKER. I do not want this to take that long. You are 

going to make sure that second liens are totally extinguished first, 

is that correct, before first liens are taking any heat, which is the 

way law works. 

Mr. DONOVAN. The minimum—we are basically using the standards for the HAMP program. The minimum is that it is at least 

pari passu, and any seriously—— 

Senator CORKER. So equal—— 

Mr. DONOVAN. If I could just finish, any seriously delinquent second has to be completely written off in the—— 

Senator CORKER. So you are going to do pari passu, equalequal—— 

Mr. DONOVAN. Equal—— 

87 

Senator CORKER. ——and even though contract law would say 

that first lien holders have priority, you are going to pari passu. 

You are going to let the second lien holder have equal rights to the 

first lien holder, is that what you are saying? 

Mr. DONOVAN. Senator, it is actually not correct that law requires—if a second lien is current, for example, there is no requirement that says it has to be totally written off. These are standards 

that are in place for the HAMP program and that work. I think 

they absolutely respect lien priority. It is at least pari passu, but 

if it is significantly delinquent, it has to be written off entirely in 

any of these transactions. 

Senator CORKER. How many of the homes—you all are really interesting when you use the word ‘‘improperly’’ foreclosed. What percentage would be your guess of loans that were improperly foreclosed on over a technicality and over those that actually were not 

making payments or behind, or maybe they were making payments 

and were not behind but were foreclosed upon? 

Mr. DONOVAN. I think this is a very important point, because I 

think the perception is somehow that the settlement was all about 

folks who lost their homes that should not have, and the percentage, as I think you imply, rightly, there are a very few folks who 

actually lost their home that should not have because of some error 

in the—still—— 

Senator CORKER. It would be very good if you all would actually 

say that instead of continuing down this rhetorical path that 

you—— 

Mr. DONOVAN. Senator, I—— 

Senator CORKER. ——and in your testimony alluded to on the 

front end. 

Mr. DONOVAN. I am not sure—I would be interested in your point 

on the testimony, but what we did find was very significant and 

very pervasive errors in the servicing process more broadly that 

have real impacts on families. And we have taken criticism, why 

is it only $1,500 or $2,000, the compensation, because most of the 

errors did not cause somebody to lose their home wrongly. Most of 

the errors were smaller errors that might have delayed help for a 

month or fees that should not have been charged, and that is why 

the predominant help that we are providing is a smaller number. 

Senator CORKER. Yes. 

Mr. DONOVAN. But if somebody did lose their home wrongly, they 

should obviously be compensated, and we have set up a system 

that can do that, as well. 

Senator CORKER. Do you think it is a good idea for someone with 

a credit score of 580, just out in the private sector, to come on the 

FHA’s balance sheet? Do you think that is good public policy? 

Mr. DONOVAN. What I will tell you is the large majority of the 

homeowners with 580 credit scores that we are making loans to are 

successful homeowners—— 

Senator CORKER. Yes. 

Mr. DONOVAN. ——and I do not believe we should take away the 

ability for somebody who can be a successful homeowner to be one. 

We obviously have to make sure that we are implementing risk 

controls. That is why when we first came in we raised the downpayment requirement for low credit score borrowers, and we have 

88 

taken a series of other steps to protect that. But I think if you look 

at the performance of our new books of loans, what you see is the 

best credit quality in the history of FHA and I think we are—you 

know, given that we have to find a balance between protecting the 

fund and helping homeowners get access to a home, and, frankly, 

making sure that the housing recovery continues. 

Senator CORKER. You know, every now and then, a guy comes 

along, or a person comes along in public service that you really are 

excited to be here and you think that they are going to be here 

really putting forth their honest opinions about things and really 

be here about good public service. You are one of those people. 

Mr. DONOVAN. Thank you. 

Senator CORKER. You and I have talked often. I am really disappointed in the overly political approach that you have taken, and 

you and I talked about a GSE proposal and you put forth a white 

paper a long, long time ago that had a multiple choice. 

I just want to tell you that I hope at some point you will recover 

from the mode that you are in right now and that you will actually 

bring forth solutions to our housing programs, including a real 

GSE reform bill. I just want to tell you, I am personally disappointed and I hope we will begin addressing the real issues that 

we have here in our country in housing in a way that is fair to all 

Americans, and I hope to talk to you soon. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

Mr. Secretary, I want to thank you for your leadership. 

Mr. DONOVAN. Thank you. 

Senator REED. I think most people acknowledge that this Attorney General’s settlement, although ably led by Attorney General 

Miller of Iowa, would probably not have come together without 

your personal involvement, and that is an extraordinary achievement. 

Mr. DONOVAN. Thank you. 

Senator REED. I think the paralysis that we have seen around 

here, maybe it has been broken, because now, at least, we have 

taken a step forward. There is tangible relief to homeowners. It is 

not perfect. Seldom do we do perfect things here. But it is progress 

and we have not seen a lot of progress over the last few years. 

Not only that, you have led the way with proposals to expand the 

effectiveness of the HAMP program to make it more useful, to 

apply it to a broader spectrum of Americans. All of those have been 

practical solutions to this gnawing problem of a housing market 

that was collapsed, frankly, not on your watch but on your predecessor’s watch, and you have been trying to rehabilitate it. We have 

seen some modest progress, but not enough. 

Now, one of the things I think is interesting, and I think you 

have sensed it, too, is that if you look at the people who are the 

commercial banks that hold loans in their portfolio that are—and 

bound by fiduciary obligations to make money for their shareholders, they are actually writing down principal as a way to keep 

people in their homes. In fact, yesterday, the American Banker reported 80 percent of homeowners who received a modification from 

these commercial banks saw their principal cut, and yet we have 

not seen that by the GSEs and by others, although I think you 

89 

have made progress in the HAMP program by giving further financial incentives. Could you talk about this issue of principal reduction as the way to keep people in their homes? 

Mr. DONOVAN. Senator, thank you for asking about this because 

I think it is—if I look at the sort of range of tools that we have 

tried to use through the last few years in the housing crisis, principal reduction is the one tool that we have made perhaps the least 

progress on until recently. And there is growing evidence that, particularly where someone is deeply underwater, if they are looking 

at, you know, 10, 15 years of paying their mortgage without being 

able to start building equity again, that at some point, that will 

have a real impact on their ability to keep going and keep paying 

their mortgage. 

So the ability to begin to sort of break the logjam, if you will— 

there are so many frictions that we see in this system that we have 

to principal reduction, to be able to break through some of those 

frictions to get interests aligned among all the trustees and the 

owners of the loans and others is one of the things that we have 

been focused on, particularly over the last few months. And I think 

between the settlement itself as well as these other incentives that 

we are providing, that those are very important steps that we hope 

can jump-start more principal reduction happening, which, again, 

we do think is good both for homeowners and communities, but 

also for investors in those loans where it can allow people to pay, 

stay in their homes, and increase the value of those mortgages. 

Senator REED. As a follow-on point, one of the perceptions, and 

I think this is borne by people throughout this country, is that we 

have gone to extraordinary lengths to provide support for financial 

institutions, mainly through Federal Reserve policy of lowering interest rates very close to zero. And yet many homeowners cannot 

take advantage of that because their property values have deteriorated so much. 

But if, in fact, through these principal reductions they can refinance, that would be a tremendous boom to them. And as I think 

it is reflected by the commercial banking experience, it is a lot 

smarter for a bank to keep someone in their home paying rent and 

maybe even have a principal kicker at the end than to foreclose, 

maintain the property, pay property taxes on the property, and in 

many cases watch the property deteriorate despite all of that. That 

logic seems to be compelling to most people back home, but it is 

having a—you are having a hard time persuading lots of people 

here, is that fair? 

Mr. DONOVAN. Well, look, I do think that given the scale of the 

housing declines that we saw across the country, we are in a little 

bit uncharted territory in terms of what this means. It is one of the 

reasons why the settlement, we think, is important, because it can 

establish a track record for principal reduction. But there is increasing data available, we believe, that shows that this principal 

reduction can be good not only for homeowners and communities 

but for investors, as well. 

The other thing I would just say is we have a very big opportunity with interest rates where they are today. Typically, any 

homeowner who is less than about 130 percent loan-to-value by refinancing to today’s low interest rates can get back above water in 

90 

5 years or less just through plowing their savings from refinancing 

into rebuilding their equity. And that is something we want to encourage with our plan. It is why we have proposed eliminating closing costs and providing other incentives to folks to choose to take 

their savings from refinancing and plow it back into rebuilding 

their equity. 

Senator REED. Thank you. 

Chairman JOHNSON. Senator Johanns. 

Senator JOHANNS. Thank you, Mr. Chairman. 

Mr. Secretary, it is good to see you again. I was looking at your 

written testimony, and let me quote something that you wrote. You 

did not say this in your oral testimony, but it is here in front of 

me. You say on page one, near the bottom, ‘‘Today, because the 

Obama administration moved to keep interest rates low and restore confidence in Fannie Mae, Freddie Mac, and the Federal 

Housing Administration,’’ then you go on to talk about homeowners 

refinancing. 

Mr. Secretary, on both points, you do not seriously believe that 

it was the Obama administration that kept interest rates low, do 

you? I always thought that was the Federal Reserve function. 

Mr. DONOVAN. What I would say—I think it is perfectly fair to 

point out the Federal Reserve had taken very significant steps. 

There were additional steps that the Administration took, particularly through Treasury, early on in the Administration to keep interest rates low, as well. So if you read as us taking full credit for 

that, it is certainly not accurate. There are steps that we took, 

however, that contributed to keeping interest rates low. 

Senator JOHANNS. Now, on your second point, I have not run into 

a single person since I joined the Senate 3-plus years ago that 

came up to me and said, ‘‘You know, Mike, thanks for your efforts 

back in Washington. I now have confidence in Fannie and Freddie.’’ 

Do you really believe that, that confidence has been restored in 

these gigantic operations that have been nothing but a liability for 

taxpayers? 

Mr. DONOVAN. Senator, there is no question that there are additional steps that need to be taken and we continue to take, and certainly as we laid out our plan for what should be done with Fannie 

and Freddie, we said very clearly that it is structurally a model 

that we should discontinue. It is not the right model for the future. 

On the other hand, in the midst of the crisis, we were very dependent on ensuring that a new homeowner trying to buy a home, 

because private capital was not available in the midst of the crisis, 

that we needed to ensure at least that new loans were available. 

And so when we talk about confidence that those loans will stand 

the test of time, we took very difficult steps to stand behind, to 

back those loans, to make sure that interest rates continue to be 

at a level that folks could buy homes. 

So when we talk about confidence, what we really meant is confidence that the backing of Fannie and Freddie would be good for 

homeowners that were looking to buy homes or refinance. 

Senator JOHANNS. Well, let me ask you about that, because I 

think you are making my point. How much today would the taxpayers be on the hook for when it comes to Fannie and Freddie? 

Everything, right? 

91 

Mr. DONOVAN. There is no question that taxpayers are at risk for 

those loans being made. What I would also say, though, is all the 

evidence that we have is that the new loans being made are safe, 

good loans. The exposure that taxpayers have is to the legacy loans 

that were made before they went into conservatorship, and this 

is—— 

Senator JOHANNS. And how much—— 

Mr. DONOVAN. and I think this is where the confidence issue is 

important. The single most important thing we can do to protect 

taxpayers is ensure that those old loans, which we cannot make go 

away, perform in a way that improves their value rather than has 

their value decline. And in that sense, improving the housing market more broadly, keeping confidence in the securities that are 

issued by Fannie and Freddie is critical going forward. 

Senator JOHANNS. How much are those legacy loans? If you are 

the average taxpayer out there and you are tuned into this hearing 

and you want to know how much you are on the hook for, how 

much is that? 

Mr. DONOVAN. I am sorry, Senator, I do not have a number in 

front of me. Perhaps—I know that FHFA will be testifying on the 

next panel. I am sure that they would have more specific details. 

But it is obviously substantial, in the over a trillion dollar range. 

Senator JOHANNS. To me, that is not a confidence builder. The 

average taxpayer is out there saying, are you kidding me? I am on 

the hook for that, too, in addition to the massive national debt? 

Let me, if I might, ask you a quick question about the investigations. When you talk about servicing errors, could that be something like the failure of Mike Johanns to sign one of the pieces of 

paper that you get at a closing? 

Mr. DONOVAN. We did not look at closing specifically, but there 

are clearly failures to properly review and sign documents in the 

servicing and in the foreclosure process. 

Senator JOHANNS. What percentage of all of that would you say 

was due to just outright fraud? I want to take advantage of this 

poor innocent person sitting in front of me. 

Mr. DONOVAN. I would say the minority of those errors that we 

found, I would say, could be linked directly to outright fraud. On 

the other hand, the extent of the errors, as I said, up to 60 percent 

error rates, serious error rates, in the worst of the companies that 

we reviewed, did real damage to families and to communities. So 

what I want to make sure people understand about these investigations, what we found were not just trivial errors that had no impact on families. These were significant errors that had real impacts, cost families real money, caused some families to lose their 

homes that should not have. And, frankly, we felt they needed to 

be held accountable. They were violations of FHA’s rules, among 

other things, and that is why we took them so seriously. 

Senator JOHANNS. Mr. Chairman, thank you. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman, and Mr. Secretary, thank you for your service. I think you have done an extraordinary job. 

Mr. DONOVAN. Thank you. 

92 

Senator MENENDEZ. I want to follow my colleague, Senator 

Johanns, line of question. What is the time frame in which this explosion at Fannie and Freddie took place, of the challenges we are 

facing now in terms of taxpayer exposure? What is the time frame 

in which that took place? 

Mr. DONOVAN. Well, their market share really took off sort of in 

the middle of the 2000 decade, in the 2005 range, and they were 

obviously taken into conservatorship before the Administration 

came into office in 2009. 

Senator MENENDEZ. So—— 

Mr. DONOVAN. And so it is really those legacy loans in that period that are at issue. 

Senator MENENDEZ. So everything you just described with Senator Johanns was largely—that explosion took place somewhere in 

the time frame of 2005 leading up to conservatorship prior to 2009? 

Mr. DONOVAN. That is correct. 

Senator MENENDEZ. So largely during the Bush years is when 

this explosion took place. So I find it ironic at times that we hear 

about these concerns, which are legitimate—they are legitimate 

concerns, I share them—but there was no one putting the brakes 

on during that period of time to make sure that these institutions 

did not follow the marketplace in excesses. 

Let me ask you about principal reduction. I know that my colleague, Senator Reed, began on this. When you look at loans that 

are in the banks’ own private portfolios, the banks are finding it 

profitable to give principal reductions to about 20 percent of their 

own loans, while, ironically, the Government is not allowing principal reductions on any loans. Do you think, or do you believe that 

it should be completely taken off the table as an option in literally 

all cases, as the FHFA has done with Fannie and Freddie? 

Mr. DONOVAN. Clearly, given our focus in the servicing settlement and the work we are doing elsewhere in HAMP that I described, we believe principal reduction is an important tool in the 

tool kit, if you will, that should be available where it can be the 

most help to homeowners. 

Senator MENENDEZ. So, clearly, if the private sector is looking at 

20 percent and saying, this makes sense for us, and we always 

hear about how the private sector can lead us in a way, it seems 

to me that they are leading in a way in which 20 percent has already been principally reduced. So it is an indicator, at least. 

In that context, I have introduced a bill that basically promotes 

shared appreciation mortgages at the FHFA and FHA as a creative 

solution to the housing crisis, in part, and principal reduction problems. In essence, a shared appreciation mortgage or debt for equity 

is basically when lenders reduce principal now in exchange for getting a percentage of future increases in home prices. It seems to 

me that a lot of things are resolved in that process. The homeowner 

can be kept in their home, be a responsible—continuing to be a responsible borrower. The question of moral hazard is largely resolved because the appreciation value to the lender is there. And 

so, therefore, they have opportunity to recoup equity. Do you believe that we could see such a pilot program at FHA? 

Mr. DONOVAN. First of all, I want to compliment you on the work 

on this legislation. It is a creative solution, I think, that you have 

93 

come up with to what can be a very complex problem of misaligned 

incentives between homeowners and lenders. We have done a lot 

of work with your team and look forward to continuing to do that. 

I do think that it is something that could be valuable as a tool 

going forward. 

I also would just say, on your earlier point, I do think the fact 

that where—and this is what is increasingly being found—where 

principal reduction is happening, it is happening more frequently 

in the portfolios of banks with their own loans, and I think that 

does show that where the barriers to principal reduction are removed, which is exactly what we are trying to do through HAMP, 

through the servicing settlement, that more principal reduction will 

make sense because it is better for those investors. If banks are 

doing that with their own portfolios, I think it shows they have 

clearly made the decision. It protects their own investments. So 

your point is a very important one. I want to make sure it does not 

get lost. 

Senator MENENDEZ. And my final question is, how do you anticipate that the settlement that was entered into with all the AGs 

will interact with the appeals of foreclosures that are being implemented by the consent orders between the OCC and the Federal 

Reserve and the major servicers? It seems that there are two parallel tracks going on. I want to clarify what that means for homeowners. 

Mr. DONOVAN. Yes. This is a great question because there has 

been a lot of misunderstanding when you think about this—— 

Senator MENENDEZ. I only ask great questions. 

[Laughter.] 

Senator MENENDEZ. I am kidding, of course. 

Mr. DONOVAN. And this relates to some of the earlier discussion 

with Senator Corker and otherwise. What we have to recognize is 

that many of the sort of harms that were done here did not lead 

to somebody losing their home, but it might have been a fee that 

was imposed that should not have or a month delay in getting help 

which cost a homeowner a month’s payment. And we wanted to 

make sure that homeowners did not have to go through a lengthy 

process of putting together documentation, maybe even getting a 

lawyer that might cost more than the help they would actually get. 

So we created through the settlement almost like a class action 

process, where somebody can come in very simply, in a very efficient, streamlined process, and get help that averaged sort of 

$1,500 to $2,000. 

For someone who was harmed much more significantly, the OCC 

and the Fed have set up a separate process where they can come 

in, demonstrate exactly what that harm is, and get full restitution. 

If they lost their home and it was a cost of $100,000 to them, they 

can get that restitution. 

Those two processes work in concert, if you will, to make sure that there are options available. Somebody taking $1,000 or $1,500 

or $2,000 from the settlement does not stop them from pursuing 

the longer, more detailed process. And, frankly, neither of them 

stops a homeowner from going into court if they feel like they have 

been wronged and their harm has not been adequately addressed. 

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

94 

Chairman JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chair, and thank 

you, Mr. Secretary—— 

Mr. DONOVAN. Thank you. 

Senator MERKLEY. ——for the hard work you are doing to try to 

figure out the strategies in a very, very complex mortgage world. 

One thing I wanted to draw attention to was your commentary 

over the Mutual Mortgage Insurance Fund, where you note that 

there is a series of basis point insurance premium increases and 

then some additional changes announced yesterday, and you conclude that with these additional revenues, the capital reserve is estimated to have sufficient balances to cover all future projected 

losses without triggering a mandatory appropriation under the 

Federal Credit Reform Act. 

Essentially, since 2009, as you observe, we have been under the 

2 percent reserve ratio and kind of hanging by the seat of our 

pants, but as I read this, I get the feeling that the adjustments 

that have been made, that there is a little bit of a sigh of relief that 

we are not going to have a major solvency problem in MMI, that 

it is looking fairly decent minus a major unexpected downturn in 

the economy. 

Mr. DONOVAN. Yes. I would not say it is a sigh of relief at this 

point from my perspective. I think we have to remain very vigilant, 

because, frankly, the single most important thing that drives the 

reserves of the fund and whether they are adequate is what the 

performance of the housing market is going to be more broadly. 

And given the expected direction of the market, given what we 

have seen lately in terms of the most recent numbers, we have 

taken steps between the settlement and the additional premium increases that should protect us this year. But, obviously, we are 

going to continue to watch very closely, and if there are other unexpected changes in the market, we will react accordingly. 

Senator MERKLEY. In any event, it is good news and I appreciate 

the vigilance going forward. 

Mr. DONOVAN. Thank you. 

Senator MERKLEY. Turning to HARP 2.0, I appreciate the Administration really working hard to have the FHFA have this program. 

How many actual HARP 2.0 loans have they actually closed, if you 

will? 

Mr. DONOVAN. So the estimates that we have at this point are 

that about 50,000 loans have actually closed and that there are 

about 300,000 applications that have been filed. Recognize that the 

improvements—the HARP 2.0 improvements really started to go 

into effect only in mid- to late-December and that the most important change, perhaps, particularly for the hardest-hit communities 

is the ability to refinance above 125 percent loan-to-value. That 

was completely unavailable before HARP 2.0. That only started to 

go into effect really this month. 

So what I will tell you is we are encouraged thus far in terms 

of the response. There are higher than we expected response rates 

coming in terms of homeowners saying, yes, I want to participate, 

and particularly in that above 125 percent loan-to-value. So we are 

encouraged by those numbers so far. 

95 

Senator MERKLEY. So that is good, because I had not heard that 

50,000 had closed, so I think that is great news, and that there is 

a whole pipeline coming into effect. 

When folks come into my casework team with housing challenges, there is always a bit of a lottery as to whether or not their 

loan is owned by Fannie or Freddie and, therefore, whether they 

are eligible for HARP 2.0. So the work the Administration is doing 

to try to find a strategy to address the non-GSE is important and 

very difficult. 

I did want to ask you about one feature that you mentioned, 

which is if a family does a 20-year loan, keeping their payments 

higher and essentially gaining equity faster, they are incentivized 

by having their closing costs covered. And the reason I found this 

interesting is at first glance, it felt counterintuitive to me in this 

sense, that one of our goals is to reduce strategic defaults. So if 

your monthly payments are lower, you therefore have less incentive, if you will, to walk away and go to a rental. And second is 

to decrease financial defaults, and if your monthly payment is 

lower, you therefore are much less likely to financially default if 

your income changes, you lose a part-time job or new job that pays 

less. 

And so in some ways, I would have thought that maybe the incentive would work the other way, encourage people to have the 

lower monthly payment and, therefore, more robust or more resilient finances. So I just thought I would have you share just a little 

bit more of the thinking that went into that strategy. 

Mr. DONOVAN. Clearly, that is an option that is up to the homeowner. They can make that choice, and they could even take a portion of the savings and plow it into rebuilding equity. It is not an 

all or nothing proposition. 

We simply felt that given the substantial challenges that negative equity provides, that—and the likely natural sort of short-term 

focus that many homeowners would have on reducing those payments, that we wanted to ensure that those homeowners took seriously the option of rebuilding equity, as well. Again, the numbers 

do show that it is not just payment reduction that matters, but also 

how deeply underwater a family is to be able to do that. 

Senator MERKLEY. Thank you, and just a very short closing question, which is it is my understanding that the AGs still do not have 

all of the details in writing for the settlement, and it is a little surprising that they have been asked to sign on before having all the 

details in writing because, like every contract, the details make a 

difference. When are the AGs going to have all the details, and is 

it possible that when folks look at those details, some that have 

said, ‘‘Yes, I am in,’’ might say, ‘‘Hmm, I am going to rethink that’’? 

Mr. DONOVAN. The documents were finalized in terms of all the 

significant aspects of the agreement when they signed on, and so 

they had those documents. What is being finalized, and, in fact, we 

expect the documents to be registered in court this week and then 

they would become public—but what was being finalized, for example, each State has the option to decide how to direct their own 

funding through the AGs. There are a series of individual qui tam 

actions that were being finalized in particular States. Those had to 

be reflected in the documents. 

96 

So I would put it more in the dotting ‘‘I’’s and crossing ‘‘T’’s rather than in any significant terms of the settlement that are being 

finalized in terms of the documents. And again, they have been finalized. We expect them to be registered in court this week and become available publicly. 

Senator MERKLEY. Thank you. 

Mr. DONOVAN. Thank you. 

Chairman JOHNSON. Senator Hagan. 

Senator HAGAN. Thank you, Mr. Chairman. 

Secretary Donovan, thank you for being here today. 

Mr. DONOVAN. My pleasure. Thank you. 

Senator HAGAN. The premium changes announced by FHA this 

week are expected to increase receipts to the FHA by $1 billion 

and, obviously, improve the fund’s capital position. Can you discuss 

how and when we will know what this move—whether this move 

has proven to be sufficient to restore the fund’s capital position? 

Mr. DONOVAN. To be honest, Senator, we really will not know 

until the end of the fiscal year. We will be watching it very carefully and we will have early signs of that. But the—it really will 

depend on the volume of business that comes in and the trajectory 

of home prices over the remaining year, and we will have a new 

actuarial report available to Congress in the fall that will redo 

those projections based on these new premiums as well as where 

we expect the fund to go. 

Senator HAGAN. The FHA is limited in statute from taking certain emergency actions that could restore the fund’s capital position if an appropriation from the Treasury Department became 

more likely. Can you discuss some of those limitations and what 

additional authorities might benefit the FHA in its efforts to avoid 

a draw on the Treasury? 

Mr. DONOVAN. Well, first of all, I would just say this Committee 

has been very helpful, has given us in the past few years greater 

statutory authority to raise our premiums. We are using that authority here. 

But what I would also say is while we are focused on premiums 

for new loans, it is very, very important that we continue to take 

steps to make sure that prior loans that were made that did not 

meet our standards can be held to account and that we are enforcing effectively. We have dramatically increased our enforcement. In 

fact, the settlement is the single biggest recovery the FHA Fund 

has ever made from our enforcement. 

But there are additional steps. For example, we have limited authority to go after lenders on a national basis. We are required to 

go after them on a sort of region by region basis, which we do not 

think is as efficient. We have legislation that is, in fact, reflected 

in the House bill right now that we would like to continue to work 

with the Committee to get done this year that would increase our 

enforcement authorities on that issue and on a number of others, 

as well. 

Senator HAGAN. Thank you. Last year, the FHA was seeing improvements in mortgage delinquency rates in early period delinquencies. What is the FHA seeing in delinquency rates today and 

are those rates improving? 

97 

Mr. DONOVAN. Yes. So what we are seeing on the sort of early 

delinquencies, 30-day, 60-day, continues to improve and really 

tracks what is happening, probably most of all, in the jobs market 

and the improvement we have seen there. 

We have seen our serious delinquencies and in foreclosure tick 

up somewhat and that is really due to two factors. One is that because of the problems that we found in servicing our loans with a 

number of the institutions, some of them have held off on foreclosing and presenting claims to us, and so that has kept those 

loans in the foreclosure process longer. And so instead of having— 

it has also made our claims go down, which is a good thing, but 

it has increased the number that are in the foreclosure process and 

seriously delinquent. And so that has sort of had them tick up. 

The other thing, frankly, is just simply that we have had very 

large books of business in the last couple years. There is a natural 

sort of seasoning process that happens with loans and you do not 

generally see them start to have delinquencies or defaults until 

they are typically kind of 2 years old. And so these very large books 

are—the delinquencies are increasing for those. But, frankly, we 

looked very carefully at how those loans are performing relative to 

past years. We are still very confident that those new loans are 

performing extremely well. But as an average, it has kind of driven 

the delinquency rates up somewhat because they are just so much 

larger, those books, than the prior years, which were much worse 

loans. 

Senator HAGAN. The FHA announced the discretionary up front 

premium increases and changes to annual premiums that were 

mandated by law in December. Can you discuss how these changes 

will impact the borrowers who will be refinancing under FHA? 

Mr. DONOVAN. So in the budget was reflected a ten basis point 

increase across the board for these loans, for all FHA single-family 

loans. What we also did, though, which I think is important, we 

implemented or are implementing a higher premium increase for 

larger loans. We want to make sure that the higher loan limits 

that FHA has are seen as temporary and that we are encouraging 

private capital to come back into the market more broadly, but particularly in those larger loans, so that as we transition back to our 

lower loan limits, private capital is already filling that space. 

Yesterday, we announced an additional 75 basis point increase 

on the up front premium that complements the other changes that 

were in the budget. In total, if you combine the ten basis point annual premium and the 75, for our typical loan, you are going to see 

an increase that is about $15 a month for the average homeowner. 

So that is when you combine them. The annual premium is close 

to $10 a month. The up-front will add about $5 a month. So that 

is the impact. And we think given where interest rates are, we 

have tried to balance the health of the fund with making sure that 

we do not impede the recovery of the housing market. 

Senator HAGAN. Thank you. 

Mr. Chairman, I did want to state that North Carolina’s Commissioner of Banks, Joe Smith, I am pleased to see that he has 

been named—I cannot remember his exact title—— 

Mr. DONOVAN. He is the monitor for this—— 

Senator HAGAN. ——the monitor for the fund, so—— 

98 

Mr. DONOVAN. He will do a terrific job. 

Senator HAGAN. ——we have an excellent individual in that position. Thank you. 

Mr. DONOVAN. Thank you. 

Chairman JOHNSON. I would like to thank Secretary Donovan for 

his testimony and for being here with us today. We appreciate your 

testimony, Mr. Secretary. 

With that, I would like to call forward the second panel for this 

hearing. 

[Pause.] 

Chairman JOHNSON. The second panel of witnesses that we have 

here today are no strangers before this Committee and need very 

little introduction. 

Governor Elizabeth Duke is a member of the Board of Governors 

of the Federal Reserve System. She has served in this position 

since June of 2008. 

Mr. Edward DeMarco is the Acting Director of the Federal Housing Finance Agency. He has held this position since September of 

2009. 

Governor Duke, you may proceed with your testimony. 

STATEMENT OF ELIZABETH A. DUKE, GOVERNOR, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Ms. DUKE. Thank you. Chairman Johnson, Ranking Member 

Shelby, Members of the Committee, thank you for inviting me to 

talk about the current situation in housing markets. 

The Federal Reserve has a keen interest in the state of housing 

and has been actively engaged in analyzing issues in the housing 

and mortgage markets. Issues related to the housing market and 

housing finance are important factors in the Federal Reserve’s various roles in formulating monetary policy, regulating banks, and 

protecting consumers of financial services. 

In particular, the failure of the housing market to respond to 

lower interest rates as vigorously as it has in the past indicates 

that factors other than financial conditions may be restraining improvement in mortgage, credit, and housing market conditions and, 

thus, impeding the economic recovery. 

Federal Reserve staff have been actively working to understand 

the reasons behind the impairment in housing and mortgage markets and the tradeoffs involved in designing policies that would remove obstacles to normal market functioning. 

On January 4, 2012, the Federal Reserve released a staff paper 

titled, ‘‘The U.S. Housing Market: Current Conditions and Policy 

Considerations,’’ which is attached at the end of my written statement. The paper provides information on current conditions in the 

housing market and analytic background on some housing market 

issues. Although the paper does not include recommendations for 

any specific policy actions, it does lay out a framework for discussion, outlining some options and tradeoffs for policy makers to consider. My testimony today will be drawn from this paper. 

Six years after aggregate house prices first began to decline and 

more than 2 years after the start of the economic recovery, the 

housing market remains a significant drag on the U.S. economy. In 

a typical economic cycle, as the economy turns down, households 

99 

postpone purchases of durable goods such as housing. Once the 

cycle bottoms out, improving economic prospects and diminishing 

uncertainty usually help unleash this pent-up demand. This upward demand pressure is often augmented by lower interest rates, 

to which housing demand is typically quite responsive. 

The current economic recovery has not followed this script, in 

part because the problems in the housing market are a cause of the 

downturn as well as a consequence of it. The extraordinary fall in 

national house prices has resulted in $7 trillion in lost home equity, more than half the amount that prevailed in early 2006. The 

substantial blow to household wealth has significantly weakened 

household spending and consumer confidence. 

Another result of the fall in house prices is that around 12 billion 

households are now underwater on their mortgages. That is, they 

owe more on their mortgages than their homes are worth. Without 

equity in their homes, many households who have experienced 

hardships, such as unemployment and unexpected illness, have 

been unable to resolve mortgage payment problems through refinancing their mortgages or selling their homes. The resulting mortgage delinquencies have ended in all too many cases in foreclosure, 

dislocation, and personal adversity. Neighborhoods and communities have also suffered profoundly from the onslaught of foreclosures as the neglect and deterioration that may accompany vacant properties makes neighborhoods less desirable places to live 

and may put further downward pressure on home prices. 

An ongoing imbalance between supply and demand exacerbates 

these problems in the housing market. For the past few years, the 

actual and potential supply of single-family homes for purchase has 

greatly exceeded the effective demand, in part because of the large 

number of homes that have come back onto the market after moving through the foreclosure process. The elevated pace of foreclosures, unfortunately, is likely to be sustained for quite a while 

and, therefore, will continue to put downward pressure on home 

prices. 

At the same time, a host of factors have been weighing on housing demand. Many households have been reluctant or unable to 

purchase homes because of concerns about their income, employment prospects, or the future path of home prices. Tight mortgage 

credit conditions have also prevented many households from purchasing homes. Although some retrenchment in lending standards 

was necessary and appropriate given the lax standards that prevailed before the crisis, current lending practices appear to be limiting or preventing lending even to creditworthy households. 

In the paper, we discuss the benefits and costs of a variety of policy options that have been proposed to respond to difficult housing 

issues, including increasing credit availability for households seeking to purchase a home or to refinance an existing mortgage; exploring the scope for further mortgage modifications, including encouraging short sales and deeds in lieu of foreclosure in cases 

where foreclosure cannot be avoided; and expanding the options 

available for holders of foreclosed property to dispose of their inventory responsibly. Any policy proposals, though, will require 

wrestling with difficult choices and tradeoffs as initiatives to benVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00103 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
100 

efit the housing market will likely involve shifting some of the burden of adjustment from some parties to others. 

I greatly appreciate the leadership that the Senate Banking 

Committee has shown on the profound challenges facing the housing market. For its part, the Federal Reserve will continue to use 

its policy tools to support the economic recovery and carry out its 

dual mandate to foster maximum employment in the context of 

price stability. In its supervisory capacity, the Federal Reserve will 

continue to encourage lenders to find ways to maintain prudent 

lending standards while serving creditworthy borrowers. 

Thank you again for inviting me to appear before you today. I 

would be happy to answer any questions you may have. 

Chairman JOHNSON. Thank you, Governor Duke. 

Mr. DeMarco, you may proceed with your testimony. 

STATEMENT OF EDWARD J. DEMARCO, ACTING DIRECTOR, 

FEDERAL HOUSING FINANCE AGENCY 

Mr. DEMARCO. Thank you, Mr. Chairman. Chairman Johnson, 

Ranking Member Shelby, Members of the Committee, I am pleased 

to be invited here today to discuss the actions FHFA is taking in 

our role as conservator for Fannie Mae and Freddie Mac to aid recovery of the U.S. housing market. 

My written statement responds to the Committee’s request for a 

description of FHFA’s work as conservator of Fannie and Freddie, 

or the Enterprises, as I will refer to them, to address barriers to 

housing recovery, including preventing foreclosures through loss 

mitigation, facilitating refinancing at today’s low interest rates, 

and initiating an REO sales program. My written statement also 

summarizes the recent strategic plan for conservatorship that I 

submitted to you last week. 

In contrast to how they are sometimes portrayed, the Enterprises 

are playing a leading role in providing assistance to homeowners 

seeking to avoid foreclosures. On a nationwide basis, Fannie Mae 

and Freddie Mac own or guarantee 60 percent of the mortgages 

outstanding, but they account for a much lower proportion, 29 percent, of seriously delinquent loans. And let me add here, there was 

a little discussion in the prior panel regarding market share. During the period 2005 to 2007, the Enterprises’ market share was actually generally declining. More of this was—more mortgage activity was being financed through the private label market, which is, 

of course, where a good bit of our difficulties today are and where 

a lot of troubled loans reside. 

Even though the Enterprises have a smaller share of seriously 

delinquent loans than other market participants, they account for 

about half of all HAMP modifications. Between HAMP modifications and their own proprietary loan modifications, Fannie and 

Freddie have completed over one million loan modifications since 

the fourth quarter of 2008. 

We have also made great strides in improving mortgage servicing 

standards. The Servicing Alignment Initiative, which FHFA announced last year, focuses servicers’ resources and attention on 

moving all borrowers in trouble into alternatives to foreclosure and 

to do so quickly, efficiently, and aggressively. The Servicing AlignVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00104 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
101 

ment Initiative aligned the requirements of the Enterprises to remove inconsistencies that could cause servicer confusion and delay. 

Fannie and Freddie are also at the forefront of refinance activity 

for current borrowers. Since April 1 of 2009, the Enterprises have 

completed more than ten million mortgage refinances. The Home 

Affordable Refinance Program, or HARP, provides refinancing opportunities to borrowers that might otherwise be unable to refinance due to house price declines. Changes to this program that we 

announced last October are still being implemented, but early indications are promising. 

Just yesterday, we announced the first transaction in our Real 

Estate Owned, or REO, Initiative Pilot Program. This transaction 

includes approximately 2,500 properties divided into eight subpools 

by geographic area. We also want to enhance the opportunity for 

smaller-scale investors to bid on properties and obtain financing 

should initial efforts to market these properties to owner-occupants 

fail. 

Now, at FHFA, we are faced with a fundamental task of directing the operations of two companies that account for roughly threequarters of current mortgage originations and have approximately 

$5 trillion in outstanding obligations and credit guarantees. To the 

question from the earlier panel, that is the answer. Five trillion 

dollars is what the American taxpayer is standing behind through 

the Treasury Department’s Senior Preferred Stock Purchase Agreement. Our task in overseeing this is complicated by the very uncertain future of the Enterprises. 

Now, last week, I submitted to Congress a strategic plan for the 

next chapter of conservatorship. The plan sets forth three strategic 

goals. Build—build a new infrastructure for the secondary mortgage market. Contract—gradually contract the Enterprises’ dominant presence in the marketplace while simplifying and shrinking 

their operations. And maintain—maintain foreclosure prevention 

activities and credit availability for both new and refinanced mortgages. 

Achieving these strategic goals will fulfill the statutory responsibilities Congress assigned to FHFA as conservator and also prepare the foundation for a new, stronger housing finance system. Although that future may not include Fannie and Freddie, at least 

as they are known today, this important work in conservatorship 

can be a lasting positive legacy for the country and its housing system. Properly implemented, we believe this strategic plan should 

benefit homeowners by ensuring continued emphasis on foreclosure 

prevention and credit availability, taxpayers by furthering efforts 

to limit losses from past activities while simplifying risk management and reducing future risk exposure, market participants by 

creating a path by which the Enterprises’ role in the mortgage 

market is gradually reduced while maintaining market stability 

and liquidity, and finally for lawmakers by building a foundation 

on which you may develop new legal frameworks and institutional 

arrangements for a sound and resilient secondary mortgage market 

of the future. 

Thank you again for the opportunity to be here and I would be 

happy to answer any questions you may have about my testimony 

or about our strategic plan. 

102 

Chairman JOHNSON. Thank you, Mr. DeMarco. 

Governor Duke, we have heard arguments that the market 

should be left to hit bottom. The Fed’s white paper seems to indicate that there are barriers or frictions to the market healing itself. 

Governor Duke, can you discuss some of the barriers your staff has 

identified. Are there any risks to permitting housing prices to fall 

further? 

Ms. DUKE. Thank you. Yes. The bulk of our work was on trying 

to identify barriers for the market to seek its own level. One of the 

most obvious signals is the difference in the rental market and the 

owner occupied market. Right now, you have prices falling and vacancies falling in the owner occupied market, and then you have 

lower vacancies and higher prices in the rental market, which indicates that the market wants to move housing from owner occupied 

to rental. 

Some of the frictions that are involved in this are difficulties in 

aggregating the properties together in getting the properties for 

rental, financing for these properties, and in some cases, regulatory 

barriers to facilitating a movement to rental in these properties. So 

that is why there is a strong discussion of REO to rental. 

Other barriers that we identified were barriers to refinancing, 

primarily loans that were underwater, high loan-to-value loans, 

and so we discuss some of the changes that might be made in order 

to facilitate refinancing of those loans. 

Chairman JOHNSON. Mr. DeMarco, at our last housing hearing, 

Democrats, Republicans, and experts stated that there is more 

FHFA can do and should be doing to expand refinancing opportunities. Yes or no, will you act without delay to take additional steps 

to provide more Americans with the opportunity to refinance at 

historically low market rates? If so, what steps will you take? 

Mr. DEMARCO. Mr. Chairman, I believe we have already taken 

those steps through the changes we announced to the HARP program in October. The program actually became effective in December and we are seeing just the first fruits of that. So if there are 

additional changes to the HARP program that anyone would like 

to suggest to us, I would be quite pleased to immediately take a 

look at it and see if we can implement them, if that is going to help 

further this process along. But I believe the steps we took in creating the HARP 2.0 program, if you will, was a very responsive and 

responsible set of actions and I am very encouraged by the early 

indications from the marketplace regarding this program. 

Chairman JOHNSON. Mr. DeMarco, your plan is currently a highlevel document without much detail. You have indicated that you 

will be conducting additional analysis to implement the plan to 

contract the role of the GSEs. What is your time line for doing so? 

In this analysis, how will you account for factors that are important to the operations of a healthy secondary market? 

Mr. DEMARCO. So, Mr. Chairman, you are right. What we sent 

up here was a strategic plan. It is meant to set the broad goals, 

the things that we want to achieve in this next period of conservatorship. Now that we have established those goals, the next 

step is to develop specific operating plans, to examine particular 

options for how we go about achieving those goals, and it is in that 

103 

process that we will develop specific time lines with regard to particular actions. 

But I will say this, Mr. Chairman. You asked with regard to the 

second goal, the contracting. There are several things there that I 

would fully expect that during this calendar year, you are going to 

see activity from Fannie and Freddie in that regard. We have already begun with one, and that is raising guarantee fees. We have 

already had our first announcement of that, actually, the end of 

December, based upon the legislation Congress enacted. But we are 

also proceeding with both loss sharing as well as additional guarantee fee increases and looking to see if we cannot get some additional transactions in which private mortgage insurance companies 

start undertaking additional credit risks to the extent they have 

got the capacity to do so. I would like to see all of that begin this 

year. 

Chairman JOHNSON. Mr. DeMarco and Governor Duke—Mr. 

DeMarco, you have stated in your testimony that the secondary 

market for mortgages would not exist if not for the Enterprises. 

Could you state what might happen if the Enterprises’ activities 

were to be terminated immediately? Governor Duke, could you also 

comment on this? 

Mr. DEMARCO. Well, Secretary Donovan would certainly be a 

busy man. 

Chairman JOHNSON. Yes. 

Mr. DEMARCO. In the absence of Fannie and Freddie, if we literally, Mr. Chairman, to your question, simply turned off the lights 

tonight and did not startup again, there is no immediate infrastructure for secondary market transactions outside of FHA and 

Ginnie Mae securitization. So it would take market participants a 

while to be able to step in and redo this. Certainly, some lending 

would go on. Banks would book some of this in portfolio. But I 

think the near-term impact would clearly be to constrain mortgage 

credit. 

Chairman JOHNSON. Governor Duke, could you also comment on 

this scenario? 

Ms. DUKE. Well, first of all, I would agree with Mr. DeMarco. 

There would be much, much less lending going on. But I think for 

the private market to come in and take up that slack, to begin to 

do that lending, it is going to take a couple of things. It is going 

to take some certainty, some visibility as to what is going to happen to the mortgage market in the future, so some idea of what is 

going to happen ultimately to the GSEs because the investments 

in the infrastructure to do securitization, to do servicing, to do all 

the parts of the mortgage market are so large that it takes an understanding of what the future is going to be before anybody is 

going to be able to make those kinds of investments. 

Mr. DEMARCO. If I might add, Mr. Chairman, I would strongly 

endorse that. I think that while—if I may go back to the previous 

question you asked me about contracting—these are things we can 

do at the margin to shift some amount of mortgage credit risk off 

of the balance sheet of Fannie and Freddie and, hence, away from 

the taxpayer. But fundamentally, Governor Duke is quite right. 

Market participants, if they are going to make a permanent and 

lasting investment in bearing mortgage credit risk, they are going 

104 

to need much more long-term certainty about the role of the Government and what the institutional and legal arrangements are 

going to be. I very much agree with that. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

Director DeMarco, your strategic plan, as I understand it, would 

shrink Fannie and Freddie’s footprints in the marketplace and seek 

to establish a unified securitization platform. And it is my understanding that the actions would be designed to set the stage for 

broader housing finance reform. 

Mr. DEMARCO. That is correct, Senator. 

Senator SHELBY. Are there legal limits on how much the Federal 

Housing Finance Administration can reform the GSEs without further Congressional action? In other words, Congress has got to step 

in here, have they not? 

Mr. DEMARCO. Yes, Senator Shelby, that is quite correct. We 

have no authority to alter the charters of Fannie Mae and Freddie 

Mac, nor do we actually have the authority to abolish those charters. 

Senator SHELBY. Could you describe the legal limitations in this 

regard that Congress placed on the Director of the Federal Housing 

Finance Administration, which is you, relating to the approval of 

any business activity, such as principal write-downs, so long as 

these institutions remain in conservatorship. 

Mr. DEMARCO. So the way we interpret this is that Congress has 

given us a responsibility as conservator to preserve and conserve 

the assets of the company for the benefit of the company owners—— 

Senator SHELBY. To protect the taxpayer, right? 

Mr. DEMARCO. Protect the taxpayers, yes, Senator, and that is 

what we are trying to do. 

Senator SHELBY. If Congress enacts housing finance reform, 

which we desperately need, could such an action perhaps help the 

housing market recover by providing the legal certainty needed to 

attract private capital, which they are going to need? And if Congress continues to delay the needed reform, could this not continue 

to undermine the recovery of our housing market? How do you see 

that? 

Mr. DEMARCO. I would concur with that view. 

Senator SHELBY. That the sooner we do a comprehensive reform 

of Freddie and Fannie, the better off the taxpayer is going to be 

and the better off the housing market is going to be, is that—— 

Mr. DEMARCO. Yes, Senator. 

Senator SHELBY. Thank you. In your running the Federal Housing Finance Administration, describe the risk and what it could ultimately mean to the taxpayers regarding human capital. In other 

words, how do you keep the human capital, the executives, the 

knowledgeable people that know these markets that help you preserve these entities and the taxpayers’ risk here. 

Mr. DEMARCO. Yes, Senator. This is actually, I believe, one of the 

key risks that FHFA faces as conservator, because what we have 

here is we have got two large, complex financial institutions, but 

they are operating with a great deal of uncertainty regarding their 

future. The Administration has made clear they want—— 

105 

Senator SHELBY. What does that mean to personnel? 

Mr. DEMARCO. It means that these folks do not know if the—— 

Senator SHELBY. I mean, you are in the market for high-quality 

personnel, are you not? 

Mr. DEMARCO. Yes, Senator, we certainly are, and the people 

working at these companies today do not know if that company is 

going to be there 2 years from now, 3 years from now, and so what 

is it that induces them to stay given that uncertainty? Certainly, 

as financial markets more generally recover, we are seeing pick-up 

in the labor market for this kind of talent, and so their opportunity 

to go work elsewhere continues to get better. 

Senator SHELBY. Governor Duke, in your written testimony, you 

refer to the Fed’s white paper on housing, quote, as a ‘‘staff paper,’’ 

end quote. You also state that the paper, and I will quote you 

again, ‘‘does not include recommendations for any specific policy actions.’’ To be clear here in the Committee, it seems that the Fed 

is not making policy recommendations to Congress in its housing 

white paper, is that correct? 

Ms. DUKE. That is correct. 

Senator SHELBY. Did all the members of the Board of Governors, 

on which you serve as a Governor, approve the white paper, and 

if not, who did and who did not? Is that an internal matter or is 

that something you can supply to the Committee? 

Ms. DUKE. I want to make sure I am correct, but I think that 

the members of the Board of Governors saw the white paper but 

did not vote on the white paper. 

Senator SHELBY. OK. The Fed’s white paper, among other things, 

discusses several ways to address the inventory of Real Estate 

Owned properties, REOs, and lays out options for the REO to rental program. Governor Duke, if the REO rental, Real Estate Owned, 

policies outlined in the white paper were to be adopted, how much 

faster will housing markets recover, in your judgment, and how 

long will it take them to recover in the absence of such policies? 

In other words, it seems like you have got to do something to move 

the market. 

Ms. DUKE. I wish I could estimate the exact amount of time that 

it would take or how much difference this would make. We are beginning to see multifamily housing construction pick up in response 

to these market requests, so—— 

Senator SHELBY. Excuse me a moment. Now, we do not have 

many foreclosures, do we, with multifamily housing? 

Ms. DUKE. I do not know how many foreclosures there are—— 

Senator SHELBY. We have had testimony here before this Committee that it was less than one-half of 1 percent. I do not know 

if that is correct. Mr. DeMarco might want to comment on it. 

Mr. DEMARCO. That may be, Senator. Yes. It is certainly not 

anywhere near the proportion we are having with single family. 

Senator SHELBY. But in multifamily housing, as a rule, people 

have to put more skin in the game, do they not, Mr. DeMarco? 

They have to pay down—— 

Mr. DEMARCO. Yes, Senator. 

Senator SHELBY. ——with your loans. They have to put some 

money into the game, is that correct? 

Mr. DEMARCO. Yes, Senator. 

106 

Ms. DUKE. But Senator, if I could—— 

Senator SHELBY. Governor Duke. 

Ms. DUKE. My point was that an alternative to multifamily housing are portfolios of single-family housing that are offered for rental. But the difficulty there is that there has not historically been 

large-scale rental of single-family houses. So you do not have an infrastructure that is developed to manage them. You do not have 

the infrastructure for financing—— 

Senator SHELBY. Explain what you mean. Give us some examples 

here. 

Ms. DUKE. Let us say you had a 100-unit apartment building or 

you had 100 single-family units that you were going to rent in a 

market area. 

Senator SHELBY. You have got two different games there. 

Ms. DUKE. Two different games. There is financing experience 

with the multifamily. There is not financing experience with the 

large number of single-family houses. 

Senator SHELBY. So just to put foreclosed properties or inventoried properties out there, single houses, is a lot more difficult 

than it would be with somebody experienced in multifamily housing—— 

Ms. DUKE. Right. If somebody wanted to build a 100-unit apartment building, they could build it—— 

Senator SHELBY. Right—— 

Ms. DUKE. ——but if somebody wanted to acquire 100 properties, 

one at a time, it gets very difficult. Now, the unfortunate truth is 

that there are a number of properties that exist that have been acquired within the GSEs, FHA, on bank books, with servicers, so 

those properties are already on the books of various entities, and 

so a mechanism where those properties can be acquired by investors would seem to be an alternative to multifamily housing. 

Senator SHELBY. Has the Fed done an inventory on their portfolio, their securities and how many houses there are at risk? 

Ms. DUKE. The Fed does not have a—— 

Senator SHELBY. And if not, why not? 

Ms. DUKE. The Fed certainly does not have a large portfolio because we do not foreclose on houses. The securities that we own are 

agency securities, and so the houses that would be foreclosed on in 

those loans would be on the books of the GSEs, not on our books. 

Senator SHELBY. They would have to handle it. 

Ms. DUKE. Right. 

Senator SHELBY. OK. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

thank you, Governor Duke and Director DeMarco. 

Director DeMarco, in response to a question I posed to your IG, 

he indicated that FHFA, in his words, quote, ‘‘has too few examiners to ensure the efficiency and the effectiveness of its GSE oversight programs.’’ You have repeatedly told us that your responsibility is to minimize losses to taxpayers, but if, according to your 

IG, you cannot ensure the effectiveness of your oversight program, 

how can you assure us that you are carrying out this duty to minimize taxpayer losses? 

107 

Mr. DEMARCO. The IG’s report also points out that we have been 

undertaking a number of steps regarding both restructuring our organization regarding safety and soundness oversight and reallocating resources toward it and his report also commends us for 

those actions. 

I would point out that we recently hired a new head of Enterprise Regulation. It is actually a statutorily stipulated position at 

the agency. It is an individual that actually spent most of his career at the Federal Reserve System as a Senior Examiner and one 

of the most senior executives in supervision at the Fed. And we are 

continuing in the process of not just increasing our staffing levels 

with regard to supervision, but under this new Deputy Director’s 

leadership, we are restructuring, reorganizing the deployment of 

those resources to be more effective in our supervisory oversight. 

Senator REED. And how long has it taken to hire the individual 

and to begin to bulk up your resources? 

Mr. DEMARCO. It took a fair amount of time to find the right person for this position, Senator, but he is on board now and we have 

hired—since the IG’s report came out, we have hired over a dozen 

new examiners and that hiring process continues. 

Senator REED. The IG also pointed out, in response to my question, that the FHFA, quote, ‘‘trend of deference to the Enterprises, 

including a reliance on the determination of the Enterprises without independently testing and validating them. This largely handsoff approach to the conservatorships exacerbates FHFA’s challenges 

in anticipating problems.’’ Given your deferential approach, it appears from the IG, is it just business as usual back at Fannie and 

Freddie? And given the fact that until very recently you have not 

had a significant number of staff at a significantly high level to 

overtake your responsibilities, that you have not been able fully to 

guarantee that the taxpayer loss is being minimized? 

Mr. DEMARCO. I do not believe that to be the case, Senator. We 

have over 500 very hard working people at the Federal Housing Finance Agency. I believe the IG and I have a somewhat different 

perspective on the degree of involvement FHFA shall have in the 

day-to-day business operations of Fannie Mae and Freddie Mac. 

Long before I became Acting Director, at the time the 

conservatorships were established, FHFA made clear that it was 

delegating day-to-day business operation decision making back to 

the companies with a set of stipulated goals and things that the 

Enterprises were supposed to accomplish in conservatorship. We 

have reconstituted new Boards of Directors in order to assist FHFA 

in ensuring that these companies operated with proper internal 

controls and governance processes. That, to me, is part of conserving the value in these entities for lawmakers to ultimately dispose of. 

But I believe that in all critical matters where there is a question 

about the appropriateness of an action or a decision for the 

conservatorships, I am in close communication and discussions 

with the companies regarding such matters. 

Senator REED. Have you directed Fannie or Freddie or both to 

independently conduct an evaluation of the pros and cons of principal reduction as a way to, hopefully, in the long run, enhance the 

value of their franchises? 

108 

Mr. DEMARCO. Both companies have been reviewing principal 

forgiveness alternatives. Both have advised me that they do not believe it is in the best interest of the companies to do so. But as you 

know, Senator, FHFA has done a great deal of independent review 

itself of this important matter because I believe that assuring that 

we are taking appropriate steps to provide assistance to troubled 

borrowers is very much at the heart of what we are trying to do, 

but we need to do so in a way in which we are meeting our mandate to protect the taxpayers. 

Senator REED. Have you personally reviewed the independent 

analysis that Fannie and Freddie have done? 

Mr. DEMARCO. I have met with and been briefed by both companies on this and I have certainly reviewed all the work that my 

staff has done on multiple occasions, which I have shared with the 

Congress. 

Senator REED. Do you review the SEC filings that Fannie and 

Freddie make? 

Mr. DEMARCO. Senator, I have drafts of them before they go up, 

so I have an opportunity to see them, yes. But those filings are the 

responsibility of the companies. 

Senator REED. But you are the conservator. You are representing 

the Federal Government in everything that they do or fail to do. 

And again, you simply allow deference to what they decide? You review the drafts and—have you ever made any comments or 

changes in their SEC filings? 

Mr. DEMARCO. We have made some observations to them about 

their SEC filings. But even in conservatorship, Senator, these companies remain private companies with responsibilities under the 

securities laws for the filings that are submitted, and the individual executives at those companies that have to sign those filings 

are subject to all of the legal responsibilities and potential penalties that other private firms are when they do securities filings, 

Senator. 

Senator REED. But—— 

Mr. DEMARCO. That is part of being in conservatorship. 

Senator REED. As conservator, you feel no responsibility similarly? 

Mr. DEMARCO. Senator, I do not share the responsibility under 

the Sarbanes-Oxley Act for the filing of those documents. The executives of the companies do. 

Senator REED. Can you assure us that you believe there are no 

material misstatements or material omissions in those statements? 

Mr. DEMARCO. We would certainly be concerned about such 

things, Senator, and we would have responsibilities both as conservator and as regulator for that and would execute that appropriately both in terms of our oversight of the companies and in 

terms of our interactions with the Securities and Exchange Commission. 

Senator REED. So the answer is you have no concerns. 

Mr. DEMARCO. That is correct, Senator. I have not raised any 

concern with the filings that have been done while they have been 

in conservatorship. 

Senator REED. Thank you. 

Chairman JOHNSON. Senator Corker. 

109 

Senator CORKER. Thank you, Mr. Chairman. 

Governor Duke, I appreciate your testimony, talking about the 

fact that the lack of knowledge about what is going to happen, 

whether GSEs continue to keep the private market off balance and 

not knowing what to do. Let me ask you, the $25 billion settlement 

that just occurred where—I think a lot of people think this is coming out of the hides of the servicers, but actually, they can cram 

down mortgage investors and get credit for that, which is pretty 

unique and I do not think most Americans understand that is what 

is really happening, but let me just ask you this. Would that also 

potentially create some lack of consistency and concern about the 

private sector being involved in buying mortgages when these types 

of things can happen and the mortgage investor had nothing whatsoever to do with what happened but was just trying to play a role 

in financing housing with no underwriting themselves? 

Ms. DUKE. I think mortgage investors are certainly going to be 

interested in all the ways that they can recover the money that 

they have loaned and ways that they would not recover that 

money. One thing, though, that the settlement does do is remove 

an uncertainty, and it is these various uncertainties that are out 

there about what is going to happen in the mortgage servicing settlement and what is happening with mortgage servicing standards. 

And so with that information, then various market participants 

will decide either to invest in mortgages, to invest in servicing and 

origination platforms, and what they are going to do in that market. 

Senator CORKER. But it just continues the lack of knowledge of 

knowing that settlements can occur that affect them that they had 

nothing to do with. We just continue down this path of Government 

getting involved in areas, breaking rationality and creating issues. 

I appreciate you saying what you just said. 

I would ask—and I am going to move on to Mr. DeMarco—I 

know you wrote a white paper on housing and I know it met with 

a degree of criticism. But I would appreciate if you guys would 

write a white paper on financial reform as it is taking place and 

share with us the pros and negatives that you are seeing there. I 

would ask for you to commit to that and maybe send something up 

to us, giving some editorial comments about something that is actually in your central core area. That would be great to hear. 

Ms. DUKE. I think as financial reform gets implemented, one of 

the things we will be following very closely is what are the effects 

of that financial reform, and as we get that information, yes, we 

would be happy to share it with you. 

Senator CORKER. So you do not have input now? 

Ms. DUKE. We have input now, but we are still developing the 

regulations, and so we are trying—as we develop the regulations, 

we are absolutely looking at ways that they will impact the market 

and ways that they will impact the financial system. But I think, 

further, after all of the regulations are implemented, it is going to 

be important to then test the assumptions of what you expected to 

happen and—— 

Senator CORKER. If you could do those on an interim basis before 

this is all done over the next 3 years, it would be helpful. But 

110 

again, I appreciate your testimony about the lack of consistency out 

there in the private side. 

Mr. DeMarco, I just want to tell you, you guys have to go back 

and just laugh. Here you have tried to lay something out to begin 

the process of doing something with GSEs, lay out a strategic 

paper that I think has been met widely as a good step, and here 

Congress up here has not done a single thing, is totally feckless— 

feckless—as it relates to these issues. The Administration has done 

nothing except sending a multiple choice plan up here that, you 

know, you can choose, each of which is very different than the 

other. 

What is it like to be out there, a person who basically is there 

to serve the taxpayers, has done a good job at doing that, is trying 

to move things ahead, and to have people up here criticize you 

when they themselves do not have the courage, the will, the desire 

to address these issues? 

Mr. DEMARCO. There is a lot of conflict in this job and a lot of 

balancing, and you are quite right, Senator. There appears to be a 

lot of criticism. 

Senator CORKER. So what do you think it is? I mean, I think 

most Americans would love to see us deal with the GSEs. I think 

if you did a poll nationally, people would really love to see us move 

back to the private sector being more involved. What is it about 

Congress, do you think, that likes to instead have an entity like 

this that they can play with and have principal reductions and 

serve the social purposes that they would like to see that are really 

outside the norms of the housing industry? What is it about a body 

like ours, do you think, that causes us to want to do that? 

Mr. DEMARCO. Well, there is something about the structure of 

Congress chartering companies like this, giving it certain benefits 

unavailable to other market participants, that certainly Congress is 

then going to want something in return for all those favors. And 

that goes back well before conservatorship, Senator. For many, 

many years, Fannie Mae and Freddie Mac operated in a very 

unique place in our financial system and were viewed very uniquely by Congress and it affected in an adverse way the ability to have 

appropriate oversight of them, and it certainly has politicized housing and housing finance to a very troubling degree. 

Senator CORKER. I know that you have to be diplomatic in your 

approach, and I appreciate the way you handle yourself and I certainly appreciate you taking the first steps, but I will tell you, if 

I were in your position and I had any criticism whatsoever from 

Congress about what you were doing, I would ask them to lay out 

their plan. And obviously, we have no plan. We like to criticize. I 

thank you for your leadership. I hope at some point Congress will 

do its job and reform these entities that I think every American— 

most every American, except for those who serve in Congress— 

would like to see reformed. I thank you for your service. 

Mr. DEMARCO. Thank you, Senator. When the Congress is ready, 

we are sure ready to work with them. 

Senator CORKER. Thank you. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

111 

Well, let us see if we can get some things that Congress and you 

can agree on. For starters, would you agree that if we have a foreclosure, on average—I know there is a Freddie Mac study, but 

maybe you have a different study—that says the loss in foreclosure 

is, on average, about $60,000? 

Mr. DEMARCO. That sounds ballpark. 

Senator MENENDEZ. OK. So if we can either conserve the—as I 

look at the law and think about how do we preserve and conserve 

FHFA to minimize losses on behalf of taxpayers, we can either preserve that loss either by proceeding to foreclosure, which has a 

$60,000 loss, or we might very well be able to look at principal reduction at the end of the day if it is somewhere at least in that 

ballpark. 

And so it seems to me that what we get, however, in principal 

reduction is a homeowner who continues to stay in that home instead of become a vacant property, a homeowner who can under 

that guise be a responsible borrower, a homeowner who is paying 

taxes on a ratable base and not creating a ripple effect on the community in which multiple foreclosed homes create depressed values 

for the community in general, and the savings that takes place in 

not having to take that property and go through our present challenges on the REO to move it so that we can get this housing market to move. 

If that is the case, then why is it that you have taken the view 

that principal reduction is not within the domain of the possibility 

of what you can do under the law, because it would preserve and 

conserve just as well, certainly in that universe, as a foreclosure, 

and it would also meet under the Emergency Economic Stabilization Act the other goal that you have, which is a responsibility to 

implement a plan that seeks to maximize assistance for homeowners. 

Mr. DEMARCO. So, Senator, I have not said that we do not have 

the legal authority to reduce principal. And in the spirit of your 

question, which is let us find things we can agree on, there is much 

that we do agree on here, Senator. We agree that foreclosure—— 

Senator MENENDEZ. Well, I was listening to Senator Corker and 

you and I thought there was nothing we agreed on, so that is why 

I wanted to—— 

Mr. DEMARCO. Well, I will be happy to clear that up—— 

Senator MENENDEZ. OK. 

Mr. DEMARCO. ——because, Senator, there is much that we 

agree on, specifically in the context of your question. Foreclosure 

is the worst possible outcome in almost all instances. It is the most 

costly. It is the most devastating to the family. It is most devastating to the neighborhood and surrounding community. And we 

have a responsibility to make all prudent actions to find a remedy 

to a troubled borrower short of foreclosure because of these costs. 

So we agree there. 

We also agree that if a borrower is committed to their home and 

perhaps has had a change in circumstances where they have more 

limited ability to make their mortgage payment, that as one of the 

approaches to trying to avoid foreclosure, this borrower should be 

offered an opportunity to have their loan restructured in a way 

that is affordable to them. And we have taken a great leadership 

112 

role at FHFA and through Fannie and Freddie to ensure that borrowers get this opportunity. 

And I would like to expand on this, because this is very important for everybody to understand. What we did in the Servicing 

Alignment Initiative is we made clear in terms of aligning Fannie 

and Freddie’s instructions to mortgage servicers that as soon as a 

borrower goes delinquent, that is the time to get a hold of the borrower, find out what the problem is, and develop quickly an appropriate response to that borrower’s condition. If it is just a very limited short-term thing, then it is a pretty simple thing to handle. If 

it has been a permanent decline in the financial circumstances of 

the family, then it might require something different, like a loan 

modification. 

But we are doing that, Senator, and we are doing that aggressively. We are outpacing the market, as my testimony shows, with 

regard to the amount of that activity that we are doing—— 

Senator MENENDEZ. I do not want to cut you short, but my time 

is going to expire—— 

Mr. DEMARCO. You have asked about—— 

Senator MENENDEZ. Can you get to the point about principal reduction for me—— 

Mr. DEMARCO. Yes—— 

Senator MENENDEZ. ——and then I have one other quick question. 

Mr. DEMARCO. Yes, I will, Senator. So to understand principal 

reduction, here is how this works, because there has certainly been 

a lot of attention focused on us on this issue. Principal reduction 

alternative in the HAMP modification program is the fourth tool 

for how to provide assistance to a troubled borrower to make good 

on their mortgage. HAMP gets—in all of these HAMP modifications, the objective is to get something to—get the borrower to an 

affordable payment, and it defines affordable payment as 31 percent of their monthly income would go to their mortgage. That is 

the target when you are doing a loan modification in HAMP, is to 

get to a 31 percent payment. That can be done by reducing the interest rate. It can be done by extending the term of the loan. It can 

be done by forbearing on the underwater portion of principal. Or 

it can be done by principal forgiveness. So these are four tools, 

using Secretary Donovan’s description, in the tool kit for loan modifications. 

What FHFA has consistently found in its analysis is that the 

first three of those tools work better than the fourth one with regard to our fundamental mandate of preserving and conserving, 

and I think it would be helpful to understand principal forbearance 

and why that is the case, because it actually—— 

Senator MENENDEZ. No, I understand what principal forbearance 

is—— 

Mr. DEMARCO. But, Senator—— 

Senator MENENDEZ. You put it at the back end of the loans—— 

Mr. DEMARCO. Well, but it works very much in accord with the 

spirit of your proposal, Senator, about shared appreciation, because 

it takes that underwater—it takes the underwater portion of the 

principal, sets it aside and says, we are not going to focus on that. 

We are going to focus on getting you, the borrower, into an affordVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00116 Fmt 6601 Sfmt 6601 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
113 

able payment. You pay that and this underwater portion is going 

to sit over here to the side, and if you are successful, then we are 

all going to share in your success. 

Senator MENENDEZ. Well, let me ask you this question and then 

I will yield. We have a disagreement, obviously, in that respect. 

Mr. DEMARCO. Mm-hmm. 

Senator MENENDEZ. I think there is a fundamental difference 

that when the marketplace on the private sector is looking at 20 

percent of its portfolios and saying it makes sense for us in the 

marketplace to do so, and they certainly want to preserve their assets as much as possible as you do as a conservator, but I get concerned about this issues on principal reduction, looking at these 

other issues, because I look at the stories that came out about 

Freddie making investments that paid off in the event that homeowners are kept in higher-cost loans. And I would assume that 

they would not make those bets if at the end of the day they were 

not hopeful that the bet would pay off. 

And so it seems to me, is that leading—do you believe that that 

has influenced Freddie’s policies that discourage refinancing for 

homeowners, because if your bet is that you are going to keep 

homeowners in the higher rate, then, in fact, why would you make 

that bet when you can—you would hope to win that bet, and when 

you can influence that bet at the end of the day by not permitting 

refinancing, principal reduction, and other elements to take place. 

Mr. DEMARCO. Senator, there is no betting going on here. When 

someone makes a mortgage to a borrower, right, let us say that 

mortgage is made at 6 percent. If the mortgage rates then subsequently go down to 4 percent, then the holder of that mortgage 

knows that they have got the risk the borrower is going to exercise 

their right to refinance that mortgage and, hence, they are going 

to get their money back faster than they expected and then they 

are going to have to reinvest it, if they are going to stay in mortgages, they are going to have to reinvest it at lower mortgage rates. 

If interest rates go from 6 percent to 8 percent, right, then the borrower—the investors holding this 6 percent—— 

Senator MENENDEZ. Are you telling me Freddie did not make investments—— 

Mr. DEMARCO. I am saying—— 

Senator MENENDEZ. ——I called them bets, but they made investments in saying that the consumers would—that it would pay 

off in the event that homeowners were kept in higher-cost loans. 

Why would they do that? 

Mr. DEMARCO. I am saying, Senator, anybody that is holding a 

premium mortgage in this mortgage environment has an investment—— 

Senator MENENDEZ. Your staff is shaking their head behind you. 

Maybe you can explain what she is shaking her head about. 

Mr. DEMARCO. Do I need to consult—all right. So anyone that is 

holding a 6-percent mortgage in a 4-percent mortgage environment, 

Senator, is holding an investment by which if the borrower refinances, they are going to get their money back and have to reinvest at a lower rate. This is not a bet against the homeowner. 

Senator MENENDEZ. I do not think Freddie would take its money 

and make investment decisions and say, let me invest to ensure 

114 

that at the end of the day, I am going to have a positive result in 

my investment, and the only way I have a positive result in my investment is if the mortgage borrower is kept in a higher rate. I just 

find that ethically troubling, to say the least. 

Chairman JOHNSON. Senator Toomey. 

Senator TOOMEY. Thanks, Mr. Chairman. I would like to thank 

our witnesses for joining us today. 

I just want to briefly follow up on a comment or line of questioning that Senator Corker raised, which, I guess from my point 

of view, had to do with the impact on the private market’s ability 

to provide mortgage financing, especially after this settlement has 

demonstrated the fact that the Government can come along and 

change the value of a contract that you have pretty much as it sees 

fit. Frankly, I worry about how much more it is going to cost homeowners to be able to finance their mortgages in light of that. But 

that is not what I actually wanted to talk to you about, and I 

would like to direct my questions to Mr. DeMarco. 

First, I have a copy here of a cover letter that you sent to Representative Elijah Cummings, and it is dated January 20. And in 

it, you stated that the FHFA has essentially three principal mandates, the first of which is a statutory responsibility as conservator 

to preserve and conserve the assets and property of the regulated 

entities. Is this not a way of saying to protect taxpayers? Is that 

not—— 

Mr. DEMARCO. Yes, Senator. 

Senator TOOMEY. You go on—now, you mentioned the other two 

mandates, and then you have a discussion in the next paragraph 

that—and you state right here, you did not conclude that principal 

reduction never serves the long-term interests of the taxpayer 

when compared to forbearance. But you did compare, as I understand it from your letter, the relative cost to taxpayers, and your 

conclusion, as I read it here, is that by avoiding the principal forgiveness, the net effect is a smaller loss to taxpayers. Is that a fair 

way to characterize this? 

Mr. DEMARCO. Yes, Senator. 

Senator TOOMEY. You go on to then quantify what it would cost 

in this letter if the FHA set out to actually provide the principal 

forgiveness that would be enough to diminish the value of mortgages to make them equivalent to the value of homes, and you estimate that that would cost almost $100 billion and that that would 

and this is your language—you say, this would be in addition to 

the credit losses both Enterprises are currently experiencing. So 

that is a lot of additional cost to taxpayers, right? 

Mr. DEMARCO. Yes, Senator. 

Senator TOOMEY. And then, last, you have a discussion about 

this fact that I do not think has been discussed as much as it ought 

to be, namely that nearly 80 percent of Enterprise underwater borrowers are current on their mortgage. And, in fact, those who have 

a loan-to-value ratio above 115 percent are 74 percent current, 

which seems to me to present a real dilemma of how you would go 

about doing this. 

For instance, if you provided principal forgiveness for everybody 

who was underwater, you would be asking taxpayers to pick up the 

tab for people who are actually clearly demonstrating that they are 

115 

capable of making the payments for the loan that they chose to 

take. If you did not and you said, no, it is only the people who are 

not making payments, why, then how fair would that be to the people who are making payments, and would that not create an incentive for people who are currently making payments to stop? Is that 

not a pretty tough dilemma? 

Mr. DEMARCO. I think that says it quite well, Senator. I think 

that one of the under-reported things here is that while this country has many borrowers with mortgages that are underwater, the 

vast majority of them are making their payment every month, and 

they must wonder about some of these discussions we are having. 

Senator TOOMEY. And then I will conclude on this, Mr. Chairman. In the next paragraph, you say, ‘‘given that any money spent 

on this endeavor,’’ and by that you are referring to principal reductions, ‘‘would ultimately come from taxpayers, and given that our 

analysis does not indicate a preservation of assets for Fannie and 

Freddie substantial enough to offset the costs, an expenditure of 

this nature would at this time, in my judgment’’—that is you talking—‘‘require Congressional action.’’ 

I just want to say I share that view. I commend you for taking 

that view and I want to recognize that you have been under a lot 

of pressure to change that view and I hope you will not change it. 

I hope you will stick to that view because I think that is the correct 

view. 

Mr. DEMARCO. Thank you, Senator. 

Chairman JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you to the 

panel for your testimony. 

One of the things that I found very interesting recently was the 

article in American Banker, ‘‘Why FHFA is Wrong On Principal 

Forgiveness,’’ and I am sure you have had a chance to read that 

article as it has been widely discussed. And essentially, the author, 

Kevin Wack, says that in the third quarter of 2011, I believe it was 

18 percent of bank modifications involved principal reduction and 

he raises the question why it is that for-profit institutions are 

doing nearly a fifth of their loans with principal reduction and finding that that is the most cost effective way to their profits but you 

have not found any similar results. And I do want you to give brief 

responses so that we can actually have a bit of a dialog over several issues. 

Mr. DEMARCO. A number of these institutions have purchased 

these mortgages at a discount. They have bought them at a price 

at which doing the principal forgiveness was not something where 

they were taking a loss by doing so. 

Senator MERKLEY. Well, fair enough, but no matter what you 

paid for it, the alternative of the strategies that you use with the 

individual would still be the same range of options that you have 

if you had paid a lot more for the loan. So in that context, your 

logic does not hold, and do you want to further try some other argument? 

Mr. DEMARCO. No. I am comfortable with where I have left it. 

Senator MERKLEY. OK. You provided the six-page report to the 

House, and I believe Representative Cummings has said, really, on 

such a major issue, you ought to provide the full analysis and they 

116 

have asked you to do so by February 29. Do you intend to make 

public the full analysis? 

Mr. DEMARCO. I provided Representative Cummings and others 

with the full three different analyses that we had done on this 

issue and he has come back with some follow-up questions and 

asked for yet additional information and we are working on that. 

Senator MERKLEY. So does that meet his request for the February 29, or—— 

Mr. DEMARCO. I will not have additional information tomorrow 

for him. 

Senator MERKLEY. One of the notes has been that your analysis 

did not make one of the most fundamental distinctions, that is, between folks who have mortgage insurance and people who do not 

have mortgage insurance. Obviously, that has a huge bearing on 

the net present value impact. Why was such a fundamental distinction not analyzed or not laid out, at least in what you presented 

to Congress? 

Mr. DEMARCO. Because we were able to reach the conclusion 

about principal forgiveness without going to that point. But if we 

want to go there, that is quite right. Another issue with principal 

forgiveness is that I am then putting the taxpayer, jumping them 

ahead of the mortgage insurance company who is in the first loss 

position on this mortgage. I would say the same thing holds for any 

second liens that might exist on this mortgage. So this is reorienting the priority of loss absorption that is part of the structure 

that is in place today. But we have not had to go to that issue with 

regard to the analysis that we have done. 

Senator MERKLEY. Other observers have noted that in your analysis, you did not look at the shared appreciation model, which actually is forgiveness plus funds that come back to the originator 

which changes the net present value calculation. So you gain the 

advantages of people having lower monthly payments, therefore, 

less likely to strategically default, less likely to financially default, 

and yet there is a back-end funds that return. Do you intend to— 

you actually mentioned shared appreciation earlier. Do you intend 

to do an analysis of that, and if you have not already done it, why 

not? 

Mr. DEMARCO. Shared appreciation mortgages are complex instruments that are not widely articulated in the marketplace. What 

I was trying to convey to Senator Menendez is that principal forbearance modifications, which we are doing and we are doing a lot 

of them, are effectively principal forgiveness with a shared appreciation on the mortgage attached to it. It is economically approximately the same thing. So we are, in fact, doing that now, Senator. 

Senator MERKLEY. OK. I did not see that in the analysis you presented to Congress. Do you intend to provide that analysis to us? 

Mr. DEMARCO. I believe I will try to articulate this more clearly 

in our next round of discussions regarding principal forgiveness. 

Senator MERKLEY. OK. One of the things that was disturbing to 

folks across the country is when you said in October you had not 

met any homeowner who has suffered a foreclosure. Have you had 

a chance to actually talk to homeowners in the real marketplace 

since October? 

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Mr. DEMARCO. You know, Senator, I do know families that have 

suffered foreclosures and I believe that my—people I know personally, things in my personal life really are not relevant to the realm 

of this because I believe my responsibility goes to analyzing the 

law, analyzing the options that are available to us, and proceeding. 

I will say something I have done since that time, Senator, that 

you may find meaningful in this regard. In December, I went up 

to the city of Baltimore and I met with people from the Baltimore 

City Housing, the Maryland State Housing Finance Agency, and a 

local community bank there as well as some community activists 

and had a lengthy discussion about the impact of the housing crisis 

in Baltimore. We took a tour of several neighborhoods, some of 

which one might call—for which this housing crisis has been very 

damaging. And we have talked about what happened. We have 

talked about demographic issues. We talked about alternatives for 

trying to generate recovery in those neighborhoods. 

I take this seriously, Senator, that we have communities and 

families across the country that have been greatly harmed by this, 

and FHFA is trying very hard to be part of bringing some solutions 

and stability back to this. But I will do so in a disciplined way following the mandate that I believe Congress has given us. 

Senator MERKLEY. I believe what you just said is that you are 

correcting the record from your October statement, or were you 

misquoted in October? 

Mr. DEMARCO. I was not misquoted. That is what I had told the 

Congresswoman. I thought she meant it in the form of as part of 

my work effort, had I been going out and meeting with foreclosed 

homeowners. 

Senator MERKLEY. Well, I applaud what you did in Baltimore because I think actually seeing communities on the ground gives one 

an understanding that analysis and ivory towers do not gain. I 

think you would be hard pressed to find a street in a working class 

community like the one I live in that does not have one or two families on it that are foreclosed on. I mean, the impact is very real, 

very evident, the destruction of families’ dreams, the destruction of 

their finances. I applaud you for going to Baltimore and doing what 

you can to kind of see the real impact on the ground. Thank you. 

Chairman JOHNSON. I would like to thank Governor Duke and 

Mr. DeMarco as well as Secretary Donovan for being here with us 

today. 

This hearing has provided this Committee important insight toward achieving realistic solutions to many of the problems confronting the housing market. Stabilizing this market remains a top 

priority of this Committee and I will continue to work to find bipartisan consensus to achieve it. 

This hearing is adjourned. 

[Whereupon, at 12:34 p.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 

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PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON 

I thank our witnesses for joining us. Today’s hearing is part two of our examination of the state of the housing market and steps that can be taken in the near term 

to remove housing market barriers to economic recovery. 

This Committee has undertaken a bipartisan, in-depth look at long-term housing 

finance reform. I hope to continue this effort with additional hearings and by working with Ranking Member Shelby and Committee Members to seek bipartisan consensus. In today’s hearing, we will focus on the immediate problems confronting the 

housing market and the larger economy, which is a critical first step in finding a 

long-term solution. 

In January, the Federal Reserve released a white paper entitled ‘‘The U.S. Housing Market: Current Conditions and Policy Considerations.’’ In this paper, the Fed 

stated that ‘‘continued weakness in the housing market poses a significant barrier 

to a more vigorous economic recovery.’’ 

As I stated during our February 9th hearing on this topic, I share the concern 

that ongoing challenges in the housing market are acting as a drag on economic recovery. I want to find practical solutions to help overcome them. 

Today’s hearing provides a good opportunity to discuss the current housing market environment with regulators and the Administration’s top housing official. I 

would like to hear from our witnesses about potential solutions, both legislative and 

administrative. 

In addition to the Federal Reserve’s recent white paper, other analysts, regulators, and the Administration have offered up options and proposals to address barriers to housing and economic recovery. Earlier this month, the Administration outlined a new Housing Plan to give more families the opportunity to refinance at today’s low rates. Just yesterday, the Federal Housing Finance Agency announced its 

first pilot sale in an Initiative to address the large volume of Real Estate Owned 

properties held by the Government-Sponsored Enterprises. 

At our February 9th hearing, the witnesses and a number of Committee Members 

on both sides of the aisle cited helping families refinance at today’s low interest 

rates as a powerful example of an action that would help bolster the housing market 

and stabilize housing prices. This is particularly true for mortgages held by the 

GSEs. I would like to see the FHFA take additional steps to facilitate refinancing 

for families currently stuck in higher-interest mortgages held by Fannie and 

Freddie. I look forward to hearing more from Acting Director DeMarco on steps that 

FHFA is planning to take to speed these refinancings. 

Without a robust housing market recovery, our economy will continue to drag and 

millions of Americans will continue to struggle to make ends meet. I look forward 

to continuing to work with our witnesses and Members of the Committee to find 

workable solutions to improve the housing market and lead us further down the 

road to prosperity. 

PREPARED STATEMENT OF SHAUN DONOVAN 

SECRETARY, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

FEBRUARY 28, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for this opportunity to testify about how the Administration’s housing initiatives are helping remove barriers to economic recovery. This hearing comes at an 

important moment—a moment President Obama described in his State of the Union 

as ‘‘a make or break moment for the middle class and those trying to reach it.’’ In 

that address, he said that what’s at stake is the survival of the basic American 

promise—the idea that if you work hard, you can do well enough to raise a family, 

own a home, and put a little away for retirement. 

Mr. Chairman, I couldn’t agree more. As the President said, the defining issue 

of our time is how to keep that promise alive—to build a Nation where everyone 

gets a fair shot, everyone does their fair share, and everyone plays by the same 

rules. And nowhere is that challenge clearer than in the homes where we live—from 

when we buy a home—and make the biggest financial decision of our lifetimes—to 

our ability to refinance that loan, to the way banks treat us as customers should 

we ever lose a job or experience a medical crisis that puts our homes at risk. 

Indeed, as this Committee knows well, too often in the years leading up to the 

crisis, mortgages were sold to people who couldn’t afford or understand them. Banks 

made huge bets and bonuses with other people’s money. The resulting recession cost 

more than 8 million jobs and our economy and the world plunged into a crisis from 

which we are still recovering. 

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Thanks in part to the partnership of this Committee, today we face a very different environment than the one we faced when President Obama took office. Back 

in January 2009, America’s economy was shed 818,000 jobs alone. Housing prices 

had fallen for thirty straight months. And foreclosures were surging to record levels 

month after month after month. 

Today, because the Obama administration moved to keep interest rates low and 

restore confidence in Fannie Mae, Freddie Mac, and the Federal Housing Administration, more than 13 million homeowners have refinanced their mortgages since 

April 2009—putting nearly $22 billion a year in real savings into the hands of 

American families and into our economy. 

Today, because we provided a range of solutions to responsible families fighting 

to hold on to their homes, more than 5.6 million families have been able to reduce 

their payments and modify their loans to more sustainable terms and foreclosure 

notices are down nearly 50 percent since early 2009. Because we provided resources 

for communities struggling with concentrated foreclosures, today we are on track to 

help them fund better uses for almost 100,000 vacant and abandoned properties 

through our Neighborhood Stabilization Program. Most important of all, because of 

our commitment to economic growth and recover, our economy has added private 

sector jobs for 23 straight months, totaling 3.7 million jobs. 

Mr. Chairman, this represents important progress. But we know there is much 

more to be done. Three key barriers prevent our housing market—and our economy—from fully recovering. 

While the number of homeowners at risk of losing their home is down significantly, there are still too many families that face hardships and are underwater— 

and their unaffordable monthly payments put them at an increased risk of default, 

dragging down markets, reducing labor mobility and consumer spending alike. 

While targeted support to markets struggling with foreclosures, blight and abandonment has reduced vacancy rates, increased home prices and shrunk the inventory of homes for sale, an overhang of properties at risk of or in foreclosure continues to drag down property values and harm the hardest-hit communities. 

While we put an end to the worst abuses that caused this crisis and stabilized 

the market, it is too difficult to get a mortgage today—largely because of uncertainty over making loans attributable to lack of clarity around mortgage servicing, 

and continued market volatility. 

And so today, I want to talk about the new tools we are providing to overcome 

these three key barriers—keeping people in their homes, the shadow inventory and 

access to credit—and the steps we still need to take to move forward. 

Relief for Responsible Homeowners, Keeping People in Their Homes 

First and foremost, we needed to ramp up our efforts to keep people in their 

homes and provide relief for homeowners who’ve done the responsible thing time 

every month when that mortgage bill arrives in their mailbox. 

Mr. Chairman, millions of responsible homeowners who are current on their mortgages and could benefit from today’s low interest rates face substantial barriers to 

refinancing through no fault of their own. Sometimes homeowners with good credit 

and clean payment histories are rejected because their mortgages are underwater. 

In the end, these responsible homeowners are stuck paying higher interest rates, 

costing them thousands of dollars a year. 

Indeed, as economist Mark Zandi said, ‘‘There is no better way to quickly buoy 

hard-pressed homeowners than helping them take advantage of the currently record 

low fixed mortgage rates and significantly reduce their monthly mortgage payments.’’ 

That’s why, on February 1st, President Obama announced a package of administrative actions and legislative proposals to help responsible homeowners save thousands of dollars through refinancing. Under his proposal, borrowers with loans insured by Fannie Mae or Freddie Mac (GSE-insured loans) would have access to 

streamlined refinancing through the GSEs. Borrowers with FHA insured loans will 

be able to take advantage of an enhanced FHA streamline refinance program. And 

borrowers whose loans are held by private banks or are securitized in private label 

securities would have access to refinancing through a new, low-cost, streamlined refinance program that would be facilitated by the FHA. 

Allow me to explain each of these efforts in detail. 

Refinance Assistance for Borrowers With GSE Loans—HARP 2.0 

In his jobs speech to Congress last September, President Obama charged HUD 

and Treasury to work with the Federal Housing Finance Agency to lower barriers 

to refinancing. Following weeks of intensive discussions with lenders, mortgage insurers, regulators, and investors, FHFA announced changes to help borrowers 

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whose loans were purchased or guaranteed by Fannie Mae or Freddie Mac and who 

are located in areas suffering from house price declines. 

With the Administration’s Home Affordable Refinancing Program previously limiting refinancing to borrowers with high loan-to-value ratios (LTVs) of 125 percent 

and responsible for less than a million refinances, the need to pick up the pace was 

clear. Announced in October 2011, HARP 2.0 eliminates the LTV ceiling, reduces 

certain risk-based loan-level guarantee fees (also referred to as loan level pricing adjustments, or LLPAs), extends the program’s end date to December 2013, streamlines automated valuation model (AVM) coverage and foregoes appraisal requirement when AVM is available, and provides representations and warranties relief. 

Eliminating the LTV cap will allow those GSE borrowers who have been responsible in paying their mortgage, but happen to be deeply underwater, the opportunity 

to take advantage of unprecedented mortgage interest rates. The extension of the 

program for 2 years will allow lenders to hire staff and upgrade systems to assure 

all eligible borrowers will have the opportunity to take advantage of the HARP program. It will minimize the amount of funds borrowers would be required to obtain 

for a refinance because the GSEs reduce the fees that borrowers have to pay on 30- 

year fixed rate loans with an LTV over 80 percent from 2 percent to .75 percent 

of the loan amount. And by ensuring that the GSEs do not require the HARP originator to take responsibility for the quality of the loan that is being refinanced, it 

will expand the universe of responsible borrowers to whom they offer the refinancing option. 

In addition to these changes, the Administration continues to work with FHFA 

on ways to increase uptake. Specifically, the Administration is evaluating automated valuation models as approval alternatives to manual appraisals, removing 

operational barriers that preclude or hinder cross-servicer refinances, and seeking 

to extend HARP 2.0 to those borrowers with LTVs under 80 percent so that more 

responsible, current homeowners have the opportunity to refinance. 

We expect most lenders will have their HARP 2.0 operations fully up and running 

by the end of March. These changes have met with a very positive response from 

homeowners. Already, according to an informal survey almost 300,000 families have 

filed applications for refinancing and stand to save on average $2,500 per year— 

the equivalent of a pretty good-sized tax cut—speeding our efforts to help responsible families stay in their homes and start to rebuild the wealth they lost in the 

economic crisis. 

We look forward to working with Congress to further reduce the barriers to refinancing under HARP 2.0, including easing costs associated with mortgages that 

have greater equity than 80 percent, easing underwriting standards, and easing appraisal requirements. 

Refinance Assistance for FHA Borrowers—FHA Streamlined Refinance 

FHA Streamline Refinances allow borrowers with loans insured by the Federal 

Housing Administration who are current on their mortgage to refinance into a new 

FHA-insured loan at today’s low interest rates without requiring additional underwriting, allowing these borrowers to reduce their mortgage payments in a low-cost, 

simple manner. This program benefits current FHA borrowers—particularly those 

whose loan to value may exceed the current value of their home. This both lower’s 

a borrower’s payment and reduces risk to FHA. As part of our efforts to help responsible homeowners who are current on their mortgages and because we see potential 

for more widespread use of this product, FHA will make changes to the way in 

which streamline refinance loans are displayed in the Neighborhood Watch Early 

Warning System (Neighborhood Watch), so that these lenders are not on the hook 

for loans they did not originate and thus will be more willing to provide the refinancing. 

In addition to taking steps to make these refinance loans more widely available, 

FHA is working on adjusting the premium structure for all Streamline Refinance 

transactions that are refinancing FHA loans endorsed on or before May 31, 2009, 

to further incentivize refinance activity. These changes will ensure that borrowers 

benefit from a net reduction in their overall mortgage payment while still ensuring 

FHA has the resources to pay any necessary claims. 

Broad Based Refinancing for Non-GSE, Non-FHA Borrowers 

Lastly, the President has called on Congress to open up opportunities to refinancing for responsible borrowers who are current on their bills and paying their 

mortgage but whose loans aren’t GSE or FHA-insured. Under the proposal, borrowers with standard non-GSE, non-FHA loans will have access to refinancing 

through a new program run through the FHA. For these responsible borrowers, 

there will be no more barriers and no more excuses. 

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Key components of this plan include: 

Providing Non-GSE, Non-FHA Borrowers Access to Simple, Low-Cost Refinancing: 

The program will be simple and straightforward. Any borrower with a loan that is 

not currently guaranteed by the GSEs or insured by FHA can qualify if they meet 

the following criteria—each of which is designed to help reduce risk to the taxpayer: 

• They are current on their mortgage: Borrowers will need to have been current 

on their loan for the past 6 months and have missed no more than one payment 

in the 6 months prior. 

• They meet a minimum credit score. Borrowers must have a current FICO score 

of 580 to be eligible. Approximately 9 in 10 borrowers have a credit score adequate to meet that requirement. 

• They have a loan that is no larger than the current FHA loan limits in their 

area: Currently, FHA limits vary geographically with the median area home price—set at $271,050 in the lowest cost areas and as high as $729,750 in the 

highest cost areas. 

• The loan they are refinancing is for a single family, owner-occupied principal 

residence. This will ensure that the program is focused on responsible homeowners trying to stay in their homes. 

• They are currently employed. To determine a borrower’s eligibility, a lender need 

only confirm that the borrower is employed. 

Borrowers will apply through a streamlined process designed to make it simpler 

and less expensive for both the borrower and the lender. The President’s plan includes additional steps to reduce program costs, including: 

• Establishing loan-to-value limits for these loans. The Administration will work 

with Congress to establish risk-mitigation measures which could include requiring lenders interested in refinancing deeply underwater loans (e.g., greater than 

140 LTV) to write down the balance of these loans before they qualify. This 

would reduce the risk associated with the program and relieve the strain of negative equity on the borrower. 

• Creating a separate fund for new streamlined refinancing program. This will 

help the FHA better track and manage the risk involved and ensure that it has 

no effect on the operation of the existing Mutual Mortgage Insurance (MMI) 

Fund, which is FHA’s already established insurance fund. 

Cost-Savings to the Borrowers who Participate in This New Program: Given today’s record low interest rates, we estimate that on average, borrowers who participate in this program would reduce their monthly payments by between $400 and 

$500 a month. 

Option To Rebuild Equity in Their Homes Through This Program: All underwater 

borrowers who decide to participate in this refinancing program through the FHA 

outlined above will have a choice: they can take the benefit of the reduced interest 

rate in the form of lower monthly payments, or they can apply that savings to rebuilding equity in their homes. The latter course, when combined with a shorter 

loan term of 20 years, will give the majority of underwater borrowers the chance 

to get back above water within 5 years, or less. 

To encourage borrowers to make the decision to rebuild equity in their homes, we 

are proposing that the legislation provide for the closing costs of borrowers who 

chose this option—a value averaging about $3,000. To be eligible, a participant in 

this option must agree to refinance into a loan with a term of no more than 20 years 

and with monthly payments roughly equal to those they make under their current 

loan. For those who agree to these terms, their lender will receive payment for all 

closing costs directly from the FHA or another entity involved. 

A Separate FHA Fund: The broad based refinance program will have a separate 

fund that is funded through premiums established and direct funding provided 

under this program with its net cost offset by the financial crisis fee. The program’s 

premium structure will be designed in a way to ensure that homeowners have the 

incentive for lower monthly payments through the program. By maintaining a separate fund and funding source for this program the broad-based refinance will not 

be contingent on appropriations action and will have no impact on FHA’s MMI Fund 

which, as the Committee knows, has been strained in recent years. 

We look forward to working with Members of this Committee to craft legislation 

to accomplish these goals and offset the costs associated with establishing a broadbased refinance program. 

Further easing refinancing through HARP 2.0, the FHA streamlined refinance, 

and expanding refinance options for homeowners with non-GSE and non FHA loans 

finally ties together a critical patchwork of refinance programs. By working together 

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with Congress, we can ensure that every family can have the opportunity to take 

advantage of today’s historically low interest rates. This will save homeowners thousands of dollars a year, and as a result provide much needed payment relief and 

further strengthen the economy. 

HAMP Changes and Extension 

In February 2009, the Obama administration introduced the Making Home Affordable Program and the Home Affordable Modification Program (HAMP) to stabilize the housing market and to help struggling homeowners get relief and avoid 

foreclosure. 

As I noted at the beginning of my testimony, since that time more than 5.6 million families have received mortgage modifications with affordable monthly payments—which include more than 1.7 million HAMP trial modification starts. HAMP 

is managed primarily by Treasury. 

There is no question that HAMP has had a positive impact on the private market. 

Before President Obama took office, as many of you know, many mortgage modifications actually increased costs for borrowers. HAMP has not only helped keep families in their homes—it’s also helped set a standard for affordability in the private 

market, where families today save an average of $333 per month. 

And we’ve made changes to respond to evolving challenges. For instance, when 

foreclosures began to migrate from the subprime to the prime market because of unemployment, we expanded our focus to offer more help for unemployed homeowners—requiring servicers participating HAMP to give borrowers a minimum of 12 

months to catch up on payments while they are looking for work. 

In addition, last month, the Administration took a series of steps to expand the 

eligibility for HAMP and maximize its impact. 

Expanded Eligibility: To ensure HAMP reaches a broader pool of distressed homeowners, we opened the program up to those who struggle with secondary debt, such 

as second liens, medical bills, and credit cards. 

In particular, the Administration has created a second tier that would provide 

modification relief to borrowers not currently eligible. This tier would include: 

• Mortgages secured by properties that are currently tenant occupied or properties that are vacant but which the borrower certifies intention to rent. 

• Borrowers failing to satisfy the 31 percent debt-to-income (DTI) test, unable to 

achieve the target monthly mortgage payment ratio without excessive forbearance or who have received a negative net present value (NPV) test due to other 

factors. 

These changes will not only not only help homeowners, but also stabilize neighborhoods struggling with foreclosures by helping hundreds of thousands of owners 

who rent their properties avoid foreclosure—in turn, keeping more families in their 

homes. 

Principal Reduction: Still, it’s not enough to lower the barriers to participation in 

HAMP—we also need to increase its impact. HAMP has made a real difference for 

the families who have received a modification—saving an average of more than $500 

per month. But to rebuild the equity these families have lost, lowering payments 

isn’t enough. 

That’s why we are also increasing incentives for cost-effective mortgage modifications that include a write-down of the borrower’s principal balance through HAMP. 

With these changes to the Principal Reduction Alternative (PRA), whereby investors are eligible for financial compensation incentives whenever the servicer provides a borrower with a permanent modification that reduces mortgage principal, 

we are tripling the incentives provided to encourage modifications that rebuild equity. 

Specifically, with respect to loans which were less than or equal to 6 months past 

due at all times during the 12-month period prior to the NPV evaluation date, investors will be entitled to receive, effective in May 2012: 

• $0.63 per dollar of principal reduction equal to or greater than 105 percent and 

less than 115 percent mark-to-market LTV (MTM) ratio; 

• $0.45 per dollar of principal reduction equal to or greater than 115 percent and 

less than or equal to 140 percent MTMLTV ratio; and 

• $0.30 per dollar of principal reduction in excess of 140 percent MTMLTV ratio 

With respect to loans which were more than 6 months past due at any time during the 12-month period prior to the NPV evaluation date, irrespective of MTMLTV 

(mark-to-market loan-to-value) ratio range, investors will be paid $0.18 per dollar 

of principal reduction and will not be eligible for incentives in the above extinguishVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00126 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
123 

ment schedule. These improvements to HAMP augment incentives in a meaningful 

way for investors to allow for a greater degree of principal reduction of loans underlying the securities they own, thus keeping more people in their homes with mortgages they can afford. 

To further increase the amount of principal reduction provided to borrowers, we 

are also working to expand it to those with loans guaranteed by the GSEs. Borrowers with GSE loans have been unable to benefit from the PRA modification due 

to FHFA restrictions on the use of principal reduction in modifications. So homeowners couldn’t benefit solely because they had a GSE loan. In order to ensure consistency throughout the HAMP program, and to ensure that homeowners can be 

considered for rebuilding equity modifications, we have notified FHFA that Treasury 

will pay these incentives to the GSEs if they participate in the program. 

Sunset Extension: Lastly, we have extended HAMP’s sunset deadline. Originally 

slated to sunset at the end of 2012, HAMP has been extended to December 31, 2013, 

which conforms to the recently extended deadline for HARP and provides an expanded window of time for homeowners to gain relief which investors provide while 

preserving their investments. 

Strengthening FHA’s Mutual Mortgage Insurance Fund 

The books of business in the few years before 2009 have largely driven the high 

number of claims to the MMI Fund. This was driven by overall economic and unemployment trends as well as by the combined effects of poor underwriting, unscrupulous and noncompliant practices on the part of lenders, and a seller-funded downpayment assistance program that allowed many borrowers to obtain mortgages that 

they shouldn’t have or without a meaningful down payment. As a result, the books 

of business FHA insured prior to the start of this Administration have severely impacted the health of FHA’s MMI Fund. But thanks to our efforts, I can say confidently that FHA is moving in another direction, and that the long term outlook 

for FHA and the Fund are now much better than they were in 2009. Through systematic tightening of risk controls, increased premiums to stabilize near-term finances and expanded usage of loss mitigation workout assistance to avoid unnecessary claims, the efforts of this Administration have led to the highest quality of 

loans FHA has seen in its history. 

And still, we continue to take steps to further strengthen the Fund. In the 

FY2013 Budget submission we included 10 bps annual premium increase passed 

late last year by Congress on all FHA insured loans mandated by law in December, 

as well as an additional 25 bps annual premium increase on ‘‘jumbo’’ loans making 

the total increase for these larger loans 35 bps. And, just last yesterday, we announced a series of premium changes that will further increase receipts to FHA by 

$1 billion in fiscal years 2012 and 2013, beyond the receipts already included in the 

President’s budget submission. In addition, we have also taken significant additional 

steps to increase accountability for FHA lenders discussed in more detail below. 

Yet, despite the unprecedented efforts of the Administration to alter the trajectory 

of FHA, considerable risks remain. The FHA Mutual Mortgage Insurance (MMI) 

Fund has two components: the Financing Account, which holds enough money to accommodate expected 30-year losses on FHA’s insured portfolio as of the end of the 

current fiscal year; and the Capital Reserve Account, which is required to hold an 

additional amount equal to 2 percent of the insurance in force. Since 2009, the 

Fund’s capital reserve ratio has been below that 2 percent level. 

Annually, the President’s Budget includes estimates regarding the status of the 

capital reserve at the end of the current fiscal year. This prediction is based on estimates and projections of future economic conditions, including house prices and 

other economic factors. The 2013 Budget estimate for the FHA Capital Reserve account in fiscal year 2012 did not include the added revenue from the further increased premiums and the proceeds from the recently announced settlements with 

FHA-approved lenders. With these additional revenues accounted for, the Capital 

Reserve is estimated to have sufficient balances to cover all future projected losses 

without triggering a mandatory appropriation under the Federal Credit Reform Act. 

What’s more, the Budget estimates, FHA will add an additional $8 billion to the 

Capital Reserve Account in 2013, and will return to the congressionally mandated 

capital reserve ratio of 2 percent by 2015. 

As we undertake efforts to strengthen FHA and lay the foundations for the return 

of private capital, it is important to recognize the critical role that FHA has and 

continues to play in times of stress on the housing market. One of the critical purposes of the FHA is to stand as a bulwark of liquidity in a time when capital has 

fled the market, and in such times the FHA will inevitably grow beyond the size 

that we would be comfortable with, taking on more risk that we would normally be 

comfortable with. We are in such a time now. So while we will continue to take the 

124 

steps needed to ensure an FHA that is as strong as we can make it, and we will 

gradually take the steps needed to pull the FHA back from the market to crowd 

in more private capital, we must not forget that it is playing an absolutely critical 

role today, ensuring access to capital in an environment when capital is extremely 

difficult to come by. As we discuss and consider ways to strengthen FHA and to create an environment for the return of private capital, we must be mindful of its continued critical role inherent in its mission—providing home ownership opportunities 

to families that do not have access to traditional financing, and to serve as vital 

source of credit, when the broader market undergoes stress. 

Reducing the Overhang and Shadow Inventory 

At the same time we provide relief to responsible homeowners and keep families 

in their homes, we also need to attack the second barrier to our housing recovery: 

the shadow inventory—the overhang of properties that are at risk of or already in 

foreclosure. 

REO to Rental 

With the rental market recovering faster, we need to think creatively about ways 

we can dispose of this shadow inventory. 

With the purchase market continuing to be dragged down by the glut of vacant 

foreclosed properties and rental rates rising as those who lose their homes to foreclosure seek rental housing, there is an unprecedented imbalance of supply and demand between the purchase and rental markets. 

When there are vacant and foreclosed homes in neighborhoods, it undermines 

home prices and stalls the housing recovery. As part of the Administration’s effort 

to help lay the foundation for a stronger housing recovery, the Department of Treasury and HUD have been working with the FHFA on a strategy to transition REO 

properties into rental housing. Repurposing foreclosed and vacant homes will reduce 

the inventory of unsold homes, help stabilize housing prices, support neighborhoods, 

and provide sustainable rental housing for American families. 

With about a quarter-of-a-million foreclosed properties owned by HUD and the 

GSEs, this August, HUD joined with FHFA and Treasury to issue a ‘‘Request for 

Information’’ to generate new ideas for absorbing excess inventory and stabilizing 

prices. In all, about 4,000 submissions were received. 

Over the past several months, the interagency task force has been reviewing the 

submissions and formulating strategies based on the best practices gathered from 

the RFI. Throughout this process, the task force has continuously met with industry 

members, community groups and other key stakeholders to make sure they are 

heard in the strategy development process. 

We expect a range of strategies to emerge; however the most commonly discussed 

centers around selling REO properties to buyers who will convert and market them 

as rental units. 

Recently, the FHFA, in conjunction with Treasury and HUD, announced that investors may prequalify for the first major pilot sale of foreclosed properties 

repurposed into rental housing. This marks the first of a series of steps that the 

FHFA and the Administration are taking to develop a smart national program to 

help manage REO properties, and ease the pressure of these distressed properties 

on communities and the housing market. 

We plan to learn and leverage all we can from this initial pilot as we work towards conducting a series of additional pilots throughout the rest of the year. 

Project Rebuild 

While expanding REO-to-Rental is a critical tool, in the hardest-hit markets, 

where prices have dropped most and the most vacant and abandoned buildings are 

found, more needs to be done to jumpstart construction and reduce vacancy rates. 

As I mentioned earlier, the Neighborhood Stabilization Program (NSP) has helped 

improved sale prices and vacancy rates in areas with concentrated investments. In 

fact, three-quarters of communities across the country with targeted neighborhood 

stabilization investments have seen vacancy rates go down—and two-thirds have 

seen home prices go up compared to surrounding communities. Further, the $7 billion that has been allocated under the three phases of NSP will support an estimated 88,000 jobs by the time the funding is fully spent. These jobs are created in 

a variety of fields including housing construction, infrastructure construction, maintenance and repair, management, technical consulting services, real estate, State 

and local Government. 

In Hernando County, Florida, our NSP investments have helped families move in 

to once-foreclosed homes in hard-hit places. Just as importantly, they’ve helped keep 

construction workers on the job and given real estate agents the opportunity to 

show and sell homes once again. Indeed, in the La Puente community, a predomiVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00128 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
125 

nately Hispanic suburb outside Los Angeles, these efforts have helped increase 

home prices by nearly 15 percent. 

However, even in these NSP investment clusters, NSP has been able to reach only 

46 percent of the census tracts in the United States that are hardest hit by the foreclosure and unemployment crisis. That is why President Obama has proposed 

Project Rebuild to further stabilize neighborhoods and communities, an initiative 

which would create 200,000 jobs in the places that need them most. 

Nearly two thirds of the $15 billion Project Rebuild funding will be provided to 

States and local governments by formula as specified in the American Jobs Act. The 

remaining third will be allocated by competition—which is open to State and local 

governments, nonprofits, and for profit entities and consortia of these parties. 

Project Rebuild proposes important modifications to the NSP model to extend the 

benefits of the program beyond affordable housing, enabling greater job creation, 

and a broader positive impact on neighborhoods. 

Recognizing that it’s not just abandoned homes that can drag down an entire 

neighborhood, but also vacant commercial properties, Project Rebuild broadens eligible uses to allow commercial projects and other direct job creating activities, capped 

at 30 percent of funds. Up to 10 percent of formula grants may be used for establishing and operating jobs programs to maintain eligible neighborhood properties. 

Formula funding will go directly to States and entitlement communities across the 

country. Competitive funds will be available to States, local governments, for-profit 

entities, nonprofit entities and consortia of these entities. 

Each State will receive a minimum of $20 million of the $10 billion in formula 

funds. Funds will be targeted to areas with home foreclosures, homes in default or 

delinquency, and other factors, such as unemployment, commercial foreclosures, and 

other economic conditions. Project Rebuild also will expand the ability of the private 

sector to participate with localities—ensuring there is the expertise and capacity to 

bring these neighborhoods back in a targeted way. I urge the Committee to join with 

the Administration in working toward the enactment of this proposal. 

Reducing Uncertainty, Improving Access to Credit 

Of course, underlying many of the issues in our housing market is a lack of certainty—of a clear understanding of the rules of the road lenders need to do business 

and our housing market needs to recover. And one way to reduce uncertainty is to 

clear away barriers to recovery—to resolve these matters in a way that holds those 

responsible accountable, but moves us forward by creating conditions more conducive for lending. 

Lender Indemnification 

As part of FHA’s continued efforts to protect and strengthen the MMI Fund, facilitate access to mortgage credit for qualified borrowers and provide clarity to our 

lending partners, last month FHA issued final rule governing the process for receiving and maintaining approval to participate in the Lender Insurance (LI) process. 

These new regulations will provide greater clarity regarding our expectations for our 

LI lending partners, as well as the actions we will take to prevent losses when those 

standards are not met. 

The regulations reiterate FHA’s commitment to ongoing quality assurance reviews 

of lenders with LI authority. In addition, the rule sets a standard for what constitutes a ‘‘serious and material violation’’ of FHA origination requirements. Serious 

and material violations, as well as instances of fraud or misrepresentation, will require indemnification by LI mortgagees. In providing a standard for these violations, 

along with a clear process by which FHA will require indemnifications for loans that 

do not meet these standards, FHA is providing a level of certainty to our partners 

with regard to the types of violations which are actionable under HUD policy. 

It is significant, however, that FHA currently has the ability to exercise this indemnification authority with respect to only one of our two classes of FHA approved 

lenders. FHA Direct Endorsement (DE) Lenders are currently not subject to the 

same regulations with regard to indemnification. In order to protect the MMI Fund 

and ensure the term viability of the FHA, the Administration continues to pursue 

legislation to allow FHA to pursue indemnifications from these DE lenders. 

In addition, we believe it is important for the Federal Housing Finance Agency 

to work with Fannie Mae and Freddie Mac to make clear the rules of the road for 

GSE lenders with straightforward and well defined representations and warranties 

that will further reduce uncertainty around repurchase risk. Equipping banks with 

a better understanding of what mortgages they can be held responsible for can yield 

positive externalities with respect to REO inventory overhang and the damaging impact of foreclosures on house prices. 

126 

Homeowner Bill of Rights 

Consumers need certainty and clarity most of all. The Homeowners Bill of Rights 

recently announced by President Obama would guarantee consumers access to a 

simple mortgage disclosure form, so borrowers understand the loans they are taking 

out; full disclosure of fees and penalties; guidelines to prevent conflicts of interest 

that end up hurting homeowners; support to keep responsible families in their 

homes and out of foreclosure; and, protection for families against inappropriate foreclosure, including right of appeal. 

Tackling All Three Barriers: Mortgage Servicing Settlement 

All three of the barriers I have described—keeping people in their homes, the 

shadow inventory, and uncertainty—are addressed by the historic mortgage servicing settlement the Obama administration and a bipartisan coalition of attorneys 

general from 49 States reached providing at least $25 billion on behalf of American 

homeowners. 

The product of 16 months of intensive negotiations between the five banks and 

an unprecedented coalition of State attorneys general and Federal agencies, including the Departments of Justice, Treasury, and HUD, that spanned partisan lines, 

the settlement helps families keep their homes and reduces the shadow inventory 

by providing relief to homeowners, in part by forcing banks to reduce the principal 

balance on many loans, refinancing loans for ‘‘underwater’’ borrowers. In addition 

the settlement will pay billions of dollars to States to stabilize communities and 

cover the costs associated with the foreclosure crisis and consumers who have been 

foreclosed upon. 

And it reduces uncertainty by providing clear servicing standards going forward 

for these five institutions which currently service over 70 percent of all mortgages— 

standards that can set the stage for servicing standards going forward. 

Background 

In the summer of 2010, HUD initiated a large-scale review of the FHA’s largest 

servicers, devoting thousands of hours to reviewing servicing files for thousands of 

FHA-insured loans. While we began with a focus on failure to engage in loss mitigation, the scope of this review encompassed a long list of mortgage servicing issues, 

such as lost paperwork, long delays and missed deadlines. As HUD’s Office of the 

Inspector General found, the country’s five largest loan servicers routinely signed 

foreclosure related documents without really knowing whether the facts they contained were even correct. 

In effect, many of the very same financial institutions responsible for selling loans 

to people who couldn’t afford them and then packaging those mortgages to make 

profits, effectively fueling the housing crisis, were actually making it worse—harming families, neighborhoods and our economy. 

Following revelations of widespread use of ‘‘robo-signed’’ affidavits in foreclosure 

proceedings across the country, the Federal–State working group launched an investigation into the problem and confronted the 5 largest servicers, representing more 

than 80 percent of the loans serviced, about these problems. These banks soon acknowledged that individuals had been signing thousands of foreclosure affidavits 

without reviewing the validity or accuracy of the sworn statements. Several national 

banks then agreed to stop their foreclosure filings and sales until corrective action 

could be taken. 

Other servicer-related problems were identified as well, including deceptive practices in the offering of loan modifications (for example, telling consumers that a loan 

modification was imminent while simultaneously foreclosing). These performance 

failures resulted in more than just poor customer service. Unnecessary foreclosures 

occurred due to failure to process homeowners’ requests for modified payment plans. 

And where foreclosures should have been concluded, shoddy documentation led to 

protracted delays. This misconduct not only harmed homeowners—but communities, 

our housing market and economy. 

Relief for Homeowners 

The settlement imposes monetary sanctions on the banks while providing immediate and continuing relief to homeowners. The single largest Federal–State civil 

settlement ever agreed to—and the largest financial recovery from the banks during 

this crisis—the accord will enable hundreds of thousands of distressed homeowners 

to stay in their homes through enhanced loan modifications. It will also fund payments to victims of unfair foreclosure practices and provide support for housing 

counseling and State-level foreclosure prevention programs. 

One of the most important features of the settlement is the $17 billion in consumer relief options that will offer homeowners a variety of home retention and 

127 

home disposition alternatives. Because the banks will receive credit for employing 

these options at specified credit rates (e.g., a deficiency waiver carries a 10 percent 

credit, so for every dollar supplied by the bank, it would only count 10 cents), this 

$17 billion has the potential to provide as much as $32 billion in relief. 

Much of this relief will come in the form of principal reduction for distressed 

homeowners. Enabling these families to restructure their debt and start building equity again not only improves their prospects—but also those of their neighbors who 

have watched property values plummet by $5,000–10,000 simply because there are 

foreclosures on their block. 

In addition, it provides: 

• $3 billion for refinances for current homeowners who, because their home values are underwater, would not be able to refinance their mortgages into lower 

interest rate loans. 

• Approximately $2.6 billion to States which can choose to apply funds to repay 

public funds lost as a result of servicer misconduct, fund housing counselors, 

legal aid, and other similar purposes determined by State attorneys generals. 

• A $1.5 billion Borrower Payment Fund for borrowers who were foreclosed upon 

on or after January 1, 2008. Banks must notify those borrowers of their right 

to file a claim. Payout is anticipated to be approximately $2,000 per person, depending upon levels of claim and whether they meet some relatively basic criteria. Borrowers receiving claims will not have to waive any legal rights or 

claims against the banks, and can seek additional relief. 

With specific regard to the Borrower Payment Fund, as I noted earlier, when 

HUD initiated a large-scale review of the FHA’s largest servicers in the summer of 

2010, we found that families who should not have gotten into trouble—and who 

should have been able to get some help early on that was both good for them and 

good for the lender—didn’t get that help—help that in many cases banks were legally obligated to provide. 

These $2,000 payments will be made to families who suffered from these kinds 

of errors—where borrowers were charged fees that they shouldn’t have been or had 

dropped calls or lost paperwork when they sought help with their mortgages. 

For families who suffered much deeper harm—who may have been improperly 

foreclosed on and lost their homes and could therefore be owed hundreds of thousands of dollars in damages—the settlement preserves their ability to get justice in 

two key ways: 

First, if a borrower can document that they were improperly foreclosed on, they 

can receive every cent of the compensation they are entitled to through a process 

established by Federal banking regulators. The agreement also preserves the right 

of homeowners to take their servicer to court. Indeed, if banks or other financial 

institutions broke the law or treated the families they served unfairly, they should 

pay the price—and with this settlement they will. 

I would note that these funds are paid entirely by the banks. The taxpayer doesn’t 

pay a dime. 

And homeowners aren’t the only ones who will see the benefits of this settlement. 

So, too, will the taxpayer who has paid a steep price for financial institutions’ failure to follow the law when it came to families who had FHA-insured loans. In addition to the steps I mentioned earlier that FHA is taking to protect its MMI fund, 

approximately $900 million from this settlement will help shore up the FHA’s finances, preserving this critical resource for the future and protecting taxpayers’ investment. 

Residential Mortgage Backed Security Group 

While this historic settlement will offer significant help to those who suffered the 

most harm and provide a path toward stability for our housing market and our 

broader economy, it isn’t designed to address all the issues of the housing crisis. 

While it resolves certain violations of civil law based on the banks’ mortgage loan 

servicing activities, the United States and the State attorneys general preserved the 

right to pursue claims in a number of important areas, including criminal authorities, securities claims, and loan origination claims. 

Indeed, in some ways, just as important as what this settlement accomplishes is 

what it does not do. It will not prevent State attorneys general or regulators from 

pursuing criminal cases or conducting investigations that get to the bottom of the 

crisis. Last month, Attorney General Holder and I joined New York Attorney General Schneiderman and several other State attorneys general in announcing a working group comprised of representatives from DOJ, HUD, SEC, and the State AGs 

focused on investigating the conduct of financial servicers that broke the law and 

128 

contributed to the crash of the housing market, including securities- and origination-related cases. 

New Customer Service Standards 

That’s why this agreement forces the banks that service nearly 2 out of every 3 

mortgages to take action to address the problems uncovered during our investigations. 

In particular, these standards prohibit robo-signing, improper documentation and 

lost paperwork; clarify what servicers have to do on foreclosures and modifications, 

including requiring strict oversight of foreclosure processing, including of third-party 

vendors; make foreclosures a last resort by requiring servicers to evaluate homeowners for other loan mitigation options first; restrict banks from foreclosing while 

the homeowner is being considered for a loan modification; and establish procedures 

and timelines for reviewing loan modification applications, and give homeowners the 

right to appeal denials. Having to satisfy these requirements, banks are also more 

certain of the costs associated with them. 

These standards will set the stage for clear, national servicing rules for all 

servicers which the new Consumer Financial Protection Bureau, under the leadership of Director Richard Cordray, and along with an interagency team comprised 

of independent regulators as well as Treasury and HUD, are working to craft These 

national standards are an aggressive and critical first step in a broader Administration effort to provide a single, straightforward set of commonsense rules that are 

in keeping with Homeowner Bill of Rights that families can count on when they’re 

buying a home and paying their mortgage. The standards in this settlement will 

serve as benchmark for the development of these uniform rules, giving people the 

confidence that lenders and servicers are following a long list of rights should they 

ever lose a job or have a medical emergency that puts their home at risk. 

Lastly, the settlement’s release of limited origination claims with both Bank of 

America and Citibank which, coupled with the Lender Insurance indemnification 

rule discussed earlier, provides clarity for lenders on when the FHA will take action, 

reducing concerns over lawsuits and additional reputational risk. In the same way, 

clarifying representations and warranties at the GSE level will help to achieve a 

well-defined and well understood buyback policy that fosters a degree of uniformity 

and certainty across the Government-backed space. 

An Economy Built to Last 

And so, Mr. Chairman, as you can see, we have made very important, significant 

progress in recent months to get our housing market back on track—helping tens 

of thousands of additional families refinance, putting in place the most significant 

principal reduction effort in history and establishing critical consumer protections 

that hold powerful institutions accountable for their actions, help our housing market recover and give every homeowner the dignity, respect and fair treatment they 

deserve. 

But for all this progress, we can’t declare victory and go home. We still need Congress to act to ensure that every responsible family in America, regardless of who 

services their loan, has the opportunity to refinance. 

We still need to continue our work together to create a robust private system of 

housing finance and protect the FHA fund for the future. 

And we still need a balanced national housing policy that ensures Americans have 

access to credit for those in a position for sustainable home ownership, assistance 

for those who feel the strain of high housing costs, rental options near good schools 

and good jobs, and above all—choices in housing that make sense for them and for 

their families. 

That is the goal of all this work—and it is fundamental to creating an economy 

built to last. And I look forward to working with Congress to make it possible. 

Thank you. 

PREPARED STATEMENT OF ELIZABETH A. DUKE 

GOVERNOR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 28, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for inviting me to talk about the current situation in housing markets. 

The Federal Reserve has a keen interest in the state of housing and has been actively engaged in analyzing issues in the housing and mortgage markets. Issues related to the housing market and housing finance are important factors in the Federal Reserve’s various roles in formulating monetary policy, regulating banks, and 

129 

protecting consumers of financial services. In particular, the failure of the housing 

market to respond to lower interest rates as vigorously as it has in the past indicates that factors other than financial conditions may be restraining improvement 

in mortgage credit and housing market conditions and thus impeding the economic 

recovery. Federal Reserve staff have been actively working to understand the reasons behind the impairment in housing and mortgage markets and the tradeoffs involved in designing policies that would remove obstacles to normal market functioning. 

On January 4, 2012, the Federal Reserve released a staff paper titled ‘‘The U.S. 

Housing Market: Current Conditions and Policy Considerations’’, which is attached 

at the end of my written statement. The paper provides information on current conditions in the housing market and analytic background on some housing market 

issues. Although the paper does not include recommendations for any specific policy 

actions, it does lay out a framework for discussion by outlining some options and 

tradeoffs for policy makers to consider. My testimony today will be drawn from this 

paper. 

Six years after aggregate house prices first began to decline, and more than 2 

years after the start of the economic recovery, the housing market remains a significant drag on the U.S. economy. In a typical economic cycle, as the economy turns 

down households postpone purchases of durable goods such as housing. Once the 

cycle bottoms out, improving economic prospects and diminishing uncertainty usually help unleash this pent-up demand. This upward demand pressure is often augmented by lower interest rates, to which housing demand is typically quite responsive. 

The current economic recovery has not followed this script, in part because the 

problems in the housing market are a cause of the downturn as well as a consequence of it. The extraordinary fall in national house prices has resulted in $7 

trillion in lost home equity, more than half the amount that prevailed in early 2006. 

This substantial blow to household wealth has significantly weakened household 

spending and consumer confidence. Another result of the fall in house prices is that 

around 12 million households are now underwater on their mortgages—that is, they 

owe more on their mortgages than their homes are worth. Without equity in their 

homes, many households who have experienced hardships, such as unemployment 

or unexpected illness, have been unable to resolve mortgage payment problems 

through refinancing their mortgages or selling their homes. The resulting mortgage 

delinquencies have ended in all too many cases in foreclosure, dislocation, and personal adversity. Neighborhoods and communities have also suffered profoundly from 

the onslaught of foreclosures, as the neglect and deterioration that may accompany 

vacant properties makes neighborhoods less desirable places to live and may put 

further downward pressure on house prices. 

An ongoing imbalance between supply and demand exacerbates these problems in 

the housing market. For the past few years, the actual and potential supply of single-family homes for purchase has greatly exceeded the effective demand, in part 

because of the large number of homes that have come back onto the market after 

moving through the foreclosure process. The elevated pace of foreclosures, unfortunately, is likely to be sustained for quite a while and therefore will continue to put 

downward pressure on home prices. 

At the same time, a host of factors have been weighing on housing demand. Many 

households have been reluctant or unable to purchase homes because of concerns 

about their income, employment prospects, and the future path of home prices. 

Tight mortgage credit conditions have also prevented many households from purchasing homes. Although some retrenchment in lending standards was necessary 

and appropriate given the lax standards that prevailed before the crisis, current 

lending practices appear to be limiting or preventing lending even to creditworthy 

households. 

In the paper, we discussed the benefits and costs of a variety of policy options 

that have been proposed to respond to these difficult housing issues, including increasing credit availability for households seeking to purchase a home or to refinance an existing mortgage; exploring the scope for further mortgage modifications, 

including encouraging short sales and deeds-in-lieu of foreclosure in cases where 

foreclosure cannot be avoided; and expanding the options available for holders of 

foreclosed properties to dispose of their inventory responsibly. Any policy proposals, 

though, will require wrestling with difficult choices and tradeoffs, as initiatives to 

benefit the housing market will likely involve shifting some of the burden of adjustment from some parties to others. 

I greatly appreciate the leadership that the Senate Banking Committee has 

shown on the profound challenges facing the housing market. For its part, the Federal Reserve will continue to use its policy tools to support the economic recovery 

130 

and carry out its dual mandate to foster maximum employment in the context of 

price stability. In its supervisory capacity, the Federal Reserve will continue to encourage lenders to find ways to maintain prudent lending standards while serving 

creditworthy borrowers. 

Thank you again for inviting me to appear before you today. I would be happy 

to answer any questions you may have. 

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22812001.eps

January 4, 2012 

The U.S. Housing Ma rket: Current Conditions and Polic)' Considerations 

The ongoing problems in the U.S. housing market continue to impede the economic recovery. 

House prices have fallen an average of about 33 percent from their 2006 peak, resulting in about 

$7 trillion in household wealth losses and an associated ratcheting down of aggregate 

consumption. At the same time, an unprecedented number of households have lost, or are on the 

verge of losing, their homes. The e",1raordinary problems plaguing the housing mmket refl ect in 

part the effect of weak demand due to high unemployment and heightened uncertainty. But the 

problems also reflect three key forces originating from within the housing market itself: a 

persistent excess supply of vacant homes on the market, many of which stem from foreclosures; 

a marked and potentially long-tenn downshift in the suppl y of mortgage credit; and the costs that 

an often tmwieldy and inefficient foreclosure process imposes on homeowners, lenders, and 

commtmities. 

Looking forward, continued weakness in the housing market poses a significant barrier to a more 

vigorous economic recovery. Of course, some of the weakness is related to poor labor market 

conditions, which will take time to be resolved. At the same time, there is scope for 

policymakers to take action along three dimensions that could ease some of the pressures 

amicting the housing market. In particular, policies could be considered that would help 

moderate the inflow of properties into the large inventory of unsold homes, remove some of the 

obstacles preventing creditworthy borrowers from accessing mortgage credit, and limit the 

number of homeowners who find themselves pushed into an inefficient and overburdened 

foreclosure pipeline. Some steps already being taken or proposed in these areas will be 

discussed below. 

Taking these issues in tum, the large inventory of foreclosed or surrendered properties is 

contributing to excess supply in the for-sale market, placing downward pressure on house prices 

and exacerbating the loss in aggregate housing wealth. At the same time, rental markets are 

strengthening in some areas of the country, refl ecting in part a decline in the homeownership 

rate. Reducing some of the barriers to collverting foreclosed properties to rental units will help 

redeploy the existing stock of houses in a more effi cient way. Such conversions might also 

increase lenders' eventual recoveries on fore closed and surrendered properties. 

Obstacles limiting access to mortgage credit even among creditworthy borrowers contribute to 

weakness in housing demand, and barriers to refinancing blunt the transmission of monetary 

policy to the household sector. Further attention to easing some of these obstacles could 

contribute to the gradual recovery in housing markets and thus help speed the overall economic 

recovery. 
132 


22812002.eps

- 2-

Finally, foreclosures inflict economic damage beyond the personal suffering and dislocation thai 

accompany them. l In particular, foreclosures can be a costl y and inefficient way to resolve the 

inability ofhollseholds to meet their mortgage payment obligations because they can result in 

"deadwe ight losses," or costs that do not benefit anyone, including the neglect and deterioration 

of properties that often sit vacant for months (or even years) and the associated negative effects 

on neighborhoods.2 These deadweight losses compound the losses that households and creditors 

already bear and can result in further downward pressure on house prices. Some of these 

foreclosures can be avoided if lenders purSLIe appropriate loan modifications aggressively and if 

servicers are provided greater incentives to pursue alternatives to foreclosure . And in cases 

where modifi cations cannot create a credible and sustainable resolution to a delinquent 

mortgage, more-expedient exits from homeownership, such as deeds-in-lieu of foreclosure or 

short sales, can help reduce transaction costs and minimize negative effects on communities. 

Intertwined in these issues is the unresolved role of the government-sponsored enterprises 

(GSEs) Fannie ivlae and Freddi e Mac, in both the near teml and long ternl. 3 TIle GSEs hold or 

guarantee significant shares of delinquent mortgages and foreclosed properties. Because of their 

outsized market presence, the GSEs' actions affect not only their own portfolios, but also the 

housing market overall. However, since September 2008, the GSEs have operated in 

conservatorship under the direction of the Federal Housing Finance Agency (FHFA), with 

specific mandates to minimize losses for taxpayers and to support a stable and liquid mortgage 

market. In many of the policy areas discussed in this paper--such as loan modifications, 

mortgage refinancing. and the disposition of foreclosed properties--there is bound to be some 

tension between minimizing the GSEs' near-temllosses and risk exposure and taking actions 

that might promote a faster recovery in the housing market. Nonethel ess, some actions that 

cause greater losses to be sustained by the GSEs in the near tenn might be in the interest of 

taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery. 

1 This paper does not address the imJX>rtant issues surrounding whether lenders arxl servicers have appropriately 

carried out their roles in foreclosures. In April 2011 , the Federal Reserve, along with the other federa l banking 

agencies, announced formal enforcement actions requiring many large banking organizations to address a pattern of 

misconduct and negligence related to deficient practices in residential mortgage loan sen' icing and foreclosure 

processing. These deficiencies represented significant and pelVasive compliance failures and unsafe and unsound 

practices at these institutions. For further information, see Board of Governors of the Federal Resen'e System 

(2011), "Federal ReselVe Issues Enforcement Actions Related to Deficient Practices in Residential Mortgage Loan 

SelVicing arxl Foreclosure Processing," press release, April 13, 

www.federalreselVe.govlnewseventsipresslenforcementl2011 0413a.htrn, and Board of Governors of the Federal 

ReselVe System (2011), "Federal ReselVe Board Announces a Fonnal Enforcement Action against the Goldman 

Sachs Group, Inc., and Goldman Sachs Bank USA," press release, September I, 

www.federalreselVe.gov/newseventslpresslenforcementl2011090lb.htrn . 

2 See, for example, John Y. CampbelL Stefano S. Giglio, and Parag P. Pathak (2011), "Forced Sales and House 

Prices," American EconomicReview, vol. 101 (August), pp. 2108- 31, 

www.aeaweb.orgiatypon.php?retum_to=/doilpdfpluslIO. 1257iaer.lOI .5.2108; and Dan Immergluck and Geoff G. 

Smith (2006), ihe External Costs of Foreclosure: The Impact of Single-Family Mortgage Foreclosures on 

Property Values," Housing Policy Debate, vol. 17 (I), pp. 57- 80 (Washington: Fannie Mae Foundation), 

http://content.knowledgeplex.orgikp2lcache/documentsfI860/186040.pdf. 

J This paper does not discuss alternatives for longer-term restructuring of the housing finance market, including the 

future form or role of the GSEs. 
133 


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22812004.eps

- 4 -

Fig. 2: Ratio of Home Equity to Disposable Personal 

Income Percent 

Quarterly 

2011 

Q3 

1950 1960 1970 1980 1990 2000 2010 

Source: Flow- of Funds Accoonts of the United States. 

140 

120 

100 

80 

60 

40 

ll1is substantial blow to household wealth has significantly weakened household spending and 

consumer confidence. Middle-income households, as a group, have been particularly hard hit 

because home equity is a larger share of their wealth in the aggregate than it is for low-income 

households (who are less likely to be homeowners) or upper-income households (who own other 

[omIs of wealth such as financial assets and businesses). According to data from the Federal 

Reserve's Survey of Consumer Finances, the decline in average home equity for middle-income 

homeowners from 2007 through 2009 was about 66 percent of the average income in 2007 for 

these homeowners. In contrast, the decline in average home equity for the highest-income 

homeowners was only about 36 percent of average income for these homeowners.s 

For many homeowners, the steep drop in house prices was Illore than enough to push their 

mortgages underwater--that is, to reduce the values of their homes below their mortgage balances 

(a situation also referred to as negative equity). This situation is widespread anlong borrowers 

who purchased homes in the years leading up to the house price peak, as well as those who 

e).1racted equity through cash-out refinancing. Currently, about 12 million homeowners are 

underwater on their mortgages (figure 3)--more than one out of fi ve homes with a lllortgage. 6 In 

states experiencing the largest overall house price declines--such as Nevada, Arizona, and 

Florida--roughly half of all mortgage borrowers are underwater on their loans. 

j Middle-income households are defined as those in the 40'" through 60th percentiles of the household income 

distribution. High-income households are defined as those with income exceeding the 901h percentile of the 

household income distribution. In 2007, the 40

1h percentile was around $40,000; the f:lJlh percentile was around 

$65,000; and the 9(/' percentile was around $1 50,000. 

6 This calculation does not account fully for second liens. The share of underwater 'oorrowers would likely be a bit 

higher if we had complete coverage of these liens. These estimates are derived from CoreLogic and LPS Applied 

Analytics data 
135 


22812005.eps

- 5 -

Fig. 3: Mortgages with Negative Equity 

Millions of loans 

Quarterly 

2005 

FHANA 

Nonprime 

Prime 

2006 2007 2008 2009 2010 

Note: Nega~ve equity number likely understated because of 

incomplete data on junior liens. Nonprime category includes all-A and 

subprime loans. 

2011 

16 

l ' 

12 

10 

8 

6 

, 

2 

o 

Negative equity is a problem because it constrains a homeowner's ability to remedy fitliUlCial 

difficulties. When house pri ces were rising, borrowers facing payment diffic ulties could avoid 

default by selling their homes or refinancing into new mortgages. However, when house prices 

started falling and net equity started turning negative, many borrowers lost the ability to 

refinance their mortgages or sell their homes. Nonprime mortgages were most sensitive to house 

price declines, as many of these mortgages required linle or no down payment and hence 

provided a limited buffer against falling house prices. But as house price declines deepened, 

even many prime borrowers who had made sizable down payments fell undenvater, limiting their 

ability to absorb financial shocks such as job loss or reduced income. 1 

The resulting surge of delinquencies (figure 4) has oven"helmed the housing finance system. 

Iortgage servicers were unprepared for the large number of delinquent borrowers and fail ed to 

invest the resources necessary to handle them properly, resulting in severely flawed and, in some 

cases, negligent servicing practices. Exacerbating the problem, some of the incentives built into 

servicing contracts encouraged foreclosures rather than loan modificati ons. 

7 For more discussion, see Cluistopher lvIayer, Karen Pence, and Shane M. SherlWld (2009), "The Rise in Mortgage 

Defaults," JOllrnal o/Economic Perspecm·es, vol. 23 (Winter), pp. 27-50, 

www.aeaweb.crglatypottphp?retUITl_to=/doilpdfpluslIO. 125 7/jep.21 1.27 . 
136 


22812006.eps

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138 


22812008.eps

- 8 -

in the past 2 years than it was 10 years earlier. 12 The same data show that the drop-off was more 

pronounced among individuals with less-than-excellent credit scores, even in parts of the country 

where unemployment rales are better than the national average.!3 These data suggest a large 

decline in mortgage borrowing by potential first-time homebuyers due to not only weaker 

housing demand, but also the effect of tighter credit conditions on all but the highest-creditquality borrowers. 

At the same time, a host of factors have been weighing 011 housing demand. High 

unemployment and weak income growth have made it difficult for many households to purchase 

homes despite the large declines in house prices and mortgage rates. Uncertainty about the 

future prospects for the economy and labor market has aJso likely made some households 

reluctant to buy homes. TIle combination of weak demand to purchase homes and the restricted 

supply of mortgages has put considerable downward pressure on house prices in many areas. 

Addressing Foreclosed Properties: REO to Rental 

Background 

At the same time that housing demand has weakened, the number of homes for sale is elevated 

relative to historical norms, due in large part to the swoll en inventory of homes held by banks, 

guarantors, and servicers after completion offorecl osure proceedings. These properties are often 

called real estate owned, or REO, properties. While the total stock of REO properties is difficult 

to measure precisely, perhaps one-fourth of the 2 million vacant homes for sale in the second 

quarter of 2011 were REO properties. The combination of weak demand and elevated suppl y 

has put substantial downward pressure on house prices, and the continued flow of new REO 

properties-·perhaps as high as 1 million properties per year in 2012 and 2013--will continue to 

weigh on house prices for some time.!4 To the e>..1ent that REO holders discount properties in 

order to sell them quickly, the near-tenn pressure on home prices might be even greater. 

In contrast to the market for owner-occupied houses, the market for rental housing across the 

nation has recently strengthened somewhat. Rents have turned up in the past year (figure 6), and 

the national vacancy rate on multifamily rental properties has dropped noticeabl y from its peak 

in late 2009. These developments have been fairly widespread across metropolitan areas. The 

relative strength of the rental market refl ects increased demand as famili es who are unable or 

unwilling to purchase homes are renting properties instead. Rental demand has also been 

I! In particular, 17 percent of individuals in this age group acquired a mortgage for the first time between mid-l999 

and mid-200!, while only 9 percent did so between mid-2009 and mid·2011. These figures were calculated using 

data from the FRBNYlEquifa" Consumer Credit Panel. l' For example, among individuals with credit scores between 620 and 740 and who lived in counties with 

unemployment rates less than 9 percent in 2010, the share obtaining first·time mortgages was 23 percent from 1999 

through 2001 and only 14 percent from 2009 through 2011 . In contrast, individuals with credit scores above 740 in 

the same counties experienced a decline of just 2 percentage points (26 percent to 24 percent). These figures were 

calculated using data from the FRBNY lEquifax Consumer Credit Panel. 

14 The timing of future REO flows is difficult to forecast because the foreclosure process has slowed considerably in 

many states since the October 2010 revelations of significant deficiencies in foreclosure processes at many sclVicers. 

Foreclosures in states with judicial foreclosure processes have been particularly affected. 
139 


22812009.eps

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140 


22812010.eps

- 10-

Characteristics of REO Properties 

Fann ie Mae, Freddie Mac, and the FHA together hold abollt half orthe outstanding REO 

inventory and so might be able to aggregate enough properties to facilitate a cost-effective rental 

program in many rental markets. As of early November 2011, about 60 metropolitan areas each 

had at least 250 REO properties currcntl1s for sale by the GSEs and FHA--a scale that could be 

large enough to realize efficiency gains. 8 Atl anta has the largest number of REO properties for 

sale by these institutions with abollt 5,000 units. The next-largest inventories are in the 

metropolitan areas of Chicago; Detroit; Phoenix; Riverside, California; and Los Angeles, each of 

which have between 2,000 and 3,000 lUlits. 

Other financial instituti ons also hold or control substantial inventories of REO properties. More 

than one-fourth of REO properties are held by non-agency securitized pools, which are 

controlled by mortgage servicers under the tenm of pooling and servicing agreements. Because 

these properties are more likely to have been financed by subprime and alt-A loans, they are 

concentrated in somewhat different metropolitan areas than the inventory held by the GSEs and 

FHA. About 50 metropolitan areas appear to have at least 250 REO properties held by 

securitized pools, with the largest inventories in Miami; Los Angeles; Riverside, California; 

Chicago; and Las Vegas. 19 The remaining REO inventory--a bit less than one-fourth--is held by 

commercial banks and thrifts. Roughly 50 metropolitan areas each have at least 250 properties 

held by these instituti ons, and the geographic distribution of these properties is similar to that of 

the inventory held by the GSEs.

20 

Not all of these REO properties are good candidates for rental properties, even in geographic 

markets with suffi cient scale. As discussed in more detail later, some properties are badly 

damaged, in low-demand locations, or otherwise low value. Nonetheless, according to Federal 

Reserve staff calculations, many REO properties appear to be viable rental properties in terms of 

both physical adequacy and potential anractiveness to tenants. For example, most REO 

properties are in neighborhoods with median house values and incomes that are roughly similar 

to the medians for the metropolitan area overal1. 21 Similarly, the vast majority of REO properties 

are in neighborhoods with an average commute time that is similar to the average for the entire 

metropolitan area, suggesting that the properties are not located unusually far from employment 

centers.

22 

of REO properties in securitized pools may be, or may feel, restrained from renting properties by provisions in the 

~ling and servicing agreements. 

8 Federal Reserve staff calculations from data on the Department of Housing and Urban Development's Real-Estate 

O\\71ed Properties Portal, available at www.huduser.orgfreolreo,html. Recently, only around half of the properties in 

the REO inventories of the GSEs have been offered for sale at any given point. The other properties are leased to 

existing tenants under the provisions of the Protecting Tenants at Foreclosure Act, are located in states with a 

redemption period after foreclosure, or are under renovation or otherwise unavailable for sale. 

19 Federal Reserve staff calculation based on data from CoreLogic 

20 Federal Reserve staff calculation based on data provided by McDash Analytics, LLC, a wholly owned subsidiary 

of Lender Processing Services, Inc 

21 About three-fourths of REO properties are in neighborhoods where the median house values and incomes are 

greater than 80 percent of the medians for the metropolitan area. 

2! Data on median house values, income, and commute times are from the 2()X) Census. 
141 


22812011.eps

- \ \-

Many REO properties also appear to be viable rental properties in tcnm of improving loss 

recoveries to the REO property holder. One method of gauging the profit ability of renting a 

particular property is to calculate its cap itaJization rate, or cap ralc--the expected annual cash 

flows from renting the property relative to the ~ri ce at which the REO property holder could 

expect to sell it in the owner-occupied market. 3 Preliminary estimates suggest that about twofi~hs ?fFannic. Mae 's REO in e~tory ll id have a cap rate above 8 percen.t--sufficiently hi~ 

to mdlcate rentmg the property l1ught dehver a bener loss recovery tlum selhng the property.-

Estimated cap rates on the FHA's REO inventory are a bit higbcr--abollt half orthe current 

inventory has a cap rate above 8 percent--because FHA properties tend to have somewhat lower 

values relative to area rents. These cap rate calculations are illustrative examples subject to a 

number of assumptions, and do not control fo r the fact that holding on to properties and renting 

them may ent ail more risk than selling into the owner-occupied market. In particular, the REO 

holder receives cash in the event of a sale, but earns a potentially higher but more uncertain 

return from renting a property. 

Finally, the number of properties currently in Ihe foreclosure process is more than fOllf times 

larger than the number of properti es in REO inventory. TIle geographic distribution of these 

"pipeline" properties is similar to that of REO properties, although states that are experiencing 

significant foreclosure delays tend to have larger backlogs. 25 If recent trends continue, the share 

of REO inventory held by the GSEs and FHA should increase. 

REO to Rental Program Design 

The data cited earlier suggest that a goverrunent-fa cilitated REO-Io-rental program has the 

potential to help the housing market and improve loss recoveri es on REO portfolios. The FHFA 

released a request fo r infonnation on August to, 201 1, to collect infornlation from market 

participants on possible ways to accomplish this obj ective and received more than 4,000 

responses. An interagency group in which the Federal Reserve is participating is considering 

iss ues related to the design of a program that would facilitate REO-to-rental conversions. As no 

such progranl currently exists, predicting its success or effi cacy is difficult. Ongoing 

experimentation and analysis will be a cmcial component of developing such a program. 

II For further discussion of cap rates in the real estate context more generally, see Board of Governors of the Federal 

Reserve System, Division of Banking Supervision and Regulation (2009), "Interagency Policy Statement on Prudent 

Commercial Real Estate Loan Workouts," Supervision and Regulation Letter, SR 09-07 (o:tober 30), p. 31 , 

www.federalreserve.govlboarddocslsrlettersl'2009/sr0907a l.pdf. 

:!-I The return from renting is the annual gross rental income less leasing costs, maintenance expenses, property taxes, 

management fees, and foregone rent when the property is vacant. This estimate assumes leasing costs are equal to 

one month's re ~ management fees are 8 percent of monthly ren~ maintenance expenses are 2 percent of the 

property's market value, and the property is vacant for one month per year. Data on rents are from Zillow and the 

2010 American Community Survey, and data on property taxes are from the 2007-09 American Community Survey. 

The cap rate estimates are based on FalUlie Mae's and the FHA's REO portfolios as of midsummer 2011. 

2J Of course, it is possible that properties will transition from foreclosure to REO at a faster rate in some locations 

than others, for irntance due to state foreclosure laws, so the flow of incoming REO could be distributed somewhat 

differently than the current stock. 
142 


22812012.eps

- 12-

A govemment-facilitated REO-to-rental program could take many [onllS. The REO holder could 

rent the properties directly, sell the properties to a third-party investor who would rent the 

properties, or enter into a joint venture with such an investor. In making this decision, 

policymakers should consider what program design will provide for the best loss recoveries and 

the best outcomes for communities. 

To date, REO holders have avoided selling properties in bulk to third-party investors because the 

recoveries that REO holders receive on such sales are generally lower than the corresponding 

recoveries on sales to owner occupants. Investors considering such bulk-sale transactions tend to 

demand a higher risk premiulJl than owner occupants and thus will purchase only at lower prices. 

Investors in such transactions also mi ght have more difficulty obtaining debt financing than 

owner occupants. Although mortgage products are available for individual one-to four-fami ly 

houses and for multifamily properties (albeit currently at tight tenus), no mortgage products 

currently exist for a portfolio of single-family homes.26 In addition, REO holders must absorb 

the costs of assembling inventory for bulk sale--that is, holding properties off the market until 

enough properties have been assembled to cover the fixed costs of a rental program. Until the 

inventory is assembled, the REO ho lder receives no revenue from the property but incurs direct 

financing costs; carrying costs such as taxes, utilities, and maintenance expenses; and the 

continued depreciation of the property. 

An REO-to-rental program that relies on sales to third-party investors will be more viable if this 

cost-pricing differential can be narrowed. REO holders will likely get better pricing on these 

sales if the program is designed to be attractive to a wide variety of investors. Se lling to 

third-party investors via competitive auction processes may also improve the loss recoveries. 

Providing investors with debt financing will likely also affect the prices they offer on bulk pools 

of REO properties. As noted, such financing is largely unavailable now, thus limiting the 

number of potential investors. In the current tight mortgage lending environment, private lenders 

may not have the capacity to flUld a large-scale rental program, and it may be appropriate for 

REO holders to fill the gap. However, whether such funding should be subsidized is an 

important question. Subsidized financing provided by the REO holder may increase the sales 

price of properties, but at the cost of reducing the REO holder's future income stream. If so, the 

costs of such financing need to be accounted for in the rental program. 

In addition, a program thaI minimizes Ihe mnount of time that a vacant property lingers in REO 

inventory before being renled would reduce disposition costs to the REO holder. 111ese costs 

might be reduced by including properties that are already rented, such as properties rented under 

the provisions of the Protecting Tenants at Foreclosure Act. 27 Another possibility is to auction to 

26 lt is unclear whether these mortgages have not existed because of a historical lack of demand (that is, under earlier 

housing market conditions, investors did not find operating large-scale rental programs of single-family homes 

attractive) or because lenders perceived such loans as not worth the risk. 

27 The Protecting Tenants at Foreclosure Act of 2009 protects tenants from immediate eviction by persons or entities 

that become owners of residential property though the foreclosure process. Title VII of the Helping Families Save 

Their Homes Act of2009. Public Law 111-22, effective May 20, 2009 (www.gpo.gov/fdsyslpkgiPLAWIII publ22/pdf/PLA W-IllpubI22.pdf). 
143 


22812013.eps

- 13-

investors the rights to acquire, in a given neighborhood, a future stream of properties that meet 

certain standards instead of auctioning the rights to current REO holdings. A th ird possibility is 

to encourage deed-for-lease programs, which circumvent the REO process entirely by combining 

a deed-in-lieu of foreclosure--wbereby the borrower fetUntS the property to the lender--with a 

rent-back arrangement in which the borrower remains in the home and pays market rent to the 

lender. 

If, after addressing these obstacles, selling to third-pru1y investors still provides lower loss 

recoveries than selling to owner occupants, policymakers might want to consider the merits of 

allowing or facilitating the rental of properties by REO holders themselves. Altematively, 

policymakers may judge that the broader positive effects on the economy from redirecting 

properties to the rental market justify a moderate decline in loss recoveries. Finally, even if the 

cost differential is large at this point, the calculation may change if the foreclosure process 

accelerates in some states and REO holders experience signifi cant increases in their inventories. 

An REO-to-rental program should also consider the effects that poorly managed or maintained 

properties have on communiti es and, in particular, ensure that communities are not damaged by 

rental practices. For example, investors might be allowed to bid on properties only after 

demonstrating some experience with property management and commitment to rehabilitation of 

properties. Experienced nonprofit organizations with established ties to the community could 

also playa natural role as rental managers. In the case of for-profit companies or joint ventures, 

im'estors might be given an incentive to provide appropriate property management by defelTing 

some of their compensation. Investors might receive some proportion of their payment onl y 

after several years of renting properties in a manner consistent with "good landlord" practices 

and compliance with pertinent landlord-tenant and fair-housing requirements. 

A final consideration is the length of time REO properti es are rented before they are placed on 

the for-sale market. Given the depressed state of the housing market, properties may remain 

rental properties for an e~1ended period. Rent-to-own provisions, which would give existing 

tenants the option to purchase their properties during their tenancies, mi ght facilitate the 

transition of some renters back to the owner-occupied market. Such provisions may also reduce 

costs by encouraging renters to maintain their properties to a greater extent. 

The Role of Banks 

1lle GSEs, of course, do not hold all of the residential REO exposure. As of September 2011 , 

U.S. commercial banks had $10 billion in residential REO properties on their balance sheets, 

while savings and loans had an additional $1.4 billion. 28 Generally, banking organizations are 

not pennitted to engage in real estate ownership or property management, and supervisory policy 

typicaJly encourages banking organizations to dispose of REO property as early as practicable. 

However, CUITC1lt law clearly contemplates some scope for REO ownership to last beyond the 

fastest-possible disposition. In particular, federal laws dealing with bank holding compani es and 

28 ln aggregate, the serviced-for-others REO portfolios managed by banking organiwtions are significantly larger 

than their owned portfolios. These statistics are for the owned portfolios in depository institutions, as disclosed in 

bank and thrift regulatory reports 
144 


22812014.eps

- \4-

national banks and state laws dealing with state-chru1ered banks typically allow banking 

institutions to hold REO properties for a time (such as up to fi ve years), and often include a 

possibility of cl\1ending the pennissib le holding period, if approved by the appropriate regulator. 

During this holding period, banking organizations are pennitted to rent the REO properties on 

their balance sheets, as well as manage the properties directly or through a third-party vendor, 

and take steps necessary to keep lip the properties' condition and value. Regulators generally 

expect thaI such rentals would be done with the goal of improving the ultimate recovery to the 

banking organizations. Regulators also expect that banking organizations engaged in rental of 

REO properties demonstrate ongoing good faith efforts to sell the properties within the statutory 

and regulatory time periods and as appropriate under prevailing market conditions. 

In light of the current unusually difficult circumstances in many housing markets across the 

nation, the Federal Reserve is contemplating issuing guidance to banking organizations and 

examiners to clarify super.'isory expectations regarding rental of residential REO properties by 

such organizations while such circumstances continue (and within relevant federal and statutory 

and regulatory limits). If finalized and adopted, such guidance would explain how rental of a 

residential REO property within applicable holding-period time limits could meet the 

supervisory expectation for ongoing good faith efforts to sell that property. Relatedly, if a 

sllccessful model is developed for the GSEs to transition REO properties to the rental market, 

banks may wish to participate in such a program or adopt some of its features. 

Land Banks: An Option/or Low-Value Properties 

Some REO properties are low value and less likely to be viabl e for an REO-to-rental program. 

About 5 percent of properties in the REO inventory of the GSEs and FHA are appraised at less 

than $20,000. In some markets, the share is significantly higher; for example, in Detroit and 

Cleveland, more than half of the REO inventory of these institutions is appraised below this 

value. In these markets, low-value properties are less suitable for disposition through sales in the 

owner-occupied market or through rental market strategies, iUld alternative disposition strategies 

may be needed. 

Currently, a small number of these properties are disposed of through land banks, which are 

typicaJl y public or nonprofit entities created to manage properties that are not dealt with 

adequately through the private market. Land banks are government entities that have the ability 

to purchase and sell real estate, clear titles, and accept donated properties. Properties may be 

rehabilitated as rental or owner-occupied housing, or demolished, as market conditions dictate. 

While the number of land banks has increased significantly over the past few years, capacity 

nationwide remains quite limited, in tenns of both institutional infrastructure and funding. Only 

a handful of states have passed legislation to establish land banks, and, as a result, many areas 

lack land banks altogether. Only about half of the GSE and FHA inventory oflow-value REO 

properties (properties with a value of $10,000 or less) is in metropolitan areas with an existing 

land brulk. In addition, the land banks that have been created have only limited resources--the 

largest lruld brulk can handle about 100 properties per month, but most handle just a few each 

month. This capacity pales in comparison with the number oflow-vaJue REO properties in 

current inventory. One potential strategy would be to consider increasing funding (at the federal, 
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state, or local level) and teclmical assistance to hmd banks in existence, encourage the creation of 

more land banks on the local or regional level, or create a national land bank program, in order to 

scale up capacity to match current low-value inventories. Such initiatives would need 

appropriate controls to promote value to the communities affected and maximize efficiency 

whenever possible. 

Credit Access and Pricing 

As noted earlier, mortgage credit conditions have tightened dramatically from their pre-recession 

levels. Lax mortgage lending standards in the years before the hOllse pri ce peak contributed to 

problems in the housing market, so some tightening rdative to pre-crisis practices was necessary 

and appropriate. The important question is whether the degree of tightness evident today 

accurately refl ects sustainable lending and appropriate consumer protection. 

Financial regulators have been in consultation with the GSEs and originators about the sources of 

the apparent tightness in lending standards. Continued efforts are needed to find an appropriate 

balance between prudent lending and appropri ate consumer protection, on the one hand, and not 

unduly restricting mortgage credit, on the other hand. In particular, poli cymakers should 

recognize that steps that promote healthier housing and mortgage markets are good for safety and 

soundness as well. 

Addressing Homeowners at Risk of Default or Foreclosure 

Obstacles to Refinancing 

Many homeowners have been unable to take advantage of historically low mortgage rates 

because of low or negative home equity, slightly blemished credit, or tighter credit standards. 

Perhaps only about half of homeowners who could profitably refin ance have the equity and 

creditworthiness needed to qualify for traditional refinancing. 

In response to some of these obstacles, the FHFA introduced the Home Affordable Refinance 

Program (HARP) in 2009. HARP allows qualifying borrowers who are current on their 

payments, and whose mortgages are owned or guaranteed by Fannie Mae or Freddie Mac, to 

refinance even if they have insufficient equity to qualify for a traditional refinance. 29 

Participation in the program to date has been re latively modest, with only about 925,000 

mortgages refinanced through HARP. 3o 

19 A tmditional GSE refinance requires a loan-to-value (LTV) mtio of 80 percent or less unless the mortgage is 

enhanced with mortgage insurance provided by a third party. Initially, HARP allowed refinances of qualifying loans 

with L TVs up to 125 percent. To have qualified, loans must have been originated before tviay 3 I, 2009, and have 

been current with certain restrictions on late payments over the preceding year. 

JO Data from the FHF A's quarterly Foreclosure Prevention & Refinance Report. See Fedeml Housing Finance 

Agency (2011), "Foreclosure Prevention & Refinance Report: Third Quarter 201 1," report (Washington: FHFA, 

October), www.fhfa.govlwebfilesl22827I3Q2011ForePrevFulIReponI2611 .pdf. 
146 


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TIle low participation rate has been attributed, in part, to lender worries about aSE putback risks. 

When a lender refinances a loan originated by a competitor, the new lender in effect takes on 

some of the original lender's putback risk. Because lenders are reluctant to take on this added 

risk. they tend to refinance onl y their own loans and do not aggressively market the program to 

borrowers. 

GSE fees known as loan-level pricing adjustments (LLPAs) are another possible reason for low 

rates of refi nancing. Under !lomlal circumstances, LLP As are lIsed to provide hi gher 

compensation to the aSEs fo r the risk that they tmdertake when new loans are e.\1ended to 

borrowers with high loan-la-value (LTV) ratios or low credit scores. In a HARP refi nancing. 

however, the GSEs already carry the credit risk on the original mortgage, and refinancing to a 

lower rate could even lower the credit risk of some such loans; thus, it is difficult to justify 

imposing a higher LLPA when refinancing in this circumstance. 

To reduce these and other obstacles to refinancing, the FHF A announced changes to HARP in 

October 20 11 .

31 LLPAs for HARP loans were eliminated for borrowers shortening the ternt of 

their loans to 20 years or less and reduced for longer-ternt loans, certain representation and 

warranty requirements were wai ved, loans with LTVs greater than 125 percent were made 

eligible for the program, the appraisal process was largely automated, servicers were given 

greater fl exibility to notify borrowers of their eligibility for refinancing through HARP, and 

private mortgage insurers agreed to facilitate the transfer of mortgage insurimce. Some estimates 

suggest that another million or so homeowners could refinance their mortgages with these 

changes in effect. 

Nonetheless, more might be done--for example, reducing even further or perhaps eliminating 

remaining LLPAs for HARP refinances (again, on the rationale that the GSEs already carry the 

credit risk on such loans); more comprehensively reducing putback risk; or fu rther streamlining 

the refinancing process for borrowers with LTVs below 80 percent, a potentially large group of 

borrowers who face some (though not all) of the same obstacles confronting high-LTV 

borrowers. Fannie Mae has reduced putback risk for all loans (including those below 80 percent 

LTV as well as those above 80 percent LTV), while Freddie Mac has reduced putback risk for 

loans above 80 percent LTV but not those below 80 percent LTV. Hamlonizing traditional 

refinancing programs for borrowers with LTVs less than 80 percent, so that these programs 

become operationally consistent with HARP, could facilitate more refinancing among this group 

of borrowers. 

An important group of borrowers who are not able to take advantage of the HARP program is 

homeowners with high LTVs but whose mortgages are not guaranteed by the GSEs. For the 

most part, these borrowers are not able to refinance through any public or private program. One 

possible policy option might be to expand HARP--or introduce a new program--to allow the 

GSEs to refinance non-GSE, non-FHA loans that would be otherwise HARP eligible. Unlike 

HARP refinances, however, these refinances would introduce new credit risk to the GSEs 

Jl Federal Housing Financing Agency (2011), "Fannie Mae and Freddie Mac Armounce HARP Changes to Reach 

More Borrowers," press release, October 24, www.fhfa.gov/webfilesl2272IIHARPJelease_I02411]inal.pdf. 
147 


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because the GSEs do not currently guarantee the loans, even ifthe loans were offered only to 

borrowers who are current on their payments and would meet underwriting standards (for 

example, debt-to-income ratio and credit score), if not for their high loan-Io-value ratios. 

Perhaps I million to 2· 1/2 million borrowers meet the standards to refinance through HARP 

except for the fact that their mortgages are not GSE_guarantecd. 32 

To be sure, this change would introduce a host of risk-management issues, and the GSEs would 

likely require new underwriting and fe es for insuring these loans. Moreover, legislative changes 

to aSE governing statutes would likely be needed because the GSEs are prohibited from 

purchasing or guaranteeing mortgages with LTV ratios exceeding 80 percent unless the 

mortgages have credit enhancement such as mortgage insurance. This policy, because it requires 

a potentially large expansion of the GSE balance sheet, would also have to be balanced against 

the other policy goals of winding down the GSEs over time and returning pri vate capital to the 

mortgage market. 

The structure orthe HARP program highlights the tension between minimizing the GSEs' 

exposure to potential losses and stabilizing the housing market. Although the GSEs would take 

on added credit risk from expanding HARP to non-GSE loans, the broader benefits from an 

expanded program might offset some of these costs. In particular, some homeowners who are 

unable to refinance because of negative equity, slightly blemished credit, or tighter underwriting 

standards could reduce their monthly payments significantly, potentiall y reducing pressures on 

the housing market. A stronger housing market would in tum likely imply an earlier stabilization 

of house prices and reduced rates of mortgage delinquency, helping both borrowers and lenders. 

Neighborhoods would benefit from reduced rates offoreclosure and fewer vacant homes, while 

localities would experience gains, or less pronounced reductions, in property tax receipts. The 

reduction in aggregate mortgage payments could also provide some boost to consumer spending, 

although the net effect would likely be relatively small, in part because the gains to homeowners 

may be partially offset by corresponding reductions in the incomes of investors in mortgagebacked securities. 

However, many GSE and non-GSE mortgages are not eli gible fo r traditional or HARP 

refinancing because they are already delinquent or have been sufficiently delinquent in the past. 

1l1ese mortgages might be best addressed through loan modification programs--the topic of the 

ne.\1 section. 

Loan Modifications and the HAMP Program 

Loan modifications help homeowners stay in their homes, avoiding the personal and economic 

costs associated with foreclosures. dif in g an existing mortgage--by e.\1ending the tenn, 

reducing the interest rate, or reducing principal--can be a mechanism for distributing some of a 

homeowner's loss (for example, from falling house prices or reduced income) to lenders, 

guarantors, investors, and, in some cases, taxpayers. Nonetheless, because foreclosures are so 

n Federal Reserve stalT calculation based on data from CoreLogic and from McDash Analytics, LLC, a wholly 

owned subsidiary of Lender Processing Services, Inc 
148 


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costly, some loan modifications can benefit all parties concemed, even if the borrower is making 

reduced payments. 

About 880,000 penllanent modifi cations have been made through the vo luntary Home 

Affordable odificati n Program (HAMP), which is part of the Making Home Affordable 

UvIHA) program. HAMP pays incentives to lenders, serviccrs, and borrowers to facilitate 

modifications. Among its key program tenns, HAMP reduces monthl y payments for qualifying 

borrowers to 31 percent of income. For borrowers who have received HAM P modifications, the 

help is often substantial. For example, the median monthly payment after a pemlanent I-lAMP 

modification is about $831, compared with about $1,423 before the modification.

33 Millions of 

additional mortgages have been modified by lenders, guarantors, and the FHA. 

As is the case with all loan modifications, some mortgages that have been modified under 

HAMP have ended up defaulting after modification. For example, among HAMP modifi cations 

made pemlanent in the first quarter of201O, 16 percent of mortgages were more than 90 days 

late a year after modifi cation, and 22 percent were 90 days late after 18 months.

34 These redefault rates are lower than those fo r nOIl-HAMP modifications, according to Office of the 

Comptroller of the Currency (OCC) statistics. 35 Such defaults after modification highlight the 

difficulty that some homeowners have had in sustaining even substantially reduced mortgage 

payments over time. In some cases, this difficulty likely owes to the burden from other 

expenses, such as medical or elder care, or other debt, such as a second mortgage or consumer 

debt, which may make a 31-percent-of-income first mortgage payment unaffordable. 

On the other hand, the 31 percent payment-to-income target has also precluded the participation 

of borrowers who might benefit from a modification even though their first-lien pa)ment is 

already less than 31 percent of income. One potential method of expanding the reach ofHAMP 

that may be worth exploring would involve allowing payments to be reduced below 31 percent 

of income in certain cases. TIlis exploration might consider incorporating all of a borrower's 

mortgage payments on a property in the debt-to-income cal culation, instead of just the first lien. 

Altematively, taking the entirety of a borrower's balance sheet into account or making 

33 Data from the October 2011 Making Home Affordable program servicer performance report. See u.s 

Department of the Treasury (2011), October 201 I Making Home Affordable Report and Sen-icer Assessments for 

Third Qllarter 201 I, report (Washington: U.S. Department of the Treasury, December), available at 

www. treasury .gov/initiativesffinancial-stability/resultslMHA-ReportslPagesidefault.aspx. 

34 More recent modifications may have different default experiences due to different economic conditions during the 

life of the loan 

3S For example, according to the OCC Mortgage Metrics Report for the third quarter of2011 (table 32), some 17 

percent ofHAMP pennanent modifications finalized in the second quarterof20iO at a sele<:t group of national 

banks and thrifts had fallen 60 days delinquent within 12 months of the modification. In contrast, for this same 

group of financia l instiwtiol'lS. some 31 percent of non-HAM!' modifications made permanent in the second quarter 

of2010 had become 60 or more days delinquent within the same interval. The lower rate of delinquency for HAMP 

permanent modifications has likely been influenced by differences in documentation standards, magnitudes of 

payment reduction, and requirements for a trial period. For the OCC report, see U.S. Department of the Treasury. 

Office of the Comptroller of the Currency (2011 ), oce Mortgage Metrics Report. ThirdQllarler 2011 

(Washington: Department of the Treasury. December). www.occ.treas.gov/publicationsfpublications-by-type/otherpublications-reportslmortgage-metrics-20 111mortgage-metrics-q3-20 II.pdf. 
149 


22812019.eps

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Broadly speaking, HAMP emphasizes modifications in which the net present value to the lender 

orthe modification exceeds the net present value ofpuI'Suing a foreclosure. It should be 

recognized that other types of loan modifications may be socially beneficial, even ifnot in the 

best interest or the lender, because orthe costs that foreclosures place on communities, the 

housing market, and the broader economy. However, although policymakers might very well 

decide thaI the social costs··while obviously difficult to gauge··are great enough to justify 

additional loan modifications, lenders are unlikely to be willing to make such modifications on 

their own. Moving further in this direction is thus likely to involve additional taxpayer funding, 

the overriding of private contract rights, or both, which raises difficult public policy issues and 

tradeoffs. 

Loan Modifications with Principal Reduction 

Reducing monthly payments to a sustainabl e level for distressed borrowers who are significantly 

under.vater on their mortgages may require principal reductions--that is, reductions in their 

mortgage balances--in addition to interest rate concessions and tenn e).1ensions. Consequently, 

HAMP allows principal reduction to be used as part of its standard protocol when interest rate 

reduction and tenn e).1cnsion are not sufficient to reduce a borrower's debt-to-income ratio to 31 

percent. hl addition, the HAMP program introduced the Principal Reduction Alternative (PRA), 

which allows the servicer to use principal reduction as the first step in modifying the loan. In 

both cases, HAMP uses principal reduction primarily as a means to improve the affordability of a 

borrower's mortgage, though with the concomitant benefit of reducing negative equity.36 The 

Hardest Hit Fund has also funded principal reduction programs at the state level. 

Negative equity is a probl em, above and beyond affordability issues, because it constrains the 

ability of borrowers to refinance their mortgages or sell their homes if they do not have the 

means or will ingness to bring potentially substantial personal funds to the transaction. An 

inability to refinance, as discussed previously, blocks underwater borrowers from being able to 

take advantage orthe large decline in interest rates over the past years. An inability to sell could 

force underwater borrowers into defauh if their mortgage payments become unsustainable, and 

may hinder movement to pursue opportunities in other cities. 

Principal reduction has been proposed and debated as one possibl e policy response to negative 

equity, including fo r borrowers current on their mortgage payments. Principal reduction has the 

potential to decrease the probability of default (and thus the deadweight costs offoreclosure) and 

to improve migration between labor markets. Principal reduction may reduce the incidence of 

default both by improving a household 's financial position, and thus increasing its resilience to 

economic shocks, and by reducing the incentive to engage in "strategic" default (that is, to 

default solely based on the household's underwater position rather than on the afTordability of 

the payments). 

J6 Reflecting the preference for capitalization and interest rate reduction that is built into the HAMP "waterfall," 

98 percent of HM1P modifications reduced the interest rate and 31 percent reduced principal. Since its inception in 

October 2010, the PRA program has modified 32,000 loans. 
151 


22812021.eps

- 21 -

ll1ese potential benefits, however, are hard to quantify. Based on the evidence to date, the effect 

of negati ve equity on migration between labor markets appears to be fairly small.37 TIle effect of 

reducing negative equity on default is hard to estimate because borrowers with high LTV ratios 

tend to have other characteristics correlated with default.

38 For example, high·LTV homeowners 

often made small initial down payments··pcrhaps due to a lack of financial resources··and tend 

to live in areas with greater declines in house prices, where unemployment and other economi c 

conditions also tend to be relatively worse. Hence, principal reduction is likely to lower 

delinquency rates by less than the simple correlation between LTV and default rates would 

suggest. Further research or policy experiments in this area would be usefuL 

At the same time, the costs of large-scale principal reduction would be quite substantial. 

Currently, 12 million mortgages are underwater, with aggregate negative equity of $700 billion. 

Of these mortgages, about 8.6 million, representing roughly $425 billion in negative equity, are 

current on their payments.39 These costs might be reduced if it was possible to target borrowers 

who are likely to default without a principal reduction. However, identifying such borrowers 

among the many who are current on their payments is diffi cult. lvloreover, targeting principal 

reduction efforts on those most likely to default raises fairness issues to the e).1ent that it 

discriminates against those who were more conservative in their borrowing for home purchases 

or those who rent instead of own. Depending on the requirements for relief, such a program may 

also give some borrowers who otherwise would not have defaulted an incentive to do so. 

An alternative to large-scale principal reduction for addressing the barriers that negative equity 

poses for mortgage refinancing and home sales could involve aggressively facilitating 

refinancing for underwater borrowers who are current on their loans, expanding loan 

modifications for borrowers who are stmggling with their payments, and providing a streamlined 

exit from homeownership for borrowers who want to sell their homes, such as an expanded deedin-lieu-of-foreclosure progrrun (described later). This approach focuses on reducing payments 

rather than reducing principal per se, and could be more effective at keeping committed 

borrowers in their homes if affordability is the prime consideration driving default. 

Alternatives to Foreclosure 

Despite the potential for loan modifications and targeted forbearance programs to prevent 

unnecessary foreclosures, many borrowers will not be able to keep their homes. In these cases, 

the most efficient solution may be to find an alternative to foreclosure such as a short sale or a 

deed-in-lieu-of-foreclosure (OIL). In a short sale, the home is sold to a third-party buyer 

offering less than the amount owed by the homeowner. In a OIL, there is no sale, but the 

31 See Raven Molloy, Christopher Smith, and Abigail Wozniak (2011 ), "Internal Migration in the United States," 

Joumal ojEconomic Perspectives, vol. 25 (Summer), pp. 173-%, 

www.aeaweb.crglarticles.php?doi=10.1257/jep.25.3. 173 

:IS See Neil Bhutta, Jane Dokko, and Hui Shan (2010), 'The Depth of Negative Equity and Mortgage Default 

Decisions:" Finance and Economics Discussion Series 2010-35 (Washington: Board of Governors of the Federal 

Reserve System, June), www.federalreserve.gov/pubslfedsl2010l20 1 035120 1 035pap. pdf. 

J9 About 660,000 mortgages are 30 days past due, 310,000 are 60 days past due, 1 million are 90 days or more past 

due, and 1.4 million are in forec losure. 
152 


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property is transferred directly to the lender or guarantor, rather than going through the fonnal 

foreclosure process. Both options are within the bounds of mortgage contracts and avoid some 

orthe economic damage potentially caused by the foreclosure process. Short sales can be 

anracti ve because the property is transferred to a (presumably sustainable) new owner, keeping 

the property Ollt of REO and reducing potential negative effects on communiti es from vacant 

properties. OIls can also be helpful because they can sometimes be easier to execute than a 

short sale and because they can fit into an REO·to-rental program to prevent a discounted sale 

that would otherwise occur. Both options may be particularly attractive to borrowers if lenders 

partially or fully waive borrower liability for deficiency balances. The MHA's Home Affordab le 

Foreclosure Altematives program provides incentive payments to facilitate both short sales and 

DILs. 

Both short sales and OILs, however, face barriers in current markets. Short sales require a 

willing buyer, a price that is acceptable to all parti es, and a time line that allows the transaction to 

close before foreclosure (which is likely proceeding on a parallel path). OIls may not be 

actively pursued because of infonnational or logistical obstacles. Further, short sales and OIls 

often present additional obstacles to lenders, such as the disposition of second liens, the cost and 

uncertainty of loss recovery via mortgage insurance or deficiency judgmcnts, and (in the case of 

OIls) accumulating additional REO properties. For their part, borrowers may not know about 

OIls or short sales as an altemative to foreclosure and, in some cases, may see little reason to 

engage in a short sale or OIL rather than stay in their homes throughout the often drawn-out 

foreclosure process. Given the scope of the economic losses associated with forecl osure, 

figuring out ways to surnlount these obstacles is cmcial. 

Mortgage Servicing: Improving Accountability and Aligning Incenth'es 

Mortgage servicers interact directly with borrowers and play an important role in the resolution 

of delinquent loans. TItey are the gatekeepers to loan modifi cations and other foreclosure 

altematives and thus play a central role in how transactions are resolved, how losses are 

ultimately allocated, and whether deadweight losses are incurred. 

TIllis far in the foreclosure crisis, the mortgage servicing industry has demonstrated that it had 

not prepared for large numbers of delinquent loans. They lacked th e systems and staffing needed 

to modify loans, engaged in unsound practices, and significantly failed to comply with 

regulations. One reason is that servicers had developed systems designed to efficiently process 

large munbers of routine payments from perfonning loans. Servicers did not build systems, 

however, that would prove sufficient to handle large numbers of delinquent borrowers, work that 

requires servicers to conduct labor-intensive, non-routine activities. As these systems became 

more strained, servicers exhibited severe backlogs and internal control fa ilures, and, in some 

cases, violated consumers' rights. A 2010 interagency investigation of the foreclosure processes 

at servicers, coll ectively accounting for more than two-thirds of the nation's servicing activit y, 

uncovered critical weaknesses at all institutions examined, resulting in unsafe and unsound 
153 


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practices and violations of federal and state iaws. 40 Treasury has conducted compliance reviews 

since the inception of HAMP, and, beginning in June 2011 , it released servicer compliance 

reports on major HAMP servicers. These reports have shown significant fa ilures to comply with 

the requirements of the MHA program.41 In several cases, Treasury has withheld MHA 

incentive payments until better compliance is demonstrated. 

ll1ese practices have persisted for many reasons, but we focus here on four factors that, if 

addressed, might contribute 10 a morc functional servicing system in the future. First, data are 

not readily a,'uiiable for investors, regulators, homeowners, or others to assess a servicer's 

perfomlallce. Second, even despite this limitation, if investors or regulators were able to 

deteffiline that a servicer is perfoffiling poorly, transferring loans to another servicer is difficult. 

111ird, the traditional servicing compensation stmcture can result in servlcers having an incentive 

to prioritize foreclosures over loan modifications.42 Fourth, the existing systems for registering 

liens are not as centralized or as efficient as they could be. 

The lack of consistent metrics for assessing the quality of practices across servicers is a 

signifi cant probl em. Helpful metrics might include measures of borrowers' ability to contact 

representatives through call centers, results from third-party satisfaction surveys, or measures of 

investors' abilities to get data on loss-mitigation activities. Treasury has taken steps toward 

addressing this lack of consistent metrics in its monthly MHA reports, which include data on 

error rates, complaint response quality, and conversion rates (from trial to pennanent 

modifi cations). lllese data could help infonn the development of appropriate metrics for the 

industry. 

11le infonnation provided by the metrics could be even more helpful if combined with lower 

costs when transferring servicing rights to a competing servicer. In a well-functioning servicing 

market, lower quality servicers would quickly lose business to competitors who are better able to 

reduce losses to investors, deliver a high quality of interaction with homeowners, and comply 

with regulations. However, because servicing systems are not interoperable or designed to easily 

import or export new records, transferring servicing responsibilities from one servicer to another 

is expensive, time consmning, and prone to error. 

A third potential area for improvement in mortgage servicing is in the stmcture of compensation. 

Servicers usually cam income through three sources: "float" income earned on cash held 

temporarily before being remitted to others, such as borrowers' payments toward taxes and 

hazard insurance; ancillary fees such as late charges; and an annual servicing fee that is built into 

40 See Federal Reserve System, Office of the Comptroller of the Currency, and Office ofThrift Supervision (2011 ), 

Interagency RfNiew of Foreclosure Policies and Practices, report (Washington: Board of Governors of the Federal 

Reserve System, April), 

www.federalreserve.govtboarddocslrptcongresslinteragency_review _foreclosures _2011 04 I lpdf. 

41 The latest quarterly servicer assessment reports (through Cktober) can be fOlmd in the Treasury's October 2011 

Making Home Affordable Report (see note 33). 

41 See Larry Cordell, Karen Dynan, Andreas Lehnert, Nellie Liang, and Eileen Mauskopf (2008), uThe Incentives of 

Mortgage Servicers: Myths and Realities;' Finance and Economics Discussion Series 2008-46 (Washington: Board 

of Governors of the Federal Reserve System, November), 

www.federalreserve.gov/pubslfedsl200812008461revisionlindex.html. 
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homeowners' monthly payments. For prime fi xed-rate mortgages, the servicing fee is usually 

25 basis points a year; for subprime or adjustable-rate mortgages, the fee is somewhat higher. 

From an accounting and risk-management perspective, the expected present value of this future 

income stream is treated as an asset by the servicer and accounted fo r accordingly. 

The value or the servicing fee is important because it is expected to cover a variety of costs that 

are irregular and widely varying. On a perfonlling loan, costs to servicers are small··especially 

for large servicers with highly automated systems. For these loans, 25 basis points and other 

revenue exceed the cost incurred. But for Ilonperfonn ing loans, the costs associated with 

collections, advancing principal and interest to investors, loss mitigation, foreclosure, and the 

maintenance and disposition of REO properti es might be substantial and unpredictable and might 

easily exceed the servicing fee. 

TIle standard servicing compensation model assumes that the revenue streams are more than 

enough in low-default environments, allowing servicers to cross-subsidize for high-default 

scenarios. But most servicers do not appear to have invested in enough infrastmcture, or 

reserved suffic ient capital, for high-stress conditions. Thus, tbey were ill equipped to deal witb 

the magnitude of the ongoing foreclosure wave. Also, the fee stmcture of the servicing industry 

helped create perverse incentives fo r servicers to, for example, reduce the costs associated with 

working out repayments and moving qui ckly to foreclosure, even when a loml modification 

might have been in the best interest of the homeowner mId investor. 

Possible changes to the compensation model might include aligning servicing fees more closely 

witb expenses, such as smaller mlll ual servicing fees for perfomling loans but higher 

compensation for servi cing delinquent loans, with fees tied directly to expenses incurred and 

with incentives for loan perfomlance. 43 A small part of the current servicing business, including 

niche institutions known as "special servicers," already operates under such a payment regime. 

In addition, servicers' contractual requirement to continue advancing payments of principal and 

interest to investors, even when a loan is delinquent, strengthens servicers' incentives to move 

quickly to foreclosure. One possibility might be to advance mortgage principal mId interest only 

60 days beyond the first missed payment. This cbange would affect payment streams to 

investors modestly, and the market could adjust pricing accordingly, but it could also help align 

the int erests of servicers, borrowers, mId investors in reaching final resolution of delinquent 

mortgages. 

A final potential area for improvement in mortgage servicing would involve creating ruI online 

registry of liens. Among other problems, the current system for lien registration in many 

jurisdictions is antiquated, largely manual, and not reliably available in cross-jurisdictional form. 

Jurisdictions do not record liens in a consistent maimer, and moreover, not aU lien holders are 

required to register their liens. This lack of organization has made it difficult for regulators and 

policymakers to assess and address the issues raised by junior lien holders when a senior 

mortgage is being considered fo r modification. Requiring all holders of loans backed by 

43 The FHF A has proposed and sought comment on alternative servicer compensation structures. See Federal 

Housing Finance Agency (201 1), "Alternative Mortgage Servicing Compensation Discussion Paper," white paper 

(Washington: mFA, September), www.fhfa.gov/webfiles/22663/ServicingCompDiscussionThperFinal092711.pdf 
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- 25-

residential real estate to register with a national lien registry would mitigate this infoffilation gap 

and would all ow regulators, poJicymakers, and market participants 10 construct a more 

comprehensive picture of housing debt. 

TIle national lien registry could also record the name of the servicer. Currently, parties with a 

legitimate interest in contacting the servicer have little to go all from the land records because, 

among other reasons, many liens have been recorded only in the nrune of the trustee or of 

Mortgage Electronic Registration Systems (MERS).44 Registering the servicer, and updating the 

infoffilation when servicing is transferred, could help local govenUllcnts and nonprofits, for 

example, who might be working to resolve the status of vacant or abandoned properties. 

Implementing a modernized registry could build on systems that have been put in place locally in 

some jurisdictions and could be designed to retain a role for state and local governments as the 

default collectors of infonnation, as long as the infonnation is coll ected in an efficient and 

consistent malUler.45 

Conclusion 

TIle challenges faced by the U.S. housing market today reflect, in part, major changes taking 

place in housing finance ; a persistent excess supply of homes on the market; and losses arising 

from an often costly and inefficient foreclosure process (and from problems in the current 

servicing model more generally). The significant tightening in household access to mortgage 

credit likely reflects not only a correction of the unsolmd underwriting practices that emerged 

over the past decade, but also a more substantial shift in lenders' and the GSEs' willingness to 

bear risk. Indeed, if the currently prevail ing standards had been in place during the past few 

decades, a larger portion of the nation's housing stock probably would have been designed and 

built for rental, rather than owner occupancy. TIlliS, the challenge for policymakers is to find 

ways to help reconcile the existing size and mi x of the housing stock and the current 

environment for housing finance. Fundamentally, such measures involve adapting the existing 

housing stock to the prevailing tight mortgage lending conditions--for example, devising policies 

that could help facilitate the conversion of for eclosed properties to rental properties--or 

supporting a housing finance regime that is less restrictive than today's, while steering clear of 

the lax standards that emerged during the last decade. Absent any policies to help bridge this 

gap, the adjustment process will take longer and incur more deadweight losses, pushing house 

prices lower and thereby prolonging the downward pressure on the wealth of current 

homeowners and the resultant drag on the economy at large. 

In addition, reduc ing the deadweight losses from foreclosures, which compound the losses that 

households and creditors already bear and result in further downward pressure on house prices, 

would provide further support to the housing market as well as provide assistance to stmggling 

homeowners. Policymakers might consider minimizing unnecessary foreclosures through the 

.j.I MERS provides services related to tracking and registering residential mortgage ownership and servicing, acts as 

mortgagee of record on behalf of lenders and servicers, and initiates foreclosure actions. The April 2011 

enforcement action included an action against MERS (see note I) 

4j Although most of the information that would be registered is already in the public record, safeguards would be 

needed to protect privacy. 
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use of a broad menu of types of loan modifications, thereby allowing a better tailoring of 

modifications to the needs of individual borrowers; and servicers should have appropriate 

incentives to pursue alternatives to foreclosure. Policymakers also may want to consider 

supporting policies that facilitate deeds-in-lieu of foreclosure or short sales in order to reduce the 

costs associated with foreclosures and minimize the negative effects Oil communities. 

Restoring the health of the housing market is a necessary part of a broader strategy for economic 

recovery. As this paper suggests, however, there is unfortunately no single solution for the 

problems the housing market faces. Instead, progress will come only through persistent and 

careFul efforts to address a range of diffi cult and interdependent issues. 
157 

PREPARED STATEMENT OF EDWARD J. DEMARCO 

ACTING DIRECTOR, FEDERAL HOUSING FINANCE AGENCY

FEBRUARY 28, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, I 

am pleased to be invited here today to discuss the actions the Federal Housing Finance Agency (FHFA) has taken or will take in our role as Conservator for Fannie 

Mae and Freddie Mac (the Enterprises) to aid recovery of the U.S. housing market. 

In my testimony, I will respond to the Committee’s request for a description of 

FHFA’s work as Conservator of the Enterprises to address barriers to housing recovery, including our leadership role in preventing foreclosures through loss mitigation, 

facilitating refinancing at today’s low interest rates, and initiating a real estate 

owned (REO) program to address the supply of foreclosed homes. 

Current Activities 

Let me start by describing some of the key activities that FHFA and the Enterprises have undertaken to address problems in the mortgage market. In contrast to 

how they are sometimes portrayed, the Enterprises are playing a leading role in 

providing assistance to homeowners and seeking to avoid foreclosures. As I have 

stated before, these activities are based on FHFA’s statutory responsibilities as Conservator, and the Enterprises’ historic statutory missions. 

Enterprise Loss Mitigation Activities 

The Enterprises have been leading the effort on foreclosure prevention since they 

entered conservatorship. On a nationwide basis, Fannie Mae and Freddie Mac own 

or guarantee 60 percent of the mortgages outstanding, but they account for a much 

lower proportion, 29 percent of seriously delinquent loans. These are loans that have 

been delinquent for 3 or more months or are in the process of foreclosure. However, 

the housing crisis is concentrated in a handful of States. Ten States account for approximately half of loans serviced and 60 percent of the country’s seriously delinquent loans. Similar to the nationwide proportions, the Enterprises hold approximately 59 percent of the loans in those States but account for 29 percent of seriously 

delinquent loans in those States. As such, while the Enterprises are taking a leadership role in solving the crisis, similar actions from the holders of the other 70 percent of seriously delinquent loans are crucial to a successful outcome. 

Even though the Enterprises have a smaller share of seriously delinquent loans 

than other market participants, they account for about half of all Home Affordable 

Modification Program (HAMP) permanent modifications. Similarly, data from the 

Office of the Comptroller of the Currency (OCC) show that in the 2 years ending 

in the third quarter of 2011, modifications on Fannie Mae and Freddie Mac loans 

accounted for 40 percent of all loan modifications. Between HAMP modifications and 

their own proprietary loan modifications, Fannie Mae and Freddie Mac have completed over one million loan modifications since the fourth quarter of 2008. These 

modifications typically lowered borrowers’ payments by substantial amounts and 

have yielded positive results. 

The performance of Enterprise modified loans has improved relative to Enterprise 

loan modifications from before HAMP was fully implemented, and it is better relative to contemporaneous modifications on Federal Housing Administration (FHA) 

or Veterans’ Administration (VA) loans and loans held by private investors. For Enterprise loans modified throughout 2010, fewer than 20 percent of the loans had 

missed two or more payments after 9 months. Comparable redefault rates are down 

from the 40 percent range for their loans modified in 2008 and most of 2009. 

Some observers have cited declines in the number of loan modifications completed 

by Fannie Mae and Freddie Mac over the past year or so as evidence of a lack of 

support for foreclosure prevention. In fact, this trend is applicable to all investors 

in mortgages as illustrated by the OCC’s report. The quarterly number of loan modifications peaked in the second and third quarters of 2010 for all investors in mortgages (i.e., the GSEs, FHA, VA, portfolio investors, and private investors). A contributing factor to this trend may be that the initial backlog of eligible borrowers in 

2009 has been addressed to some extent. 

The continued leadership and improvements in the Enterprises’ foreclosure prevention efforts is based on continued program evaluations and efforts to make these 

programs work better. In particular, the Servicing Alignment Initiative (SAI) established new borrower communication requirements for servicers to ensure that borrower outreach occurs at the earliest stage of delinquency, when foreclosure prevention measures are most effective. Furthermore, under SAI, Fannie Mae and Freddie 

Mac made clear that servicers are expected to evaluate borrowers for the full range 

of loss mitigation options simultaneously. This allows the borrower and servicer to 

158 

pursue and lock in an alternative to foreclosure as quickly as possible. Servicers are 

obligated to collect information from borrowers and assess their eligibility for a 

modification well before a loan is referred for foreclosure and such referrals may 

only occur after an independent review of the case to ensure that the borrower was, 

in fact, considered for an alternative to foreclosure. 

To encourage loan modifications, the Enterprises offer substantial incentive payments to servicers to motivate them to meet the aggressive timelines for offering 

loan modifications, be they HAMP or Enterprise standard modifications. The payments should cover the servicers’ costs for engaging in more borrower outreach, such 

as ‘‘door-knocking’’ and other face-to-face techniques. 

The SAI improvements represent a highly targeted approach, the goal of which 

is to refocus the servicers’ resources and attention on moving all borrowers into alternatives to foreclosure, quickly, efficiently, and aggressively. The SAI aligned the 

requirements of the Enterprises to remove inconsistencies that could cause servicers 

confusion and delay. 

Furthermore, under the SAI the Fannie Mae standard modification program was 

adopted by Freddie Mac, again, to ensure that borrowers had easy access to a simple and straightforward modification option. I am pleased to see that the Treasury 

Department has acknowledged the benefit of this program, creating a Tier 2 program under the HAMP that is modeled on the Enterprise program. As the data 

show, more borrowers have benefited from the Enterprise modification programs 

than from HAMP, so I think that this program change will help more households 

access a modification. 

The Home Affordable Refinance Program 

Fannie Mae and Freddie Mac are at the forefront of refinance activity for current 

borrowers. Since April 1, 2009, the Enterprises have completed more than 10 million 

refinances, accounting for 63 percent of refinance originations over that period. With 

respect to underwater borrowers, Fannie Mae and Freddie Mac account for less than 

half of underwater borrowers compared to their 60 percent share of total mortgages 

serviced. However, Fannie Mae and Freddie Mac are the only institutions that currently operate a large-scale refinancing program for underwater borrowers. Since 

the inception of the Home Affordable Refinance Program (HARP), the Enterprises 

have completed over one million HARP refinances. Furthermore, since the inception 

of HARP, Fannie Mae and Freddie Mac have completed 1.9 million streamlined refinances that expedited the refinance process for borrowers. 

HARP was designed in 2009 to allow borrowers with loans backed by Fannie Mae 

and Freddie Mac, whose loan-to-value (LTV) ratios had increased as a result of declining home values, a refinancing option that did not require new or additional 

mortgage insurance coverage. In October 2011, FHFA announced a set of changes 

to HARP meant to enhance access to the program. 

The program allows lenders to qualify borrowers using a very streamlined underwriting process, relying on the borrower’s payment history as an indication of capacity and willingness to repay the new loan. While this streamlined underwriting approach is available for most borrowers with loans backed by Fannie Mae and 

Freddie Mac, those with the highest LTV ratios stand to benefit most because they 

have fewer or no other refinance options available to them. HARP is intended to 

serve these borrowers, whose LTV ratios are greater than 80 percent. 

FHFA and the Enterprises have been closely tracking program participation and 

performance since the program’s inception in 2009. The eligible population for the 

program is fairly limited, but the data, reported monthly in the FHFA Foreclosure 

Prevention and Refinance Report, suggested that some borrowers were not being 

reached or were not taking advantage of the program. 

To better understand why eligible borrowers were not accessing the program, 

FHFA and the Enterprises established a task force to work with the industry to assess and streamline program operations. The research showed that increasing access to the program would not be driven by addressing any single or obviously restrictive program feature. Rather, a variety of operational constraints and risk mitigation measures put in place by program participants, to control for and limit a 

transfer of risk from one party to another required revision. By working through the 

broad set of issues with a cross-section of market participants, FHFA and the Enterprises were able to create an environment where all parties were willing to accept 

some degree of risk and to streamline program requirements and operations in a 

way that was mutually beneficial. 

In the end, the set of policy changes announced by FHFA were fairly simple— 

(a) extend the program sunset date to December 31, 2013, to provide lenders with 

more time to execute against the more liberal program terms; (b) provide lenders 

with additional relief from representations and warranties, to provide comfort that 

159 

the Enterprises would not pursue repurchases for defects in original loan files; (c) 

transmit property value data to lenders to use when originating the new loans, limiting the need for appraisals; (d) reduce the loan-level pricing adjustments for all 

borrowers and eliminate them altogether for borrowers who choose mortgage terms 

of 20 years or less, a product option that reduces risk to the Enterprises and helps 

a borrower build equity faster; and (e) remove the loan-to-value cap, previously set 

at 125 percent. The program modifications took effect on December 1, 2011, for 

those lenders who were able to update and implement quickly; for most in the industry, including the Enterprises, implementation will continue through the next 

few months. 

In exchange for these program changes, lenders and mortgage insurance companies agreed to remove their own restrictions and overlays, to offer the program in 

a manner that is consistent with the parameters set out by the Enterprises. This 

agreement across the industry was unprecedented and the participation and support 

of the industry is to be commended. Already many of the largest lenders are seeing 

tremendous borrower interest and we expect to see an increase in HARP volume in 

the upcoming reports. 

Some have suggested that the program changes made to HARP ought to be carried over to the rest of the book of business at Fannie Mae and Freddie Mac. In 

fact, both companies do have streamlined refinance programs available today. The 

data suggests that borrowers are not having any excessive difficulty accessing these 

and other refinance programs as over 10 million households have refinanced with 

Enterprise-backed loans over the last 3 years. 

Real Estate Owned Initiative 

The Enterprises are also in the process of evaluating alternative methods for selling Real Estate Owned (REO) in ways that produce value for taxpayers and contribute to improved housing market stability. Yesterday we announced the first 

transaction in our REO Initiative pilot program. This transaction includes approximately 2,500 properties, divided into 8 subpools by geographic area. Information on 

the number of properties in each location is available on FHFA’s Web site, but let 

me say here that the targeted Metropolitan Statistical Areas are likely no surprise 

to you because they represent hard-hit parts of the country: Las Vegas, Nevada; 

Phoenix, Arizona; various communities in Florida; Chicago, Illinois; Riverside and 

Los Angeles, California; and Atlanta, Georgia. 

With this next step, prequalified investors will be able to submit applications to 

demonstrate their financial capacity, relevant market experience, and specific plans 

for purchasing pools of foreclosed properties with the requirement to rent the purchased properties for a specified number of years. 

Future transactions will also be targeted to these types of markets, where the 

supply of homes for sale is greater than the demand from homebuyers and where 

demand for rental housing is strong. The pilot is not intended to be a national bulk 

sale program, where the entire existing inventory is pooled for sale to investors; we 

are engaged in a targeted effort that is focused on markets with a large number 

of foreclosed properties and where local market conditions suggest a possible benefit 

from this approach. 

The number of properties available for sale by Fannie Mae and Freddie Mac represents only a fraction of the total supply that is depressing home values in certain 

affected markets. The existing retail sales strategy at both companies works well 

for moving properties into the hands of new owner-occupants at close to market values. However, through FHFA’s REO Initiative, we are testing to see if FHFA can 

help address the broader set of market conditions with pilot programs that could 

serve as models to be replicated by other market players and in differing market 

situations. 

In addition to this pilot work, which is focused on moving properties in bulk, both 

companies are looking for ways to enhance their existing retail sales strategies, reexamining the programs available for homebuyers and for small investors. The Enterprises’ retail execution has been very successful to date. Our primary goal will 

continue to be selling properties first to homebuyers who will use them as their primary residences or nonprofits that include homes in mission-oriented activities. We 

also want to enhance the opportunity for smaller-scale investors to bid on properties, and obtain financing, should initial efforts to market the properties to owneroccupants fail. 

Strategic Plan 

At FHFA we are faced with a fundamental task of directing the operations of two 

companies that account for roughly three-quarters of current mortgage originations 

and have approximately $5 trillion in outstanding obligations and credit guarantees. 

160 

FHFA’s task is complicated by the uncertain future of the Enterprises and increasing dissatisfaction with various aspects of their business operations. Conflicting 

opinions abound about what our responsibilities should be. Some think FHFA 

should be doing more to help housing recover, others think that FHFA should be 

winding down the Enterprises’ operations more quickly, others think that FHFA 

should be making all the business decisions at the Enterprises, and others think 

that the Enterprises are part of the Federal Government. 

To address these issues, what FHFA has done since conservatorship is to be clear 

about how we view our legal responsibilities as Conservator, and what actions we 

are going to take to fulfill those responsibilities. 

Two years ago, FHFA sent a letter to Congress that set forth the agency’s understanding of its conservatorship obligations and what actions we intended to take to 

fulfill those obligations. In that letter, we focused on four main areas, including: Enterprise focus on loan modifications and mitigating credit losses; reduction in the 

Enterprises’ retained portfolios; no new product deployments by the Enterprises; 

and meeting the Enterprises’ affordable housing goals. 

It is time to update and extend that plan in view of where the Enterprises and 

the country’s housing system are today. In particular, with the conservatorships operating for over 3 years and no near-term resolution in sight, it is time to assess 

the goals and directions of conservatorship. 

The strategic plan FHFA released last week, which is attached to this testimony, 

outlines the steps FHFA has taken and will be taking to address these challenges. 

The plan sets forth three strategic goals for the next phase of conservatorship: 

1. Build. Build a new infrastructure for the secondary mortgage market. 

2. Contract. Gradually contract the Enterprises’ dominant presence in the marketplace while simplifying and shrinking their operations. 

3. Maintain. Maintain foreclosure prevention activities and credit availability for 

new and refinanced mortgages. 

The first goal—building a new infrastructure—recognizes that the country would 

be without a secondary market for non- Government-insured mortgages without the 

Enterprises. No private sector infrastructure exists today that is capable of 

securitizing the $100 billion per month in new mortgages being originated. This goal 

establishes the steps FHFA and the Enterprises will take to create that necessary 

infrastructure and upon which Congress and market participants may use to develop the mortgage market of the future. 

The ‘‘Build’’ component includes the following activities, some that FHFA has already been working on over the last year: 

• New securitization platform 

• Standardized pooling and servicing agreements, including transparent servicing 

requirements 

• Servicing compensation structure that promotes competition 

• Enhanced loan-level data for investors 

• An efficient system for document custody and record keeping 

The second goal—contracting Enterprise operations—describes steps that FHFA 

plans to take to gradually shift mortgage credit risk from the Enterprises to private 

investors and eliminate the direct funding of mortgages by the Enterprises. This 

goal is consistent with the fundamental goals of the conservatorship, of the Enterprises operating in a sound and solvent condition, and of limiting future risk exposure in the face of uncertainty. 

The ‘‘Contract’’ component includes the following activities: 

Single-Family Credit Guarantees 

• Increase guarantee fee pricing 

• Develop loss-sharing arrangements 

• Expand ways of using mortgage insurance 

Multifamily Credit Guarantees 

• Market analysis of the viability of the Enterprises’ multifamily operations 

Capital Markets 

• Portfolio already on a steady path of reduction 

The third goal—maintaining foreclosure prevention efforts and credit availability—recognizes that the work begun 3 years ago is not finished. Programs and 

strategies to ensure ongoing mortgage credit availability, assist troubled homeVerDate Nov 24 2008 13:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00164 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\02-09 AND 02-28 DISTILLER\20911.TXT JASON
161 

owners, and minimize taxpayer losses while restoring stability to housing markets 

continue to require energy, focus, and resources. 

The ‘‘Maintain’’ component includes the following activities: 

• Implementation of recent HARP changes 

• Continued implementation of SAI and loss mitigation activities 

• Further implementation of REO disposition initiative 

• Renewed focus on short sales, deeds-in-lieu, and deeds-for-lease foreclosure prevention options 

• Alignment and greater transparency on Enterprise representation and warranty 

policies 

Achieving these strategic goals will fulfill the statutory responsibilities Congress 

assigned FHFA as Conservator and also prepare the foundation for a new, stronger 

housing finance system in the future. Although that future may not include Fannie 

Mae and Freddie Mac, at least as they are known today, this important work in 

conservatorship can be a lasting, positive legacy for the country and its housing system. 

Properly implemented, this strategic plan should benefit: 

• Homeowners, by ensuring continued emphasis on foreclosure prevention and 

credit availability; 

• Taxpayers, by furthering efforts to limit losses from past activities while simplifying risk management and reducing future risk exposure; 

• Market participants, by creating a path by which the Enterprises’ role in the 

mortgage market is gradually reduced while maintaining market stability and 

liquidity; and 

• Lawmakers, by building a foundation on which they may develop new legal 

frameworks and institutional arrangements for a sound and resilient secondary 

mortgage market of the future. 

The public interest is best served by ensuring that Fannie Mae and Freddie Mac 

have the best available corporate leaders and business professionals to carry out the 

work necessary to meet the critical goals set forth here. The managers and staff at 

each company also have critical roles to play since the numerous activities and 

changes necessary to accomplish the strategic goals will require substantial effort 

by many people at Fannie Mae and Freddie Mac. 

Conclusion 

The strategic plan provides an outline for the next chapter of conservatorship, one 

that focuses in earnest on building a secondary mortgage market infrastructure that 

will live beyond the Enterprises. The steps envisioned in the strategic plan are consistent with various approaches to housing finance reform. 

The final chapter, though, remains the province of lawmakers. Fannie Mae and 

Freddie Mac were chartered by Congress and by law, only Congress can abolish or 

modify those charters and set forth a vision for a new secondary market structure. 

This plan envisions actions by the Enterprises that will help establish a new secondary mortgage market, while leaving open all options for Congress and the Administration regarding the resolution of the conservatorships and the degree of Government involvement in supporting the secondary mortgage market in the future. 

I would be happy to answer any questions you may have about my testimony or 

FHFA’s new strategic plan. 

162 


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A Strategic Plan for" Enterprise Consen'atorships: 

The Next Chapter in a Story that Needs an Ending 

Ftbruary 21 , 2012 
163 


22812028.eps

Stlmmary 

Since establishing conservatorships for Fannie Mae and Freddie Mac (the Enterprises) in 2008, 

the Federal Housing Finance Agency (FHF A) and the Enterprises have focused on three key 

goals: 

• mitigating Enterprise losses, which ultimately accme to taxpayers; 

• ensuring families have access to mortgages to buy a home or refinance an existing 

mortgage; and 

• offering borrowers in trouble on their mortgage an opportunity to modify their loan or 

otherwise avoid foreclosure. 

Two years ago, FHF A sent Congress a letter setting forth the agency's understanding of its 

conservatorship obligations and how it platmed to fulfill those obligations. 11 is time to update 

and e).1end that plan in view of the status of the Enterprises and the country's housing system 

today. In particular, with the conservatorships operating for more than three years and no nearteon resolution in sight, it is time to assess the goals and directions of the conservatorships. 

This assessment has been made in light of FHF A's statutory mandate to 'lake such action as may 

be necessary to put [Fannie Mae and Freddie Mac] in a sound and solvent condition." FHFA 

also needs to make sure strategic decisions about the Enterprises' future are in accord with the 

statutory purpose of the conservator for "reorganizing, rehabilitating, or winding up the affairs of 

a regulated entity." 

This strategic plan outlines the steps FHFA has taken and will be taking to address these 

challenges. The plan sets forth three strategic goals for the ne}.1 phase of conservatorship: 

I. Build. Build a new infrastmcture for the secondary mortgage market. 

2. Contract. Gradually contract the Enterprises' dominant presence in the marketplace 

while simplifying and shrinking their operations. 

3. l\'laintain. Maintain foreclosure prevention activities and credit availability for new and 

refinanced mortgages. 

The strategic plan explores each of these goals and identifies particular actions FHF A is 

contemplating, or already taking, to accomplish them. 

The first goal - building a new infrastmcture - recognizes that the cowIlry would be without a 

secondary market for non-govemment-insured mortgages without the Enterprises. No private 

sector infrastructure exists today that is capable of securitizing the $100 billion per month in new 

mortgages being originated. Simply shutting down the Enterprises would drive up interest rates 

and limit mortgage availability. This goal establishes the steps FHF A and the Enterprises will 

take to create that necessary infrastructure, including a securitization platfoml and national 

2 
164 


22812029.eps

standards for mortgage securitization that Congress and market parti cipants may use to develop 

the mortgage market of the future. 

TIle second goal - contracting Enterprise operations - describes steps that FHFA plans to take to 

gradually shift mortgage credit risk from the Enterprises to private investors and eliminate the 

direct funding of mortgages by the Enterprises. This goal is consistent with the fundamental 

goals of the conservatorship, of the Enterprises operating in a sound and solvent condition, and 

of limiting future risk exposure in the face of uncertainty. 

TIle third goal - maintaining fo reclosure prevention efforts and credit availability - recognizes 

that the work begun three years ago is not finished. Programs and strategies to ensure ongoing 

mortgage credit availability, assist troubled homeowners, and minimize taxpayer losses while 

restoring stability to housing markets continue to require energy, focus, and resources. 

Achieving these strategic goals will fulfill the legal requirements Congress assigned FHF A as 

conservator and also prepare the foundation fo r a new, stronger housing finance system in the 

future. Although that future may not include Fannie IV[ae and Freddie Mac, at least as they are 

known today, this important work in conservatorship can be a lasting, positive legacy for the 

country and its housing system. 

Properly implemented, this strategic plan should benefit: 

• Homeowners, by ensuring continued emphasis on foreclosure prevention and credit 

availability; 

• Taxpayers, by furthering efforts to limit losses from past activities while simplifying risk 

management and reducing future risk exposure; 

• Market participants, by creating a path by which the Enterprises' role in the mortgage 

market is gradually reduced while maintaining market stability and liquidity; and 

• Lawmakers, by building a foundation on which they may develop new legal frameworks 

and institutional arrangements for a sound and resilient secondary mortgage market of 

the future. 

TIle public interest is best served by ensuring that Fannie Mae and Freddie Mac have the best 

available corporate leaders to carry out the work necessary to meet the critical goals set forth 

here. TIle managers and staff at each company also have critical roles to play since the numerous 

activities and changes necessary to accomplish the strategic goals will require substantial effort 

by many people at FalIDie Mae and Freddie Mac. 

The early chapters of the conservatorship story focused on market functioning and loss 

mitigation. More recent chapters have covered renewed efforts to enhance refinancing 

opportunities and real estate owned (REO) disposition. The strategic goals and perfomlaJlce 

objectives set forth here provide an outline for the ne:-..1 chapter of the story, one that focuses in 

earnest on building a secondary mortgage market infrastructure that will live beyond the 

3 
165 


22812030.eps

Enterprises. 1l1is ne;..1 chapter will also see a graduaJ reduction in the Enterprises' dominant 

position in holding mortgage credit risk as private capital is encouraged back into that role. 

The final chapter, though, remains the province of lawmakers. Fannie Mae and Freddie Mac 

were chartered by Congress and by law, only Congress can abolish or modify those charters and 

set forth a vision for a new secondary market stmcture. 

One critical point The steps envisioned in this strategic plan are consistent with each of the 

housing finance refonll frameworks set forth in the white paper produced last year by the U.S. 

Department of the Treasury and the U.S. Department of Housing and Urban Development as 

well as with the leading congressional proposals introduced to-date. This plan envisions actions 

by the Enterprises that will help establish a new secondary mortgage market, while leaving open 

all options for Congress and the Administration regarding the resolution of the conservatorships 

and the degree of govcmment involvement in supporting the secondary mortgage market in the 

future. 

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A Strategic Plan for Enterprise Conservatorships: 

The Next Chapter in a Story that Needs an Ending 

Introduction 

The Housing and Economic Recovery Act 0[2008 (HERA), which created the Federal Housing 

Finance Agency (FHF A), granted the Director of FHF A discretionary authority to appoint FHF A 

conservator or receiver of the Enterprises "for the purpose of reorganizing, rehabilitating, or 

winding up the affairs of a regulated entity."] 

On September 6, 2008, well over three years ago, FHF A exercised that authority. placing the 

Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage 

Corporation (Freddie Mac) (together, the Enterprises) into conservatorships. FHF A has since 

overseen the largest, most complex conservatorships in history. 

Two years ago, FHF A sent Congress a letter setting forth the agency's understanding of its 

conservatorship obligations and how it plalUled to fulfill those obligations. It is time to update 

and e)'1end that plan in view of the status of the Enterprises and the country's housing system 

today. 

The two companies have received more than $180 billion in taxpayer support. The benefit to the 

country from maintaining their operations has been to ensure the secondary mortgage market 

continues to fu nction. During this time, the Enterprises have completed more than 2 million 

fo reclosure prevention actions, including more than I million loan modifications and they have 

refinanced more than 10 million mortgages. Together they are guaranteeing roughly $100 billion 

per month in new mortgage production, representing about 3 of every 4 mortgages being 

originated. But the Enterprises' ongoing operations are entirely dependent on taxpayer support 

provided through the Senior Preferred Stock Purchase Agreements with the U.S. Department of 

the Treasury. 

The future of the Enterprises and the housing finance system continues to be the subject of many 

questions and much debate. A new stmcture for housing finance requires congressional action, 

1 Housing and Economlc Recovery Act of 2008, Section 1367 (a)(2), amending the Federal Housing Enterprises 

Financial Safety and Soundness Act, 12 USC 4617(a)(2) 

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but no clear legislative consensus has emerged from the Administration or Congress. In the 

meantime, like other large, complex financial institutions, the Enterprises require strategic 

direction though they face an uncertain future. arke l participants are also seeking answers 

about the future. 

This strategic plan provides lawmakers and the public with an outline for how FHFA as 

conservator intends to guide the Enterprises over the next few years. FHF A has developed this 

plan because of the following: 

• The Enterprises' boards of directors and management teams can more readily fulfill the 

goals of conservatorship witb a clear and transparent course of action. 

• As investors in the Enterprises today, taxpayers deserve a plan on how their continued 

support will be used. 

• Proposals for rebuilding the secondary mortgage market vary in their reliance on 

govenmlent credit guarantees but most assume some sort of securitization infrastructure 

to take the place of the Enterprises or asswne the Enterprises' securitization 

infrastmct ures are used in some way in the future. 

• Lawmakers have asked FHFA for ideas on a stable transition from a secondary market 

dominated by the Enterprises to one that could operate without them. 

• FHF A commined to provide a strategic plan for the ne.\l stage of the conservatorships in 

response to a request from the Chaim131l of the House Financial Services Subcommittee 

on Oversight and Investigations in December 20 II. 

As with any strategic plan, this document is not a step-by-step guide. Rather, it sets forth certain 

broad objectives that are consistent with FHF A's legal mandate and the policy direction that has 

emerged from the Administration and Congress. Importantly, this plan is consistent with each of 

the housing finance refonn frameworks set forth in the white paper produced last year by 

Treasury and the U.S. Department of Housing and Urban Development (HUD) and with the 

leading congressional proposals introduced to-date. This plan envisions actions by the 

Enterprises that will help establish a new secondary mortgage market, while leaving open all 

options for Congress and the Administration regarding the resolution ofthe conservatorships and 

the degree of government involvement in supporting the secondary mortgage market in the 

future. 

FHF A remains committed to its obligation to ensure a stable and liquid secondary mortgage 

market while preserving and conserving Enterprise assets to minimize taxpayer losses. FHF A 

looks forward to continuing to work with Congress and the Administration on a resolution of the 

conservatorships and a comprehensive review of the country's housing finance system. 

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Background: The Early Chapters of the ConseITatorship Story 

The La", 

As consen'alor and regulator, FHF A has three legal obligations that direct the agency's activities 

and decisions involving the Enterprises. 

First, HERA specified two conservator powers, stating that the agency may "take such action as 

maybe 

(i) necessary to put the regulated entity in a sound and solvent condition; and 

(ii) appropriate to carryon the business orthe regulated entity and preserve and conserve the 

assets and property of the regulated entity.,,2 

FHF A has reported on numerous occasions that, with taxpayers providing the capital supporting 

Enterprise operations, this "preserve and conserve" mandate directs FHF A to minimize losses on 

behalf of taxpayers. 

Second, although each Enterprises is in conservatorship, without statutory changes their mission 

of supporting a stable and liquid mortgage market remains the same as before the 

conservatorships. FHFA has a statutory responsibility to ensure each Enterprise "operates in a 

safe and sound manner"] and that ''the operations and activities of each regulated entity foste r 

liquid, efficient, competitive, and resilient nat ional housing finance markets.,,4 

Third, WIder the Emergency Economic Stabilization Act of 2008 (EESA), FHF A has a statutory 

responsibility to "implement a plan that seeks to maximize assistance for homeowners and lise its 

authority to encourage the servicers of tile underl ying mortgages, and considering net present 

value to the taxpayer, to take advantage of ... available programs to minimize fo reclosures. ,,5 

, 12 USC 4617(bX2XD) 

, 12 USC 4m(aXI)(B)(i) 

• 12 USC 4m(aXI)(B)(ii) 

, 12 USC 522C(bXI) 

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Conservatorship Goals 

In 2008, the immediate objectives of conservatorship were to help restore confidence in the 

companies, enhance their capacity to fulfill their mission, and mitigate the systemic risk that 

contributed directly to instability in financial markets. Because the private mortgage 

securitization market had already retreated and there were no other effective secondary market 

mechanisms in place, the Enterprises' continued operations were necessary fo r most Americans 

to obtain a mortgage or refinance an existing mortgage. 

Since 2008, several govemment efforts have kept the country's housing finance system 

functioning, including: 

• the Treasury Department 's financial backstop of Enterprise debt and mortgage-backed 

securities (MBS); 

• Treasury's and the Federal Reserve 's MBS purchases; 

• FHF A's and the Enterprises' actions to ensure the continued functioning of the 

secondary mortgage market; and 

• the Federal Housing Administration's (FHA) rapidly growing market presence. 

As a result, credit has remained available, albeit with more restrictive undenvriting tenns, and 

more than 10 million Americans have refinanced Fannie Mae and Freddie Mac mortgages. 

During these years, these same govemment agencies together with the Enterprises and other 

market participants undertook a series of efforts to help families avoid foreclosure through loan 

modification progrruns and foreclosure alternatives. For FHF A and the Enterprises, these efforts 

directly relate to the "preserve ruld conserve" mruldate because such activities are designed to 

reduce credit losses on mortgages originated primarily in the years before conservatorship. In 

addition, these efforts are consistent with FHF A's other mandates, including the EESA mandate 

to maximize assistance for homeowners. Since conservatorship began, the Enterprises have 

completed more thrul two million foreclosure prevention actions, including more thrul one 

million loan modifications. 

Today, loss mitigation efforts focus on helping households as early as possible when they 

become delinquent on their mortgages, and employing inIlovative strategies for retuming 

foreclosed properties back to the market. The continued high level of mortgage delinquencies 

shows that more is left to do, but several programs now exist to address these challenges. FHF A 

and the Enterprises will remain vigilrult in ensuring that appropriate assistance and support is 

offered to all homeowners in distress through lorul modifications and other foreclosure avoidrulce 

tools. 

Three years into conservatorship, it is time to update and e;..1end the goals of conservatorship in 

light of FHFA's statutory mandate and the market environment that has evolved since 2008. As 

noted, the operations of the Enterprises in conservatorship are unlike an)1hing the country has 

experienced. TIle conservatorship structure was designed to allow a temporary period for an 

institution to stabilize and return to the market or to lead to an orderly disposition of a finn . 

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Unlike the banking industry, there are not thousands of potential finns ready to step into the 

business of mortgage securitization. Indeed, outside of the securitization available through the 

Government National Mortgage Association (Ginnie Mae) for loans primarily backed by FHA, 

there is little else in place today to assume the secondary market functions served by the 

Enterprises. 

What Needs to Be Done Now 

Policymakers need to address the future stmcture of housing finance, which would allow for a 

smooth transition from today's market. Without action by Congress, FHF A must continue to 

look to the existing statutory provisions that guide the conservatorships. In particular, FHF A 

must consider what it means to "take such action as may be necessary to put [Fannie Mae and 

Freddie Mac] in a sOlmd and solvent condition" when it is clear that the draws the companies 

have taken from the Treasury are so large they cannot be repaid under any foreseeable scenarios. 

Without further statutor), direction, FHF A views the mandate to restore the Enterprises to a 

sound and solvent condition as best accomplished not only through aggressive loss mitigation 

efforts, but also by reducing the risk exposure of the companies, through appropriate 

underwriting and pricing of mortgages. Such actions are consistent with what would be expected 

of a private company operating without govennuenl support. AI the same time, the unanticipated 

length of the conservatorships poses additional risks for taxpayers and markets not contemplated 

by HERA. FHF A views those risks as best managed by contracting the Enterprises' footprint in 

the marketplace. 

To achieve these outcomes, FHF A will need to make strategic decisions regarding the 

Enterprises' level of participation in the market while developing ways for the taxpayers to 

ultimately derive value, consistent with FHF A's "preserve and conserve" mandate. 

Reviewing the Existing Landscape: ConsideratioDs for Moving Fonvard 

In view of FHFA's statutory mandates and in light of the current environment, it is necessary to 

define new goals for the Enterprises operating in conservatorship. Key issues and circumstances 

FHF A faces include the following: 

• The Enterprises' losses are of such magnitude that the companies catillot repay taxpayers 

in any foreseeable scenario. 

• The operational infrastructures at each company are working but require substantial 

investment to support future business. The question is whether to improve the current 

infrastructure or to consider this an opportunity to build something new. 

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• In the absence of other comparable market infrastructure, minimizing future taxpayer 

losses and ensuring market liquidity and stability requires preserving the Enterprises as 

working companies. But some of the things this approach requires, such as retaining 

some semblance of private sector pay comparability, have generated concerns because 

the compani es receive substantial taxpayer assistance. 

• Although the housing finance system cannot be called healthy, it is stable and 

functioning, albeit with substantial ongoing govenmlent support. 

• Congress and the Administration have not reached consensus on how to resolve the 

conservatorships and define a path for housing finance. Legislative proposals have begun 

to emerge, but enactment soon appears unlikely. 

Absence of consensus on a resolution ofthe conservatorships does not imply a lack of consensus 

on general direction. Both the Administration and Congress have expressed discomfort with the 

level of govenunent involvement in the mortgage market and a desire for greater private sector 

participation and risk-taking. A central issue remains: whether a government guarantee is 

essential to a functioning mortgage market. On other market issues, some consensus has 

emerged on what is needed to fi x the problems we have witnessed over the past several years. 

At a minimum there is a desire for greater standardization and more equitable and transparent 

treatment of borrowers and investors in mortgage origination, mortgage servicing, and securities 

disclosure. 

Over the past two years, FHF A has initiated severallong-tenn improvements to the housing 

finance system that address shortcomings in the current system, meet the goal of reducing 

taxpayer exposures, and provide flexibility for lawmakers as they move toward legislative action 

on housing finance. These improvenlents include the following: 

• The Unifonn Mortgage Data Program will improve the consistency, quality, and 

unifonnity of data coll ected at the beginning of the lending process. Developing standard 

tenns, definitions, and industl]' standard data reporting protocols will decrease costs for 

originators and appraisers and reduce repurchase risk. It will allow new entrants to use 

industl]' standards rather than having to develop their own proprietary data systems to 

compete with other systems already in the market. Common data definitions, electronic 

data capture, and standardized data protocols will improve efficiency, lower costs and 

enhance risk monitoring. Standardizing data will be a key building block ofhousing 

finance refoml. 

• The Joint Servicing Compensation Initiative is considering alternatives for future 

mortgage servicing compensation for single-family mortgage loans. The goals of any 

changes to the current Enterprise model of compensation will be improving service for 

borrowers, reducing fi nancial risk to servicers, and providing flexibility for guarantors to 

better manage non-penorming loans, while promoting continued liquidity in the ''To Be 

Announced" mortgage securities market. Iore broadly, the goals of the initiative are to 

consider changes to the servicing compensation structure that would improve competition 

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in the market for mortgage servicing and which could be replicated across any fonn of 

housing finance reform. 

• The Servicing Alignment Initiative has produced a single, consistent set of protocols for 

sen'icing Enterprise mortgages from the moment they first become delinquent. "Ibis 

initiative responds to concerns about how delinquent mortgages have been serviced and it 

simplifies the rules for mortgage servicers by giving them just one set of procedures to 

follow whether a mortgage is owned by Fannie Mae or Freddie Mac. The first phase of 

this initiative has already been implemented. Developed in consultation with the federal 

banking agencies and state attorneys general, the new requirements could sen'e as the 

basis for establishing broad national mortgage servicing standards. 

• The Loan-Level Disclosures Initiative will produce loan-level investor disclosures on 

Enterprise MBS, both at the time of origination and throughout a security's life. 

Improving !vIBS disclosures will help establish consistency and quality of data. With 

better information, private investors can efficiently measure and price mortgage credit 

risk, which will likely be a hallmark of any fonn of housing finance reform. 

Writing the Next Chapter: Setting the Strategic Goals 

Looking ahead, three broad goals will define the focus of the conselVatorships for the nei\1 few 

years: 

I. Build. Build a new infrastructure for the secondary mortgage market. 

2. Contract. Gradually contract the Enterprises' dominant presence in the marketplace 

while simplifying and shrinking their operations. 

3. Maintain . . Maintain foreclosure prevention activities and credit availability for new and 

refinanced mortgages. 

Achieving these strategic goals will fulfill the legal requirements Congress assigned FHF A as 

cOllsen'ator and also prepare the foundation for a new, stronger housing finance system in the 

future. Although that future may not include Fannie Mae and Freddie Mac, at least as they are 

known today, this important work in conservatorship can be a lasting, positive legacy for the 

country and its housing system. 

Properly implemented, this strategic plan should benefit: 

• Homeowners, by ensuring continued emphasis on foreclosure prevention and credit 

availability; 

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• Taxpayers, by furthering efforts to limit losses from past activities while simplifying risk 

management and reducing future risk exposure; 

• Market participants, by creating a path by which the Enterprises' role in the mortgage 

market is gradually reduced while maintaining market stability and liquidity; and 

• Lawmakers, by building a foundation on which they may develop new legal frameworks 

and institutional arrangements for a sOlmd and resilient secondary mortgage market of 

the future. 

Srrategic Goal J: Building a New Infrastructure 

The absence of any meaningful secondary mortgage market mechanisms beyond the Enterprises 

and Ginnie Mae is a dilemma for policymakers expecting to replace the Enterprises. This fact 

was a key motivation fo r the conservatorships and for the Treasury support agreements in the 

first place. Without an alternative market infrastructure that investors could rely on, new 

mortgages would have been largely unavailable if the Enterprises suddenly had been shut down. 

The elements for rebuilding the market system are known and work on them can begin without 

knowing whether there will be a go,'ernment guarantee apart from FHA in the mortgage market 

of the future. In fact, the four initiatives FHFA and the Enterprises have already begun would 

be essential to any new infrastmcture. 

A secondary mortgage market infrastructure without Fannie Mae and Freddie Mac would likely 

include the following elements: 

• A framework to connect capital markets investors to homeowners - specificall y, a 

securitization platfoml that bundles mortgages into any of an array of securities structures 

and provides all the operational support to process and track the payments from 

borrowers through to the investors. 

• A standardized pooling and servicing agreement that replaces the Enterprises' current 

Servicer Participation Agreement and corrects the many shortcomings found in the 

pooling and servicing agreements used in the private-label MBS market before the 

housing bubble burst. 

• Transparent servicing requirements that set forth requirements for mortgage servicers' 

responsibilities to borrowers and investors across a spectrum of issues including 

delinquent loan servicing, solicitation for refinance or loan modifications, and servicing 

transfers. 

• A servicing compensation structure that promotes competit ion for, ratherthan 

concentration of, mortgage servicing. Such a structure would take fu ll account of 

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mortgage servicers' costs and requirements, and consider the appropriate interaction 

between origination and servicing revenue. 

• Detailed, timely, and reliable loan-level data for mortgage investors at the time a security 

is issued and throughout the life of the security. Such transparency is a prerequisite for 

private capital to bear a meaningful portion of mortgage credit risk. 

• A sound, effi cient system for document custody and electronic registration of mortgages, 

notes, titles, and liens that respects local property laws but also enhances the liquidity of 

mortgages so that borrowers may benefit from a liquid secondary market for buying and 

selling mortgages. Such a system should be especially attuned to privacy and security 

issues while providing full transparency where required by law or in the interest of 

borrowers. 

• An open architecture for all these elements, to fa cilitate entry to and exit from the 

marketplace and an ability to adapt to emerging technologies and legal requirements over 

time. 

Securitization Platfoml 

Beyond the initiatives FHF A and the Enterprises have begun, a cornerstone to building for the 

future is a new securitization platfornl. While competing securitization platfornls may emerge in 

the future, back-office operations arguably lend themselves to a public utility construct, at least 

in the early stages of building a new secondary mortgage market infrastructure. The economies 

of scale are substantial as are the potential market benefits of standardization to a single 

securitization platfornl. Neither Enterprise has a securitization infrastructure capable of 

becoming a market utility today. Taking 0 11 that role would require substantial investment of 

both human capital and infonnation technology resources. 

Both Enterprises would have to draw from the Anlerican taxpayer to make such a long-tenn 

infrastructure investment, so it makes more sense to do this only once. FHF A will deternline 

how FaiUlie Mae and Freddie Mac can work together to build a single securitization platfonn that 

would replace their current separate proprietary systems. 

In the intennediate ternl, a single platfonn would allow for a single mortgage-backed security. 

Accomplishing this objective will take time. FHF A and the Enterprises will provide market 

participants with ample time to adjust to the new structure in order to minimize disruptions and 

uncertainty. Ensuring, indeed enhancing, liquidity for mortgage-backed securities wi ll be a 

central objective. 

For the platfonn to have long-ternl value, it should have an open architecture that will pennit 

mUltiple future issuers of mortgage-backed securities to access the platfonn and it should be 

fl exible enough to pennit a wide array of securities and mortgage structures. Since this platfonn 

could become a type of public utility (in effect) that would outlast the Enterprises as we know 

them today, input from all market stakeholders will be sought. 

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The intended outcome of such an important infrastmcture investment is to provide a sound 

securitization platfornl on which to rebuild the country's secondary mortgage market. The 

platfonn itself will be one way American taxpayers realize a return on their substantial 

investment in the Enterprises while also making it possible to retire the Enterprises' proprietary 

systems and programs from the marketplace. TIle platfoml will be designed to issue securities 

supported with or without a government guarantee. 

Pooling and Servicing Agreements 

Beyond building the operational infrastmcture to issue mortgage-backed securities, building for 

the future also requires developing and implementing standards for underwriting, disclosures, 

servicing and other considerations. Creating a robust and standardized pooling and servicing 

agreement is key. TIle strategic goal is to learn from the Enterprises' existing practices and the 

shortcomings identified in the private-label mortgage-backed securities market and to solicit 

broad public input to build a better standard for the future. Input from investors and a careful 

review of appli cable Securities and Exchange Commission rules and best practices will be 

essentia1. 

As with the securitization platfonn, the goal is not to rebuild Fmmie Mae and Freddie Mac but 

rather to leverage the experience and human capital expertise at these finns to build a new 

infrastmcture for the future. The goal is not a proprietary system but rather an open system that 

promotes competition and transparency while fonning a basis for a stable, liquid, and efficient 

secondary mortgage market. 

Developing these standards will not only correct past problems, it will make the existing system 

better. We know how past shortcomings have hanned borrowers and investors. Since the point 

of a secondary mortgage market is to operate an infrastructure that most effi ciently brings 

investor capital to individual families seeking to finance a home, standards must be more 

transparent and accessible for both of these "end-users." 

Smuegic Goal 2: Contracting Enterprise Operations 

Since entering conservatorship in September 2008, Fatmie Mae and Freddie Mac have bought or 

guaranteed roughly three of every four mortgages originated in the country. Mortgages 

guaranteed by FHA make up most of the rest. Reducing the Enterprises' position in the 

marketplace and doing so in a safe and sound maruler, in the absence of other comparable 

private-sector players operating in this market, is the second strategic goal. 

The Enterprises operate three lines of business: a single-fanlily mortgage credit guarantee 

business, a multifamily mortgage credit guarantee business, and a capital markets business that 

finances single-family and multifamily mortgages by issuing debt securities in the capital 

markets. 

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Single-Family Credit Guarantees 

TIle first strategic goal sets forth a plan for moving away from each company's proprietary 

securitization platfonn but it does not address the mortgage credit insurance business. It is that 

business for which the securitization platfonn provides the architecture for delivering the 

Enterprise guarantee to investors. Establishing a path for shifting mortgage credit risk from the 

Enterprises (and, thereby, taxpayers) to private investors is central to the second goal. 

Gradually shifting mortgage credit risk from Farulie Mae and Freddie Mac to private investors 

could be accomplished in several ways. The following are under consideration or already being 

implemented: 

• Increase guarantee fee pricing. Continued gradual increases in the Enterprises' guarantee 

fee (or, g-fee) pricing may move their pricing structure closer to the level one might 

expect to see if mortgage credit risk was bome solely by private capital. In September 

20 I I, FHF A announced its intention to continue a path of gradual price increases based 

on risk and the cost of capital. In December 2011, in the Temporary PayToll Tax Cut 

Continuation Act of2011 , Congress directed FHFA to increase guarantee fees by at least 

an average of 10 basis points and further directed that FHFA consider the cost of private 

capital and the risk of loss in setting guarantee fees. Congress also encouraged FHF A to 

require guarantee fee changes that reduce cross-subsidization of relatively risky loans and 

eliminate differences in fees across lenders that are not clearly based on cost or risk. 

• Establish loss-sharing arrangements. Most Enterprise mortgage securitization yields 

securities fully guaranteed by the Enterprises. Altemative securities structures could 

result in private investors bearing some or all of the credit risk. FHF A is considering 

various approaches, incl uding senior-subordinated security structures. 

• Expand reliance on mortgage insurance. As required by law, most mortgages purchased 

or guaranteed by the Enterprises with less than 20 percent borrower equity in the property 

have private mortgage insurance in the first-credit-loss position. While some mortgage 

insurers are facing financial challenges as a result of housing market conditions, others 

may have the capital capacity to insure a portion of the mortgage credit risk currently 

retained by the Enterprises. TIus could be accomplished through deeper mortgage 

insurance coverage on individual loans or through pool-level insurance policies. 

Multifamilv Credit Guarantees 

Unlike the single-family credit guarantee business, each Enterprise's multifamily business has 

weathered the housing crisis and generated positive cash flow. In contrast to their common 

approach to their single-family businesses, Farulie to..fae and Freddie lvlac do not take the same 

approach to their multifamily businesses. For a significant portion of its business, Falmie Mae 

shares multifamily credit risk with loan originators through its delegated underwriting program. 

For a signifi cant and increasing portion of its business, Freddie Mac shares multifamily credit 

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risk with investors by issuing classes of securities backed by multifamily mortgages where the 

investor bears the credit risk. Both approaches are broadly accepted in the marketplace. 

Rising rental rates and declining vacancy and delinquency rates refl ect. in part, the shift of some 

households from home ownership to renting as well as other demographic trends. The demand 

for Enterprise employees with expertise in this specialized market is also strong; both companies 

have lost key personnel to other market participants. 

Multifamily lending has played an important role in how the Enterprises have fulfilled past 

affordable housing mandates, but the activity itself is more akin to other commercial rea1 estate 

lending than to the Enterprises' single-family businesses. In conservatorship, the Enterprises 

have seen their market share grow in the multifamily sector but they do not dominate that market 

as they do in single-family. 

Given these conditions, generating potentia1 va1ue for taxpayers and contracting the Enterprises' 

multifamily market footprint should be approached differently from single-fami ly, and it may be 

accomplished using a much different and more direct method. To evaluate how to accomplish 

the second strategic goal in the multifamily business, each Enterprise will undertake a market 

analysis of the viability of its multifamily operations without government guarantees. This will 

require market reviews of their respective business models and the likely viability of those 

models operating on a stand-alone basis after attracting private capital and adjusting pricing, if 

needed, to attract and retain that capital. 

Capital Markets 

Before conservatorship, many Enterprise observers and analysts thought capital market activities 

to be each company's source of greatest profits, controversy and risk. With the numerous 

subsidies inherent in the government-sponsored enterprise (GSE) charters granted by Congress, 

the Enterprises have long been ab le to borrow money in the capital markets by issuing debt 

securities at interest rates approaching those of Treasury securities. They did this not by virtue 

of their financial strength and strong capital base, but because of a broad perception in the 

marketplace that the government would not let the companies default on their obligations. With 

this borrowing advantage, which was unavailable to other investors, the Enterprises issued debt 

to buy mortgages, including their own MBS, in competition with private investors. 

The Enterprises fund their retained portfolios through their capital markets operations, which 

need to continually monitor and hedge the interest rate risk inherent in mortgages, including the 

risk that changing interest rates could lead to either sudden mortgage prepayments or a 

slowdown in mortgage prepayments. Interest rate risk overwhelmed the savings and loan 

industry in the 1980s and made Fannie Mae technically insolvent in the early 1980s. A1though 

capital markets operations were not the leading contributor to the losses that led the Enterprises 

into conservatorship and the accompan ying taxpayer support, it remains a complex business 

activity requiring specialized and expert risk managers. 

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Today, this business line is already on a gradual wind-down path. The Treasury support 

agreements require the Enterprises to shrink their retained mortgage portfolios at a rate of 10 

percent per year. Most mortgages the Enterprises add to their retained portfolios today are 

delinquent mortgages removed from their mortgage-backed securities. Each Enterprise also has 

certain legacy assets from before conservatorship, including private-label IvIBS, for which there 

is little or no liquidity in the marketplace. TIlliS, over time the Enterprises' retained portfoli os 

are becoming smaller, but also less liquid. 

M:L"I:imizing retums for taxpayers on the $1.4 trillion in mortgage assets currently owned and 

financed by the Enterprises is a key element ofFHF A's mandate as conservator. TIle gradual 

wind-down of the retained portfolios since 2009 has led FHF A to consider strategic sales of 

assets that maximize value for the conservatorships. But depressed market prices for many of 

these assets, particularly when tied to market illiquidity rather than a penllanent decline in asset 

value, argues for holding some of them for a longer period to minimize taxpayer loss. 

In view ofthe need to retain capital market expertise to operate this business, accomplishing the 

second strategic goal for this line of business has two basic options: retain each company's inhouse capital markets expertise to continue to manage these portfolios to maximize value while 

managing risk or retain a third-party investment finn(s) to manage each company's portfolio. 

TIle first is less disruptive but retains human capital risk, especially in view of proposed 

legislation on Enterprise compensation. TIle second option would hasten the shrinkage in 

Enterprise headcount but is likely to be the more costly, and it poses new control and oversight 

challenges for FHF A. 

Strategic Goal 3: Maintaining Foreclosure Prevention Efforts and Credit 

Availability 

Amidst the building up and winding down activiti es defined by the first two strategic goals, there 

remains a critical third goal: ensuring ongoing stability and liquidity in the marketplace for new 

mortgages and mortgage refinancing. and continuing the critical tasks of foreclosure prevention 

and loss mitigation. This third goal has been central to the conservatorships since they began 

and it continues to be essential today. 

Together, the Enterprises purchase or guarantee roughly $100 billion in home purchase and 

refinanced mortgages each month. Market confidence in the Enterprises' ongoing ability to 

provide th is stable, liquid fl ow of mortgage-backed securities to investors is essential to 

stabilizing house prices and ensuring stability in the value of nearly $3.9 trillion in outstanding 

Enterprise mortgage-backed securities. 

Other ongoing Enterprise activities that must be continued and enhanced include: 

• Successful implementation of the Home Affordable Refinance Program (HARP), 

including the significant program changes alU10unced in October 2011. 

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• Continued implementation of the Servicing Alignment Initiative, including its rigorous 

approach to loss mitigation through loan modifications and other means by reaching out 

to borrowers at the first signs of distress. 

• Renewed focus on short sales, deeds-in-lieu, and deeds-for-Iease options that enable 

households and the Enterprises to avoid foreclosure. The frictions and barri ers to more 

successful use of these tools should be identified and removed using the same renewed 

focus brought to HARP last year. Enhanced use of these foreclosure avoidance tools may 

have important benefits for borrowers, neighborhoods, and taxpayers. Given the large 

backlog of pending foreclosures, renewed focus on these alternatives is a near-tenn 

priority. 

• Further development and implementation of the real estate owned (REO) disposition 

initiative aImounced by FHF A last year. Adding creative strategies for placing 

foreclosed homes back into the marketplace, including efforts to convert properties into 

rental units, remains a promising path to reduce losses and to stabilize house prices and 

neighborhoods hit hard by the housing crisis. 

Beyond these sensible strategies to assist homeowners and reduce taxpayer losses, achieving the 

third strategic goal will require FHF A and the Enterprises to work harder to resolve certain longstanding concerns in the marketplace that may be suppressing a more robust recovery and 

limiting credit availability. Each of these will be particularly challenging to resolve as they are 

essential to conservatorship efforts to minimize losses and to put the Enterprises in a more sound 

and solvent condition to manage the new business being taken on with taxpayer support. 

First, representations and warranties are a long-standing means for enhancing liquidity in the 

mortgage origination process while protecting the Enterprises from loans not underwritten to 

prescribed standards. Representations and warranties are a loan originator's assurance to an 

Enterprise that a mortgage sold to the Enterprise has been underwritten as specified by contract, 

and, if that is found not to be the case, the originator undertakes responsibility for buying the 

loan back at par. Enforcing these claims ensures the Enterprises are compensated for losses that 

are the legal responsibility of aIIother party. Still, such enforcement is costly and some have 

argued it has delayed market recovery because it led to new mortgage originations being 

underwritten to stricter standards than the Enterprises require. 

FHF A aIId the Enterprises will respond to this market concern by aligning and making policies 

for representations and warranties more transparent (consistent with the first strategic goal). As 

noted earlier, a long-tenn goal associated with the Unifonn Mortgage Data Program is to reduce 

representation and warranty risk through up-front monitoring of loan quality. In conjwIction 

with this initiative and, in the interim, defining more clearly under what conditions 

representations and warranties will be employed to put back mortgages is an objective under the 

third strategic goal. Completing the resolution of outstanding "put back" requests is a related 

objective. 

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Second, FHF A has filed 18 separate lawsuits in connection with alleged securities law violations 

in private-label mortgage-backed securities purchased by the Enterprises. Speedy resolution of 

these claims would also help restore some vibrancy to the mortgage market and put claims 

related to past deficiencies to rest. 

Accomplishing the Strategic Goals: Human Capital and Business Realities 

No business endeavor can be successful without careful consideration of human capital. The 

numerous activities and changes necessary to accomplish the three strategic goals described here 

cannot be accomplished solely by legislation or declaration. They require substantial effort by 

many people at both Fannie Mae and Freddi e Mac. 

The boards and executives responsible for the business decisions that resulted in the Enterprises 

entering conservatorship and subsequent taxpayer support are long gone. Nearly every current 

top executive at each company either joined the company after the conservatorships were 

established or were promoted from within to replace departed executives. It is also worth noting 

that shareholders of each Enterprise effectively have already lost their entire investment. 

TIle public interest is best served by ensuring that Fannie Mae and Freddie Mac have the best 

available corporate leaders to carry out the work necessary to meet the critical goals set forth 

here. FHF A and the Enterprises' boards of directors currently are engaged in a search for a new 

chief executive officer (CEO) for each company. We are seeking accomplished corporate 

leaders willing to lmdertake the unique challenge of nmning a large, complex financial 

institution while fulfilling the public goals described here in an uncertain legislati ve 

environment. FHFA and the boards are seeking hi ghly qualified executives willing to take on 

these daunting challenges as a foml of public service, despite the ongoing criticism of the 

companies and their executives. The success of these new CEOs will depend directly on tlle 

stability and experience of the executive teams and staff already in place at each company. 

Dismpting what has taken more than three years to achieve will only add to taxpayer losses and 

threaten the fragile housing recovery. 

FHF A and the Enterprise boards of directors have taken seriously the concerns raised by 

members of Congress and the public regarding executive compensation. For 2012, work on a 

new compensation stmcture that eliminates bonuses is nearly complete. The new stmcture will 

be all salary, some paid currently, but a larger portion will be deferred. TIle deferred salary will 

be at-risk, meaning it may be reduced (but not increased) from the target amount, and reductions 

would be based on shortcomings in achieving individual perfonnance goals and corporate 

conservatorship goals tied to this strategic plan. 

Mid-level managers and rank and file staff have been held to a pay freeze the past two years. 

Yet retention ofthese staff is at least as important as retaining senior management. The day-today running of the businesses and the countless decisions that result in gains or losses are made 

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in these ranks. Even with the great uncertainty as to the future of their companies, many 

Enterprise staff have remained committed to the important work taking place there. 

When the conservatorships were created, FHF A made clear to Enterprise employees, Congress, 

and the public that retaining corporate managers and staff was essential to the work of the 

conservatorships. Conservatorship did not tum once-private companies into government 

agencies, nor their workers into govemment employees. As with evef)1hing else with these 

conservatorships, there has been a challenging yet critical balancing required. 

In addition to the senior managers and staff, the Enterprises' boards of directors have played, and 

continue to play, an important role in assisting Enterprise management and FHF A. Board 

members themselves are engaged in a fonn of public service while retaining fiduciary 

responsibility as board members, and they too face lUlique challenges as boards of companies in 

govenllnent conservatorship. 

From FHFA's standpoint, part of what is being preserved and conserved at the Enterprises is the 

processes and procedures, including business decision-making and requirements, of private 

financial institutions. These are critical to safe and sound operations, and can be dismpted by a 

fai lure at the senior management or operational staff levels. Each board's oversight of its 

Enterprise helps to preserve and reinforce among managers and staff these important privatesector disciplines. Each board's review and consideration of risk management practices, key 

business decisions, hlUnan capital management, and other key fWlctions greatly assists FHF A in 

its regulatory and conservatorship responsibilities by providing the discipline and rigor expected 

of corporate boards. In these ways, the boards help FHFA enhance the corporate value at each 

Enterprise for ultimate disposition by Congress. 

Consen'atorship: Writing the Final Chapter 

The early chapters of the conservatorship story focused on market functioning and loss 

mitigation. More recent chapters have covered renewed efforts to enhance refinancing 

opportunities and REO disposition. TIle strategic goals and perfornlance objectives set forth here 

provide an outline for the ne!\1 chapter of conservatorship, one that focuses in earnest on building 

a secondary mortgage market infrastmcture that will live beyond the Enterprises themselves. 

TIlis ne!\1 chapter will also see a gradual reduction in the Enterprises' dominant position in 

holding mortgage credit risk as private capital is encouraged back into that role. 

TIle final chapter, though, remains the province of lawmakers. Fannie Mae and Freddie Mac 

were chartered by Congress and by law, only Congress can abolish or modify those charters. 

The strategic plan set forth here will move the housing finance system forward and enhance the 

foundation on which Congress can make decisions about the role of govemment in the future of 

the country's housing finance system. Congress then can decide on the disposition of the 

Enterprises and their business operations. 

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TIlis plan does not anticipate Falmie Mae and Freddie Mac continuing as they existed before 

conservatorship. And though the Enterprises may well cease to exist at some point in the future, 

at least as they are known toeL.,y, the cowltry's $10 trillion single-fanlily mortgage market will 

n01 go away. Therefore, an orderly transition to a new stmc1ure is needed. 

Ensuring the ongoing liquidity and stability ofthe market, and establishing new conduits that 

connect local mortgage originators with the capacity of global capital market investors, will 

require new institutions and legal frameworks. The executives and employees of FalUlie Mae 

and Freddie rvIac are well situated to begin the process of building for that future and they can be 

expected to remain key contributors to housing finance in whatever new companies and 

institutional arrangements arise to replace Fannie rvlae and Freddie Mac. Getting the most value 

for taxpayers and bringing stability and liquidity to housing finance during this long transition 

remain the overriding obj ectives of FHF A as conservator. 

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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM SHAUN DONOVAN 

Q.1. Secretary Donovan, in your testimony before the Committee, 

you stated that the non-GSE loans that would be eligible for refinancing through the Federal Housing Administration as part of the 

President’s recently announced housing plan are ‘‘already low-risk 

loans.’’ The President’s plan, however, appears to include loans 

that do not fall into this category. For example, it specifies that the 

refinancing program would be open to borrowers with a low FICO 

score of 580 as well as borrowers with ‘‘deeply underwater loans.’’ 

How do you define ‘‘low-risk loans?’’ 

A.1. Although the plan calls for loans with FICOs as low as 580, 

the plan explicitly states that the loan must be current at the time 

of the refinancing. Furthermore, the borrower must have exhibited 

a strong track record of on-time payments, with no late payments 

in the 6 months prior to the refinancing and no more than one 30 

day late in the 6 months prior to that. The borrower may have suffered one or more hardships in the past which may be the reason 

the credit score is low, however, the borrower has reestablished the 

ability to pay and has proven responsibility with the strong 12- 

month payment history. 

Q.2. Specifically, what are the expected default rates for borrowers 

eligible for this program? What is the expected participation rate, 

and how many foreclosures do you expect this program would prevent? What is the projected subsidy for this program, and how 

would it be offset? 

A.2. We expect that that with homeowners experiencing lower interest rates, the likelihood of default would be decreased. However, 

at this time we do not have official estimates of default rates, participation rates, or other performance parameters. 

It is estimated, based on the current program guidelines that 

roughly three million borrowers would be eligible to participate. We 

cannot estimate exactly how many homeowners will participate in 

this program, as the decision to refinance is contingent on many 

personal factors, such as expected time in a residence, employment, 

etc. 

This is not an explicitly targeted foreclosure prevention program 

like HAMP, but we do expect that home ownership sustainability 

will improve when homeowners can refinance to lower rates. This 

in turn improves neighborhood stability and reduces the likelihood 

of default in the long run. 

We are working with members of the Senate to develop program 

parameters and identifying sources of funding to serve as a backstop to the premiums that would be collected through the program 

to absorb unexpected large losses.