U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

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

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

76–281 PDF 2013

S. HRG. 112–571 

STRENGTHENING THE HOUSING MARKET AND 

MINIMIZING LOSSES TO TAXPAYERS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

HOUSING, TRANSPORTATION, AND COMMUNITY 

DEVELOPMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING ACTIONS THAT CAN STRENGTHEN THE MORTGAGE 

MARKET AT NO OR MINIMAL COST TO TAXPAYERS 

MARCH 15, 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 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON HOUSING, TRANSPORTATION, AND COMMUNITY DEVELOPMENT

ROBERT MENENDEZ, New Jersey, Chairman 

JIM DEMINT, South Carolina, Ranking Republican Member 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

MICHAEL PASSANTE, Subcommittee Staff Director 

JEFF R. MURRAY, Republican Subcommittee Staff Director 

BETH COOPER, Professional Staff Member 

(II)

C O N T E N T S 

THURSDAY, MARCH 15, 2012 

Page 

Opening statement of Chairman Menendez .......................................................... 1 

WITNESSES 

John C. DiIorio, Chief Executive Officer, 1st Alliance Lending .......................... 2 

Prepared statement .......................................................................................... 21 

Mark Calabria, Director of Financial Regulation Studies, CATO Institute ....... 4 

Prepared statement .......................................................................................... 22 

Laurie S. Goodman, Senior Managing Director, Amherst Securities .................. 6 

Prepared statement .......................................................................................... 31 

(III)

(1) 

STRENGTHENING THE HOUSING MARKET 

AND MINIMIZING LOSSES TO TAXPAYERS 

THURSDAY, MARCH 15, 2012 

U.S. SENATE, SUBCOMMITTEE ON HOUSING, TRANSPORTATION, AND

COMMUNITY DEVELOPMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee convened at 2:33 p.m., in room SD–538, Dirksen Senate Office Building, Hon. Robert Menendez, Chairman of 

the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN ROBERT MENENDEZ 

Chairman MENENDEZ. This hearing will come to order. Thank 

you all for being here today. 

The hearing of the Banking Subcommittee on Housing, Transportation, and Community Development will examine actions that can 

strengthen the mortgage market at no or minimal cost to taxpayers, including mortgage modifications, such as principal reduction or shared appreciation, reducing distressed property sales, and 

increasing demand and people’s ability to buy homes. This hearing 

is an important one since the housing market is often what anchors 

the broader economy and we need to be able to fix the housing 

market to get the broader economy moving more robustly again 

and to create jobs. 

On a regular basis, I hear from New Jersey homeowners who 

have trouble with their home loans, whether it is being denied the 

opportunity to refinance at today’s lower interest rates because 

they are either underwater, or the lost paperwork and years of 

waiting to get an answer on their request from a mortgage modification from their bank, is a constant challenge. 

Like the private sector, the Government should employ more creative tools to reduce defaults and help the housing market recover, 

such as principal reductions and shared appreciation models, 

among other methods. In particular, I would note that private 

banks are finding it more profitable than other methods of mortgage modifications to do principal reductions on about 20 percent 

of their own portfolio loans, and yet the Government is not even 

allowing principal reduction on any of its loans, completely removing that tool from the toolbox. So I would like to explore whether 

or not that makes sense from a simple business judgment perspective about how to best protect taxpayer assets and I look forward 

to examining these innovative methods, among others, to get the 

housing market back on track. 

2 

With no other Member at this point before the Subcommittee, let 

me welcome all of our witnesses and I will introduce you. John 

DiIorio is the Chief Executive Officer for 1st Alliance Lending. Mr. 

DiIorio spent 15 years of experience in the mortgage industry and 

has been at the forefront of loss mitigation and refinance efforts. 

First Alliance is a leading originator of both Hope for Homeowners 

and short refinance loans, so we appreciate you coming. 

Dr. Mark Calabria is the Director of Financial Regulation of the 

CATO Institute, has worked there since 2009. Before that, he was 

a senior member of the professional staff of this Subcommittee and 

we appreciate him coming back. In that position, he worked on 

issues related to housing, mortgage finance, economics, banking, 

and insurance for Ranking Member Shelby and he has appeared 

before the committee many times and we appreciate him coming 

back to discuss today this issue. 

Dr. Laurie Goodman is a Senior Managing Director at Amherst 

Securities responsible for research and business development. Before joining the firm in 2008, she was head of Fixed Income and 

Research at UBS. She has also worked at CitiCorp, Goldman 

Sachs, Merrill Lynch, and the Federal Reserve Bank of New York, 

and she has appeared before us many times and offered great experience. 

So thank you all for coming. With that, Mr. DiIorio, we will start 

with you and ask you to synthesize your oral testimony to about 

5 minutes. All of your statements will be completely included in the 

record and this way we will have a little time to have a discussion. 

Mr. DiIorio. 

STATEMENT OF JOHN C. DIIORIO, CHIEF EXECUTIVE OFFICER, 

1ST ALLIANCE LENDING 

Mr. DIIORIO. Thank you, Senator. Chairman Menendez, Ranking 

Member DeMint, and other Members of the Subcommittee, I appreciate the opportunity to testify before you today. I am the CEO of 

1st Alliance Lending, a mortgage origination firm that is a leader 

in originating FHA loans that offer both affordability and principal 

reduction. We specialize in these loans, which reduce principal for 

underwater borrowers and provide affordable monthly mortgage 

payments. 

There are a number of programs and loan options that have been 

created in the last several years to help troubled homeowners, including HAMP loan modifications, HARP, Fannie Mae, and Freddie 

Mac refinancings, FHA streamlined refinancings, and assistance to 

unemployed homeowners. While these programs address affordability, generally, they do not provide principal reduction. 

We argue, and our experiences substantiate, that principal reduction is critical in concert with affordability efforts in providing 

long-term solutions to American homeowners. Moreover, we are 

finding that sophisticated financial entities with their own money 

at risk in these assets are using principal reduction in a targeted 

manner to maximize the recovery value of these mortgages. There 

is a growing consensus that supports these conclusions and I appreciate the opportunity to share our experiences on this subject. 

According to CoreLogic, at the end of 2011, 11.1 million homes 

are underwater. That simply means the amount of the current 

3 

mortgage exceeds the value of the property. It seems hard to understand how we can address our underlying housing problems and 

restore health to the housing market without addressing this issue. 

Homeowners who are underwater are house-locked, unable to 

sell their home should they need to move for employment. Homeowners who are significantly underwater, particularly in areas 

where housing prices are less likely to recover, face the prospect of 

a very long period in which they will have no equity in their home. 

HAMP and other proprietary loan modifications address affordability problems, but even HAMP assistance phases out over time 

and ultimately borrowers receiving payment modifications will continue to be faced with the challenge of negative equity. 

An often overlooked fact is that principal reduction, done correctly and in a targeted manner, is sometimes the best economic 

option for the holder of the mortgage and often significantly enhances the value of the asset. In fact, we increasingly see holders 

of underwater mortgages utilizing principal reduction as part of 

their asset maximization efforts. These are sophisticated counterparties acting in their own financial best interest. Of course, where 

they utilize this option, it is also good for the homeowner and, by 

extension, for housing markets by reducing risk of default and foreclosure. 

First Alliance Lending works with a number of major banks, investment banks, and sophisticated financial counterparties who 

hold or purchase pools of single-family loans, including loans to 

currently distressed and underwater borrowers. First Alliance analyzes these pools to identify borrowers who qualify for our programs and for whom it makes sense financially to utilize this option. 

We have utilized FHA refinance principal reduction programs, 

which provide opportunities for these types of distressed homeowners to refinance their existing loan, but only the existing first 

mortgage holder forgives a portion of principal in order to meet 

FHA’s loan-to-value requirements. 

For homeowners that qualify, we do far more than the cursory 

calculations that are done for loan modifications. We do full underwrites. We analyze the borrower’s total debt burden-to-income to 

make sure the homeowner is financially sound and capable of 

meeting their financial obligations. These steps are important in 

reducing redefault and foreclosure risk because modifications which 

focus only on payment affordability of the first mortgage loan do 

not take into account the financial stress of other debt that the 

homeowner may have. 

Again, let me emphasize, these investors and mortgage holders 

that we work with agree to principal reductions voluntarily. Moreover, they make the decision to do so in their own financial best 

interest. 

First Alliance has been underwriting FHA loss mitigation loans 

long enough that we now have a track record with seasoned loans. 

From the perspective of the FHA, I am very pleased to let you 

know the redefault rates on these loans are very low, far lower 

than ever expected. As of March 1, our default rate—cumulative 

default rate—was just below 8.6 percent. This performance, we contend, shows the powerful impact of principal reduction. 

4 

There is significant question about moral hazard when it comes 

to principal reduction. I hope we take some time to address those 

questions today because I think it is an important part of the discussion, and I want it to be known, we do not experience a lot of 

moral hazard in our process. We are not seeing borrowers who are 

looking for a free ride or a handout. These are people that have 

genuine hardship. Refinance with principal reduction offers them a 

long-term solution. 

Thank you. I look forward to your questions. 

Chairman MENENDEZ. Thank you very much. 

Dr. Calabria. 

STATEMENT OF MARK CALABRIA, DIRECTOR OF FINANCIAL 

REGULATION STUDIES, CATO INSTITUTE 

Mr. CALABRIA. Chairman Menendez, Senator Corker, other Members of the Committee, thank you for the invitation to appear at 

today’s hearing. 

Before delving into maybe the less cheery aspects of my testimony, let me first say that I believe that there is a very strong 

likelihood that 2012 is going to be the year that the national housing market hits bottom. I expect there to be continued depreciation, 

but I expect it to be small, on the order of around 3 percent. I also 

say I think a number of metropolitan markets might actually see 

positive appreciation later in this year. So the positive is, I do 

think we are getting very close to a bottom. 

A turn around in the housing market, even if it is modest, would 

have a substantial impact on both the mortgage market and the 

overall economy. As importantly, the recent improvements in the 

labor market will ultimately filter through to the housing market. 

In fact, I would say I do not think there is any bigger driver behind 

the housing market today than the labor market. Stabilization or 

modest improvement in house prices will also change the incentive 

for borrowers to default. It is not simply the level of prices, but also 

the direction of prices that impacts a borrower’s decision to default. 

Further appreciation, even from a position of negative equity, will 

reduce the rate of defaults. 

As we know, our housing and mortgage markets are in distress. 

Rather than repeat that here, let me focus on what I think are a 

few bright spots as well as a few dark spots. 

First, despite all the talk about negative equity and strategic default, the vast majority of underwater borrowers continue to pay 

their mortgages. For prime borrowers, over 75 percent of underwater borrowers are current. Even the majority of subprime borrowers are current. The fact is that most Americans believe they 

have an obligation to honor their commitments. According to a recent Fannie Mae National Housing Survey, only about 10 percent 

of respondents thought it was appropriate to walk away from a 

mortgage they could not otherwise pay. On the other hand, about 

a fifth of subprime borrowers with significant positive equity are 

currently 90 days late or more—60 days late or more. We have to 

keep in mind that foreclosure is driven by far more than just equity. 

On the gloomier side, about 40 percent of loans currently in foreclosure have not made a payment in over 2 years. Over 70 percent 

5 

of loans have not made a payment in over a year. Quite frankly, 

it is hard for me to imagine many of these borrowers ever becoming 

current again. 

Almost half of loans currently entering foreclosure today were 

previously in foreclosure at some point in the past. The good news 

is that new problem loans, that is, loans that were current 6 

months previous to becoming late, actually peaked in the spring of 

2009 and have been steadily declining ever since. 

Before turning to where I disagree with my fellow panelists, let 

me first emphasize there is a considerable amount of agreement. 

For instance, I believed increased bulk sales by the GSEs can serve 

as a useful way to get properties back into the marketplace. I believe there is a substantial amount of investor money willing and 

able to purchase GSE REOs in bulk. These purchases could then 

be converted into rental or rehab and sold for home ownership. Of 

course, this must be done in a way to maximize the return for the 

taxpayer. 

Let me emphasize another point of agreement, which is that improving credit availability is perhaps, you know, in my opinion, the 

most important piece. What is holding back our housing market is 

a combination of weak demand and excess supply. Part of that 

weak demand is a result of excessively tight credit standards. My 

estimate is that between 2006 and today, about a fifth of the mortgage market has disappeared. Obviously, some of that credit we do 

not want to come back, but some of it, we do. Of course, drawing 

the appropriate line is always harder in practice than in theory. 

One line that I believe that has been drawn too tightly are the 

Federal Reserve’s 2008 changes to HOEPA. Under these changes, 

and at today’s interest rate, any mortgage over 5.5 percent would 

be considered high cost. We all know that, historically speaking, 

5.5 percent is not a bad rate. Some would say it is actually a great 

rate and is certainly not per se predatory. We also know the 

HOEPA label carries with it substantial regulatory, reputational, 

and litigation risk. While it is hard to measure the exact impact 

of this regulation, the evidence indicates to me that the 2008 

HOEPA changes have eliminated a significant part of our mortgage 

market. 

Laurie in her testimony also touches upon the qualified mortgage 

definition. I think that is something that needs to be rethought, as 

well. It would have a detrimental impact on mortgage availability. 

Now moving to the point of disagreement, namely the topic of 

principal reduction, first, let me say I applaud those lenders and 

investors who have found a way to make it work. I think other 

lenders should take a look at that. I think other investors should 

try to take a look at it. 

But I think that it is important to remember that the Government plays by a different set of rules and incentives. Lenders have 

been able to do principal reduction on a case-by-case basis. I think 

in a world of both politics and, just as importantly, due process, we 

should not pretend that the GSEs should be able to operate in the 

same manner. 

My fellow panelist modified his suggestion for principal reduction 

by saying, quote, ‘‘done correctly and in a targeted manner.’’ Quite 

frankly, these are not terms that I would generally use to describe 

6 

our Federal foreclosure efforts. My fellow panelist has also stated 

that his firm uses principal reduction for borrowers who have experienced an adverse life event and not simply for those who do not 

want to pay. I think this is an incredibly important qualification. 

Ms. Goodman also suggests in her testimony to limit principal reduction to those who are already delinquent. I would agree with 

that here. But if you are going to do principal reduction, which I 

have a great deal of skepticism about, I do believe you need to limit 

it to borrowers who are both already late and have exhibited some 

inability to pay. For those who simply do not want to pay, quite 

frankly, I think we should treat them as anyone else who does not 

want to honor their obligations. Let us be clear that anybody who 

defaults on a GSE or FHA loan is costing the taxpayer and should 

be treated as such. 

Now, I believe the reason that the GSEs should not be forced to 

preserve principal reduction is that loan forbearance, in my opinion, is already an effective and generous method for dealing with 

the inability to pay. If a borrower cannot pay now, then we should 

not require them to do so. In the future, when we hope that they 

can pay, we can require such. I will note that this also allows for 

the preservation of GSE assets that is consistent with the statutory 

language of HERO. 

Again, I thank you for your attention. I look forward to your comments and questions. 

Chairman MENENDEZ. Thank you. 

Dr. Goodman. 

STATEMENT OF LAURIE S. GOODMAN, SENIOR MANAGING 

DIRECTOR, AMHERST SECURITIES 

Ms. GOODMAN. Chairman Menendez and Members of the Subcommittee, thank you for the invitation to testify today. My name 

is Laurie Goodman and I am a Senior Managing Director at Amherst Securities Group, a leading broker-dealer specializing in the 

trading of residential and commercial mortgage-backed securities. 

I am in charge of our strategy effort, which performs extensive 

data-intensive studies in an effort to keep ourselves and our customers informed of critical trends in the market. 

As you know, the housing market remains in very fragile condition. To strengthen the market, we need to decrease the number 

of distressed homes for sale. This is best done by increasing the 

success rate on modification through greater reliance on principal 

reduction. We also need to increase the demand for distressed 

homes, both through a ramp-up of the bulk sales program coupled 

with financing for these properties and a careful vetting of new 

rules that affect already tight credit availability. 

Investors recognize that foreclosure is the worst outcome for both 

the borrower and the investor. If a home is foreclosed on, it will 

sell at a foreclosure discount and the recovery to the investor will 

be further reduced by the heavy costs and expenses that are associated with long foreclosure timelines. It is far more economic for the 

investor if the borrower is given a sustainable modification. 

The types of modifications have changed dramatically over time. 

There are fewer capitalization modifications in which neither interest rate nor principal balance are decreased. There are many more 

7 

rate modifications, and more recently, increased use of principal reduction. As you point out, banks have long used principal reduction 

on their own portfolio. They are now using it extensively for loans 

and private label securities as it has been shown to be the most 

effective type of modification. This makes sense, because you are 

re-equifying the borrower. 

The one place principal reduction is not being used is on Fannie 

and Freddie loans. Fannie and Freddie have no regulatory obstacles to using principal reduction but have chosen not to. Ed 

DeMarco submitted a letter to Congress detailing the results of an 

FHFA study showing that principal reduction does not result in a 

higher value to the GSEs than forbearance. We have reviewed the 

study and have a number of very substantial objections. 

First, there are quite a number of serious technical flaws in the 

conduct of the study, which is outlined in my written testimony, all 

of which have the effect of making forgiveness a less attractive option. One example: The results assume that either all borrowers 

will modify using forgiveness or all modified using forbearance. 

Looking at the benefit to the GSEs of using multiple strategies was 

not considered. 

Second, the Treasury NPV model, a theoretical model, was used 

for the analysis. The principal reduction alternative under HAMP 

has been available for almost 18 months. We have real results and 

they should have been used. 

Finally, the FHFA did not break out loans with and without 

mortgage insurance. Principal forgiveness is most likely not going 

to be NPV-positive for loans with mortgage insurance because the 

GSEs bear the entire cost of the write-down. The insurer does not 

cover the written down amount if the borrower defaults. We believe 

that if the analysis was done correctly, the FHFA would have 

found principal forgiveness makes sense for loans without mortgage insurance, which is two-thirds of their book of business. 

FHFA and the GSEs are very concerned about the moral hazard 

issue. Will borrowers who are current default in order to get a principal write-down? This is a particular worry as more than 90 percent of their book of business is current. We think the moral hazard issue can be easily contained. A provision can be included that 

the borrower has to be delinquent by a certain date to take advantage of it. Alternatively, a feature can be included such that if the 

borrower takes the principal reduction, he shares future appreciation with the lender. Senator Menendez, I know you have been supportive of this idea. 

New measures permitting the GSEs to be eligible for principal 

reduction incentive payments and the recent tripling of these incentives should make it more attractive for the GSEs to do forgiveness. In light of these changes, I would urge the FHFA to redo 

their results, correcting the technical flaws in their study and separating loans with and without mortgage insurance. 

Now, I would like to turn to measures that will increase the demand for housing, bulk sales, and credit availability. We are very 

pleased to see Fannie Mae initiate their bulk sales program. We 

believe the execution will be very favorable to taxpayers because 

large-scale investors will pay a bulk sales premium in order to buy 

a block of homes in a given geographic area. A bulk purchase 

8 

makes it easier to justify the costs of initiating a professional property management organization in that area. Providing financing 

will allow for even more favorable execution, encouraging increased 

use of these programs. I testified before this Subcommittee last 

September on this issue. 

Finally, we are very concerned about credit availability. Lending 

standards were certainly too loose in the 2005 to 2007 period, as 

Dr. Calabria pointed out, but are now too tight, and we are concerned that every single action that is being contemplated will actually make it tighter. Our particular concern is the qualified mortgage, or QM, standards. Dodd-Frank required the CFPB to define 

a qualified mortgage, which is an ability-to-pay measure. The 

CFPB is unlikely to provide servicers with a safe harbor. Most likely, this will be done as a rebuttable presumption. If this is the case, 

a bright line test is critical, as lenders are concerned that default 

itself is evidence of a lack of ability to repay. There is unlikely to 

be a vibrant market for non-QM loans because of the liability associated with originating these loans. Careful crafting of the QM rule 

is critical. A greater uncertainty for lenders means that already 

tight credit availability will get tighter. 

In my testimony today, I have discussed three actions that can 

strengthen the mortgage market at no or minimal cost to taxpayers: Increasing reliance on principal reduction modifications, a 

ramp-up of the bulk sales program coupled with financing for these 

properties, and a careful vetting of new rules that affect already 

tight credit availability. We urge Congress to do everything they 

can to facilitate these actions. 

Thank you very much. 

Chairman MENENDEZ. Thank you all for your testimony. I appreciate it. 

Let me start off the line of questioning. I have a lot of questions, 

but let me start off with one line with you, Ms. Goodman, and it 

is to follow some of your testimony. You know, you cited a number 

of reasons why FHFA’s analysis of principal reduction is either 

flawed or incomplete and I wanted to go through those with you. 

First, I would note that FHFA’s own analysis show that principal 

reduction and principal forbearance are extremely close in their 

value to taxpayers, so even forgetting about the benefits to homeowners of the overall stability of the housing market, just on that 

basis alone, there is an argument to be made from their own analysis. Did the FHFA analysis of principal reduction versus principal 

forbearance include the effect of the Administration’s tripling of incentives for principal reduction? 

Ms. GOODMAN. It did not. 

Chairman MENENDEZ. Could you put your microphone on. 

Ms. GOODMAN. It did not include it. 

Chairman MENENDEZ. Do you think that if they had included 

those incentives, the analysis would change the outcome? 

Ms. GOODMAN. Absolutely. As you point out, it was very close to 

begin with. Their study was done before the triple incentives were 

announced and before Fannie and Freddie were eligible for any of 

these payments. Including these results would most certainly have 

changed the analysis, which, as you point out, was very close to 

begin with. 

9 

Chairman MENENDEZ. You also stated in your testimony that 

FHFA should use principal reduction data in its analysis, not just 

the NPV analysis which has problems. Why is it important to use 

actual data on principal reduction or shared appreciation? 

Ms. GOODMAN. If you were looking to extend a medical drug and 

had some trial results, you would be using those results in your 

case to seek approval to extend the drug. If you have got real results, you should use those real results rather than some theoretical model which was done before those results were available. 

And remember, we have almost 18 months of real HAMP data on 

the principal reduction alternative that should be mined. 

Chairman MENENDEZ. Let me ask you, you went on to say that 

the FHFA should have analyzed loans with mortgage insurance 

and without mortgage insurance—— 

Ms. GOODMAN. Yes. 

Chairman MENENDEZ. ——separately, and that the analysis 

would have likely shown that principal reduction makes sense for 

many loans without mortgage insurance. 

Ms. GOODMAN. Correct. 

Chairman MENENDEZ. Can you explain why breaking down the 

analysis this way matters in terms of targeting loans for which 

principal reduction would be both beneficial to the taxpayer as well 

as the homeowner? 

Ms. GOODMAN. That is correct. You know, the problem with 

doing principal reduction on loans with mortgage insurance is that 

Fannie and Freddie are essentially subsidizing the mortgage insurer. That is, the mortgage insurer does generally not cover the 

amount of forgiven principal. So if you have got a Fannie or 

Freddie loan that a mortgage insurer will cover down to, say, 70 

percent—and Fannie does principal reduction on that loan down to, 

say, 80 percent, the mortgage insurer’s liability is limited to 10 percent rather than to 30 percent as it originally was. 

Chairman MENENDEZ. Now, let me ask you one other thing. 

What does not make sense to me, and maybe you can explain it to 

me, is that the FHFA seems to be saying that there are no GSE 

borrowers in the entire country for whom principal reduction 

makes sense. I mean, this is not a question of just using it across 

the board. But they say it does not make sense anywhere. And yet 

the private sector seems to be saying it makes sense—and they 

make decisions based on the bottom line—for about 20 percent of 

their loans. How does one reconcile that? 

Ms. GOODMAN. I think the FHFA study was seriously flawed in 

that it did not allow some borrowers to get forbearance and some 

borrowers to get forgiveness. It required either all forbearance or 

all forgiveness. And in reality in the private sector, we optimize 

each loan. That is how it should be done and that is how the GSEs 

should be doing it, as well. If they had done this analysis in that 

manner, they would have found that for some loans, principal forgiveness was beneficial both to the taxpayer and to the borrower. 

I think, to some extent, their fears of moral hazard sort of 

clouded the analysis, because every single decision that was made 

in the analysis skews the analysis against finding principal forgiveness to be a profitable strategy. 

10 

Chairman MENENDEZ. And on that question, Mr. DiIorio, you 

said you wanted to talk about moral hazard, the challenge it has 

presented that you did not find in your experiences. Can you talk 

about that for a moment. 

Mr. DIIORIO. Sure. I think one of the problems with moral hazard is it is often misunderstood. Moral hazard is really the assumption that one party in a contractual agreement is going to act irresponsibly because there is lack of consequence. 

We do not see that, and these borrowers are referred to us directly by sophisticated counterparties who are making the decision 

that this is their best economic option. And the borrower really 

does not have much choice as to whether or not that transaction 

proceeds. It is really more in the hands of the current holder of the 

asset. 

So the idea that that is somehow going to lead to mass default 

just does not seem to be supported by reality. It is just not what 

we see every day. 

Chairman MENENDEZ. Thank you. 

Senator Corker. 

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

you for being here. 

Mr. DiIorio, I appreciated your comments about this being tailored appropriately and you all knowing your customers. And I 

guess one of the concerns that people have had with the HAMP 

program is that when Government is doing this in a very broadbased way and does not know its customers, it is very difficult for 

principal reduction programs that, you know, you have a ‘‘check the 

box,’’ you do this box, you do this box. It is a very different arrangement than the way you deal with your customers. And I wonder 

if you might have any additional comments regarding the differences between an entity like you that knows your customers and 

deals with them in a tighter way versus these massive programs 

that we put in place that cannot work in that manner. 

Mr. DIIORIO. Sure. I think that Dr. Goodman’s testimony was 

spot on when she talked about the FHFA analysis, right. They 

were assuming either one blanket solution for their entire portfolio 

or another blanket solution for the entire portfolio. 

Senator CORKER. But is that not the way HAMP is? 

Mr. DIIORIO. Uh—— 

Senator CORKER. I know we are not talking about HAMP for the 

GSEs—— 

Mr. DIIORIO. Yes—— 

Senator CORKER. ——but that is the way our HAMP program is, 

is it not? 

Mr. DIIORIO. Yes, to a certain extent. But I think our experience 

with private investors, right, and all of this is driven by the private 

market, which we think is imperative, is that they are making 

these decisions in sort of a waterfall fashion. So they will say, I 

have got loss mitigation refinance, I have short sale, I have got 

foreclosure, and they have got these different options where they 

can measure their economic recovery based upon a specific situation. We think that is exactly how it needs to be done, that it needs 

to be done on a loan-by-loan analysis. 

11 

Senator CORKER. But the way we set up programs is more of a 

one-size-fits-all process and it is more difficult to do when you are 

just laying out, this is the way the Government is going to do it. 

Is that yes or no? 

Mr. DIIORIO. I do not believe there is a one-size-fits-all solution 

to this problem. 

Senator CORKER. OK. Yes, sir, Dr. Calabria. 

Mr. CALABRIA. If I could just make a quick comment, we do have 

to keep in mind that with any Government program, there are 

basic due process concerns. I mean, to say that one person would 

be eligible and one person would not, all those things are going to 

be repealed. I mean, we do not sit around with unemployment insurance and ask who is going to try harder to find a job or not. You 

are eligible, you get it. 

Senator CORKER. That is right. Following up on that, the principal reductions that we have been talking about, talk a little bit 

about how—let me give an editorial comment. It is my opinion the 

second lien holders are benefiting and the primary lien holder is 

basically having a transference of wealth here, and that is one of 

the big problems with these principal reductions, is it not? Both of 

you. 

Mr. CALABRIA. I think that is absolutely the case. Parties bargain 

for different places in the line, chains of priority. The second liens 

get a higher return. They take a higher risk. You know, quite 

frankly, before any first lien takes a hit, it is my opinion that the 

second lien should be completely wiped out, not a proportional 

change but completely wiped out before the first lien takes a hit 

at all. 

Senator CORKER. And that is not the way the massive settlement 

that we did in the AG’s Office worked, was it? I mean, the second 

lien holders are ending up having the same rights as the first lien 

holders. 

Mr. CALABRIA. Very much a transfer from the first lien holders 

to the second lien holders, which, I will note, more often than not, 

the first lien holders are the investors, whether it is pension funds 

and such, and the second lien holders are the banks. 

Senator CORKER. Yes. Dr. Goodman, do you want to comment? 

Ms. GOODMAN. I agree with everything Dr. Calabria just said, 

and the one thing I would like to emphasize is there is no one who 

has been more of an advocate of principal reduction over the last 

almost 3 years than I have. Nonetheless, the Attorney General’s 

settlement scares me a great deal because, essentially, banks are 

getting credit for writing down investor loans, and it was pointed 

out—— 

Senator CORKER. And, by the way, those investor loans, I am so 

glad that especially you are saying that at this hearing. But those 

investor loans, those are 401(k) programs and pension programs, 

and so what we did was cram down—— 

Ms. GOODMAN. Yes, and there is no—— 

Senator CORKER. ——people’s 401(k)s and investments and we 

benefited second lien holders—— 

Ms. GOODMAN. Yes. 

Senator CORKER. ——did we not? 

12 

Ms. GOODMAN. Yes. The second lien and first lien take a writedown proportionately and the second lien holder should have been 

written off completely before the first lien holder takes a hit. And 

what is even more frightening here is that the banks have broad 

authority to figure out how exactly they want to fulfill the credits 

under this, be it to write down their own loans or to write down 

investor loans. And the potential for abuse is there. 

Senator CORKER. I know the time is up, but let me just ask one 

last question. The rebuttable presumption issue that you have 

brought up that is in Dodd-Frank basically says, I mean, if a lender makes a loan and it ever goes bad, then, in essence, as if they 

should have known better in the first place, which is going to be 

incredibly dampening on credit, and not having a safe harbor is 

going to be a killer going down the road as it relates to credit, is 

that not correct? 

Ms. GOODMAN. Absolutely correct. 

Senator CORKER. Thank you so much for this hearing. 

Chairman MENENDEZ. Thank you, Senator Corker. 

Senator Merkley. 

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

of you for your testimony. 

I wanted to start, Dr. Goodman, with your testimony about the 

NPV model that FHFA used. I was really struck because Members 

of this panel have asked for the details of how that model was constructed to be shared with the U.S. Senate and we have gotten basically nothing, nothing in detail. And I look at what—you are able 

to note the attributes of the loan at origination were used in those 

models rather than current attributes, for example, in FICO scores. 

Were you able to get access to all of the data they generated, and 

how did you do that? We need some education on this, on how to 

get information. 

Ms. GOODMAN. I made about 50 phone calls. 

Senator MERKLEY. Well, good job. 

Ms. GOODMAN. You are correct. The information was not available in one place. We looked through the documentation we had on 

the NPV model and were unable to construct exactly what was 

done in the study and made a bunch of phone calls to figure it out. 

Senator MERKLEY. And so it was not because the FHFA cooperated with you and said, yes, we should make this fully transparent. 

It should be analyzed. It was not because you got that sort of cooperation. 

Ms. GOODMAN. That is correct. We are very persistent. 

Senator MERKLEY. Well, well done, and I am going to renew my 

call to Mr. DeMarco to share his study. It is important for analysts 

to be able to look at the details, because as a former analyst myself, I can tell you the assumptions that are hidden deep inside a 

model, you can bend the outcome pretty much where you want to 

take it, and I think that was your conclusion here. 

Ms. GOODMAN. Absolutely. Thank you. 

Senator MERKLEY. I want to turn to the bulk sale premium program, and I note your enthusiasm for it. And you mentioned a bulk 

sale premium. I assume that is that someone would pay more in 

order to have all the properties in a particular location to facilitate 

a management company being able to service those properties. 

13 

Ms. GOODMAN. That is correct. 

Senator MERKLEY. What level of premium would come from that 

sort of thing? 

Ms. GOODMAN. We will see when the first pilot program is actually executed. You have got a lot of private capital being raised for 

exactly this purpose, and accumulating 3 homes in Indianapolis, 12 

in Atlanta, and 15 in Dallas does a large-scale investor absolutely 

no good because they cannot put into place a professional property 

management organization. 

Being able to accumulate 200 homes in a given area is really, 

really important to being able to put into place that organization. 

So if you want to get into an area, you are willing to most likely 

pay a premium in order to do that, and more of a premium if financing is provided. We will see exactly what the premium looks 

like as a result of the trial program. 

Senator MERKLEY. OK. So I am going to share with you why I 

was not quite as excited as you were, and maybe you can tell me 

where my perspective is off here. But everything that I had seen 

before said that there would be a 30 to 40 percent discount for people who bought the homes in bulk, just because of the large transaction, and I have seen those sorts of deals done in the past, so 

that sounded reasonable to me. 

And I thought, you know, here are all these families out there 

who have a chance to buy a home at historically low prices, low interest rates. Why do we not offer that 30 to 40 percent discount for 

working families to buy these homes first, you know, create a 2- 

month window, and then if they are not sold, then offer them to 

the bulk investors. And I just feel like ordinary families, they do 

not even benefit from the home mortgage interest deduction, and 

the simple math of a $200,000 home with 10 percent down, so you 

are talking $180,000 at 5 percent, that is $9,000 in interest and the 

standard deduction is $11,000. So ordinary families do not even 

benefit from the home mortgage interest deduction. Here is a historic opportunity. Why should we not give families that 30 to 40 

percent discount opportunity, and then if they do not take it, offer 

it to investors? 

Ms. GOODMAN. I think there are a couple of things. Basically, 

there is a benefit to the entire housing market of having the overhang sort of sopped up in bulk. To the extent that you offer it on 

one-off deals first, you end up with extremely adversely selected 

homes available for sale in bulk. 

In addition, another benefit of bulk sales is quick execution. Remember, every day that a home is sitting there, whoever the lender 

is is paying the taxes and insurance on that home. Every day the 

home is sitting vacant or with a borrower who is not paying their 

mortgage, the home is deteriorating and losing value. So to the extent you do bulk sales and you are able to do a lot of properties 

very quickly, it is a benefit to the entire housing market. 

I do not think you are going to see a 30 to 40 percent discount 

on those properties. I would be absolutely shocked. And furthermore, Fannie and Freddie would not sell them at a 30 or 40 percent discount. There would just be no trade. And there are advantages to a quick sale in terms of the ultimate savings to the taxpayer. 

14 

Senator MERKLEY. I take your point. I take your point if there 

is not a substantial discount for the bulk sales, then we are not 

talking about bypassing that for working families. I have seen it 

argued otherwise, but maybe in this pilot project that will not 

exist. I will be interested in following that. 

And your point on quick execution, absolutely. But if there is a 

discount of 30 to 40 percent, you would get quick execution for 

those homes to families, as well. Some of the folks in the audience 

here are reminding us about the 99 percent in America. Sometimes 

we structure deals that continue to benefit really big investors and 

we miss opportunities to help out working families and I just want 

to make sure we do not do that in this case. 

Ms. GOODMAN. Let me just remind you that between Fannie, 

Freddie, and FHA, they have about 211,000 properties in REO 

alone, let alone what is in foreclosure. I think there is enough to 

go around for everyone. 

Senator MERKLEY. Thank you. Thank you, Mr. Chair. 

Chairman MENENDEZ. Thank you. 

I have one or two quick questions. First of all, I want to follow 

up on Senator Corker’s line of questioning. Notwithstanding what 

the AGs did and the consequences to first and second lien holders, 

but particularly first lien holders, is there anything in the line of 

questioning that you and I went back and forth over that would be 

altered by the answer you gave him? 

Ms. GOODMAN. No. Principal reduction is still the best form of 

modification. It still makes more sense to the first lien investor 

than any other alternative. 

Chairman MENENDEZ. Dr. Calabria, let me ask you, on another 

question, you mentioned that one of the major constraints on the 

market is mortgage availability, and I agree that credit issues is 

a problem. Certainly, the odds of a person getting a mortgage if 

you are not in the prime borrowers with substantial downpayment 

is pretty dismal at this time, at least without FHA. What needs to 

happen to increase credit availability for good potential borrowers, 

and is QRM part of this issue, because I am concerned that a QRM 

that some are suggesting is 20, 25 percent down as the standard, 

at the end of the day, eliminates—without looking at a series of 

other factors—eliminates a large swath of responsible borrowers at 

the end of the day. Give me your insights. 

Mr. CALABRIA. Let me say, I absolutely agree that part of the 

problem is credit availability. Part of the problem is obviously we 

do not fully want to go back to, say, 2005, 2006. Some of that credit, we do not want to come back. But absolutely, today, if you are 

a prime borrower who can put a lot down, you can get a great rate. 

If you do not fit into that box, you do not get a loan. 

And so I absolutely have very strong concerns about the risk retention and QRM rules. I have strong concerns about the QM. And 

I have strong concerns about existing HOEPA and TILA regulations in terms of that affecting it. So I do think it is very difficult 

for anybody who is Alt-A or even the higher quality of previous 

subprime to get a loan today in the absence of FHA. And so because I do think we need to have a long-term path to have the taxpayer less backing behind FHA and Freddie and Fannie, we need 

to find ways to get private investors back into this. 

15 

I do not want to beat a dead horse with the AG settlement, but 

the things that do transfer the losses from the lenders to the investors, in my opinion, pushes private capital out of that market. And 

so I do think we need to be concerned about bringing private capital back in the market and not subjecting it to political risk. So 

to the extent that we can rethink any of that and make sure that 

we are drawing the line appropriate so that we do not have predatory lending come back but we do have higher-cost responsible 

lending come back that reflects the credit risk of the borrower, we 

absolutely need to do that. 

Chairman MENENDEZ. Let me ask you one other question. You 

said that a third of all FHA borrowers are now underwater and 

that FHA should exercise their power under Section 203(b)’s program to aid borrowers. Explain to me how that would work. 

Mr. CALABRIA. OK. Well, first, let us start with that most of 

these FHA borrowers, about a third of which are underwater, these 

loans were made since the burst in the bubble, and this is why I 

think we need to draw the line correctly, because it is important 

to get credit availability, but it is also important not to simply create additional foreclosures. 

And so under 203(b), one of the things I have suggested is that 

these loans, by statute, have recourse. And so if a borrower can 

pay, should be expected to pay, and the FHA can exercise that. 

They do not. And I would emphasize that is very different than the 

situation for somebody who cannot pay. And so I think you need 

to be able to separate that. 

And a lot of the talk about principal reduction is about changing 

borrower incentives. I think I would characterize a lot of what Laurie has talked about is providing carrots. I would say that the Federal Government has some ability to provide some sticks for those 

who simply choose not to honor their obligations. For those who 

cannot honor their obligations, we can have a different set of rules. 

Chairman MENENDEZ. For those who cannot honor their obligations, do you consider the possibility—of course, this is a case-bycase basis—of principal reduction as a possibility in the portfolio, 

in the tool of things to be used? 

Mr. CALABRIA. Well, my preference would be that we have to 

keep in mind that it is always the interaction of negative equity 

with something else—job loss, unexpected expense of some sort. So 

my first—one way of sort of parsing out those who can pay but do 

not want to versus those who cannot pay is to look at the underlying cause. So if there is something we could have programs targeted directly toward—if you have lost your job—that, to me, is the 

No. 1 driver. 

But I would say in a very roundabout way to get back to answering your question, yes, that is a legitimate tool for those subset of 

families that I think want to pay, want to stay in the house, but 

are having difficulty, and the solution to me is address that difficulty directly and to remember that it is not the negative equity 

in and of itself causing the difficulty. 

Chairman MENENDEZ. All right. 

Mr. DIIORIO. Senator Menendez—— 

Chairman MENENDEZ. Yes, Mr. DiIorio, go ahead. 

16 

Mr. DIIORIO. I would—unfortunately, Senator Corker has left. On 

the second lien issue, I can promise you, every single transaction 

that goes through our firm, all subordinate liens are extinguished, 

not just second mortgages. And what we see happen is usually the 

first mortgage holder and the subordinate lien holders engage each 

other and they negotiate some sort of agreement that leaves the 

borrower with a single lien. 

So I understand the concerns that are being communicated today 

about the AG settlement and I think that they are somewhat valid, 

but that is not what is happening. Second liens are getting out of 

the way, usually for pennies on the dollar. 

Chairman MENENDEZ. You preempted my question. Thank you 

for that comment. 

Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

thank you for your testimony. I was on the floor, so forgive my late 

arrival. 

Mr. DiIorio, you noted your clients consist of major banks, investment banks, very sophisticated financial institutions. And you further state that, as I understand it, they are in favor of principal 

reduction, quote, ‘‘not out of a sense of charity but because they believe it is in their best financial interest to do so.’’ And so I just 

want to be clear that I presume from your perspective there is a 

very strong business case for principal reduction. It is not a matter 

of being kind to people. It is the bottom line. 

Mr. DIIORIO. Absolutely. Our counterparties, they are making financial decisions. There is a lot of talk about NPV, and it is interesting because they all have different NPV models and they are all 

proprietary and they are all figuring it out in different ways. 

But at the end of the day, what we see, what we see happening 

in the private marketplace is not only are they making the decision, quite frankly, for a segment of their portfolio, it is their first 

choice, and it is their first choice for one specific reason. It is the 

most economically viable solution. 

So that is—back to Dr. Goodman’s testimony about the FHFA 

analysis, you cannot blanket this. It cannot be done. It needs to be 

analyzed. There are certain segments of the portfolio. It is data 

driven. And there is no doubt that for a certain segment of every 

portfolio, principal reduction is the best answer. 

Senator REED. And that would include, obviously, Fannie and 

Freddie. 

Mr. DIIORIO. I believe it does. 

Senator REED. Thank you. You know, just to follow on, what is 

usually thrown up is just not an analytical but an emotional, oh, 

it is moral hazard, and you go on very specifically about the issue 

of moral hazard, ‘‘To the more specific criticism that we are engaging in moral hazard by giving homeowners an incentive to stop 

paying their mortgage, I emphasize, that is not our experience.’’ 

Could you just elaborate. 

Mr. DIIORIO. Sure. It is absolutely not our experience. First, 

these sophisticated counterparties that we were speaking about 

earlier, they refer these borrowers to us to be analyzed. So the borrower is not making a conscious decision to have all of this happen. 

It just kind of happens as a normal course of business. 

17 

And our experience is—and we deal with literally hundreds and 

hundreds of people—there is not this real desire for a handout. 

There is a desire for a solution. 

So is intentional default a real thing? It is real. It is absolutely 

real, but it is very identifiable. If someone is struggling and there 

is no identifiable change event that got them to the point of struggling, that is pretty easy to see. 

My personal view is that moral hazard is overplayed politically. 

I just do not see it as being a real issue. It is certainly not being 

talked about with the people that we are dealing with, that is for 

sure. 

Senator REED. Just a final point, and then I want to go on to Dr. 

Calabria and Dr. Goodman, but your analysis and your clients’ 

analysis is very much because of their duties to their shareholders 

and to the institutions focused exclusively on the benefits to that 

enterprise. But there is a broader benefit here. For example, avoiding foreclosure in neighborhoods, that also adds, and I think it goes 

to some of the failure of the analysis of the FHFA about the systemic effects. 

And just to, again, you are saying there is a business case in the 

specific institutional example, but there might be even a stronger 

argument when you consider the cumulative effect of many enterprises doing that. Is that fair? 

Mr. DIIORIO. It is fair, and, you know, I think it is interesting 

that the number that was mentioned by Senator Menendez was 20 

percent, because we find about 20 percent of our referrals are the 

ones that qualify and actually make it through. So there is probably—and I do not think that is coincidental. So, yes, there is—and 

I think Dr. Goodman referred to the just massive portfolio that 

Fannie and Freddie is holding. I mean, that is clearly where the 

biggest impact can be had from my perspective. 

Senator REED. Let me just skip for a moment over Dr. Calabria 

to go to Dr. Goodman and just follow up on that point. In individual business cases, Mr. DiIorio is better versed on the case that 

in many times, the economics dictate reduction. Fannie and 

Freddie have also the fact that the sheer size of their portfolios, 

that as they began to move in this direction, that will have effects 

beyond the individual properties and even beyond their individual 

portfolios. Is that an accurate assessment, in your view? 

Ms. GOODMAN. Yes, it is. 

Senator REED. And I think you have been, Dr. Goodman, very 

critical of the, just the technical analysis FHFA has done on why 

they do not think principal reduction makes any sense. Could you 

elaborate on what you think the—and I do not want to be redundant. If you have covered that already, let us know. But if you can 

give us sort of the top three or four points that they have missed 

in your view. 

Ms. GOODMAN. Yes. I think there were four serious technical 

issues, ignoring the mortgage insurance issue and ignoring the 

Treasury NPV issue, which we have already talked about. 

First, they used State price level indices, not MSA level indices, 

so they picked up far fewer high LTV borrowers than there actually 

are, and these high LTV borrowers are aided more by principal forgiveness than their lower LTV counterparts. 

18 

Second, and I mentioned this earlier, the results were done on 

a portfolio level, not an individual loan level. So the FHFA did not 

consider the possibility of following a forgiveness strategy for some 

borrowers and a forbearance strategy for others, which clearly 

would have dominated the use of a single strategy. 

Third, the actual HAMP program was not evaluated. That is, the 

actual forgiveness in the HAMP program is the lesser of the current LTV minus the target LTV or 31 DTI. The FHFA automatically assumed principal reduction equal to the current LTV minus 

the target LTV, so they overstated the amount of principal reduction that would have been granted, and that overstatement was 

most severe for higher-income borrowers. 

And last, attributes of the loan at origination, not current attributes, were used for the analysis. So delinquent borrowers, on 

average, have suffered a deterioration in FICO scores. By using 

origination characteristics, the health of the borrowers overstated. 

Hence, the assumed likelihood of success is too high, which overstates the cost of forgiveness. Those were sort of the four technical 

issues. 

Senator REED. I could not have said it any better myself. 

[Laughter.] 

Senator REED. Thank you, Dr. Goodman. I think what is emerging from both your testimony and Mr. DiIorio’s testimony is that 

this is a tool that should be in the FHFA inventory, as it is in the 

private sector, not used perhaps in every situation, but certainly 

used. That is fair. I think I am getting an affirmation there. 

Dr. Calabria, again, thank you for your efforts. I know one of the 

areas where you have been encouraging is REO rental, and that is 

something that FHFA, to be fair, has begun a process. I will not 

get into how there should be more deliberation and speed. But that 

is something, I presume, that you would see as a positive development of FHFA? 

Mr. CALABRIA. I would. If done correctly, to be able to speed 

those properties back into the marketplace, I think that would be 

an important effect, and not just an effect on the overall market, 

but importantly, maximizing the value of the assets of the conservatorship. 

Senator REED. Thank you. 

You know, one of the issues here, too, and it goes to the statutory 

responsibility of FHFA. I know you have considered it, Dr. 

Calabria. And they have repeatedly come back, we cannot do certain things. But there is another aspect of this. We have the Inspector General here and he has made some, based on his analysis, 

conclusions essentially saying that FHFA cannot ensure the efficiency and effectiveness of the oversight program because they do 

not have the staff. FHA is overly deferential to GSEs, that they do 

not try to—even though they seem to have absolute authority over 

them under the legislation, at least that is one impression, and 

that they are not effectively requiring servicers to use, for want of 

a better term, best practices. 

To me, that seems to be a central aspect of their sort of avowed 

statutory purpose of protecting the taxpayers. So if they cannot do 

these things, are they falling down on their first, primary responsibility? 

19 

Mr. CALABRIA. Well, let me preface with, as you know and as I 

fondly remember, one of the reasons we all worked on passing the 

Housing and Economic Recovery Act after three Congresses of trying to do GSE reform was trying to deal with the staffing issues 

of OFHEO, trying to deal with the undue deference. Unfortunately, 

I think a lot of those aspects have remained with FHFA. 

I do think that there is a tension between having these entities 

in conservatorship with the notion that they are still private entities. I think we need to move past, quite frankly, the fraud that 

they are not owned by us. We, the taxpayers, own Freddie and 

Fannie. We should admit it. We should take charge of it. And I 

would encourage, for instance, that we take them into receivership. 

I think if we regulate it, we would have far greater flexibility. I 

would also encourage that any principal reductions or modifications 

that are done are passed on to the debt holders. We are past the 

financial crisis in that regard. So I do not think this needs to be 

passed on to the taxpayer repeatedly. And, of course, that also 

maximizes the return. 

But we do need to make a decision. I think it is fair to say that 

FHFA lacks the staff to run these organizations from the top and 

has had to rely on that, and that certainly is an issue that needs 

to be fixed. 

Senator REED. A final point—and the Chairman has been very 

gracious in his time—is that in the immediate weeks, months, et 

cetera, action is called for, my view. And even though there might 

be a more preferential form, there might be more powers inhibiting 

receivership, again, working with you and your colleagues on the 

legislation creating the conservator, it was envisioned that this conservator would have some strong powers that could require the 

agencies to do certain things, would, in fact, insist that they took 

every reasonable step to fix it. And when we talked to them, they 

say they are doing that, and then we have an IG come in and say, 

well, they are not—under their current legal mandate, not doing all 

that they can. 

Mr. CALABRIA. The distinction I would draw, and I agree that I 

think that their conservatorship powers are quite broad, where I 

would draw the distinction is I do not believe they allow, in my 

opinion, FHFA to take systemic overall marketwide effects into account in what they do. I think that they have a lot of flexibility in 

trying to preserve and conserve the assets of the enterprises, and 

I think that is what they are—so to me, for those who want to 

make the argument and make the push about principal reduction, 

it really needs to be done in context of you are going to preserve 

the assets in a better way within that statutory framework. 

I will say that I have a lot of sympathy for Mr. DeMarco in the 

sense of he is not elected as you are. He is not appointed. And I 

think he has tried to be very conservative in the decisions he has 

made, given that he lacks the legitimacy of someone who has actually been Senate-confirmed, and so that is a very difficult position 

to be in. 

Senator REED. No, I think this is a tough, tough job for anybody. 

I will be the first to say that. 

Can I have a minute? Thank you. Again, the Chairman has been 

very gracious. 

20 

But under the Emergency Economic Stabilization Act of 2008, 

there is at least an argument that not only is there a duty to minimize loss to the taxpayer, FHFA, there is also a responsibility to 

maximize assistance for homeowners and to minimize foreclosures 

and we seldom hear that in the discussion of the FHFA. It is this 

drumbeat of minimizing taxpayer losses. Do they have that, also, 

that dual, or at least complementary responsibility? 

Mr. CALABRIA. What I would say is I believe my read of the statute is that their primary mandate is to nurse the companies back 

to financial health, despite the fact that we all know that they will 

never be back to a position of financial health. 

Quite frankly, I think this is something that Congress needs to 

be resolving. Again, there is—the ambiguities there are beyond 

what would give clear guidance, in my opinion, to the regulator. 

Senator REED. Thank you very much. 

Chairman MENENDEZ. Thank you, Senator Reed. Let me thank 

all of our witnesses for sharing their expertise today. 

I will just make one observation. It seems to me that there are 

two ways to preserve and conserve the assets. One is through foreclosure, and there are times in which that may be the only reality 

in which the greatest preservation or conservation of assets takes 

place. But when the private sector believes that it is in their financial interest, which they seek obviously the greatest return on the 

dollar—for all my friends who are market-driven, well, here is an 

example of 20 percent of the market saying this is the best way for 

us to get the best bottom line. 

So I think in the broad context of preserving and conserving assets, that when you have a universe within a very large portfolio 

in which principal reduction can preserve and conserve assets better than foreclosure, without looking at all the other societal benefits, it is something they should consider. And I hope that what we 

have gleaned from this hearing is that the Government needs to be 

flexible enough to adopt policies that can meet both those goals as 

well as meeting some greater societal values, including maintaining the stability and growth of both the housing market and the 

whole economy, which inures to the benefit of every American. 

So I have asked the FHFA to redo its analysis to take into account the Administration’s tripling of its incentives for principal reduction, to use real data from actual principal reductions rather 

than the NPV analysis alone, which seems to have significant problems, and looking at whether there are any differences in the outcomes between those loans that have mortgage insurance and those 

that do not, and the FHFA needs to do this all quickly and efficiently since we are already years into the foreclosure crisis and we 

have not had enough adequate answers to questions that many 

Members of this Committee have posed. So again, my thanks to all 

of you. The record will remain open for a week from today if any 

Senators wish to submit questions for the record. We look forward 

to, if anyone does, for your answers. And again, with the gratitude 

of the Subcommittee, this hearing is adjourned. 

[Whereupon, at 3:36 p.m., the hearing was adjourned.] 

[Prepared statements supplied for the record follow:] 

21 

PREPARED STATEMENT OF JOHN C. DIIORIO 

CHIEF EXECUTIVE OFFICER, 1ST ALLIANCE LENDING

MARCH 15, 2012 

Chairman Menendez, Ranking Member DeMint, and other Members of the Subcommittee, I appreciate the opportunity to testify before you today. 

I am the CEO of 1st Alliance Lending, a mortgage origination firm that is a leader in originating FHA loans that offer both affordability and principal reduction. We 

specialize in these loans, which reduce principal for underwater borrowers and provide affordable monthly mortgage payments. 

There are a number of programs and loan options that have been created in the 

last several years to help troubled homeowners—including HAMP loan modifications, HARP Fannie Mae and Freddie Mac refinancings, FHA streamlined 

refinancings, and assistance to unemployed homeowners. While these programs address affordability, generally they do not provide for principal reduction. We argue, 

and our experiences substantiate, that principal reduction is critical, in concert with 

affordability efforts, in providing long term solutions to American homeowners. 

Moreover, we are finding that sophisticated financial entities with their own money 

at risk in the mortgages are using principal reduction in a targeted manner to maximize the recovery value of these mortgages. There is a growing consensus that supports these conclusions, and I appreciate the opportunity to share our experiences 

on this subject. 

According to Core Logic, at the end of 2011, 11.1 million homes (over 23 percent 

of all homes nationwide) are underwater. A home is underwater when the amount 

of the mortgage or mortgages a homeowner has on their home exceeds the value 

of that home. It is hard to see how we can address our underlying housing problems 

and restore health to housing markets without addressing this issue. 

Homeowners who are underwater are house-locked—unable to sell their home 

should they need to move for new employment, or any other reasons. Homeowners 

who are significantly underwater, particularly in areas where housing prices are 

less likely to recover, face the prospect of a very long period in which they will have 

no equity in their home. HAMP and other proprietary loan modifications address 

affordability problems, but even HAMP assistance phases out over time and ultimately borrowers receiving payment modifications will continue to be faced with the 

challenge of negative equity. 

An often overlooked fact is that principal reduction, done correctly and in a targeted manner, is sometimes the best economic option for the holder of the mortgage; 

and often significantly enhances the value of the asset. In fact, we increasingly see 

holders of underwater mortgages utilizing principal reduction as part of their asset 

maximization efforts. These are sophisticated counterparties, acting in their own financial interest. Of course, where they utilize this option, it is also good for the 

homeowner, and by extension, for housing markets by reducing the risk of default 

and foreclosure. 

1st Alliance Lending works with a number of major banks, investment banks, and 

sophisticated financial counterparties who hold or purchase pools of single family 

loans, including loans to currently distressed and underwater borrowers. 1st Alliance analyzes these pools of loans to identify borrowers who qualify for our programs and for whom it makes sense financially to utilize this option. We have utilized FHA refinance principal reduction programs, which provide opportunities for 

these types of distressed homeowners to refinance their existing loan, but only if the 

existing first mortgage holder forgives a portion of the principal in order to meet 

FHA’s loan to value (LTV) requirements. 

For homeowners that qualify, we do far more than the calculations that are done 

for loan modifications; we do a complete underwrite. Unlike the typical loan modification analysis, we don’t just make sure a homeowner’s loan payments are affordable, we also address subordinate liens; often extinguishing multiple liens through 

our transaction. We analyze the borrower’s total debt burden and income, to make 

sure the homeowner is financially sound and capable of meeting their debt obligations. These steps are important in reducing redefault and foreclosure risk, because 

modifications which focus only on the payment affordability of the first mortgage 

loan do not take into account the financial stress of other debt that the homeowner 

has that can negatively impact their ability to pay their first mortgage. 

Again, let me emphasize—these investors and mortgage holders that we work 

with agree to principal reduction in these situations voluntarily. Moreover, they 

make the decision to do principal reduction not out of a sense of charity, but because 

they believe it is in their best financial interest to do so. They are sophisticated, 

and are doing these transactions to maximize asset value. 

22 

* Mark A. Calabria, Ph.D., is Director of Financial Regulation Studies at the Cato Institute. 

Before joining Cato in 2009, he spent 7 years as a member of the senior professional staff of 

the U.S. Senate Committee on Banking, Housing, and Urban Affairs. Prior to his service on 

Capitol Hill, Calabria served as Deputy Assistant Secretary for Regulatory Affairs at the U.S. 

Department of Housing and Urban Development, and also held a variety of positions at Harvard 

University’s Joint Center for Housing Studies, the National Association of Home Builders and 

the National Association of Realtors. He has also been a Research Associate with the U.S. Census Bureau’s Center for Economic Studies. He holds a doctorate in economics from George 

Mason University. http://www.cato.org/people/mark-calabria 

1st Alliance has been underwriting FHA loss mitigation loans long enough that 

we now have a track record, with seasoned loans. From the perspective of the FHA, 

I am pleased to report that our default rates on these loans are in the single digits. 

This performance rate is significantly better than original program projections for 

FHA principal reduction loans, and much better than redefault rates in the HAMP 

program, and we believe even better than for proprietary mods without principal reduction. This performance, we contend, shows the powerful impact of principal reduction. 

There has been much discussion over the last few years about the role of Net 

Present Value, also known as NPV, in determining which borrowers should be candidates for any assistance, and, whether or not to use principal reduction as part 

of a loan modification. I would point out that NPV results are highly dependent on 

assumptions you feed into the calculation. I would further point out that many sophisticated market players, with their own money at risk, have made the business 

decision that principal reduction does make sense for certain segments of their portfolios. Therefore, although parties like the FHFA have used NPV calculations to 

conclude that principal reduction is not justified (in their case, for Fannie Mae and 

Freddie Mac loans), I would suggest that they if they have doubts about the value 

of principal reduction, they need not commit wholesale to principal reductions, but 

could start by dipping their feet into the water on a pilot or limited basis, to test 

out how and whether principal reduction is effective. 

Finally, I would like to address the issue of moral hazard. Moral hazard is where 

individuals or firms engage in risky or careless conduct because they are insulated 

from the consequences of such conduct. Over the years, there has been extensive 

discussion about Government intervention and moral hazard—during the reckless 

lending period by allowing zero down and no document loans; in 2008 by bailing out 

financial institutions through TARP; post crisis by helping homeowners who have 

become distressed; and even now as we discuss targeted principal reduction. 

I am not here to debate the question of whether or not to help distressed homeowners, except to note that since early 2009 we have put in place a number of Federal programs to do so. I am here to discuss how to help homeowners fairly and 

effectively. As my testimony indicates, I believe principal reduction should be a component of any comprehensive loss mitigation program. To the more specific criticism, 

that we are engaging in moral hazard by giving homeowners an incentive to stop 

paying their mortgage, I emphasize that is not our experience. Our borrowers have 

experienced an objective adverse event over which they had little or no control, such 

as a loss of income or a serious health issue or problem; a true and validated hardship. None of our borrowers are suspected of intentional default. 

I am not here to advocate for beneficial loans for irresponsible homeowners. I 

have come here to testify to the effectiveness of targeted principal reduction, and 

its role in any responsible and comprehensive loss mitigation strategy. I would 

argue that it is very effective; and I believe the experience of my firm shows how 

responsible, targeted principal reduction can not only be good for the homeowner, 

the housing market, and our communities, but also good for the holders of the existing mortgages. 

Thank you again for the opportunity to testify today. 

PREPARED STATEMENT OF MARK CALABRIA 

DIRECTOR OF FINANCIAL REGULATION STUDIES, CATO INSTITUTE

MARCH 15, 2012 

Chairmans Menendez and Reed, Ranking Members DeMint and Crapo, and distinguished Members of the Subcommittees, I thank you for the invitation to appear 

at today’s important hearing. I am Mark Calabria,* Director of Financial Regulation 

Studies at the Cato Institute, a nonprofit, nonpartisan public policy research institute located here in Washington, DC. Before I begin my testimony, I would like to 

make clear that my comments are solely my own and do not represent any official 

23 

policy positions of the Cato Institute. In addition, outside of my interest as a citizen, 

homeowner, and taxpayer, I have no direct financial interest in the subject matter 

before the Committee today, nor do I represent any entities that do. 

Some Observations on Our Mortgage Market 

Policy options should be informed by facts. A few facts, which I believe are directly relevant to the state of our mortgage markets, particularly the trend in foreclosures and delinquencies are as follows: 

• The vast majority of underwater borrowers are current on their mortgages. 

Even the majority of deeply underwater borrowers are current. For prime borrowers with loan-to-values (LTV) over 125 percent, over 75 percent are current. 

Over half of deeply underwater subprime borrowers are current. (Fitch) 

• GSE underwater borrowers are also preforming, with almost 80 percent current. 

The GSEs’ book of underwater loans has actually seen the percent current increasing over the last year. 

• GSE loans display a smaller percentage (9.9 percent) underwater than loans in 

private label securities (35.5 percent underwater). 

• According to Fannie Mae’s National Housing Survey only about 10 percent surveyed believed it was appropriate for underwater borrowers to simply ‘‘walk 

away.’’ While higher than I would prefer, this does indicate that the risk of 

widespread strategic default is limited. 

• Credit quality of the borrower continues to be the primary predictor of default. 

For borrowers with FICOs in excess of 770, of those deeply underwater (125 

percent LTV) 85 percent are still current. (Fitch) 

• About a fifth of subprime borrowers who have significant equity (LTV < 80 percent) are 60 or more days delinquent. Clearly their situation has nothing to do 

with equity, and everything to do with borrower credit quality. (Fitch) 

• Total delinquencies are down over 25 percent from the peak in January 2010, 

having declined from 10.97 percent to 7.97 percent in January 2012. (LPS) 

• Over 40 percent of loans in foreclosure are over 2 years past due. These loans 

will likely never cure. Only 19 percent of loans in foreclosure are less than 8 

months past due. No one can say, with a straight face, that foreclosures, in general, are happening ‘‘too fast.’’ 

• Almost half of loans, currently entering foreclosure, were previously in foreclosure, that is they are ‘‘repeat foreclosures.’’ (LPS) 

• The rate of new problem loans, those newly seriously delinquent that were current 6 months previous, peaked in Spring 2009, when the economy was hitting 

bottom, and have been steadily declining since. 

• Including distressed transactions, the peak-to-current change in the national 

HPI (from April 2006 to January 2012) was -34.0 percent. Excluding distressed 

transactions, the peak-to-current change in the HPI for the same period was 

-24.2 percent. (CoreLogic) 

The last point is particularly relevant, as the number of underwater borrowers 

greatly depends upon current home values. If home values are based upon distressed transactions, then the number of underwater borrowers would be far greater 

than if one excludes distressed sales. There is some reason to believe the distressed 

sales are not representative of the overall market, for instance they are likely to 

have seen greater physical deterioration. 

State of the Housing Market 

The U.S. housing market remains weak, with both homes sales and construction 

activity considerably below trend. Despite sustained low mortgage rates, housing activity has remained sluggish in 2011. Although construction activity picked up in 

2001, housing starts are still below half the levels seen in 2007. In fact I believe 

it will be at least until 2015 until we see construction levels approach those of the 

boom. In addition to the 4.7 percent decline in existing home prices in 2011, we are 

likely to see additional, but small, declines in 2012. Consensus estimates run around 

a 3 percent decline in home prices for 2012. 

Housing permits, on an annualized basis, increased 0.7 percent from December 

2010 to January 2011 (671,000 to 676,000). Permits for both single family units and 

permits for larger multifamily properties (5+ units) increased slightly, but permits 

for smaller multifamily units fell 4.2 percent. Single family permits increased from 

441,000 to 445,000 in December. Permits for 2–4 unit properties fell (24,000 to 

23,000) in January. Permits for 5+ units climbed to 206,000 in January from 

204,000 in December. 

24 

1Denk, Dietz, and Crowe, ‘‘Pent-up Housing Demand: The Household Formations That Didn’t 

Happen—Yet’’, National Association of Home Builders. February 2011. 

According to the Census Bureau, January 2012 housing starts were at a seasonally adjusted annual rate of 699,000, up slightly from the December level of 689,000. 

Overall starts are up, on an annualized level, from 2011’s 610,700 units. This increase, however, is mostly driven by a jump in multifamily starts, as single-family 

starts decreased slightly. Total residential starts continue to hover at levels around 

a third of those witnessed during the bubble years of 2003 to 2004. 

As in any market, prices and quantities sold in the housing market are driven 

by the fundamentals of supply and demand. The housing market faces a significant 

oversupply of housing, which will continue to weigh on both prices and construction 

activity. The Federal Reserve Bank of New York estimates that oversupply to be approximately 3 million units. Given that annual single family starts averaged about 

1.3 million over the last decade, it should be clear that despite the historically low 

current level of housing starts, we still face a glut of housing. NAHB estimates that 

about 2 million of this glut is the result of ‘‘pent-up’’ demand, leaving at least a million units in excess of potential demand. 1 Add to that another 1.6 million mortgages 

that are at least 90 days late. My rough estimate is about a fourth of those are more 

than 2 years late and will most likely never become current. 

The Nation’s oversupply of housing is usefully documented in the Census Bureau’s Housing Vacancy Survey. The boom and bust of our housing market has increased the number of vacant housing units from 15.6 million in 2005 to a current 

level of 18.4 million. The rental vacancy rate for the 4th quarter of 2011 declined 

to 9.4 percent after increasing to 9.8 percent the previous quarter, although this remains considerably above the historic average. The decline in rental vacancy rates 

over the past year has been driven largely by declines in suburban rental markets. 

The vacancy rate for newly constructed rental units is approaching the rate for old 

construction, but for newly constructed homeowner units it remains considerably 

higher than old construction. 

The homeowner vacancy rate, after increasing from the 2nd and 3rd quarters of 

2010 to the 4th quarter of 2010, declined slowly over the year 2011 to reach 2.3 percent last quarter, a number still in considerable excess of the historic average. 

The homeowner vacancy rate, one of the more useful gauges of excess supply, differs dramatically across metro areas. At one extreme, Greensboro, NC, has an owner 

vacancy rate of well over 6 percent, whereas El Paso, Texas, has a rate of 0 percent. 

Other metro with excessive high owner vacancy rates include: Dayton, OH (6.2); Las 

Vegas (5.5); Columbia, SC (5.1); New Orleans (4.6); and Phoenix (3.6). Relatively 

tight owner markets include: Albany, NY (0.0); Norwalk, CT (0.2); and Tucson, AZ 

(0.3). 

The number of vacant for sale or rent units has increased, on net, by around 3 

million units from 2005 to 2011. Of equal concern is that the number of vacant units 

‘‘held off the market’’ has increased by about 1.5 million since 2005. In all likelihood, 

many of these units will re-enter the market once prices stabilize. 

The 4th quarter 2011 national home ownership rate fell to 66.0 percent, which 

is approximately where it was in 1997, effectively eliminating all the gain in the 

home ownership rate over the last 12 years. Declines in the home ownership rate 

were the most dramatic for the youngest homeowners, while home ownership rates 

for those 55 and over were generally stable or even increasing. This should not be 

surprising given that the largest increase in home ownership rates was among the 

younger households and that such households have less attachment to the labor 

market than older households. Interestingly enough, the decline in home ownership 

was higher among households with incomes above the median than for households 

with incomes below the median, which held steady. 

Home ownership rates declined across the all Census Regions except for the 

Northeast (which held steady), the steepest decline was in the West, followed by the 

Midwest. The South witnessed the smallest decline in home ownership since the 

bursting of the housing bubble. 

Homeowner vacancy rates differ dramatically by type of structure, although all 

structure types exhibit rates considerably above historic trend levels. For 4th quarter 2011, single-family detached homes displayed an owner vacancy rate of 2.0 percent, while owner units in buildings with 10 or more units (generally condos or coops) displayed an owner vacancy rate of 8.3 percent. Although single-family detached constitute 95 percent of owner vacancies, condos and co-ops have been impacted disproportionately. Over the last year homeowner vacancy rates have declined slightly for single-family structures but more dramatically for condos or coops, albeit from a much higher level. 

25 

2 Edward Glaeser and Joseph Gyourko, ‘‘The Case Against Housing Price Supports’’, Economists’ Voice, October 2008. 3 Also see, Robert Shiller, ‘‘Unlearned Lessons From the Housing Bubble’’, Economists’ Voice, 

July 2009. 

Owner vacancy rates tend to decrease as the price of the home increases. For 

homes valued between $100,000 and $150,000 the owner vacancy rate is 2.5 percent, 

whereas homes valued over $200,000 display vacancy rates of about 1.3 percent. The 

clear majority, almost 63 percent, of vacant owner-occupied homes are valued at less 

than $300,000. Owner vacancy rates are also the highest for the newest homes, with 

new construction displaying vacancy rates twice the level observed on older homes. 

While house prices have fallen considerably since the market’s peak in 2006—over 

23 percent if one excludes distressed sales, and about 31 percent including all 

sales—housing in many parts of the country remains expensive, relative to income. 

At the risk of oversimplification, in the long run, the size of the housing stock is 

driven primarily by demographics (number of households, family size, etc.), while 

house prices are driven primarily by incomes. Due to both consumer preferences and 

underwriting standards, house prices have tended to fluctuate at a level where median prices are approximately 3 times median household incomes. Existing home 

prices, at the national level, are close to this multiple. In several metro areas, however, prices remain quite high relative to income. For instance, in San Francisco, 

existing home prices are almost 8 times median metro incomes. Despite sizeable decline, prices in coastal California are still out of reach for many families. Prices in 

Florida cities are generally above 4 times income, indicating they remain just above 

long-run fundamentals. In some bubble areas, such as Phoenix and Las Vegas, 

prices are below 3, indicating that prices are close to fundamentals. Part of these 

geographic differences is driven by the uneven impact of Federal policies. 

Household incomes place a general ceiling on long-run housing prices. Production 

costs set a floor on the price of new homes. As Professors Edward Glaeser and Joseph Gyourko have demonstrated, 2 housing prices have closely tracked production 

costs, including a reasonable return for the builder, over time. In fact the trend has 

generally been for prices to about equal production costs. In older cities, with declining populations, productions costs are often in excess of replacement costs. After 

2002, this relationship broken down, as prices soared in relation to costs, which also 

included the cost of land. 3 As prices, in many areas, remain considerably above production costs, there is little reason to believe that new home prices will not decline 

further. 

It is worth noting that existing home sales in 2010 were only 5 percent below 

their 2007 levels, while new home sales are almost 60 percent below their 2007 

level. To a large degree, new and existing homes are substitutes and compete 

against each other in the market. Perhaps the primary reason that existing sales 

have recovered faster than new, is that price declines in the existing market have 

been larger. Again excluding distressed sales, existing home prices have declined 23 

percent, whereas new home prices have only declined only about 10 percent. I believe this is clear evidence that the housing market works just like other markets: 

the way to clear excess supply is to reduce prices. 

State of the Mortgage Market 

According to the Mortgage Bankers Association’s National Delinquency Survey, 

the delinquency rate for mortgage loans on one-to-four-unit residential properties 

decreased to a seasonally adjusted rate of 7.58 percent of all loans outstanding for 

the end of the 4th quarter 2011, 41 basis points down from 3rd quarter 2011 and 

down 67 basis points from 1 year ago. 

The percentage of mortgages on which foreclosure proceedings were initiated during the fourth quarter was 0.99 percent, 9 basis points down from 2011 Q3 and 

down 28 basis points from 2010 Q4. The percentage of loans in the foreclosure process at the end of the 4th quarter was 4.38 percent, down slightly at 5 basis points 

from 2011 Q3 and 26 basis points lower than 2010 Q4. The serious delinquency rate, 

the percentage of loans that are 90 days or more past due or in the process of foreclosure, was 7.73 percent, a decrease of 16 basis points from 2011 Q3, and a decrease of 87 basis points from 2010 Q4. 

The combined percentage of loans in foreclosure or at least one payment past due 

was 12.53 percent on a nonseasonally adjusted basis, a 10 basis point decrease from 

2011 Q3 and 107 basis points lower than 2010 Q4. 

Extent of Negative Equity 

Despite that the vast majority of underwater borrowers continue to pay their 

mortgages, concerns about negative equity dominate policy debates surrounding the 

26 

4 Andrew Haughwout, Ebiere Okah, and Joseph Tracy, ‘‘Second Chances: Subprime Mortgage 

Modifications and Re-Default’’, Federal Reserve Bank of New York Staff Reports no. 417. August 

2010. 

mortgage market. According to CoreLogic, 11.1 million, or 22.8 percent, of all residential properties with a mortgage (recall that about a third of owners own their 

homes free and clear) are in a negative equity position. This situation is highly concentrated in terms of geography. The top five States (NV, AZ, FL, MI, and GA) display an average negative share of 44.3 percent. The remaining States have a combined average negative share of 15.3 percent. Any taxpayer efforts to reduce negative equity would largely be a transfer from the majority of States to a very small 

number. 

Of those with negative equity, 4.4 million have both first and second mortgages. 

The average LTV of these borrowers is 138 percent, implying that in the event of 

a foreclosure, the second lien would likely have little, if any value. Efforts to modify 

first liens only, or to modify firsts and seconds in proportion, are, in effect, transfer 

from the first lien holder to the second. We should reject such transfers, as they 

violate the basic principles of contract and property, and require all seconds to be 

eliminated before any loss are taken on first liens. 

While less than half of those with negative equity have second liens, those that 

do constitute a far greater share of negative equity borrowers. Those with both first 

and second liens display a negative equity share of 39 percent, twice that for borrowers with a first lien only. Of the estimated $717 billion in negative equity just 

over half is from borrowers with both first and second liens. My estimate is that 

about a fourth of negative equity is in the form of second liens. 

For pressing importance for policy makers is the fact that just under 2 million 

FHA borrowers are underwater. The vast majority of these borrowers took out mortgages since the beginning of the housing bust. Just under a third of all FHA borrowers that took loans out since the housing bust are now underwater. That giving 

borrowers near-zero equity loans in a deflating housing market would result in 

widespread negative equity should have been obvious (it was to me), but that is of 

course ‘‘water under the bridge.’’ The important issue now is mitigating that risk. 

As FHA’s 203(b) program does have the power of full recourse, I urge FHA to advertise that power and implement programs to exercise it. In addition delinquent FHA 

borrowers should be reported immediately the to IRS, so that any tax refunds can 

be used instead to off-set losses to the taxpayer. My estimates are that FHA is likely 

to require between $10 and $50 billion over the next 5 to 6 years in order to honor 

all claims. 

New York Federal Reserve Study 

An August 2010 study by economists at the Federal Reserve Bank of New York 

has generated considerable interest as a road-map for reducing mortgage defaults. 4

Specifically the study has been used to argue for increased principal reduction as 

a way to reduce defaults. While the study has a number of flaws, for instancing assuming that all redefaults only occur within 12 months of a modification, the study 

does take the appropriate approach in examining borrower incentives. The study 

correctly treats borrowers as choosing to default, rather than modeling default as 

something that simply ‘‘happens’’ to the borrower. The impact of principal reduction 

is also relative small, lower the author’s estimated 12 month redefault rate of 56 

percent by 4.5 percent to 51.5 percent. So even if we adopted the author’s proposal, 

over half of modified loans would still redefault. 

Not surprisingly proponents of principal reduction are choosing which parts of 

this study they like and discarding the parts they do not. For instance the study 

finds that ‘‘each additional month that a borrower can expect to live rent-free in the 

house increases the 12 month redefault rate by 0.6 percentage points.’’ To put that 

in perspective, the difference in the overall foreclosure process between judicial 

States and nonjudicial foreclosure States in about 18 months. At 0.6 percentage 

points a month, if judicial States switched to an administrative process, redefault 

rates would decline by an estimated 10.8 percentage points or twice the impact one 

gets from a 10 percent reduction in principal. States with allow recourse have redefault rates that are 1.8 percentage points lower. Interestingly enough the authors 

find that the lower are area house prices, compared to their 2000 values, the lower 

are redefault rates. Attempts to keep prices above their pre-bubble rates have, to 

some extent, increased defaults. The logic is that a borrower’s decision to default 

is based not solely on current equity but also on the expected path of future home 

prices. If we can get to the bottom, which I believe we are nearing, then borrowers 

will have greater incentives to maintain their mortgage. 

27 

5See, C. Lowell Harriss, ‘‘History and Policies of the Home Owners’ Loan Corporation’’, National Bureau of Economic Research, 1951. http://www.nber.org/books/harr51-1 6 Nick Timiraos, ‘‘Mortgage Deal Built on Tradeoffs’’, Wall Street Journal, Monday, March 12, 

2012, C1. 

If You Are Going To Modify . . . 

While I remain quite skeptical of many of the efforts at mortgage modification, 

as most seem aimed at dragging out the problem and avoiding the inevitable correction of the housing market, if we are going to continue offering modifications to delinquent and/or underwater borrowers, we should include the following provisions: 

• All modifications should include and exercise recourse. 

• Modifications should be limited to those have been current at some point within 

the previous year. 

• Modifications should be targeted to those who display a ‘‘willingness to pay’’ but 

lack the ability to do so. 

Current modification programs have often been inspired by the creation of the 

Home Owners Loan Corporation (HOLC) in 1933, which refinanced borrowers into 

‘‘affordable’’ long term loans. Apparently the nostalgia for the HOLC has encouraged 

an ignorance of its actual workings. The HOLC practiced aggressive recourse, for 

instance. So much so that a third of its total revenues were derived from deficiency 

judgments. The HOLC also limited assistance to creditworthy borrowers who demonstrated a willingness to pay. If we wish to mimic the claimed success of the HOLC 

than we also need to understand how it functioned. 5

There are some reports that the recent robo-signing settlement with give banks 

up to $1.7 billion in credit against the overall settlement if they waive their right 

to pursue deficiency judgments. 6 The empirical literature is fairly robust on this 

point: the existence of deficiency judgments reduces foreclosures. This aspect of the 

settlement will likely increase foreclosures. 

What’s a Conservator For? 

Criticism has been directed at FHFA for not either allowing or forcing Fannie 

Mae and Freddie Mac to engage in principal reductions. Much of this criticism has 

take the form of claims that the GSEs, and hence FHFA, are not ‘‘doing enough’’ 

to turn around the housing market. Blogger Matt Yglesias suggests that ‘‘clearly the 

purpose of creating the FHFA and taking Fannie and Freddie into conservatorship 

can’t have been to minimize direct taxpayer financial losses on agency debt.’’ This 

claim, and others like it, are mistaken. The Housing and Economic Recovery Act 

(HERA) of 2008 is quite clear when it comes to the duty and responsibilities of 

FHFA when acting as a conservator. 

A simple read of the statute, Section 1145 of HERA, which amends Section 1367 

of the 1992 GSE Act, clearly states the purpose, duties, and role of a conservatorship. What does the law say the powers of a conservatorship are? They are to ‘‘take 

such action as may be—(i) necessary to put the regulated entity in a sound and solvent condition; and (ii) appropriate to carry on the business of the regulated entity 

and preserve and conserve the assets and property of the regulated entity.’’ 

Some proponents of principal reduction have found language elsewhere in HERA 

which they believe allows for considerations beyond those found in Section 1145. 

But this argument relies on general introductory sections of the statute, not the 

powers and duties of FHFA as a conservator. Statutory interpretation requires that 

more specific sections trump general introductory sections. General sections have 

‘‘no power to give what the text of the statute takes away’’ (Demore v. Kim, 538 U.S. 

510, 535). 

Given FHFA’s estimate that a broad based program of principal reduction would 

cost almost $100 billion, the argument that an unelected, unappointed, acting agency head should, in the absence of statutory authority, spend $100 billion on taxpayer 

money is simply inconsistent with our system of Government. While agencies such 

as the Federal Deposit Insurance Corporation felt free to violate the law during the 

crisis, Acting FHFA Director DeMarco should be commended for his faithfulness to 

the letter of the law. If $100 billion of taxpayer dollars is to be spent on principal 

reduction, it is the responsibility of Congress to make that decision. To suggest this 

action be implemented without Congressional approval would only further erode the 

already diluted powers of Congress relative to the other branches of Government. 

Members had the opportunity during the passage of HERA to increase the powers 

and duties of FHFA as conservator. Congress decided not to. 

28 

The Problem Is Mortgage Availability 

The problem facing our housing market is a combination of weak demand and excess supply. All policy proposals should first be evaluated on that basis. One of the 

constraints on demand is mortgage availability. If one is a prime borrower, who can 

make a substantial down payment, then mortgages are both cheap and plentiful. If 

one is not, then a mortgage is difficult, if not impossible to get. 

This decline in mortgage availability derives from a variety of factors, some good, 

some bad. For instance the most irresponsible lending, with the exception of FHA, 

is gone (for how long, who knows). That is a good thing. Unfortunately much of the 

Alt-A and higher quality subprime lending is also gone. That is not such a good 

thing. By my estimate about a fifth of the mortgage market has disappeared, holding back housing demand. One of the factors contributing to that disappearance is 

the combination of Federal Reserve interest rate policy with Federal mortgage regulation. For instance under HOEPA, today any mortgage over 5.5 percent is considered ‘‘high-cost.’’ Such mortgages now carry considerable regulatory, reputation, and 

litigation risk. Anyone with just a basic knowledge of financial history knows that 

5.5 is, historically speaking, a great rate, not a predatory one. Charts, at the end 

of this testimony, display the distribution of mortgages rates charged in 2006 and 

2011. It should be immediately clear that 2006 largely resembled a normal distribution. 2011, however, has seen the right side of that distribution largely eliminated. 

Clearly the distribution of mortgage rates in 2011 is near normal nor symmetric. 

I believe the Federal Reserve’s 2008 HOEPA regulation has contributed to this abnormality. Of course there are other factors, again some good, some bad. 

Foreclosure Mitigation and the Labor Market 

There is perhaps no more important economic indicator than unemployment. The 

adverse impacts of long-term unemployment are well known, and need not be repeated here. Although there is considerable, if not complete, agreement among 

economists as to the adverse consequences of jobless; there is far less agreement as 

to the causes of the currently high level of unemployment. To simplify, the differing 

explanations, and resulting policy prescriptions, regarding the current level of unemployment fall into two categories: (1) unemployment as a result of lack of aggregate demand, and (2) unemployment as the result of structural factors, such as 

skills mismatch or perverse incentives facing the unemployed. As will be discussed 

below, I believe the current foreclosures mitigation programs have contributed to 

the elevated unemployment rate by reducing labor mobility. The current foreclosures mitigation programs have also helped keep housing prices above marketclearing levels, delaying a full correction in the housing market. 

First we must recognize something unusual is taking place in our labor market. 

If the cause of unemployment was solely driven by a lack of demand, then the unemployment rate would be considerably lower. Both GDP and consumption, as 

measured by personal expenditures, have returned to and now exceed their precrisis 

levels. But employment has not. Quite simply, the ‘‘collapse’’ in demand is behind 

us and has been so for quite some time. What has occurred is that the historical 

relationship between GDP and employment (which economists call ‘‘Okun’s Law’’) 

has broken down, questioning the ability of further increases in spending to reduce 

the unemployment rate. Also indicative of structural changes in the labor market 

is the breakdown in the ‘‘Beveridge curve’’—that is the relationship between unemployment and job vacancies. Contrary to popular perception, job postings have been 

steadily increasing over the last year, but with little impact on the unemployment 

rate. 

Historically many job openings have been filled by workers moving from areas of 

the country with little job creation to areas with greater job creation. American history has often seen large migrations during times of economic distress. And while 

these moves have been painful and difficult for the families involved, these same 

moves have been essential for helping the economy recover. One of the more interesting facets of the recent recession has been a decline in mobility, particular among 

homeowners, rather than an increase. Between 2008 and 2009, the most recent Census data available, 12.5 percent of households moved, with only 1.6 moving across 

State lines. Corresponding figures for homeowners is 5.2 percent and 0.8 percent 

moving across State lines. This is considerably below interstate mobility trends witnessed during the housing boom. For instance from 2004 to 2005, 1.5 percent of 

homeowners moved across State lines, almost double the current percentage. Interestingly enough the overall mobility of renters has barely changed from the peak 

of the housing bubble to today. This trend is a reversal from that witnessed after 

the previous housing boom of the late 1980s burst. From the peak of the bubble in 

1989 to the bottom of the market in 1994, the percentage of homeowners moving 

across State lines actually increased. 

29 

The preceding is not meant to suggest that all of the declines in labor mobility, 

or increase in unemployment, is due to the foreclosure mitigation programs. Far 

from it. Given the many factors at work, including the unsustainable rate of home 

ownership, going into the crisis, it is difficult, if not impossible, to estimate the exact 

contribution of the varying factors. We should, however, reject policies that encourage homeowners to remain in stagnant or declining labor markets. This is particularly important given the fact that unemployment is the primary driver of mortgage 

delinquency. 

Minimizing Losses to Taxpayers 

As the title of today’s hearing implies an important objective of policy should be 

to protect the taxpayer from further loss. We should never forget that the taxpayer 

has already poured $180 billion in the rescue of Fannie Mae and Freddie Mac. It 

is unlikely that much, if any, of this will ever be recovered. In addition the taxpayer 

potentially faces the cost of rescuing the Federal Housing Administration (FHA). I 

believe there is a significant likelihood that the taxpayer will have to inject somewhere between $10 to $50 into FHA over the next 5 to 6 years. 

The most effective way to protect the taxpayer would be to simply stop. Stop covering the losses of Fannie Mae and Freddie Mae and do not impose policies that 

would dig the current hole any deeper. We are well past the height of the financial 

panic. And as the recent mortgage settlement demonstrated, policy makers appear 

to have no problem with imposing losses on investors. The same should be applied 

to Fannie Mae and Freddie Mae. Future losses should be borne by the debt-holders 

of those companies, not the taxpayer. Accordingly Fannie Mae and Freddie Mac 

should be moved immediately out of conservatorship and into receivership, where 

losses can be imposed upon those investors who willingly risked their own money 

(the same cannot be said for the taxpayer). 

As FHFA estimates that a program of principal forgiveness for all underwater 

GSE mortgages could cost as much as $100 billion, it should be very clear that such 

would not minimize losses to the taxpayer. 

Summary of Policy Proposals 

• Repeal/Suspend/Modify Existing HOEPA Regulations. 

• Require recourse for all federally related modifications. 

• End programs, like ‘‘Neighborhood stabilization,’’ that add to housing supply. If 

spending, use such to increase demand, not supply. 

• Reform FHA to minimize embedded losses. 

Conclusion 

The U.S. housing market is weak and is expected to remain so for some time. 

Given the importance of housing in our economy, the pressure for policy makers to 

act has been understandable. Policy should, however, be based upon fostering an 

unwinding of previous unbalances in our housing markets, not sustaining said 

unbalances. We cannot go back to 2006, and nor should we desire to. As the size 

and composition of the housing stock are ultimately determined by demographics, 

something which policy makers have little influence over in the short run, the housing stock must be allowed to align itself with those underlying fundamentals. Prices 

should also be allowed to move towards their long run relationship with household 

incomes. Getting families into homes they could not afford was a major contributor 

to the housing bubble. We should not seek to repeat that error. We must also recognize that prolonging the correction of the housing market makes the ultimate adjustment worse, not better. Lastly it should be remembered that one effect of boosting prices above their market-clearing levels is the transfer of wealth from potential 

buyers (renters) to existing owners. As existing owners are, on average, wealthier 

than renters, this redistribution is clearly regressive. 

30 


2006 

2011 

,~ .---------------------------------------------------------------------, 

". 

" 
31 

PREPARED STATEMENT OF LAURIE S. GOODMAN 

SENIOR MANAGING DIRECTOR, AMHERST SECURITIES

MARCH 15, 2012 

Chairman Menendez and Members of the Subcommittee, I thank you for your invitation to testify today. My name is Laurie Goodman, and I am a Senior Managing 

Director at Amherst Securities Group, LP, a leading broker/dealer specializing in 

the trading of residential and commercial mortgage-backed securities. We are a 

market maker and intermediary in these securities, dealing with many of the largest financial institutions, insurance companies, money managers and hedge funds. 

I am in charge of the Strategy effort, which performs extensive, data-intensive studies as part of our efforts to keep ourselves and our customers informed of critical 

trends in the residential mortgage-backed securities market. 

In my testimony today, I will discuss three actions that can strengthen the mortgage market, at no or minimal cost to taxpayers: increasing reliance on principal 

reduction modifications; a ramp up of the bulk sales program, coupled with financing for these properties; and a careful vetting of new rules that affect already tight 

credit availability. 

Sizing the Challenge 

As we look across the U.S. housing landscape, our empirical studies have convinced us that there are a huge number of borrowers (7.4–9.3 million) yet to face 

foreclosure and eventual liquidation. The expected liquidations break down into the 

following categories: 

Thus, if we stay on the present course, of the 52.5 million total U.S. homes with 

a mortgage, 14.1–17.7 percent, or 7.4–9.3 million of these borrowers face foreclosure 

and eventual liquidation. To absorb this large number of housing units that will face 

foreclosure and eventual liquidation, we need to both limit the supply of AND increase the demand for distressed properties. To limit supply, we need more successful loan modifications. For this, we believe increased reliance on principal reduction 

is the key. To increase demand, we need a successful bulk sales program to bring 

institutional investors into the housing market. We also need broader credit availability standards, yet every single governmental action that is being considered 

seems to further constrain credit availability. 

Most of my testimony will be focused on supply side measures; namely, improving 

modification success through greater reliance on principal reductions. Then I will 

take up demand side measures. I will touch upon the new Government program to 

sell single family properties to investors (for turning into rental units; a program 

we believe will be ultimately very successful). Finally, I will delve into the negative 

impact of constrained credit availability, and my concern about impending regulations that will exacerbate this issue. All of my recommendations in this testimony 

(expanded use of principal reductions, the bulk sales program, and fully vetting the 

impact of new rules or guidelines that affect credit availability) require very limited 

use of taxpayer money. 

Why Investors Support Modification Activity 

Modification success has improved dramatically over time. In private label (nonagency residential mortgage) securitizations, for modifications performed during the 

32 

first half of 2011, the average redefault rate after 12 months is down to 30 percent, 

versus 70 percent performed during the first half of 2009. The improved results reflect two factors: (1) the way modifications are counted has changed, which has improved reported success rates, and (2) modifications have become much more significant, increasing the appeal to borrowers remaining in the home. This has genuinely 

improved success rates. 

1. Change in modification count methodology—There was no trial period for modifications completed in early 2009 and earlier. The modification was ‘‘counted’’ 

the minute it was initiated, yet many modifications failed in the first 3 months, 

which boosted the failure rate of those early modifications. The trial period was 

introduced as part of the HAMP program, and was quickly adopted for proprietary modifications. 

2. Modifications have become more significant over time—The HAMP modification program has been important in that it provided a blueprint for significant 

pay relief for the borrower. And modifications that provide more significant relief have resulted in much lower redefault rates than earlier modifications that 

did not. 

It’s the investors in private label securitizations who bear the cost of any modification on those securities, be it a principal reduction or an interest rate decrease. 

However, investors in private label securitizations have been very supportive of 

modification efforts. Why? Investors recognize that foreclosure is both the worst outcome for the borrower AND the investor. A simple example in Exhibit 1 (next page) 

makes this argument concrete. The data in the exhibit are real, drawn from the universe of private label securities that were liquidated in the past month. The average 

loan balance is $279,184, but if we marked these homes to market, the current market value of the homes averaged only $227,046 (thus ‘‘underwater’’ with a loan-tovalue ratio of 123 percent) due to price depreciations on the properties. If the property were liquidated the investor would not realize that market value of $227,046, 

since homes in foreclosure usually sell at a discount. The investors should have realized a gross recovery, net of broker commission, on the property of $173,591 

(amounting to a 62.2 percent of the current loan balance, or 76 percent of current 

market value). Furthermore, there are other costs to subtract from the sale proceeds 

due the investor, arising from the borrower having been, on average, 26 months delinquent at liquidation. These costs are sizeable; advances for tax and insurance 

total $21,927 and other direct costs associated with foreclosure and liquidations 

total $7,452. Finally, every day a house remains in nonperforming status, with either a homeowner who is not maintaining the property, or the home sitting vacant—the property is deteriorating. We estimate that the deterioration factor decreases property value by another $13,842 over the 26-month average period of delinquency. These costs are all captured in Exhibit 1. Note that collectively an investor nets $130,370 ($173,591–$43,221), for a 46.7 percent net recovery (or a 53.3 percent loss per loan balance). The recovery to the investor in private label 

securitizations will be even lower, because, upon the liquidation of the trust, the 

servicer will be reimbursed for any payments of delinquent principal and interest 

that he has made to the trust. 

33 

An investor would be far better off if a substantial payment reduction had been 

offered to the borrower, to reduce the loan payment to an affordable level, rather 

than going through foreclosure and liquidation (and the investor ending up with 

only 46.7 percent of the loan being repaid). If the borrower were offered a principal 

reduction to 100 percent of the current market value of the home ($227,046) and 

was able to make the payments associated with this loan, both the borrower and 

the investor would be much better off. The investor now has a loan worth $227,046 

rather than $130,370. 

My representation that investors are in favor of modifications is not to say that 

there is no room for improvement—there is. Here are some of the most important 

weaknesses from the point of view of investors: 

• Servicers are in charge of performing the modification. But they are massively 

conflicted, as they often own the second lien on the same property, but service 

both the first lien and the second lien. We believe that special servicers, who 

specialize in dealing with nonperforming loans, are apt to demonstrate a track 

record for better modification success, as: (1) they are not in a position of conflict; and (2) they can review the full range of alternatives in order to maximize 

the value of the loan, not just whether a given modification is better than foreclosure (which sets a low bar for a standard of delivering final proceeds to settle 

a loan, as illustrated above). 

• A modification considering the borrower’s total debt situation (including second 

liens, credit cards, auto loans, etc., which are often collectively referred to as 

‘‘back-end debt-to-income ratio’’) will be more successful than one only considering the payments on the first lien, plus taxes and insurance (the ‘‘front-end 

debt-to-income ratio’’). In fact, we believe the best way to have structured the 

modification program was to re-underwrite the loan for sustainability, while respecting lien priority. In many cases, this means the second lien would be written off entirely, and the first lien would be resized. In a more optimal world 

other debts would also be resized. 

• Re-equifying the borrower is critical. Borrowers who are deeply underwater are 

less likely to commit to a successful modification. This suggests that principal 

reductions should be more effective than other types of modifications (rate modifications or capitalization modifications)—and they are proving to be so. 

34 

1OCC Mortgage Metrics Report—Third Quarter 2011, Office of the Comptroller of the Currency/Office of Thrift Supervision, dated 12/21/2011. 

It is important to take a step back and outline the three basic modification types: 

principal balance modifications, rate modifications, and capitalization modifications. 

In a principal modification, the principal balance is reduced. This can take the form 

of principal forbearance (deferral), in which the borrower still owes the money, but 

does not pay interest on it, and principal forgiveness, in which the borrower does 

not owe the money. In a rate modification, the interest rate is reduced. In a capitalization modification, neither the interest rate nor the principal balance is reduced, 

but the term may be extended to reduce the payment. 

Principal Reduction Is the Most Effective Form of Modification 

It has become increasingly common to modify principal balances rather than just 

modifying the rate and term on a mortgage. For example, in 2009 for private label 

securities, only 5 percent of modifications were principal modifications, whereas now 

a full 32 percent are. The reason is that this is the most effective type of modification. 

While available data on private label securities does not allow us to distinguish 

forgiveness from forbearance modifications, the OCC/OTS report 1 does. It provides 

some very interesting numbers, based on information reported by the largest 

servicers. The data shows the types of modifications that were received, sorted by 

the bearer of the risk. Note that each column adds to more than 100 percent, as 

more than one type of action is generally taken in a modification. Thus, a servicer 

may recapitalize delinquent balances, reduce the rate, and extend the term (length 

to maturity) of the loan. Or—they may recapitalize the delinquent balances, and forgive (reduce) the balance or forbear (defer) the principal. 

Look first at the data from Q4 2010 (left side, Exhibit 2, next page). Note that 

banks were doing principal reduction solely for their own portfolio (17.8 percent of 

banks’ own portfolio loans received a reduction), but few loans serviced by the banks 

for others received principal reductions. By Q3 2011 (the most recent data available, 

shown on the right side of Exhibit 2), banks were doing principal reduction both for 

their own portfolio (18.4 percent of the loans) as well as for loans serviced on behalf 

of private label investors (15.3 percent of the loans). Note that the share that received reduction on loans insured by Fannie Mae, Freddie Mac, or the U.S. Government is zero, as servicers are not permitted to do principal reduction on these loans. 

The bottom part of the table in Exhibit 2 shows that the success rate on banks’ portfolio loans is better than that on loans serviced for others. We would really like to 

know the success rate on principal reduction modifications versus other types of 

modifications (controlling for other characteristics, of course) but this information is 

not disclosed. 

35 

2 ‘‘Principal Reduction Helps To Reduce Re-Default Rates in the Long Run’’, Moodys 

ResiLandscape, Moodys Investor Service, dated 1/20/2012. 

Moreover, our discussions with individual servicers show that they are increasingly relying on principal forgiveness. Under HAMP, servicers are required to test 

a borrower for a modification using the regular HAMP waterfall (first reduce the 

interest rate, then extend the term, then forbear principal) and the principal reduction alternative (first forgive principal, then reduce the interest rate, then extend 

the term, then forbear principal). However, if the principal reduction alternative has 

a higher net present value (NPV) they are not required to use it. In May 2011, Bank 

of America announced that when the NPV test showed the superiority of the principal reduction alternative, they will start using it. And we see that the number of 

Bank of America serviced loans receiving principal modifications is up sharply since 

then. We also see large increases in the number of principal modifications on Chaseand Ocwen-serviced loans. 

At Amherst, we have done extensive empirical work and shown that there are 3 

determinants of modification success: 

1. The amount of pay relief is important. 

2. The number of months delinquent at the time of modification is quite important. If you offer a borrower a modification with 30 percent pay relief at the 

point when the loan is 2 months delinquent, the borrower is apt to regard that 

as a terrific deal. But that same modification offered to a borrower who is 12 

months delinquent is apt to be regarded as a huge increase over the thenpresent (defaulted) payment of ‘‘zero.’’ We were pleased to see changes in the 

HAMP incentive structure to encourage earlier modifications. 

3. Finally, we found that principal modifications (as opposed to interest rate or 

capitalization modifications) have the highest success rate, even controlling for 

these 2 first factors. 

We at Amherst are not the only market participants who have discovered that 

principal modifications have a higher success rate than other types of modifications. 

A study 2 by Moody’s Investor Services looked at modification success by LTV (loanto-value) bucket (a group of loans grouped along similar characteristics), and showed 

that loans with lower LTVs have higher modification success. Most importantly, 

they showed that the difference in modification success between loans grouped by 

36 

3On March 9, 2012, under HAMP Supplemental Directive 12-02, HAMP eligibility was extended to investors. However, this was not a consideration for the period covered in Exhibit 3. 

LTV buckets becomes more pronounced over time. That is, the difference between 

LTV buckets is much greater after 18 months than it is after 6 months from modification. Clearly, principal reduction will reduce the LTV on the loans, whereas 

other types of modifications will not. In further studies at Amherst, we have independently come to the same conclusion. 

We very much like the construction of the principal reduction alternative under 

HAMP. It is done as ‘‘earned forgiveness’’; the principal is initially forborne, and 1⁄3

is forgiven per year, but only as the borrower continues to make ontime payments. 

We believe this is a very important feature for a principal reduction program. Moreover, the recent tripling of the HAMP incentives under the principal reduction alternative, with the incentive going to the owner of the risk (the lender), should further 

spur the use of this alternative. We applaud the Treasury for taking this action. 

The moral hazard issue is the single largest mental obstacle many market participants face when thinking about principal reductions. Will performing borrowers intentionally go delinquent in order to get a principal reduction? We have two responses to this. First, the moral hazard issue is present even under the present program. In fact, while we believe a successful modification program is essential to restore a healthy housing market, no modification program can be designed to completely eliminate moral hazard. Second, you can structure the principal reduction 

to minimize the moral hazard issue. 

In order to show that moral hazard exists under the present program, look at Exhibit 3 (next page). We divided the universe of private label securities between 

owner-occupied borrowers and nonowner-occupied borrowers, as only owner-occupied 

borrowers were eligible for the HAMP modification program, which started in early 

2009. 3 We have confined our work to the private label securities universe, as we 

have very good payment information about these loans. Exhibit 3 shows the rate 

at which performing borrowers are going 2 payments behind for the first time; this 

is referred to as the ‘‘default transition rate.’’ Note that for borrowers whose loans 

are considered ‘‘Prime’’ and ‘‘Alt-A,’’ the default transition rate between owner-occupied and nonowner-occupied borrowers diverged significantly around the time the 

HAMP program was announced, as borrowers believed it was necessary to be 2 payments behind to receive a modification. BOTTOM LINE—Under the present program, some borrowers have clearly gone delinquent in order to qualify for a modification. 

37 

4FHFA letter to the Honorable Elijah E. Cummings, Ranking Member, Committee on Oversight and Government Reform, January 20, 2012. 

It is possible to structure a principal reduction program to minimize the moral 

hazard issue (that is, to counter the incentive that otherwise healthy borrowers 

have to default on their loan to obtain a modification). There are several ways to 

do that. The first is to require that the borrower already be delinquent at the start 

of the program, so borrowers are unable to plan to go delinquent to obtain the modification. Secondly, a shared appreciation feature can be offered. If a borrower accepts a principal write-down modification, the lender is entitled to some share of future appreciation. For the borrower whose loan is at 120 LTV—a write-down to 110 

or 115 percent LTV along with giving up some percent of the upside will look unattractive. But for a borrower at 150 LTV, who is far more likely to default, this will 

appear very attractive. Senator Menendez, I know shared appreciation is an idea 

you have championed. 

While we are huge fans of principal reduction, we are concerned about the moral 

hazard issue for both the borrower and the servicer. We have just discussed how 

it can be mitigated for the borrower. We are also concerned about the recent Attorneys’ General Settlement allowing servicers to do ‘‘abusive’’ modifications in order 

to get ‘‘credit.’’ We applaud the use of principal reductions on loans in a bank/ 

servicer’s own portfolio to meet these credits. But we have a problem with spending 

investor dollars to meet a penalty which was the result of sloppy foreclosure practices on the part of the servicer. 

The GSEs and Principal Reduction 

We were very pleased to see that under the Obama plan, incentive payments for 

principal reduction are now being offered to the GSEs. Prior to this (as Exhibit 2 

has shown), the GSEs (and FHFA as their regulator) have been reluctant to approve 

principal forgiveness modifications, as they believe it is not NPV-positive to their 

agencies, and is hence inconsistent with the idea of conservatorship. 

FHFA Chairman DeMarco recently responded 4 to a request from the House Committee on Oversight and Government Affairs to look at whether principal forgiveness on GSE loans would serve the interests of the taxpayer. That letter contained 

the results of the FHFA study (FHFA Analysis of Principal Forgiveness Loan Modifications) that compared losses to the GSEs from principal forgiveness versus prinVerDate Nov 24 2008 09:27 Jan 16, 2013 Jkt 048080 PO 00000 Frm 00041 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-15 STRENGTHENING THE HOUSING MARKET AND MINIMIZING L 31512005.eps
38 

5 In this case, the mortgage insurance covers the first $30,000 in losses. It does not cover additional losses to the holder if the loan repays $70,000 or less. 

cipal forbearance, using the HAMP NPV model. They found that the losses were 

very similar. 

We have three major criticisms of the methodology used for in the FHFA study: 

First—A hypothetical model (the Treasury NPV Model) was used for the analysis, 

and there was no effort to look at actual HAMP results. Actual results (not hypothetical ones) should clearly be used where the data are available. If I am testing 

a new medical drug and have actual data on effectiveness in humans, I would clearly use that rather than data on theoretical effectiveness. And in this case, the data 

are available. The Principal Reduction Alternative under HAMP went into effect in 

October 2010. This suggests that the HAMP program has 16 months of data which 

can be used to measure the success of the Principal Reduction Alternative (the forgiveness program) versus the standard HAMP waterfall (which reduces the interest 

rate, extends the term, and forbears principal if necessary). These actual HAMP results should have been examined. 

Second—There were four serious technical issues in the conduct of the study, 

which made principal forgiveness less appealing: 

A. State level price indices were used, not MSA level indices. Thus, the FHFA 

picked up fewer high LTV borrowers than there actually are. These high LTV 

borrowers are aided more by principal forgiveness than their lower LTV counterparts. 

B. The results were done on a portfolio level, not an individual loan level. Thus, 

the FHFA did not consider the possibility of following a forgiveness strategy 

for some borrowers and a forbearance strategy for others. This would have 

clearly dominated the use of a single strategy. 

C. The actual HAMP program was not evaluated. The principal forgiveness in the 

HAMP program is the lesser of (the current LTV—the target LTV) or 31 debtto-income. The FHFA automatically assumed principal reduction equal to (the 

current LTV—the target LTV). Thus, they overstated the amount of principal 

reduction that would have been granted for higher income borrowers. (For 

these higher income borrowers, the 31 DTI target would have required less forgiveness.) 

D. Attributes of the loan at origination, not current attributes, were used for the 

analysis. Delinquent borrowers, on average, have suffered a deterioration in 

FICO scores. By using origination characteristics, the health of the borrower 

is overstated, hence the assumed likelihood of success is too high. This overstates the cost of forgiveness. 

Third—The FHFA study did not consider any differentiation between loans with 

mortgage insurance versus loans without it. If the overall result for the GSE book 

of business were very similar for forgiveness versus forbearance, forgiveness on 

loans with mortgage insurance should be more NPV-negative to the GSEs than 

would be forbearance, and forgiveness on loans without mortgage insurance should 

be more NPV-positive than forbearance. 

The mortgage insurance point is critical. Roughly 32 percent of the GSE portfolio 

of seriously delinquent loans carries mortgage insurance. If the GSEs do a principal 

write-down, they take the loss on loans irrespective of whether or not they have 

mortgage insurance. If the loan with mortgage insurance would otherwise (no modification or a different type of modification) have defaulted, the mortgage insurer 

would have paid the GSEs the coverage amount due. We’ll use an example to make 

this clearer. Assume a borrower has a $100,000 loan, on a house worth $75,000. The 

GSEs have mortgage insurance from a mortgage insurer, which covers any loss 

down to $70,000. 5 Assume that the borrower defaults, and the GSE offers the borrower $20,000 of principal reduction, which reduces the loan balance to $80,000, and 

gives the loan a 75 percent chance of eventual success. If the loan does not redefault 

(there’s a 75 percent chance of that happening), the GSE loses the $20,000 principal 

amount they gave up. But if the loan redefaults and the house then sells for $70,000 

(25 percent chance), the mortgage insurance pays $10,000 to the GSE for the lost 

principal, in which case the GSE still loses $20,000. If principal is forborne, and the 

borrower defaults, the mortgage insurer would cover the loss. So when there is 

mortgage insurance, it is generally not NPV-positive to the GSEs to do principal forgiveness—forbearance creates the preferred outcome, as the MI does not cover the 

forgiven amount. 

For loans without mortgage insurance, it is generally NPV-positive to the GSEs 

to do principal forgiveness. Let’s assume the same defaulting borrower as above. 

39 

The borrower achieves the same payment relief under the standard HAMP waterfall 

and under the principal reduction alternative, so the NPV of the cash flows will be 

very similar (the difference will be the discounted value of the forborne amount; and 

remember that the present value of $20,000, 40 years from now, assuming a 5 percent interest rate, is approximately $2,800). However, the default rate will be lower 

on the forgiveness modification (as it will have a lower postmodification LTV), lowering any further loss as well as the expenses associated with that loss, thus making it the more attractive option for the GSEs. 

And there is no question in my mind that forgiveness could be implemented for 

part of their book of business, without implementing it on the entire book of business. Precedence for this comes from the HARP program, where only loans issued 

before the June 1, 2009, cut-off date are eligible for a streamlined refinance. 

We understand that the primary issue in the mind of the FHFA is that more than 

90 percent of GSE loans are current, and FHFA is very concerned about the moral 

hazard issue. The fear is that principal write-downs encourage borrowers to default 

who otherwise would have stayed current. As we point out above, there are two easy 

solutions to the moral hazard issue. The first solution is to require that the borrower be delinquent as of a certain date, so performing borrowers do not intentionally go delinquent in order to get the principal reduction. The other choice is 

to establish a series of frictions so that only those borrowers who need the principal 

reduction take advantage of the program. This could involve the inclusion of a 

shared appreciation feature or other frictions to default. 

We hope that new measures permitting the GSEs to be eligible for the principal 

reduction incentive payments would allow the FHFA to reevaluate their stance on 

principal forgiveness. And the newly announced triple incentive payments will be 

incorporated in Version 5.0 of the Treasury NPV model. We would urge the FHFA 

to rerun their results, using the new model which incorporates the triple incentives, 

correcting the technical flaws in their analysis, and breaking out loans with and 

without mortgage insurance separately. We believe when this is done, it will be 

clear that forgiveness is the better solution for the bulk of the 2⁄3 of their book of 

business without mortgage insurance. Moreover, we believe that once the GSEs 

start doing principal forgiveness, the program will become even more widespread in 

PLS (private label securitizations), as servicers will make the investment in the 

technology to make it available for all delinquent loans. 

Demand Side Action—Bulk Sales 

I can’t tell you how pleased we are to see the announcement of the Fannie Mae 

bulk sales pilot program. I testified before the Senate Committee on Housing, 

Transportation, and Community Development last September on the need for bulk 

sales. The argument in favor of bulk sales is that there is a huge shadow inventory 

of homes that needs to be absorbed. Roughly 2.7 million borrowers have not made 

a payment on their home in over a year. Another 400,000 homes are in REO (the 

‘‘real estate owned’’ category, which consists of troubled properties that have been 

repossessed). Collectively, they constitute a shadow inventory of 3.1 million units. 

There isn’t insufficient demand from owner-occupants to absorb this number of 

units. Thus many of these properties must transition to investors. Currently, some 

of the properties are transitioning to smaller investors, but, prior to this program, 

there was no mechanism for institutional investors to buy properties in bulk. 

Buying in bulk is important to an institutional investor, as they want to put into 

place a professional property management organization and a rental organization, 

both staffed locally. If an institutional investor has only accumulated a few homes, 

it is difficult to justify the cost of building out the necessary service organizations. 

But if they are able to accumulate a large number of homes at once, it becomes economic to do so. It also suggests that institutional investors will pay a premium to 

accumulate the properties in bulk than one-by-one. We believe that both Fannie 

Mae and FHFA will be very pleased with the execution of the pilot program, and 

will choose to implement on a larger scale, by selling both nonperforming loans and 

REO properties. 

What about the argument that selling homes one-by-one is more profitable? We 

believe that will prove to be incorrect. First, institutional investors will pay a premium to accumulate in bulk. Second, when you sell homes individually, all the properties sell more slowly, plus many don’t sell at all. Marketing costs are also higher. 

Consider the costs of a slower sale: tax and insurance payments still have to be kept 

current until the home is sold. Plus, the GSEs are either paying to maintain the 

property, or realizing a lower sales price because the condition of the home is deteriorating. 

In the construction of this pilot program, we encourage the provision of financing. 

Currently, there is no mechanism for financing scattered site single home purchases 

40 

of more than a small number of properties (Fannie will finance a maximum of 10 

properties; Freddie a maximum of 4 properties). It makes little sense to have a cutoff based on the number of properties. Rather, very conservative financing should 

be provided—and by conservative, we mean at least 30 percent down payment. The 

provision of financing would be reflected in higher bids on the property. Hence, the 

financing would be a benefit to the taxpayers, not a cost. 

We believe that by giving institutional investors the ability to purchase homes in 

bulk, large amounts of shadow inventory can be absorbed. This will make substantial progress toward cleaning up the shadow inventory, which is critical to stabilizing home prices. Once home prices stabilize, the hope is that credit availability 

will increase. 

Credit Availability Standards 

There is currently a disconnect in the housing market between affordability and 

the level of housing activity. The National Association of Realtors Home Affordability Index is at its highest since they began tracking it in 1986. This Index measures the ability of the median family to purchase the median priced home, putting 

down 20 percent and taking out a 30-year fixed rate mortgage at prevailing interest 

rates. With the Case Shiller Home Price Index down 34 percent from the peak, and 

30-year fixed rate mortgage rates at the lowest level they have been since the 1960s, 

it is not surprising that housing looks quite affordable. The real question is—Why 

is the Mortgage Bankers’ Association Index measuring purchase activity at a 15- 

year low?—why are existing home sales so low? 

The answer is that credit availability is very tight. Affordability based on median 

income is at an all-time high but, at the same time, the median family balance sheet 

cannot afford to put down 20 percent on a home purchase, nor can they qualify for 

a 30-year fixed rate mortgage at today’s qualification standards. (And if a borrower 

wants to put down more less than 20 percent on a conventional loan, they will need 

either mortgage insurance or a second lien; both have become increasingly difficult 

to obtain.) In reaction to the extremely sloppy underwriting standards prevailing in 

the 2005–2007 period, the GSEs and bank originators have dramatically tightened 

origination standards. The average GSE origination for 2009–2011 has a 762 FICO, 

and a 68 LTV. The average bank portfolio loan has a 756 FICO, 67 LTV. Moreover, 

almost 20 percent of the 2007 borrowers have defaulted or gone more than 90 days 

delinquent on their existing loan, thus ruining their credit score and making them 

unable to buy another property. 

Yes, lending standards were certainly too loose in the 2005–2007 period, but they 

are now too tight everywhere, with the exception of FHA/VA loans. And every single 

action that is being contemplated will actually make them tighter. One point of particular concern for us is the Qualified Mortgage (QM) Standards. 

We expect the CFPB (Consumer Finance Protection Bureau) to finalize an abilityto-repay rule that does not contain a safe harbor from liability for lenders who make 

a QM (Qualified Mortgage) loan. Instead, preliminary discussions indicate the CFPB 

is most likely to provide lenders with a rebuttable presumption and establish a 

‘‘bright line’’ test of what constitutes a QM loan. If a real ‘‘bright line’’ test is drawn, 

lenders might be comfortable doing QM loans even with a rebuttable presumption. 

However, it will clearly crimp credit availability for all loan applications that do 

not clearly meet the ‘‘bright line,’’ and any ambiguity in the ‘‘bright line’’ will further 

crimp the market. Moreover, the greater the consideration of ‘‘compensating factors’’ 

which makes for more rational lending standards, the less ‘‘bright line’’ the QM test 

can be. For example, a 43 percent back-end DTI does not sound like an irrational 

limit; however a borrower with limited income and substantial assets with little of 

those assets in cash, who is putting down 40 percent, may not be able to take out 

a QM loan. 

From a lender’s point of view, the fear is that default is itself evidence of lack 

of ability to repay. The penalties for non-QM compliance are substantial. Moreover, 

for loans done outside of a safe-harbor and/or the ‘‘bright line’’ test—i.e., non-QM 

loans—lenders will be subject to Truth in Lending Act (TILA) litigation risks; it is 

reasonable to expect borrowers to commonly allege lack of ability-to-repay, and to 

seek TILA damages. Litigation is expensive—on average costing lenders about 

$70,000–$100,000 per loan—costs that far exceed the few thousand dollars that a 

lender might make on originating any one loan. 

Some predict that there will be a vibrant market for non-QM loans, but that is 

not likely because of the liability associated with originating those loans. Suppose 

an investor were willing to purchase MBS backed by non-QM loans. If the non-QM 

borrower were to allege a lack of ability-to-repay, the investor could look to the originating lender for recovery, under the lender’s representations and warranties that 

the loan met the ability-to-repay requirements. We expect that investors may be 

41 

willing to buy MBS backed by non-QM loans originated by well-capitalized lenders, 

but those lenders may not be willing to make non-QM loans because the liability 

far exceeds the potential profit from loan origination. Lenders with limited capital 

may be willing to make non-QM loans, but those lenders will not be able to attract 

investors. There will be no ability to make higher cost loans to more risky borrowers. 

We expect the ability-to-repay rule to further constrain mortgage credit under any 

circumstances. However, unless the final rule includes either a safe harbor and a 

‘‘bright line’’ test or, at a minimum, a very clear ‘‘bright line’’ test in conjunction 

with the rebuttable presumption, the rule will limit the availability of mortgage 

credit. 

Conclusion 

In my testimony today, I have discussed three actions that can strengthen the 

mortgage market, at no or minimal cost to taxpayers: increasing reliance on principal reduction modifications; a ramp up of the bulk sales program, coupled with financing for these properties; and a careful vetting of new rules that affect already 

tight credit availability. 

We urge Congress to do everything they can to facilitate these actions.