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THE FEDERAL HOUSING ADMINISTRATION— 

CURRENT CONDITION AND FUTURE CHALLENGES 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE CURRENT CONDITION AND FUTURE CHALLENGES OF 

THE FEDERAL HOUSING ADMINISTRATION 

SEPTEMBER 23, 2010 

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 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

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 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

JUDD GREGG, New Hampshire 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

BETH COOPER, Professional Staff Member 

JONATHAN N. MILLER, Professional Staff Member 

WILLIAM FIELDS, Legislative Assistant 

MARK OESTERLE, Republican Chief Counsel 

ANDREW J. OLMEM, JR., Republican Counsel 

CHAD DAVIS, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

LEVON BAGRAMIAN, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

THURSDAY, SEPTEMBER 23, 2010 

Page 

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

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 3 

Senator Schumer .............................................................................................. 25 

Senator Johnson 

Prepared statement ................................................................................... 28 

WITNESSES 

David H. Stevens, Federal Housing Authority Commissioner and Assistant 

Secretary for Housing, Department of Housing and Urban Development ...... 4 

Prepared statement .......................................................................................... 28 

Responses to written questions of: 

Senator Dodd ............................................................................................. 49 

Senator Vitter ............................................................................................ 51 

Mathew J. Scire`, Director, Financial Markets and Community Investment, 

Government Accountability Office ...................................................................... 7 

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

Responses to written questions of: 

Senator Vitter ............................................................................................ 52 

(III)

(1) 

THE FEDERAL HOUSING ADMINISTRATION— 

CURRENT CONDITION AND FUTURE CHALLENGES 

THURSDAY, SEPTEMBER 23, 2010 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:23 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Christopher J. Dodd, Chairman of the 

Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order. Again, we 

are a little late getting started here this morning, and I apologize 

to my colleagues. But we have two very good witnesses here this 

morning to talk about this very, very important program, and I am 

delighted they are here. 

I have a brief opening statement, and then I am going to turn 

to my colleague from Alabama, my friend Richard Shelby. And we 

have been joined by Senator Merkley, Senator Reed, and Senator 

Corker as well. There is a strong interest in this subject matter, 

and so we will try and move along here this morning, if we can. 

I want to welcome the Members of the Committee and our two 

witnesses to this hearing, ‘‘The Federal Housing Administration— 

Current Condition and Future Challenges.’’ The Federal Housing 

Administration, FHA, has played a very critical and dramatic role 

in maintaining access to mortgage credit for millions of our fellow 

citizens at a time when the private sector has effectively disappeared from the marketplace. I think we would all agree to that 

point. 

According to recently released Government data, FHA along with 

VA and rural housing programs accounted for half—54 percent— 

of all home purchase mortgages in the year 2009 and about 30 percent of all mortgages, including refinances. Together, with Fannie 

Mae and Freddie Mac, the Federal Government now stands behind 

more than 90 percent of the entire market. In short, if it was not 

for FHA, the amount of mortgage credit that would be available for 

home purchases would be cut in half. This would result in sharply 

lower demand and drive home prices further down, further stripping American families of the hard-earned home equity they have 

acquired over the years. In other words, FHA is doing what it has 

done for decades. It is playing a stabilizing force in our housing 

and mortgage markets. It is because of the central role that FHA 
2 

is playing now and will continue, in my view, to play in the future 

that we need to ensure that the Federal Housing Administration 

is on a solid financial footing. 

There are clearly legitimate reasons for concern which have been 

expressed by many on this Committee. In 1990, the Congress established a minimum capital ratio for FHA of 2 percent. That capital cushion was established to make sure that the program premiums would be there to pay for its losses, with some margin of 

error. Last year, the annual actuarial report noted that the capital 

cushion had declined to only 0.5 percent, a dangerously low figure. 

Moreover, serious delinquency rates reached all-time highs at the 

end of 2009. I hasten to add, however, that even at their worst, 

FHA’s delinquency rates were less than one-third of those for 

subprime mortgages. This is a tribute to the fact that FHA has insisted on real underwriting. 

Just to give you an idea, by the way, in the prime real estate 

market, the foreclosure rates—delinquency rates, excuse me, were 

7 percent, the subprime were 30.6 percent, and FHA was 9.4 percent. I think it is very important to cite those numbers because I 

think there is an impression that the FHA delinquency rates were 

hovering around the subprime rates, and they were much more 

closer to the prime rates—a little bit higher, by 2.5 percent higher 

than prime rate delinquencies. Delinquencies at prime rate at 7 

percent, FHA at 9.4 percent, and subprime at 30.6 percent. So we 

are much closer to the prime, and I think those numbers are kind 

of important to keep in mind as we talk about what needs to be 

done. 

I for one do not find it surprising, obviously, that FHA has lost 

money or that it suffered higher delinquencies and foreclosures in 

the midst of the worst housing crisis that this Nation has experienced since the Great Depression. However, we do not want a program to continue operating with such a capital margin. That is unacceptable. So my point in making these statistics is not to minimize the importance of addressing the capital margins that have 

to be faced. 

So the purpose of this hearing is to examine what steps FHA is 

taking to restore its capital cushion consistent with its goals and 

mission to provide access to mortgage credit to traditionally underserved borrowers. I will say without preempting anyone’s testimony, Commissioner Stevens, that you and Secretary Donovan, in 

my view, have been very active in addressing numerous operational 

and program weaknesses at FHA. As a result, the quality and performance of the portfolio has improved significantly, and the program seems to be on a far more solid footing. 

In addition, FHA has strengthened its oversight of lenders. It is 

demanding higher performance from originators, strengthened underwriting standards, and has increased enforcement which has 

forced the industry to sit up and take notice. I strongly commend 

you and Secretary Donovan for the steps that you have been taking. 

However, as the GAO points out, while applauding your progress, 

there is far more to be done. We all agree with that. I certainly do. 

So I look forward to hearing your testimony this morning and 

working with you in the remaining weeks of my tenure here, as I 
3 

am sure the Members at this dais already who have a strong interest in this subject matter. And I see Michael Bennet of Colorado 

has joined us, and Tim Johnson is here as well. We will have a continuing interest in the subject matter when the new Congress convenes in January. 

With that, let me turn to my colleague from Alabama. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. Thank you for putting this hearing together. 

Last August, Congress passed emergency legislation to provide 

the Federal Housing Administration additional flexibility in assessing annual premiums on the loans that it insures. The legislation 

also required that the FHA Commissioner come before this Committee ‘‘to discuss the finances, including premiums,’’ of the Federal 

Housing Administration. Congress provided the premium assessment flexibility at the request of FHA. 

Commissioner Stevens stated at the time, and I quote, ‘‘Without 

this authority, FHA will face increasing challenges in meeting multiple mandates to serve underserved borrowers, maintain the congressionally mandated capital reserve ratio, and provide liquidity 

to the market.’’ 

Today, I look forward to examining not only how the FHA fund 

reached the point where emergency action was required, but also 

those steps we should consider here to improve FHA’s long-term viability. 

In addition to fulfilling the statutory requirements for FHA to 

appear before this Committee, this hearing provides a valuable opportunity for us here to hear from the GAO, the Government Accountability Office. Earlier this year, Chairman Dodd and I asked 

the GAO to examine the FHA fund, and today we will hear the results of that examination. 

We know that the capital reserves of the fund have fallen to critical levels in recent years. We also know that many new loans have 

not matured enough for their impact on the fund to be fully known 

yet. But given the hundreds of billions of dollars in taxpayer-funded bailouts to the auto companies, to Fannie Mae, and to Freddie 

Mac, I believe we must do everything here in our power to prevent 

the American people from having to pay for yet another Government bailout. This will not be an easy undertaking, and certainly 

it will not be popular with many special interest groups. Nevertheless, I believe it must be done so that the most important special 

interest group—the American taxpayers—are protected. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Do any of my colleagues here want to make a quick opening comment? If not, I will introduce our witnesses. I thank my colleagues. 

Bob, the Corker rule prevails. 

[Laughter.] 

Chairman DODD. The Corker rule lives. 

Let me first of all introduce David Stevens. I want to welcome 

him back. Commissioner David Stevens is the Assistant Secretary 

for Housing at the United States Department of Housing and 

Urban Development, as well as the Commissioner of the Federal 
4 

Housing Administration. He has significant real estate experience 

based on many years of experience. 

In fact, I remember just going through your nomination process 

and how thrilled I am, and I think the Committee, that you stuck 

with it. We went through a couple of rough weeks there, but I cannot tell you how fortunate we are to have you and have someone 

with your practical experience in this field, something that is not 

prevalent throughout the Administration, I might point out, but to 

have people like you who actually know what it is every day to get 

out and deal with these issues is very, very valuable. 

Bob Corker knows about it. Obviously, he was involved in the 

business and knows practically what it is like, and to have someone 

in a policy position who knows what it is like has been tremendously helpful. So I am glad you are with us, and I am anxious to 

hear your thoughts this morning. You have direct responsibility for 

oversight and Administration of the FHA insurance portfolio, which 

includes single-family and multifamily housing, insured health care 

facilities, and other programs. Again, we are pleased to have you 

with us. 

Mathew Scire` is a Director of GAO’s Financial Markets and Community Investment team, with almost 30 years of audit experience, 

and currently is responsible for leading GAO’s audit work involving 

housing programs. His team is focusing on a wide range of issues, 

including FHA’s mortgage insurance program, Treasury’s loan 

modification efforts, and the use of Recovery Act funds by public 

housing agencies and others. And, again, I always say that we are 

so fortunate to have GAO. It does actually just a fabulous job. You 

are highly regarded and thought of, and so we thank you for coming before us today as well. 

Mr. Stevens, we will start with you and then turn to Mr. Scire`, 

and then we will open up the floor for some questions. Take about 

5 minutes or so, if you would, 5 or 6 minutes. By the way, we will 

take any and all supporting data, evidence, testimony—not only 

from you but from my colleagues—and it will be included in the 

record. 

STATEMENT OF DAVID H. STEVENS, FEDERAL HOUSING AUTHORITY COMMISSIONER AND ASSISTANT SECRETARY FOR 

HOUSING, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT 

Mr. STEVENS. Thank you, Senator. Chairman Dodd, Ranking 

Member Shelby, Members of the Committee, thank you for the opportunity to testify today on the financial condition of the Federal 

Housing Administration. I have submitted a longer document to 

the record. 

With Congress’s help over the last year, FHA has made significant reforms that have put the agency on a stronger financial footing. I would like to discuss those reforms today and explain why 

our ability to protect the taxpayer for the future depends on Congress enacting the broader, more comprehensive set of reforms we 

have proposed. 

As you know, last year we informed Congress of the independent 

actuary’s findings that the FHA’s secondary reserves had fallen 

below 0.53 percent of the total insurance-in-force, below the re-
5 

quired 2-percent level. I told you then that Secretary Donovan and 

I would do everything in our power to ensure that the taxpayer 

was protected. And today, while we are by no means out of the 

woods, we have made significant headway toward stabilizing the 

portfolio. 

In fact, according to our third quarter report submitted to Congress, instead of losing $2.6 billion in funds, as the actuary predicted, FHA has generated an additional $1.3 billion in capital resources through the third fiscal quarter and continues to earn more 

funds for the taxpayer. Furthermore, actual foreclosures of FHA-insured homes have been 20 percent less than projected, which is 

why we have paid $3.7 billion less in claims than projected. This 

was only possible because the Administration had already begun 

implementing the most sweeping set of reforms to FHA’s credit policy, risk management, lender enforcement, and consumer protections in the agency’s history. 

Mr. Chairman, last year we said we would hire the first chief 

risk officer in the organization’s history, and with congressional approval, we have formally established a permanent Risk Management Office within FHA, headed by a Deputy Assistant Secretary, 

allowing us to assess and analyze risk more accurately and more 

proactively. We also said we would strengthen our lender enforcement policies, and we have, eliminating FHA approval for loan correspondents and increasing minimum net worth requirements for 

lenders who participate in the program. 

We suspended some well-known FHA-approved lenders and withdrawn FHA approval for over 1,500 others, and I have imposed 

over $4.25 million in civil money penalties and administrative payments to noncompliant institutions. 

We are sending a very clear message. If you do not operate ethically and transparently, we will not do business with you. 

We said we would restructure our mortgage premiums, and we 

have. In April, we raised them from 175 basis points up front to 

225 basis points across all FHA product types. In early October, 

thanks to legislation passed here, we will reduce the minimum premium up front to 100 basis points, offset by an increase in the annual premium to 85 or 90 basis points, depending on the loan-tovalue ratio. On behalf of the Secretary and myself, I want to thank 

the House—the Senate, excuse me, and particularly you, Chairman 

Dodd, and Ranking Member Shelby, for your leadership in passing 

this important legislation. 

In addition, we said we would improve the quality of the loans 

we make, and we have. We have strengthened credit and risk controls. We have implemented a two-step FICO floor for FHA borrowers. Purchase borrowers with credit scores below 580 are now 

required to have a minimum 10-percent down payment to get an 

FHA loan. And only those with stronger credit can continue to get 

the FHA program with that minimum 3.5-percent down payment. 

We also promised to reduce seller concessions which often create 

incentives to inflate appraised value and are significantly more 

likely to go into default. That is why we have proposed to reduce 

the maximum allowable seller concession from 6 percent to 3 percent. 
6 

Last, we said we would modernize the technology within the 

FHA, and with your help, we have made great strides toward improving technical capacity to handle the increased volume, delivering our first comprehensive technology transformation plan to 

Congress, and modernizing FHA’s technology infrastructure. We 

have also awarded three contracts to upgrade our risk and fraud 

tools and are building staff capacity through hiring and training. 

The early results of these efforts are encouraging. I mentioned that 

our capital reserves are growing faster than projected and that 

claims payments are less than forecasted. 

Loan quality is improving as well. Our third quarter report 

shows that loan performance, as measured by serious delinquencies 

and early period delinquencies, has improved significantly, with 

the first year-over-year decline in 90-day delinquencies in years. 

The average credit score in our current insurance endorsements 

has risen from 634 in 2007 to near 700 today. 

Going forward, the President’s budget projects that these actions 

will produce an additional $4.1 billion in FHA receipts in fiscal 

year 2011, funds that FHA earns for the taxpayer. 

Of course, despite the progress we have made, Mr. Chairman, 

the job is far from over. Secretary Donovan and I remain committed to comprehensive FHA reform legislation. In August, Senators Mark Begich and Sherrod Brown introduced Senate bill 3704. 

This bill is similar to the House-passed H.R. 5072, which would 

give FHA the tools necessary to manage risk, protect the fund, and 

protect the taxpayer. 

In addition to strengthening FHA’s lender enforcement ability, 

the bill will allow for third-party loan originators to close FHA-insured loans in their name and extend FHA’s ability to hold all 

lenders to the same standard by permitting us to recoup losses 

through required indemnification for loans that were improperly 

originated or in which fraud and misrepresentation were involved. 

Building a strong foundation for the future requires us to pass 

this legislation, and I hope that you will pass it by the end of the 

year. 

Mr. Chairman, these reforms are important not only because we 

still have a long way to go, but because home prices may still decline further, and conditions may get worse before they get better. 

They are also important because we know the critical role FHA is 

playing in the housing market right now. 

Mr. Chairman, this makes it even more important that we continue to deliver on our commitments to strengthen the FHA and 

assist responsible home borrowers who need a helping hand while 

working to facilitate the return of private capital to the housing 

market. We look forward to working with Congress closely on all 

of these issues as we further reduce risks to the American taxpayer 

and ensure FHA can continue to provide stability to the housing 

market at a moment when it is most needed. 

Thank you for the opportunity to testify, and I look forward to 

answering any questions. 

Chairman DODD. Thank you very much for that. 

Mr. Scire`. 
7 

STATEMENT OF MATHEW J. SCIRE` , DIRECTOR, FINANCIAL 

MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT 

ACCOUNTABILITY OFFICE 

Mr. SCIRE`. Mr. Chairman, Ranking Member Shelby, Members of 

the Committee, thank you for the opportunity to be here today to 

discuss FHA’s mortgage insurance program. 

Since 1934, FHA has been an important player in the mortgage 

market, especially for first-time home buyers. FHA insures these 

loans under its Mutual Mortgage Insurance Fund. Almost 1 year 

ago, HUD released the results of the latest independent actuarial 

review showing that the capital ratio used to measure the financial 

soundness of the fund had declined to 0.53 percent, well below the 

statutory minimum of 2 percent. 

At the request of this Committee, we have been evaluating the 

program and issued our first report yesterday. Overall, our work 

pointed to further actions needed to better evaluate the fund’s financial condition and guidance for rebuilding the capital ratio. 

Let me start by describing the reasons for the capital ratio’s 

steep decline since its peak in 2006. Put simply, the capital ratio 

declined because its numerator—the economic value of the fund— 

declined sharply while its denominator—the insurance-in-force— 

grew rapidly. 

Let us take first the insurance-in-force. This measure of the 

amount of all loans FHA insures rose as the demand for mortgage 

insurance grew. By the end of 2009, FHA had outstanding insurance that was more than 6 times the level it had at the end of 

2006. The decline in the fund’s economic value is due to several factors, including more pessimistic forecasts for house prices, which 

would result in higher claims, and more pessimistic assumptions 

about losses. From a budgetary perspective, the worsening expectations for loan performance ultimately resulted in HUD recognizing 

a $10 billion increase in the cost of the program in 2009 alone and 

a like reduction in the program’s capital reserve account. If this account, which now stands at $3.5 billion, were to be depleted, FHA 

would require additional Federal funds to cover its cost on outstanding insurance. 

It is important to note that the economic value of the fund depends in large measure on cash-flows derived from estimates of 

loan performance over a 30-year period. FHA and its contractor 

have enhanced their methods for assessing the fund’s financial condition, but there is more that FHA can do to improve the reliability 

of its estimates. In particular, past reviews have relied on single 

economic forecasts to determine compliance with the 2-percent requirement. However, this approach does not fully account for the 

variability in future house prices and interest rates and, therefore, 

may tend to overestimate the fund’s value. 

We recommend that FHA use an alternate approach known as 

stochastic simulation to estimate the fund’s capital ratio for purposes of assessing compliance. This approach uses hundreds of different economic paths and offers the prospect of more reliably estimating the fund’s economic value. 

Beyond steps to improve how it measures the fund’s health, FHA 

has also taken proposed steps for improving the fund’s financial 

condition, and the Commissioner describe many of those. However, 
8 

FHA has not specified when it expects to return the fund’s capital 

ratio to its minimum 2 percent, nor what further steps it needs to 

take to do so. Likewise, the Congress in 1990 specified when it expected FHA to first reach a 2-percent ratio. It did not specify what 

it expected of FHA should the ratio subsequently fall below 2 percent or specify a timeframe for returning the capital ratio to 2 percent. 

Finally, we report on changes in the performance and characteristics of FHA loans. The delinquency rate for FHA-insured loans increased in recent years. However, in some respects, the characteristics of the most recent FHA loans are less risky than in past years. 

An increasing share of FHA-insured loans went to borrowers with 

higher credit scores, for example. Also, loans with seller-funded 

down payment assistance are no longer permitted. 

On the other hand, FHA insured relatively more streamlined refinance loans in 2009. But probably most important to consider is 

the sheer size of recent loan cohorts. Because these loans now represent a substantial portion of FHA’s portfolio, they will be important to the future of FHA and its efforts to rebuild the financial 

condition of the fund. 

Overall, the challenge FHA faces today is not dissimilar to that 

it faced nearly 20 years ago when it was first required to achieve 

a 2-percent capital ratio. It met that challenge in 5 years. Then, 

as now, it may be necessary for the Congress to specify the time 

period it expects FHA to return the capital ratio to 2 percent, taking into account FHA’s statutory operational goals and its role in 

supporting the mortgage market. Also, to provide the Congress 

with more reliable estimates of the fund’s value, there is more that 

FHA can do to more fully recognize the impact that volatility in 

house prices and interest rates may have. 

We are committed to providing the Congress with effective oversight of the FHA program, including its efforts to rebuild the fund’s 

capital ratio, while serving an important role in the mortgage market. We look forward to supporting the Committee’s efforts. 

This concludes my opening remarks. Thank you again for the opportunity to speak today. I would be glad to take any questions 

that you may have. 

Chairman DODD. Well, thank you again, Mr. Scire`, and thank 

you and your staff as well for the work you have done. 

Let me jump right in, and I will ask the clerk to put around 6 

minutes or so on here so we can give everybody a chance to get involved in this discussion. 

Let me ask you, Mr. Stevens, Commissioner Stevens, a contemporary question. We are going to be passing a continuing resolution, I think probably next week, that will carry us over I think 

until December at some point. But one of the items that I hope gets 

included in that CR is a 1-year extension of the expanded loan limits for FHA and the GSEs. Commissioner Stevens, can you speak 

to the issue and why it is important to do this prior to leaving for 

our election recess? 

Mr. STEVENS. Thank you for the opportunity to answer that specific question. At this point, as you stated in your opening remarks, 

between Freddie Mac, Fannie Mae, FHA, and VA, we play a critical 

role in providing needed financing for every homeowner in America 
9 

today. And there is still a significant gap in any available private 

capital to come into the market at virtually any price. 

The issue for FHA in particular in extending the limits is not 

about the maximum dollar amount. I think it is important for everybody to recognize that. Less than 3 percent of our portfolio is 

over $417,000. We are doing very few large loans. 

The real issue is the formula itself. FHA’s floor today under 

HERA is $271,000, and it is based on a formula based on median 

sales price. If the limits were not extended for another year, we 

would, A, recalculate the median home values of every home in 

every county in America, which would be lower. In addition to that, 

the formula for FHA financing would drop from 125 percent of median value to 115 percent, which would have a double impact on 

reducing available credit for the FHA program nationwide. And 

this is not about high-cost markets. This is about every county 

across the Nation that would suddenly have a reduced access to 

home ownership. We are not talking about wealthy millionaires. 

We are talking about the average American family’s ability to access and finance a home in today’s world given the complete absence of other capital. 

So it is for this reason that not only for FHA but for the GSEs 

as well, the absence of capital and the needed availability of liquidity that this Administration does support an extension for another 

year. 

Chairman DODD. Well, isn’t there the added problem as well that 

you actually then—you are driving home prices down, therefore reducing the amount of equity that people may have accumulated in 

their home, thus reducing the wealth creation. Isn’t that also—— 

Mr. STEVENS. Absolutely. The secondary effect is absolutely as 

you say, Senator, that it will lower—lack of access means less 

available buyers, which means more inventory on the market, 

which will depress home values potentially even further. And it is 

for all those reasons that we recommend that we do an extension 

responsibly for another year, giving this market a chance to complete the healing process and begin to regain its necessary recovery. 

Chairman DODD. I have not had a chance to talk to my friend 

and colleague Richard Shelby, but I would hope my colleagues 

would take a look at this in the next 2 weeks. Whether or not we 

can include something like this as part of the CR could be very important. And I would just ask them to pay attention to it and give 

me your advice and counsel on it as well. 

Mr. Scire` raised the issue of having a legislatively mandated 

time line. We legislatively mandated the 2 percent. There is a certain attractiveness to that, but I think you may have—in fact, I 

identified one of the potential problems, which is the question I 

would like to raise with you, Mr. Scire`, and that is the potentially 

countercyclical feature of having a legislatively imposed time line. 

Are you concerned that a time line might tie the Department’s 

hands, undermine the FHA’s ability to do its job at exactly the time 

when we may want them to be more aggressive in moving these 

areas? Clearly, the program seems to be restoring the program’s 

capital without a time line. And do you believe that such a time 

line is needed? And let me ask you, Mr. Stevens, that as well. 
10 

So give me the potential problem of the counter—the procyclical 

nature. Excuse me. 

Mr. SCIRE`. Well, you saw that we were very careful in our recommendation—— 

Chairman DODD. I know. 

Mr. SCIRE`. ——because FHA obviously has some competing 

goals. And what we think is that this is an excellent opportunity 

for the Congress to weigh in on and to give direction to FHA as 

to where that balance should be between financial soundness and 

its role in supporting the mortgage market. So I think that that is 

where we would leave that. 

Chairman DODD. Well, is it overkill a little—— 

Mr. SCIRE`. There is another advantage to—— 

Chairman DODD. If you are moving in the right direction on 

these things and doing what needs to be done and the reforms that 

are necessary, does a legislatively imposed time line to achieve 

that—and it seems to sort of disregard other factors that may be 

occurring out there that could contribute to that kind of a decision 

and thus make it more procyclical. That is my point. 

Mr. SCIRE`. Well, I do not disagree that a time line, a too advanced time line would be counterproductive given where we are 

in the market today. So that is why it is important to consider 

what role you expect of FHA in the next few years or whatever 

amount of time you think makes sense to get back to a 2-percent 

ratio. 

What it does provide for you is a means for holding FHA accountable, and so, you know, one of the things that you might expect here is for FHA to lay out what it thinks might be a reasonable timeframe for achieving a 2-percent capital ratio while meeting its—— 

Chairman DODD. Well, let us ask the man right here, the man 

we have at the table. Mr. Stevens, how do you respond to that? 

Mr. STEVENS. I respond in two ways. One, I believe a time line 

would be the wrong way of approaching the FHA reform, and just 

to be very clear, the National Housing Act does not say the Secretary can, if he wants to. It is ‘‘the Secretary shall’’ do everything 

in his authority to get the capital reserves back above 2 percent. 

As you can tell by the actions that I have reviewed today, we 

have done the most aggressive, sweeping set of reforms to get the 

FHA capital return to above 2 percent, and those steps are in process. 

I do agree with at least some of the tenor of the points that you 

have made, that if you put a time line in place, it could force actions that could have broader adverse impacts to the markets. And 

so it is those unintended impacts that could ultimately be of concern. 

The other variable which I think is important is any forecast 

against an actuarial reserve is highly dependent on home price expectations. The HPI is the single biggest determinant on how it is 

going to impact capital on a broad portfolio. Despite all the other 

credit characteristics, that and our ability to bring in premium are 

the two biggest drivers we have right now that will ultimately the 

capital reserve. And so based on last year’s forecast, when we submitted and went through the minimum capital reserve results, the 
11 

actuarial firm had laid out a prospective view on when the capital 

reserves might return above 2 percent. And at that time, it was between 3 and 4 years. And, you know, at this point we remain committed to believing that that time line can be reached, and a lot 

of it has to do with our ability to implement the reforms that we 

have asked of Congress to get into the market so that they can 

take hold both in increasing premium and helping us hold lenders 

accountable for loans they should not have originated to indemnify 

the FHA. It is those kinds of actions that will help us get there. 

We do believe the time line is a challenge. 

Chairman DODD. OK, and others may raise this. One last thing. 

I have gone over the time, but let me pose just one more because 

this is one that we debated extensively in the financial reform bill, 

and that is—and my good friend Bob Corker was, I think, the leading advocate of this, though others were as well. And there is a lot 

he says that I agree with, and that is, mandating minimum down 

payment requirements. I believe 5 percent is what we were debating at the time. And I pointed out earlier that the delinquency 

rates obviously in FHA were not substantially worse than the 

prime rate area. But, nonetheless, there is an argument for it, but 

there is also an indication if you have good underwriting standards, 

mandating a certain minimum down payment requirement may 

be—would you comment on that? What are your thoughts on that? 

Mr. STEVENS. Thank you, Senator—— 

Chairman DODD. And I apologize to my colleagues. that is the 

last question I will have. 

Mr. STEVENS. I do want to reflect that I bought my first home 

in Denver, Colorado, in 1970-something with a 3-percent down payment from the FHA with at the time my young bride, and had we 

not been able to get an FHA loan, we would not have bought a 

home; neither would thousands of other people in our community 

and, obviously, many more across the country. 

Down payment alone is not the single characteristic that results 

in default, and as we have all learned through this past period, it 

is the layering of risk that caused high default rates. 

The FHA portfolio is very different. It is all owner-occupied. It 

is all primary residence. It is all—if you can believe it or not, we 

fully document every single loan. I know that is a shock to many 

in the industry. And so the only risk variable ultimately ends up 

being that 3.5-percent down payment for those borrowers that can 

qualify. 

Even the actuarial firm recognized that the changes that we had 

recommended to control that risk would eliminate the vast majority 

of the delinquency attributes that are associated with the portfolio. 

Let me give it another way. We show that loans with FICOs 

under 580 have a worse default rate at below 95 percent than our 

loans at maximum loan to value, just over 580 to 620. So you can 

get performance characteristics with a low down payment as long 

as you control the credit quality standards across the remainder of 

that spectrum. And so I think our core concern when we established our policies that we implemented was to balance the need 

to provide available liquidity for home ownership across America, 

particularly first-time homeowners in underserved markets, which 

has been core to our mission over time, without creating the unin-
12 

tended consequences of eliminating capital and slowing any recovery in the housing market. And it was those two balancing acts, 

while looking at the credit characteristics underlying them, that resulted in this two-step approach. Under 580, 10 percent down. Over 

580, the performance is clearly different and can support the minimum down payment requirement. 

Chairman DODD. Thank you very much. 

Senator Shelby, I apologize. 

Senator SHELBY. Do you believe, though, that underwriting 

standards do play a role and should play a role on any loan? 

Mr. STEVENS. Yes. 

Senator SHELBY. Of course, I know why the minimum down payment. You said you paid 3 percent down. I am sure you didn’t default, but I am sure you had good credit and you were going to pay 

that loan or die. You know, a lot of us would. But underwriting is 

the key to anything, whether it is bonds, diligence. You do diligence 

on this. Now, there are some people with bad credit and bad history that could pay 20 percent down on something and they think 

nothing—you know, if something happened, they would just walk 

off from the loan and so forth. 

But I do believe myself that underwriting is a key to a lot of this, 

a lot of this, period. And what we want, as I understand it, I certainly want a good housing program, but I don’t want a welfare 

program. I mean, that doesn’t help anybody in the long run. It 

makes you not viable down the road. 

And speaking of that, how are you going to grow to at least have 

that 2 percent and when is that? You don’t want a statutory framework, but what do you want? 

Mr. STEVENS. Senator, as I said earlier, and these are complex 

answers because there are obviously economic variables, I can take 

an existing economic scenario and say, if that scenario holds true, 

our capital would return to a level by X period. 

Senator SHELBY. You are speaking of the economy as a whole? 

Mr. STEVENS. I am talking specifically more about—— 

Senator SHELBY. And unemployment and all this, people having 

a few dollars? 

Mr. STEVENS. Yes. The big drivers are going to be the home price 

index. It is going to be the discount rates in the market and it is 

going to be recovery rates or what we recover on defaulted loans. 

Those are going to be some of the major drivers that will ultimately 

allow us to run a formulaic process that allows us to determine 

precisely when the capital gets back. That was done in the last actuarial, and the one we will submit to you in November, again, we 

will have an expectation—the independent actuarial firm will have 

an expectation of when that capital should get above 2 percent. 

There is no doubt that the premium authority you just granted 

us will add at current run rates an additional $300 million a month 

in premium, which will allow us to build faster had you not given 

us that authority. So it is those kinds of changes that will get us 

there and we will forecast that for you, again, in the upcoming actuarial review, which ends at the end of the fiscal year. 

Senator SHELBY. What is it going to take financially for a lot of 

us not to be concerned about FHA, just as we go back 10 years ago, 

close to it—— 
13 

Mr. STEVENS. Yes. 

Senator SHELBY. ——we were really concerned about Freddie 

Mac and Fannie Mae. 

Mr. STEVENS. Senator—— 

Senator SHELBY. A lot of us are concerned about FHA, and you 

know why. 

Mr. STEVENS. Yes. 

Senator SHELBY. What is it going to take to allay these concerns? 

Mr. STEVENS. Senator, I think we all should have a concern 

about FHA. I think it is the only responsible way—— 

Senator SHELBY. You are the Commissioner, so it is right in your 

lap. 

Mr. STEVENS. ——and I am concerned about it, and as you may 

recall, when I testified in front of this Committee for my nomination hearing, I stated at the time that I believed FHA was being 

adversely selected in the markets, and we have the 2006, 2007, and 

2008 portfolios are terrible books that were allowed to be originated with relatively limited scrutiny by those involved, and we are 

going to be paying the price on those loans for many years to come. 

And if home prices flatten or recover, the strength of the fund will 

grow quicker. If home prices recede and worsen, depending on that 

pace, that will make the recovery much slower. 

But I will tell you, I remain extremely concerned about it. I have 

my Chief Risk Officer here with me today. It is what he spends the 

vast majority of his time focused on. And I think we will both feel 

comfortable probably around the same time. At this point, the aggressive actions we are taking and the results we are seeing, even 

in the third quarter report we just submitted to all of you, is clearly a reflection that what we are doing is having an impact. 

But we are absolutely not out of the woods and we retain the 

same level of concern, I believe, that it would only be responsible 

and that you would want us to have. 

Senator SHELBY. Of the FHA portfolio, roughly what percentage 

are underwater right now? It has got to be growing, and high. 

Mr. STEVENS. The general consensus of economists, the Mark 

Zandis of the world, et al., are that roughly 20 to 25 percent of all 

loans in America have negative equity. Now, they are concentrated—— 

Senator SHELBY. What about FHA, though? 

Mr. STEVENS. It is going to be less dramatic simply because our 

concentration, we are not—— 

Senator SHELBY. What does less dramatic mean? 

Mr. STEVENS. I don’t have a precise number for you—— 

Senator SHELBY. It would be high, though, would it not? 

Mr. STEVENS. It would definitely—it is high for all portfolios and 

would be high for the FHA. 

Senator SHELBY. Is this the highest in the history of FHA? 

Mr. STEVENS. We have not done the analysis, Senator, to see—— 

Senator SHELBY. Can you go back and do the analysis, say, for 

the last 20 years and furnish that to the Committee and see where 

FHA was in 1990—— 

Mr. STEVENS. Sure. 

Senator SHELBY. ——2000, 2005, you know, all this—— 

Mr. STEVENS. Yes. 
14 

Senator SHELBY. ——because we would like to know. 

Mr. STEVENS. Yes, and—— 

Senator SHELBY. We want you to survive. 

Mr. STEVENS. And Senator—— 

Senator SHELBY. If we don’t have the information, we don’t want 

to be shocked like we have been before. 

Mr. STEVENS. I completely agree, and the ability to be transparent—— 

Senator SHELBY. Are you going to furnish that information and 

get it to the Committee? 

Mr. STEVENS. We will furnish you our best estimate of what that 

number is. 

Senator SHELBY. Now, wait a minute. We don’t want your judgment. We want statistics. You can go back and see. You have got 

to have data on the percentage of loans, say, in 2000, 2005 out 

there, how many foreclosures, how many underwater, and all this. 

You keep up with that. You have to. If you don’t keep up with it, 

you are in trouble. 

Mr. STEVENS. We do benchmark appraised values across the 

country and we use a home price index—— 

Senator SHELBY. By ‘‘benchmark,’’ what does that mean to FHA? 

Mr. STEVENS. You can’t—it would be an extraordinary project to 

take six million loans in every community across the Nation and 

reappraise every one of them based on today’s values. 

Senator SHELBY. Well, I am not talking about that. I am saying, 

how many people are underwater today? How many pending possible foreclosures do you have? It has got to be high, and we need 

to know, because I think that goes to the bottom line of what GAO 

is talking about. 

Mr. STEVENS. We will report to you our pending foreclosures. Underwater is based on negative equity. It requires an estimation of 

the existing value of the property, of which we have about six million loans across the country. We can do that by looking at market 

areas against local home price indexes that we use. We will go 

through that process. 

Senator SHELBY. Would you call those hard numbers? Would 

they be hard numbers? We are looking at hard numbers. 

Mr. STEVENS. They will be the best numbers that we can discern. 

I would encourage the GAO and others to take a look at them and 

come up with their best estimates, as well. 

Senator SHELBY. In other words, if somebody was going to buy 

your portfolio, they would be looking at what was really in that 

portfolio—— 

Mr. STEVENS. They would use the—— 

Senator SHELBY. ——what was performing, what was not performing, what was—— 

Mr. STEVENS. Right. 

Senator SHELBY. ——shaky, right? 

Mr. STEVENS. And, Senator, they would use the same methodology that we will embark on. 

Senator SHELBY. And you are going to furnish this information 

to the Committee? 

Mr. STEVENS. We will furnish that to the Committee, yes, sir. 
15 

Senator SHELBY. Can you do this in the next month or so? You 

should be able to do that. 

Mr. STEVENS. We will do our best. 

Senator SHELBY. I have got to ask, Mr. Scire`, are you skeptical, 

real skeptical, doubtful that FHA is going to get toward that 2 percent, just 2 percent, goal? 

Mr. SCIRE`. I don’t think we have any way of knowing when FHA 

will get to the 2 percent. FHA actually is in the best position to 

do that estimate, and so I would expect that it would be able to 

say, with the policy changes it has enacted, with the ones it is contemplating, using its modeling, and this does involve assumptions 

about future economic activity, but they should be able to tell us 

what their expectations are about getting to a 2-percent ratio. 

Senator SHELBY. What is your judgment today on the financial 

condition of FHA? For the record here and before this Committee. 

Mr. SCIRE`. Right. 

Senator SHELBY. Honestly—— 

Mr. SCIRE`. Well, today, where the capital reserve account is 

down to a $3.5 billion level—— 

Senator SHELBY. Isn’t that a dangerous level? 

Mr. SCIRE`. Well, it doesn’t leave much of a cushion. 

Senator SHELBY. That is right. 

Mr. SCIRE`. So what will be really interesting to see is over the 

next month or two, as the FHA receives the results of this year’s 

independent actuarial review, whether or not the changes and expectations for future house prices or interest rates, how that affects 

what their estimate will be for the fund and how that might trickle 

down to or reflect in that capital reserve account come next year. 

So I am very curious to see the results of this year’s actuarial 

review, and again, these estimates are based on expectations going 

out 30 years and are highly dependent on expectations for house 

prices and interest rates, so they can move around quite a bit. 

Senator SHELBY. Thank you. Thanks, Mr. Chairman. 

Chairman DODD. Thank you very, very much. 

Senator Reed. 

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

thank you, gentlemen, for your testimony today. 

Mr. Stevens, you noted that you made some significant and important changes, a risk officer, I understand the FICO scores for 

your applicants have gone up significantly, that you have got a 

much better book this year of loans than you had when you 

stepped into office, and that is positive. 

But one of the issues that is affecting all the questions we ask 

today is foreclosure rates. If they continue to accelerate, then the 

value of the portfolio goes down. Your ability to reach the 2 percent 

capital level is further put off. And there are some provisions that 

are involved with FHA mortgages that allow some mitigation tools, 

and let me ask you, are you taking specific steps to ensure that 

homeowners understand if they have FHA insurance that there is 

a full range of FHA loss mitigation tools and reducing these foreclosures? 

We are hearing that services, mortgage services or mortgage 

holders are not telling people potentially into default or on the edge 
16 

that they have these mitigation techniques. What are you doing to 

make sure they know what their rights are? 

Mr. STEVENS. I appreciate that question and it is clearly of critical concern to us. There are a couple of things in place. First of 

all, the Protecting Tenants from Foreclosure Act requires that the 

consumer be notified that it is an FHA loan. We require it of all 

servicers to notify their borrower if it is an FHA mortgage. There 

are a couple of additional steps that we mandate, which is required 

of every servicer in the FHA portfolio, is they must engage in the 

loss mitigation requirements of FHA in the early period of default 

for every consumer. I believe that in past periods, there was less 

monitoring of servicer compliance with that. 

We have instituted a very robust set of servicing reporting, which 

we review monthly, to look at exactly how they are engaging in loss 

mitigation on their portfolio and what percent of their portfolio 

they are in compliance on. There are outliers. There are outliers 

amongst some of the larger servicers and we are working very aggressively with them and we will take further actions to extend our 

ability punitively to make sure that they comply with that policy. 

But we completely share—I completely share the concern about 

making sure every homeowner is protected with every right available to them, particularly in the FHA portfolio. 

Senator REED. One of the particular tools that you have available 

is the occupied conveyance, which essentially allows someone to 

stay in the property even though legally they have lost title to the 

property. Are you using this tool, and if you are, how aggressively 

effectively are you using it? 

Mr. STEVENS. We use the occupied conveyance tool primarily for 

people who are in the property, and most often in times of illness 

or some severe situation where the Secretary deems that they 

should be protected and we provide for the occupied conveyancy. 

We do have a much broader set of loss mitigation tools, Senator, 

that can provide a number of solutions to keep people in their 

homes. Quite frankly, it is the broadest set of loss mitigation standards that I have ever seen in sort of an investor portfolio that is 

available to keep people in their homes. 

We have not broadened the occupied conveyance standard at this 

time. To do so could add some significant expense and could be extremely problematic. I would be glad to submit some further information to you if you want some further clarification of that. 

Senator REED. Thank you. One issue here, just a general comment, perhaps, is that you are also attempting to marginalize the 

technology of FHA. 

Mr. STEVENS. Yes. 

Senator REED. We had these discussions with your predecessor, 

who—one of the reasons I think you couldn’t accurately assess risk 

and control your risk was you had no idea what was going on because of technological gaps. How well are you doing in that regard? 

Mr. STEVENS. So there are two sides to that question. The first 

is we do have a number of tools that have been available without 

technology, and I want to make clear that upon being sworn in, I 

established a very specific set of protocols including very deliberate 

monthly reporting in detail of performance of our total portfolio, 

and this set of robust reporting is now being managed by the Chief 
17 

Risk Officer and it allows us to have much more data than perhaps 

previous Administrations took the opportunity to engage and look 

at. So I do think that there is a lot of data available. 

That being said, we do need enhancements. We have implemented and actually awarded the first three contracts which on our 

first focus area was risk and fraud, and we awarded our most recent, the third contract, just a few days ago to completely upgrade 

our ability to establish automated risk and fraud tools which will 

enable us to catch fraudulent transactions very early on in the 

process, something that FHA did not previously have the ability to 

do. The rest is—a lot of funding will come in the 2011 budget. In 

that, we will implement new capabilities as the funds come to us 

according to our plan that we submitted to Congress. 

Senator REED. The current level of insurance, the maximum is 

$729,750. That will expire at the end of this year. What is your position with respect to extension? 

Mr. STEVENS. As I said earlier, first of all, the Administration 

supports extending all the limits for another year. I do want to 

make clear, with FHA, we do very few loans at that limit, but it 

is more around—the formula would also expire and it would affect 

hundreds of counties across the Nation that would now have their 

loan limits reduced, even for lower sort of median-income homes if 

we were to not extend the formula. 

Senator REED. Very good. And a quick question to Mr. Scire`. In 

terms of your recommendations, the modeling of FHA, the fund, is 

being done now by contractors. You are recommending a slightly 

different approach that you feel would be more accurate in assessing capital levels, and again, one of the key questions around here 

is when do we get to 2 percent. You are suggesting perhaps if we 

measure it differently, we might be closer to it or further away. 

Can you just very briefly, because my time is expired, comment on 

what your advice would be? 

Mr. SCIRE`. Our recommendation is that FHA move away from 

using a single economic scenario for estimating the value of the 

fund for the purposes of compliance with the 2 percent, and the 

reason we recommend that is that it would tend to overstate cashflows. And so stochastic simulation is what we are recommending. 

It is a widely accepted practice. FHA itself recognizes the utility of 

it in terms of—or the usefulness of looking at many scenarios in 

terms of its stress scenarios that it does. But it is not used for purposes of compliance with the 2 percent. So we think that that is 

a direction that it needs to take. 

Senator REED. Your comments, quickly, Mr. Stevens. 

Mr. STEVENS. So first of all, we agree with the GAO’s recommendation. The new contract for our next actuarial review will 

include stochastic modeling. I do want to emphasize that we run 

multiple paths on a deterministic approach, which is how most of 

the analytics on our portfolio have been done by other agencies, as 

well, but we do believe the stochastic modeling is the right way to 

go. 

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

Chairman. 

Chairman DODD. Thank you very much, Senator. 

Senator Corker. 
18 

Senator CORKER. Mr. Chairman, thank you, and I appreciate you 

having this hearing. I know that this will be the next topic, housing finance in general, that we all wrestle with, and certainly appreciate the witnesses ending this year with this kind of testimony. 

It seems to me, Mr. Stevens, at the FHA that what is happening 

right now is we have had a down market. You had a series of sort 

of bad vintage loans that you were dealing with when you came in, 

and that what you are in essence doing is not unlike what happens 

many times in the private sector when there is a downturn. You 

are sort of building through this and building volume and hoping 

that as things stabilize with this large volume of new loans, that 

you end up back at the capital requirements you need to have. 

Would that be a good summation of what you are doing? 

Mr. STEVENS. I would say—if you don’t mind, I would clarify 

that. We are not just hoping to get back there by building volume. 

We are raising premiums, and one of the most significant ways 

that we can address the existing bad books, outside of just building 

volume with better quality loans at higher premiums, is to have 

the ability to require indemnification from the lenders based on 

things beyond just fraud and misrepresentation. If they originated 

a loan outside of our policy guidelines and it wasn’t fraud or misrepresentation, we have had limited capability to go after them and 

not pay their claim, and make them pay the claim. 

That is the way we could protect the balance sheet on even the 

past book years. That is actually in the FHA reform bill, and that 

is why we are very hopeful that Congress and the Senate particularly will not only introduce that, but get it passed so that we can 

hold the lenders accountable. That will actually strengthen the 

fund because we won’t pay claims on some of the bad loans from 

the old books as we look at it. 

Senator CORKER. In preparation for this next debate with GSEs 

and all of that, we spent a lot of time with the analysts over the 

last several weeks. Numbers of them are saying that with the volume that we have out there of unoccupied homes or homes for 

sale—I think there are about two million of them—that it is likely 

that over the next 6 months, that housing prices will continue to 

decline before things start increasing. What kind of models are you 

all using internally? 

Mr. STEVENS. We do look at the same relative forecasts that any 

economist that you and your staffs would be consulting with, as 

well, and we are seeing a series of forecast expectations that range 

from sort of a relatively flat environment to perhaps significant 

softness, particularly in some key market areas. And without question, the core point there is absolutely accurate, that the additional 

softening of any markets will clearly add incremental risk to portfolios and stress to the general housing recovery. 

The question is, if home values are going to drop, will it be 

broad-based nationally or will it be regionally or in select areas? 

What is the net impact to those particular areas that may be impacted? And then what kind of controls do you put in place? And 

more importantly, what kind of solutions do we think about to try 

to put in place to try to stabilize those markets? 

This is clearly the worst housing market any of us have ever 

lived through in our professional lives, and so attacking this in a 
19 

very methodical but thoughtful way is extremely important at this 

time. 

Senator CORKER. So the Chairman mentioned in his comments 

about extending the limit, the upper limit right now on FHA loans, 

and as a beginning point, that is something that is not particularly 

interesting to me. On the other hand, you did mention something 

about the formula and how the fact is that only 3 percent of your 

loans are above the normal limits, but the formula is the part that 

is important. 

So along the line of questioning that has gotten me in trouble 

multiple times in the past, is there a way to deal with the problem 

you have without actually raising that limit? In other words, I 

think most of us want to see—I think everybody actually wants to 

see the involvement that Government has in guaranteeing loans 

decrease. I think everybody here does. Is there a way to address 

the issue that you are talking about and still go ahead and drop 

down to the norm and somehow keep the formula in place, because 

you are only affecting, again, 3 percent of the loans that you are 

actually originating today or insuring? 

Mr. STEVENS. Senator, I think there would be a variety of ways 

to respond to the concern about FHA being able to provide ongoing 

financing for really the vast majority of the homeowners outside of 

the limit. Here would be my less than sophisticated response. We 

are under a very tight timeframe. Lenders already today are beginning to think about pricing for January loans and they are going 

to begin cutting back opportunity, home ownership opportunity, refinance opportunity, across the Nation here in just the next few 

short weeks. 

Considering the fact that the actual use of the higher loan limits 

is really not pervasive in the FHA portfolio, and quite frankly, the 

performance on them is very good, even though it is less than 3 

percent of the portfolio, it is not a real impact driver, our recommendation is to simply extend the limits for another year. 

But I do share your concern, and I know we have spoken about 

it beyond this. The role of the U.S. Government in the housing finance system has got to pull back, particularly FHA, and there has 

to be a way for private capital to reengage. My discussions with 

private investors is they don’t have an appetite for mortgages in 

this country to begin with, so even if we pulled back, there is no 

clear evidence there would be enough capital to support this housing system. So all those reasons combined that I just reviewed are 

why we recommend a simple extension for 1 more year rather than 

doing too much fine-tuning that could get lost in debate when it 

really is not particularly relevant to risk in the FHA portfolio. 

Senator CORKER. Well, it just seems to me that it would be relatively simple for you all to—I mean, we are not going to do a lot 

of fine-tuning. We take recommendations from folks like you and 

look at them. It just seems to me there would be a way of accomplishing exactly what the Chairman laid out, and that is keeping 

the mortgage market operating, and if it is not really dealing with 

those larger loans, we could also as a Congress be taking a step 

back to the norm, which I think is also important. That is another 

important thing, I think, for the economy to sort of get back to the 

norm. 
20 

I know my time is up, but it doesn’t seem to me it is that difficult 

to do some of that fine-tuning you are talking about. All we would 

do is say yea or nay. We wouldn’t be fine-tuning it ourselves, and 

I hope that—I know my time is up—that we could talk just a little 

bit more. It seems like there—or maybe is there a way to say that, 

look, you can’t do more than 3 percent? 

Mr. STEVENS. We have had these discussions before about controlling the mix of FHA loans. I think that is a difficult approach 

to getting at it. I would be glad to follow up with you on that particular item. But again, our view at this time is that, over time, 

these temporary extensions need to ease back when there is private 

capital returning. At this time, given the limited impact of any 

loans in that area to begin with, the fact that it probably has some 

meaningful value in some of the real high-cost markets, even 

though it is not a meaningful value to the FHA portfolio broadly, 

and the very short timeframe that we have to respond right now 

and the increase in anxiety that is occurring across this broad 

housing finance market with all the participants, we continue to 

recommend that we do the extension for a year, but I would be glad 

to follow up and have a conversation with you about it. 

Senator CORKER. Mr. Chairman, I thank you. I guess my only 

concern in closing is we end up with these things like SGR that 

never go away, AMT fixes that never go away. I think if there is 

a way you could help us, we understand the problem and I am very 

sensitive to the problem, but at the same time, I think we are getting into a territory which makes this a permanent extension forever and I hope you can help us think through another way. Thank 

you. 

Chairman DODD. I appreciate Senator Corker’s questioning, as 

well, and obviously, I think we are all trying to get the same result. 

I just would note before turning to my two colleagues, I believe, 

and this won’t come as any great shock, obviously, but the realtors 

and others who are all coalescing around this idea of the extension 

as they see the problem, I think one of the major points you made 

is that there is so much in the housing market that is based on 

anticipation. No one knows this better than my colleague from Tennessee, having lived in this world, that that point you made about 

January, and while this is—I don’t think most people recognize 

how much of that market depends upon that idea. And so that is 

the quandary, in a sense, we are in. 

So anyway, we will talk about it and I will talk to Senator Corker, as well, and hear any ideas on this as we go forward. I would 

like to be able to get a consensus, obviously. If we end up with a 

brouhaha on the floor of the Senate, that is not going to happen, 

so we need to figure out some way to get this, do this in a way that 

makes some sense. 

I was going to make the point—I am going to turn to Senator 

Merkley, but I wanted to make a point. When you mentioned Senator Brown and Senator Begich, the lead cosponsor on this FHA reform bill is Senator Bennet of Colorado, as well, and I wanted to 

make sure the record reflected that my colleague from Colorado is 

a lead advocate of that reform bill. 

Senator Merkley. 
21 

Senator MERKLEY. Thank you very much, Mr. Chair, and thank 

you all for your testimony. 

Commissioner, when you were talking about modeling risk, you 

mentioned, I believe, that home prices are the biggest driver. I assume that is because if home prices go down, more people walk 

away from their homes and also the recovery rate is lower, so it 

hits you on both ends. Is that kind of the correct—— 

Mr. STEVENS. That is correct. 

Senator MERKLEY. As you kind of test the boundaries of risk in 

that area, are there any scary numbers we should be aware of? For 

example, if home prices go down another 5 percent over the next 

2 years, is the insurance fund bankrupt? 

Mr. STEVENS. If it would be permissible, I would like to follow 

up with the Committee on two points. In the last actuarial review, 

we actually did testing on worsening home prices, and we will do 

it again when we submit the actuarial to you in November. It will 

show the prime path, but it will also show worst scenarios assuming deeper HPI recessions and it will show how that impacts the 

capital. 

So it is a concern and there are variances in those scenarios. But 

without giving an off-the-cuff response, if it would be permissible, 

I would like to give you more thoughtful feedback on how that—— 

Senator MERKLEY. Absolutely. I would appreciate that. And I recognize that, essentially, these parameters are being applied to 

loans that were not originated, if you will, under your leadership, 

which brings me to the next topic, which is the subprime default 

rate under the FHA portfolio is really pretty shocking when we 

compare that to more conventional loans, and I am assuming that 

is a combination of factors, that a lot of these loans were liar loans, 

that a lot of these loans involved a 2-year teaser rate that popped 

up to a much higher level and people can’t get out of them because 

of the prepayment penalties, and that a lot of people were steered 

into these loans when they actually qualified for a prime loan. I 

think the Wall Street Journal showed 60 percent of the subprime 

mortgage holders qualified for a prime loan. 

And so in 2010, there were still a lot of Alt-A loans that were 

scheduled to essentially hit the point at which families would be 

triggered from the lowest of the three payment options to the highest because they would max out their negative equity limits. Have 

we now worked our way through the vast bulk of triggers, if you 

will, that drive to higher payments and therefore trigger essentially 

default? 

Mr. STEVENS. So there are a couple of variables that I think will 

be big trigger points that we are looking at. One of them, we have 

already passed through for the most part, and that was the 228 

subprime spike, as it were, which caused an interest rate adjustment at the end of the second year, and that is why I think in the 

early phase of this default challenge we went through in this country, we saw the subprimes defaulting at a much higher rate in the 

early period. Now that seems to be moving to other potential product types and it began to evolve. 

One of the classic cases is this thing called the pay option ARM, 

which many of you are familiar with, that started with a very low 

initial teaser rate but then would escalate up over time. The chal-
22 

lenge with those loans is they originated over multiple years and 

there are two triggers that will cause an adjustment. One is they 

either have a fifth or 10-year, some of them, a 10-year adjustment, 

that if a loan won’t pay off over the remaining term, they do an 

automatic adjustment. We will see those come in in quantities over 

the next couple of years as we see this market move through, assuming no other recovery in sort of general home prices or perhaps 

on the employment side to help these borrowers stay in the home 

and pay them. 

I will add one other point, is these loans are held primarily on 

three large bank portfolios and the banks are also aggressively 

working with these loans and doing things outside of the contract 

itself to try to keep the people in the homes and offering them a 

variety of other options, whether it be the HAMP program that we 

provide or their own internal modification program. All that said, 

I think we still have a ways to go as we work through that portfolio 

and the markets in general. 

Senator MERKLEY. So you feel like your modeling has a pretty accurate reflection of the types of loans, the way in which they ripen, 

so that we have got our hands around the dimensions of the challenge? 

Mr. STEVENS. Yes. That data clearly exists and it is being reviewed by members at Treasury, National Economic Council, and 

here at HUD, and we talk through those numbers, what the products underlying are. We talk to servicers about what they are doing 

to address them and what the experience is. We go to anybody, 

economists particularly, who can help us look at reasonable analytics on the portfolio. So all of that is being done. 

Senator MERKLEY. Well, this brings me to the next piece, which 

is specifically to ask about the yield-spread premium rules, or the 

steering payments, if you will. The Fed has put rules—well, they 

haven’t put them in place yet, but April 2011 they go into effect. 

The Dodd-Frank bill severely restricts the use of such steering payments. But does it make sense not to wait for those both to go into 

effect downstream and to apply kind of strict yield-spread premium 

rules now for loans being originated and being insured by FHA? 

Mr. STEVENS. Senator, it is an important question and we are 

looking at that right now. We are looking at the implementation 

of the Dodd-Frank bill across a variety of parameters that exist in 

the FHA portfolio. 

It is interesting that the FHA loans are a little different in that 

it is sort of one product type. There is little opportunity to sort of 

game our system from that standpoint simply because every loan 

is a 30-year fixed-rate loan, fully documented, sort of vanilla, as it 

were, type of product. And so you don’t have the optionality that 

loan originators can do with other programs that are less easily understood by consumers. 

That being said, we are looking at it and I will be glad to report 

back to you in terms of our timing and what we can do and implement in the early phase here. 

Senator MERKLEY. Yes. So essentially, you are no longer insuring 

subprimes and therefore there aren’t really bonuses connected to 

steering people into subprimes? 

Mr. STEVENS. Right. 
23 

Senator MERKLEY. OK. 

Mr. STEVENS. Well, and add to that, Senator, FHA never did 

subprime. FHA was always doing 30-year fixed rate mortgages and 

there were no 228s or that kind of product. We did have much 

lower credit quality in those past book years, some of which people 

compared to the same sort of credit scores as subprime borrowers, 

but the product itself was a 30-year fully amortizing fixed rate during that period. 

Senator MERKLEY. So when I see this analysis of the FHA portfolio and I am seeing default rates of 30-plus percent on the 

subprime component of the FHA inventory, those aren’t actually 

subprimes? 

Mr. STEVENS. That is actually a comparison of our portfolio 

against how a subprime portfolio performs. 

Chairman DODD. Delinquencies in the FHA were 9.4 percent. 

Mr. STEVENS. Right. 

Chairman DODD. Prime rate was about 7 percent. And subprime, 

which was never part of FHA, was 30.6. 

Mr. STEVENS. But that particular table is designed to highlight 

the fact that Senator Dodd just emphasized, is that we aren’t really 

a subprime portfolio, and by showing subprime delinquencies, it allows us to create that distinction between the two books. 

Senator MERKLEY. I see. Well, that helps explain, because I 

thought you had insured some subprimes. I misinterpreted this 

chart, because this chart is labeled, ‘‘Characteristics of FHA Insured Mortgages,’’ and then it shows subprimes. 

Chairman DODD. That is what they have been trying to do for 

a long time, and that was the point I made this morning, that it 

really is closer to the prime rate. Actually, it was much better. 

Mr. STEVENS. I apologize for creating that confusion. That is our 

fault. We will relabel that chart so it is clear. These are complex 

data charts. That is really our fault and we shouldn’t do that, because we deal in an esoteric world and you shouldn’t have to try 

to figure that piece out. 

Senator MERKLEY. I have so many more questions for you, but 

I see I am over my time. 

Mr. STEVENS. I am always available to you, Senator. 

Senator MERKLEY. Thank you. 

Chairman DODD. Thanks, Senator, very much. 

Senator Bennet. 

Senator BENNET. Thank you, Mr. Chairman. Thank you for holding the hearing. And, Mr. Stevens, we certainly will take you back 

in Denver, Colorado, whenever you want to come. But in the meantime, you are doing important work here that I want to congratulate you on. 

I want to underscore something Senator Merkley said and you 

have heard here. The interest, I think, in this Committee about 

being able to see the stress testing you are doing of the models I 

think springs from a sense among some of us that the oversight 

here was not so good either. And the idea that, you know, we 

were—not we, FHA and others were running loan portfolios without actually knowing what the underlying risks were, then Congress was not doing the oversight it should have been doing, leads 
24 

us to want to learn from that and do a much better job. So I also 

would be very interested to see the product of your work. 

I wanted to ask you a few specific things. As the Chairman mentioned, I am cosponsoring the reform legislation that you have 

talked about today. In your testimony, the written testimony, you 

mention that FHA currently can only seek indemnification from 29 

percent of its approved lenders in cases of fraud and improper loan 

origination. The new reform legislation would enable you to seek 

indemnification from any of the lenders in such cases. 

I wonder if you could talk a little bit about what you think that 

new authority could do for FHA’s overall financial strength. 

Mr. STEVENS. Senator, we have two designations for lenders 

within the FHA portfolio. LI lenders, which really are the largest 

lender insurance providers within our portfolio, the major banks. 

We have another designation called direct endorsement, DE lenders. These are often smaller institutions, historically have been less 

well capitalized. And, quite frankly, I think the oversight of them 

has not been as strong as it otherwise could have been. 

Broadly across the country, these institutions originated a lot of 

loans over the past few years, and as we said earlier, particularly 

in 2006 through 2008, after the collapse of Alt-A and subprime, a 

lot of rogue originators came to originate FHA loans without the 

scrutiny that should have necessarily been there. 

Our ability to get the enhancement to our authority to be able 

to require indemnification of DE lenders will go beyond fraud and 

misrepresentation. It will go to just loans that were manufacturing 

quality, as we call it, loans that were underwritten, insured, but 

they did not meet actually our qualifying guidelines. And under 

those scenarios, we actually have very limited authority to go back 

to these direct endorsement lenders and says, ‘‘Guys, we are not 

paying your claim when the loan goes bad. You are paying it out 

of your own capital.’’ 

To quantify what we will be able to get out of it has been a challenge for us because, as we all know through this collapse of the 

market broadly in the housing system, many of these lenders have 

gone out of business. Many of them did not have enough capital to 

be in the business anyway. I have shut down 1,500 in the last year 

alone. I think the biggest year in history was in the 1930s or something like this. We have gone after this problem very aggressively. 

But it will allow us to at least go after the remaining companies, 

of which there are still many, that originated loans, that we can 

hold them accountable for loans that were outside of our policy and 

make them pay the claim. The quantity of that will become known 

once we start requiring them to pay claims to see if they have the 

money to actually pay them. 

Senator BENNET. Do you have a sense of the order of magnitude—was it 2006 through 2008? Is that the period that you are 

talking about?—order of magnitude what percentage of the portfolio would fall into that category, looking at it retrospectively? 

Mr. STEVENS. Yes, let me give you just a couple of examples. 

Seller-funded down payment assistance loans, which were—I will 

not go through the program in depth but—— 

Senator BENNET. The name says it all. 
25 

Mr. STEVENS. It is about 8 percent of the portfolio but 20 percent 

of our defaults. Credit scores less than 580, which, as you know, 

is where we have drawn our new line, it is about 7 percent of our 

portfolio but 22 percent of the defaults. 

The 2006 and 2008 books, just those 2 years, are 20 percent of 

our insurance but 45 percent of our defaults. So when you accumulate all this data, you know, really about three-quarters of the portfolio are based on those—in terms of our loss expectations, are 

based on that portfolio of those 2006 through 2008 book years. But, 

fortunately, you know, the vast majority of our portfolio based on 

2009–2010, about half of it now is originated in the most recent 

year. So we are bringing in better quality to reduce our overall exposure, but our real losses are coming from just these terrible portfolio years where I think lenders—and I was in the private sector 

at the time—just took unfair advantage of the FHA and, you know, 

now we are paying the price for that. 

Senator BENNET. When you got there, how did you call attention 

to the folks that were working in the agency? Did this require— 

do you have the same people doing this work? How do you change 

the culture of the place? 

Mr. STEVENS. Well, it has been a huge culture change, as many 

of the team that is here with me today will tell you, that we have 

implemented a significant culture change in the organization to 

having, you know, a regime of risk reporting, to creating a risk office. I brought in a new general Deputy Assistant Secretary, Joe 

Smith, who is here with me today. But we also had—the career 

staff is outstanding at FHA. You know, their analytic skills, their 

educational pedigree, and their understanding of the portfolio is extremely valuable. It was just a matter of leadership, providing the 

direction to them to do the work that needed to be done. 

Literally my second week on the job, I called a meeting on one 

lender, Taylor, Bean & Whitaker, and I pulled everybody in, and 

we did a review on them; and from that meeting, over the next few 

weeks on the job, before I had done anything, we went after 

changes to our streamlined refinance program and minimum capital standards that I wanted to implement. And I just sort of went 

at it very aggressively from the onshoot in a way that was in an 

effort to utilize the resources of the organization. The whole team 

is behind it and the support from the career staff as well as the 

new team I brought in collectively, we have had a big impact on 

the organization. 

Senator BENNET. Well, I want to thank you for all that. My time 

is up, and I look forward to working with you on pushing this reform legislation through. 

Mr. STEVENS. Thank you, Senator. 

Senator SCHUMER [presiding]. Well, thank you, Senator Bennet, 

and as the Acting Chair, I recognize Mr. Schumer. 

[Laughter.] 

STATEMENT OF SENATOR CHARLES E. SCHUMER 

Senator SCHUMER. Anyway, I want to thank Chairman Dodd and 

Ranking Member Shelby for holding today’s hearing on the current 

condition of FHA. I have a brief statement and a question for Mr. 

Stevens. 
26 

FHA, as you know, as we all know, helped stabilize both the single-family and multifamily housing market since the 1930s by insuring mortgages that meet specific eligibility criteria. In recent 

years, FHA’s role has become more important than ever. During 

the housing boom, their share of the market was so small, some 

people thought we should get rid of FHA altogether. Now they 

guarantee almost 30 percent of all mortgages, and it is scary to 

think of what the housing market might be like if FHA were not 

around. 

But FHA is limited in its ability to help developers construct or 

to rehabilitate affordable rental housing in many urban areas—this 

is my focus, multifamily rental housing—where the need for affordable rental housing is the greatest because of the limit on FHA 

multifamily loans, which is set well below the cost of construction 

in these areas. Let me give you an example. 

In New York City, the average construction cost for a high-rise 

building—that is defined as 16 stories or taller—is $419,000 per 

unit. That is more than double the FHA limit. This makes it hard 

to secure affordable financing for multifamily rental development 

and rehab. 

In New York City alone, there are 14 developments with over 

2,000 units. That is a lot of construction jobs and a lot of housing 

units, and our population is growing. New York has grown from 7 

million people in 1990 to 8.5 million, approximately, this census 

will show. And so we need this. 

FHA cannot help because we have tied their hands in a way that 

is unfair to high-cost areas like New York. Nationwide, there are 

51 projects with 11,000 units stalled. 

That is why I introduced legislation, along with my colleague 

from across the Hudson River, Senator Menendez, called the FHA 

Multifamily Loan Limit Adjustment Act of 2010. A similar bill was 

championed in the House by Representative Weiner and actually 

passed the House in June, the contentious, partisan House, by a 

vote of 406–4 as part of FHA reform. 

The bill would provide the Secretary of HUD the authority to 

designate high-cost areas and extremely high-cost areas for FHA 

multifamily insurance, increase the loan limits in those areas from 

$183,000 per unit to $376,000 per unit. It doubles it. 

HUD already had had this authority, but only for Alaska, Hawaii, Guam, and the Virgin Islands. Our bill puts places like New 

York City, Chicago, Los Angeles, and Boston on an equal playing 

field. It would also increase the premium allowed for construction 

or rehab of rental high-rise buildings with elevators as compared 

to buildings without elevators from 10 to 50 percent, in line with 

the actual difference in construction costs for elevator buildings. 

It is important to note my bill would not alter underwriting criteria or weaken taxpayer protections because it requires that FHA 

economists vet the credit quality of all borrowers before insuring a 

loan. 

The multifamily loan program is completely funded by its own 

premiums, separate even from FHA’s single-family program which 

has been discussed this morning. And the multifamily program has 

not experienced nearly the same difficulties as the single-family 

program. Recent data from HUD shows that default rates are only 
27 

2.2 percent multifamily for 2008–09. The program has had a seriously delinquent rate of only 0.3 percent in 2008. The delinquency 

rate for single-family homes in contrast is 7.9 percent. So actuarially it is in much better shape. 

Moreover, the bill would not raise the overall cap on the total 

amount of multifamily loans FHA can insure, so it does not present 

any risk to the taxpayer. The bill has been incorporated—and I appreciate this—in a broader set of reforms sponsored by Senator 

Begich, Senator Brown, and Senator Bennet, the latter two from 

this Committee. I would like to thank my colleagues for working 

with me in the reform package. 

So my question for you is simple, Mr. Stevens. Would FHA support this bill, my bill, to raise the multifamily loan limits for highcost areas like New York as part of a broader legislative package 

sponsored by Senators Begich, Brown, and Bennet. I am not a 

sponsor because my name does not begin with a ‘‘B.’’ 

[Laughter.] 

Mr. STEVENS. Senator, we absolutely support the higher limit authority for multifamily. Without question, all the points you made 

are of great concern to us, particularly as we move into a housing 

economy where home ownership may drop. There is going to be an 

increased demand in having safe, affordable, accessible rental properties. And to your point, where land costs are high, it becomes 

very difficult to finance an FHA multifamily property in this country, and that affects about a quarter, roughly, of all our regional 

office areas that are impacted by having the lower limits today. So 

we do support it—— 

Senator SCHUMER. So you support the legislation? 

Mr. STEVENS. Absolutely. 

Senator SCHUMER. Thank you. And on that happy note, the hearing is adjourned. I thank all of the witnesses. 

[Whereupon, at 11:45 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
28 

PREPARED STATEMENT OF SENATOR TIM JOHNSON 

Thank you, Mr. Chairman. Thank you, Administrator Stevens and Mr. Scire` for 

testifying today as we examine ways to strengthen the financial condition of FHA 

and ensure that FHA has the tools to enforce loan requirements and protect taxpayers from fraud and misrepresentation. 

FHA serves an important and countercyclical role in our housing market to ensure that mortgages are available to qualified borrowers even in tight credit markets. From 2007 to 2009, the percentage of loans insured by FHA have significantly 

increased from 3 percent to approximately 30 percent of the market. Demonstrating 

the importance of FHA is the fact that the percentage of borrowers with credit 

scores at or above 720 has doubled compared to borrowers in 2007 and 2008. Without FHA, even credit worthy borrowers may not have received loans because of the 

contraction of available credit in the private market. 

While FHA fulfills this role, it is also experiencing the strains in the housing market and larger economy. Congress and the Administration have taken action to provide FHA with new tools to mitigate the impact of the economic downturn through 

additional loan requirements and greater flexibility for insurance premiums. I look 

forward to hearing more about how these changes are affecting FHA’s balance sheet 

and what other changes are needed to ensure that FHA can continue to fulfill its 

mission while also protecting its long term financial stability and the taxpayers. 

PREPARED STATEMENT OF DAVID H. STEVENS 

FEDERAL HOUSING AUTHORITY COMMISSIONER AND ASSISTANT SECRETARY FOR

HOUSING, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

SEPTEMBER 23, 2010 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, thank 

you for the opportunity to testify today on the progress the Federal Housing Administration has made towards strengthening its financial condition. 

As you know, last year we informed Congress of the independent actuary’s findings that FHA’s secondary reserves had fallen below the required level. Ten months 

later, while there is still much work to be done, FHA is on a predicted path that 

will put the agency in a stronger financial position for the future. 

Mr. Chairman, last year at this time the independent actuaries predicted that we 

would draw down $2.6 billion of capital resources over the first three quarters of 

this year to pay for rising claim expenses. As noted in our third quarter MMI Fund 

report to Congress, instead of decreasing by $2.6 billion, net income increased by 

$450 million. Once we add interest earnings to core insurance income, our capital 

resources grew by $1.3 billion in the first three quarters of this fiscal year. While 

our actual performance to date has been significantly better than predicted by the 

actuary, the net budgetary actuals are in-line with projections in the President’s 

Budget that was provided to the Congress in February. 

While economic conditions evolve and significant risk and short-term house price 

volatility remain present, current trends indicate that as a result of the actions 

taken by the Administration and Congress, we are making progress in strengthening the FHA portfolio and rebuilding our capital reserves. 

The positive signs we are seeing are due, in large part, to the numerous reforms 

put in place and actions the FHA has taken over the last year, including an increase 

to insurance premiums in April and the suspension or withdrawal of approval for 

1,500 lenders from doing business with FHA. This does not yet account for the additional authority to change our annual premium structure passed by Congress that 

will add an estimated $300 million per month to the FHA fund. 

Of course, we remain cautious, and the job is not yet done. With home prices uncertain, our continued vigilance in strengthening both loan quality and performance 

for future loans is particularly important. To that end, it is important to note that 

the early performance data of loans insured in FY2009 and 2010 are much stronger 

than previous years. While FHA is currently playing an important and temporarily 

elevated role in providing liquidity to the housing market, it is doing so responsibly. 

With the remainder of my testimony, I will explain our efforts in greater detail. 

In particular, I will describe the role FHA is playing in the market, the reforms 

FHA and the Congress have put in place, the early results these reforms are producing, and why our ability to protect the taxpayer for the future requires Congress 

to enact the broader, more comprehensive set of reforms we have proposed. 
29 

FHA’s Current Role in the Housing Market 

I’d like to take a moment to outline the important countercyclical role FHA has 

played in our housing market during these difficult economic times. Created by 

President Franklin Roosevelt in 1934 at a time when housing prices had collapsed, 

the FHA was designed to provide affordable home ownership options that would 

keep our mortgage markets afloat during tough times. 

Indeed, when the market began its slow collapse 3 years ago, FHA comprised only 

about 2 to 3 percent of the housing market. But when private capital vanished at 

the end of 2008, it was the FHA that stepped in—insuring approximately 30 percent 

of purchases and 20 percent of refinances in the housing market. Since January 

2009, the agency has helped nearly 3 million Americans either purchase a home, 

or refinance into more stable, affordable mortgages. At the same time FHA has also 

helped more than a half million families at risk of foreclosure through 760,000 loss 

mitigation actions. 

The results of these extraordinary but necessary actions, combined with many 

others across the Administration, are clear. Home prices began to stabilize. And 

homeowner equity started growing again in the second quarter of 2009—to date, increasing over a trillion dollars, or close to $14,000 on average for the Nation’s nearly 

78 million homeowners. 

FHA’s Current Financial Condition 

Still, this heightened role comes at a cost. Last November, upon the final completion of FHA’s independent actuarial review of fiscal year 2009, we reported to Congress that FHA’s secondary reserves had fallen below the required 2 percent level— 

to 0.53 percent of the total insurance-in-force. Combined with reserves held in the 

Financing Account, FHA reported that it held more than 4.5 percent of total insurance-in-force in reserves—$31 billion set aside specifically to cover losses over the 

next 30 years. 

The Administration has taken very seriously its responsibility to ensure that FHA 

is operating on sound financial footing while minimizing risk to taxpayers. Since I 

took office as FHA Commissioner in July 2009, we have implemented a broad range 

of actions demonstrating steadfast stewardship of the fund, while carefully ensuring 

that we continue to serve communities nationwide. 

Specifically, over the past year, this Administration has announced and implemented the most sweeping combination of reforms to FHA credit policy, risk management, lender enforcement, and consumer protections in its history. These reforms have strengthened our financial condition and minimized risk to taxpayers as 

we continue to fulfill our mission. 

On behalf of Secretary Donovan and myself, I want to thank both chambers of 

Congress, and particularly the leadership of you, Chairman Dodd, and Ranking 

Member Shelby, for the partnership and cooperation exhibited in passing H.R. 5981, 

which provides FHA the authority to modernize its premium structure. As you 

know, this authority was granted through unanimous consent in the Senate and 

passed by voice vote in the House before being signed into law by President Obama 

on August 11, 2010. FHA has moved quickly to implement a new premium structure, which will take effect on October 4. Similar authority was included in H.R. 

5072, the broader FHA reform measure, which passed the House of Representatives 

in June. While the swift work of Congress has allowed us to implement the premium change, which is important for FHA’s ability to generate greater revenues for 

taxpayers in line with the President’s Fiscal Year 2011 Budget proposal, we at HUD 

remain committed to comprehensive FHA reform which will provide the tools we 

need to continue our efforts. 

As you know, on January 20th of this year, FHA proposed taking a series of administrative steps to mitigate risk and augment the Mutual Mortgage Insurance 

(MMI) Fund’s capital reserves. These proposals included: increasing the mortgage 

insurance premium (MIP); imposing a firm floor on allowable credit scores; requiring a higher down payment for borrowers with lower credit scores; further tightening the minimum credit score required for borrowers with low down payments; 

reducing the maximum permissible seller concession to match the industry norm; 

and implementing a series of significant measures aimed at increasing lender responsibility and enforcement. We have followed through with each of these reforms, 

which I will discuss in this testimony. 

In conjunction with updated down payment and credit score guidelines published 

on September 3, the changes to FHA’s premium structure are projected to result in 

an additional $4.1 billion in FHA receipts in Fiscal Year 2011. 

With the 2010 fiscal year coming to a close, the independent actuary is in the 

process of completing its annual study and projections of the capital reserve ratio 

of the FHA MMI Fund. We expect to deliver the finding of this independent study 
30 

to Congress in November, which will include the official measure of the capital reserve ratio. 

In the interim, I am pleased to inform you that tangible, measureable progress 

is being made to improve loan quality and performance compared to past years. The 

independent actuary projected that more than 71 percent of FHA’s losses over the 

next 5 years will come not from newly insured loans, but loans already on our existing books when this Administration took office. 

Indeed, the early period delinquency rates for FY2009 and FY2010 loans are 

much lower than the early period delinquency rates for loans insured in FY2007 and 

FY2008. This improvement suggests that ultimate claim rates on loans endorsed in 

FY2009 and FY2010 should be markedly better than the ultimate claim rates of 

loans endorsed in FY2007 and FY2008. 

As detailed in FHA’s third quarter report to Congress, it was clear that FHA’s 

loan characteristics and financial performance are better than had been forecast in 

the FY2009 actuarial review. 

Highlights of FY2010 Q3 Report to Congress 

On August 2, FHA delivered its third quarter report to Congress highlighting the 

status of the single family MMI Fund programs (enclosed in appendix). As mentioned above, FHA has conducted rigorous analytical reviews, established new reporting protocols and procedures, and announced some of the most extensive policy 

changes in its history. Under the supervision of our new Chief Risk Officer, these 

changes have been made to better protect the safety and soundness of the MMI 

Fund while continuing to serve our mission and support the stabilization of the 

housing market. 

As part of our commitment to increased transparency and to provide Congress 

with better information and data on the performance and operations of the MMI 

Fund, we enhanced our quarterly report to include the financial status of MMI Fund 

cash flows, early payment delinquencies and serious delinquency rates. 

As I noted earlier, the third quarter report shows that many aspects of the fund 

are in better shape. Specifically, the amount of cash reserves in the fund is nearly 

$3 billion higher than forecasted in last year’s actuarial report. 

There are other positive signs as well. FHA’s portfolio shows the average credit 

score on current insurance endorsements has risen from 634 in 2007 to nearly 700 

today. Loan performance, as measured by serious delinquency and early period delinquency rates, has improved significantly, with the first year-over-year decline in 

new 90-day delinquencies in years. And actual claim payments to date are $3.7 billion lower than had been projected by the independent actuary although this is 

somewhat offset by lower than projected property recoveries. 

Additional Reforms—Progress to Date 

The two key ways in which we have strengthened FHA fund solvency have been 

to increase revenues and engage in better risk management. Therefore, we have 

been focused on restructuring our mortgage insurance premiums and putting in 

place mechanisms and policies to protect the FHA for the future. 

In October of 2009, we hired the first Chief Risk Officer in the organization’s history. On July 28, 2010, we received Congressional approval to formally establish 

this position and create a permanent risk management office within FHA, for which 

the Risk Officer is now Deputy Assistant Secretary. With this new office and additional staffing, we have begun to expand our capacity to assess financial and operational risk, perform more sophisticated data analysis, and respond to market developments. 

Additionally, FHA introduced policy changes and improved lender oversight and 

enforcement to increase the quality of FHA insured loans. From my first day as 

FHA Commissioner, I began a thorough review of our loan practices and organizational capacity and gaps. Over the past 12 months we have introduced a number 

of new policies and taken several steps within our existing authority, all aimed at 

strengthening the quality of FHA-insured loans while focusing on ways to improve 

our operations. 

In April, we published Final Rule (FR5356-F-02) ‘‘Federal Housing Administration: Continuation of FHA Reform—Strengthening Risk Management Through Responsible FHA-Approved Lenders.’’ Most significantly, this rule eliminated FHA approval for loan correspondents and increased net worth requirements for lenders, 

thereby strengthening FHA’s counterparty risk management capabilities. 

On April 5 of this year, FHA raised its upfront mortgage insurance premium from 

175 basis points to 225 basis points across all FHA product types (purchase, conventional to FHA refinances, and FHA to FHA refinances). 
31 

Subsequently, passage of H.R. 5981 granted us the authority to adjust the FHA 

annual premium. As stated in previous testimony and noted in the proposed budget, 

once this authority to adjust FHA’s annual premium was granted, we would move 

to lower the upfront premium simultaneously with an increase to the annual premium. 

Effective October 4, 2010, FHA will reduce upfront premiums from 225 basis 

points to 100 basis points and increase the annual premium to 85 basis points from 

50 basis points for loans with loan-to-value ratios (LTV) up to and including 95 percent and to 90 basis points from 55 basis points for LTVs above 95 percent. 

We are confident this new premium structure is sound policy, more in line with 

private mortgage insurers’ pricing, and will facilitate the return of private capital 

to the mortgage market. In addition, the estimated value of this change is approximately $300 million per month of additional income to the MMI Fund. 

Our Mortgagee Review Board, which I chair, meets monthly and has uncovered 

numerous violations of FHA origination and underwriting requirements. We have 

found false certifications and omissions, such as failures to verify the borrower’s income and creditworthiness increased mortgagee review board actions. We’ve suspended some well-known FHA-approved lenders and withdrawn FHA-approval for 

over 1,500 others. In addition, we imposed over $4.27 million in civil money penalties and administrative payments to noncompliant lenders. 

Beyond steeply increasing lender enforcement, we’ve strengthened credit and risk 

controls—toughening requirements on our Streamlined Refinance program, making 

several improvements to the appraisal process and to condominium policies, and 

publishing a final rule in the Federal Register outlining new down payment and 

credit score requirements. 

Specifically, FHA implemented a ‘‘two-step’’ FICO floor for FHA purchase borrowers, which will reduce both the claim rate on new insurance as well as the loss 

rate experienced on those claims. A minimum down payment of 10 percent is now 

required of purchase borrowers with FICO scores below 579, and a minimum down 

payment of 3.5 percent is required for those with FICO scores at 580 and above. 

In addition, applicants with credit scores below 500 are no longer eligible for FHA 

insurance. 

Currently, we have a proposed rule in the Federal Register which is in the comment period to reduce the maximum permissible seller concession from its current 

6 percent level to 3 percent, which is in line with industry norms. The current level 

exposes the FHA to excess risk by creating incentives to inflate appraised value. 

FHA’s experience shows that loans with high levels of seller concessions are significantly more likely to go to claim. Experience to date on loans insured from FY2003 

to FY2008 suggests that claim rates on high-concession loans are 50 percent higher 

or more than those on low-concession loans. We anticipate the final rule to be published before the end of this calendar year. 

Within our Single Family operations, we have made significant progress in our 

postendorsement review process. This year we implemented a new algorithm for selecting recently insured loan files for postendorsement technical reviews. This enhancement gives us a more precise way to conduct quality control reviews. Today, 

loans are selected for review based on a cascade of loan level characteristics that 

target risk, making our efforts much more effective and efficient. 

To address system and staff constraints, we have been working with Congress to 

increase staff and technical capacity to handle the increased volume and market dynamics we currently face. We are focused on technology modernization and have 

teams in place working to upgrade our technology systems. We have a long way to 

go, but we successfully delivered FHA’s first comprehensive technology transformation plan to Congress last September, which we have been implementing 

throughout this year. In addition, we recently awarded contracts to begin upgrading 

our risk and fraud tools. We are well underway to awarding additional contracts, 

and we continue to make progress modernizing FHA’s technology infrastructure. 

Finally, Mr. Chairman, since I arrived in July 2009, we have added 118 net new 

hires to Housing’s payroll, and I have implemented an aggressive training and 

human capital development plan that includes managerial and technical skill building training as well as on-the-job mentoring. 

Commitment to Comprehensive FHA Reform 

Of course, the job is far from over. As important as the new premium authority 

established under H.R. 5891 is, Secretary Donovan and I remain committed to comprehensive FHA reform legislation that enhances FHA’s lender enforcement capabilities and risk management efforts critical to our ability to monitor lender performance and ensure compliance. As already mentioned, we hope Congress will pass 

comprehensive FHA legislation before the end of the year. 
32 

FHA remains committed to working with Congress to enact the full breadth of reforms introduced in H.R. 5072 and S. 3704, sponsored by Senators Begich and 

Brown. In addition to provisions strengthening FHA’s lender enforcement ability, 

the legislation also includes technical clarifications that will allow for third party 

loan originators to close FHA insured loans in their name. This third party provision is particularly important to ensuring that several hundred community banks 

are able to continue originating FHA loans. 

Additionally, HUD is seeking Congressional authority to extend FHA’s ability to 

hold all lenders to the same standard and permit FHA to recoup losses through required indemnification for loans that were improperly originated and for which the 

error may have impacted the original loan decision, or in which fraud or misrepresentation were involved. FHA currently has this authority for loans originated 

through the Lender Insured (LI) process, which accounts for 70 percent of FHA loan 

volume, but only 29 percent of FHA-approved lenders. FHA is asking that Congress 

grant explicit authority to require indemnification for loans that were improperly 

originated for the remaining 71 percent of FHA-approved lenders. FHA is simply requesting that Congress permit FHA to hold all lenders to the same standard; FHA 

is not asking for expansion of authorities beyond those already granted to FHA to 

oversee lenders participating in the LI program. Moreover, this legislation will enable FHA to prevent lenders who have demonstrated poor performance in one area 

of the country from engaging in FHA lending nationwide, because it is often only 

a matter of time before a lender that has shown it is unable or unwilling to engage 

in prudent lending in one geographic region exhibits the same recklessness and irresponsibility somewhere else. 

Facilitating Our Recovery and Protecting the Taxpayer 

Chairman Dodd and Ranking Member Shelby, as you can see, we have proposed 

a comprehensive set of reforms to improve loan performance, hold lenders accountable, and increase revenues to the FHA fund, while also ensuring that FHA continues to support the overall recovery of the housing market and fulfill its mission 

of providing home ownership opportunities for responsible borrowers. 

However, shoring up the FHA won’t solve all our housing challenges, which is 

why the Administration is working to produce a more balanced, comprehensive national housing policy that supports home ownership and rental housing alike, providing people with the options they need to make good choices for their families. 

Further, as important as the FHA is at this moment, I want to emphasize that 

the elevated role it is playing is temporary—a bridge to economic recovery helping 

to ensure that mortgage financing remains available until private capital returns. 

Thus, while we must remain mindful that qualified, responsible families need the 

continued ability to purchase a home, the changes and legislative requests that we 

have announced are crafted to ensure that FHA steps back to facilitate the return 

of the private sector as soon as possible. 

So, Mr. Chairman, while FHA must remain a key source of safe mortgage financing at a critical moment in our country’s history, we recognize the risks that we face 

and the challenges of this temporary expanded role that we play in today’s market. 

The bottom line is this: the loans FHA insures must be safe and self-sustaining over 

the long-term. With these reforms the Administration is committed to ensuring that 

they are today—and into the future. We look forward to working with Congress 

closely on all these issues and hope to gain your support for our legislative requests 

to further reduce risks to the American taxpayer. 

Thank you again for this opportunity to testify. I would be glad to respond to any 

questions. 
33 

PREPARED STATEMENT OF MATHEW J. SCIRE`

DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT

ACCOUNTABILITY OFFICE

SEPTEMBER 23, 2010 
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM DAVID H. STEVENS 

Q.1. What steps has the FHA taken to implement the PTFA? 

A.1. In conjunction with the Office of Public and Indian Housing, 

FHA issued a Federal Register Notice (Docket No. FR-5335-N-01) 

on June 24, 2009, to provide general direction to participants in 

HUD programs regarding the requirements of the PTFA. A second 

Federal Register Notice (FR-5427) was published on October 28, 

2010, which expands upon the Department’s initial guidance and 

includes additional information regarding the updated PTFA provisions resulting from P.L. 111-203. 

Additionally, FHA is presently drafting a Mortgagee Letter that 

will address the changes issuing from P.L. 111-203, as well as provide administrative guidance regarding the Occupied Conveyance 

Program and the impacts of the updated PTFA on its implementation. FHA expects to publish this Mortgagee Letter by February 1, 

2011. 

Q.2. Have these steps been fully implemented, including updating 

all notices to tenants and directions to FHA and contractor employees? 

A.2. The pending Mortgagee Letter will provide amended notices to 

occupants. Mortgagees servicing FHA-insured mortgages are required to follow all Federal, State, and local legal requirements for 

both foreclosure and eviction actions. Mortgagees are expected to 

comply with the timeline provisions afforded by the PTFA for bona 

fide tenants before issuing a notice to vacate and proceeding with 

an eviction action. 

Q.3. What steps does FHA plan to take to ensure that all renters 

in FHA-held properties are guaranteed their rights under the 

PTFA? 

A.3. FHA is committed to ensuring that all tenants of FHA-held 

properties are afforded the full measure of their rights under the 

PTFA. Since the issuance of the PTFA, most tenant occupied properties that have been conveyed to HUD have been held by mortgagees until the period of time granted to tenants by the PTFA has 

elapsed. After providing any bona fide tenant the requisite time before issuing a notice to vacate, the mortgagee then conducted any 

required eviction and conveyed the property to FHA vacant. There 

have been several situations where a servicer contacted FHA and 

advised that a bona fide tenant had a lease of 12 months or more 

and requested permission to convey a property to FHA occupied. 

For the cases that were conveyed occupied, FHA has required that 

the contractor that manages the Department’s real estate owned 

inventory not list the property for sale and expect the tenant to 

continue paying rent as required by the existing lease until it expires. FHA has not initiated eviction against any occupant of a 

HUD-held property since the issuance of the PTFA. 

Q.4. FHA Monthly Interest Charges. Why is an FHA borrower 

charged interest through the end of the month regardless of when 

an FHA mortgage is actually paid off, either at the time a home 

is sold, or when an FHA loan is refinanced? 
50 

A.4. Interest on FHA insured mortgages is calculated on a monthly 

rather than per diem basis. Originally, this policy was designed to 

give FHA approved lenders adequate time to anticipate prepayments, develop close-out balances and arrange for reinvestment of 

prepayment funds. However, most of these time constraint concerns have been resolved by the lending industry’s use of advanced 

technology. Nonetheless, there remain certain benefits to borrowers 

in calculating interest on a monthly rather than per diem basis. 

These benefits are explained in greater detail below. 

Q.5. Does the FHA have regulatory authority to change this practice and, if so, would you consider making such a change? If you 

are not inclined to change this practice, why not? 

A.5. FHA does have regulatory authority to change this. However, 

in the current market, the impact on lenders and servicers who are 

in the midst of managing tremendous challenges in the mortgage 

industry, the timing for such a change to FHA related business 

processes and systems would only compound those challenges and 

stretch resources even more thinly. Additionally, in a review of potential impact, which is based on FHA experience and discussions 

with lenders, FHA has considered the following: 

• The monthly interest calculation provides FHA borrowers a 

grace period (generally 30 days) in which to make mortgage 

payments without incurring late payment fees and additional 

interest. This flexibility is a benefit to FHA borrowers who 

typically have fewer resources than conventional borrowers. 

• The overall cost to the borrower of loans with interest calculated monthly is less than that for loans with interest calculated daily. 

• Lenders are aware of the concern regarding the requirement 

for a full month’s interest even after the loan is paid off and 

most address this concern by closing FHA insured mortgages 

at the end of the month, thereby minimizing the impact on 

borrowers at the time of loan payoff. Making a dollar value assumption of prepayment interest collections based on the number of FHA loan originations would not be accurate. 

• A change to per diem interest to accommodate only those who 

pay off their mortgage at the beginning or in the middle of the 

month would effectively create an increase in the cost of borrowing for all FHA borrowers as lenders would most likely 

make up the loss by increasing interest rates. 

• The change would require substantial changes to lender, 

servicer, and FHA systems and loan documentation. 

The aforementioned analysis is not meant to imply that FHA is 

unwilling to change its practice of utilizing a monthly interest calculation in favor of a per diem calculation, but is offered to show 

that there are considerations other than alignment with the industry that apply specifically to FHA borrowers, lenders and servicers 

and must be taken into account with regard to this issue. 

FHA acknowledges that, although the Federal Reserve has determined that the payment of interest beyond the payoff date on FHA 

insured mortgages does not constitute a prepayment penalty and 

therefore does not violate Regulation Z, it is still reviewing this 
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issue and could change that determination in the future. However 

at this time, for the reasons stated above, FHA does not plan to 

pursue a change to the interest rate calculation. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER 

FROM DAVID H. STEVENS 

Q.1. Early Term Delinquencies. What threat do early term delinquencies, those mortgages which default in the first 18 to 24 

months after origination, pose to FHA? 

A.1. Generally, early term delinquencies demonstrate that borrowers did not meet loan eligibility requirements at the time the 

loan was approved. Borrowers with early payment delinquencies 

are often unable or unwilling to meet their debt obligations, which 

results in a higher risk of foreclosure. If a lender forecloses on an 

FHA-insured loan, FHA is obligated to pay the claim. If the claims 

on aggregate exceed projections, it may impact the FHA Mutual 

Mortgage Insurance Fund. 

Q.2. What do you think about a proposal which would require the 

FHA to establish a program which would review all early term delinquencies and require that the FHA indemnify any mortgages 

that were originated fraudulently and further examine the loans of 

the company that made those loans? 

A.2. As of October 4, 2010, FHA began to review all loans 90 days 

delinquent within the first 6 payments. In addition, FHA actively 

monitors lenders for excessive early term delinquencies, fraud and 

other risks to the FHA Mutual Mortgage Insurance Fund. FHA 

uses these performance measures to determine which lenders FHA 

will select for compliance reviews. As a result of deficiencies cited 

during these compliance reviews, FHA may seek indemnification 

against losses on loans with fraud or material misrepresentation. 

Q.3. Why shouldn’t Congress require that all mortgages found to 

be originated fraudulently or not to FHA requirements be put back 

on the company that originated the loan? 

A.3. FHA takes very seriously any misconduct or deception on the 

part of participants in its programs. Such violations undermine 

public trust and negatively affect the housing industry and consumers. FHA is committed to its mission to stabilize the housing 

market, maintain and expand home ownership, and operate with 

a high degree of public and fiscal responsibility. Accordingly, all 

FHA-approved lenders must comply with applicable laws and regulations. Lenders that violate HUD program statues, regulations, 

and requirements are subject to appropriate sanctions, including, 

invalidating the contract of insurance for those loans originated or 

underwritten with fraud or material misrepresentation. The expanded indemnification authority currently being sought by FHA 

would greatly assist the Department in ensuring that lenders who 

violate FHA requirements bear the consequences of their recklessness, and that FHA’s insurance funds are better protected against 

unnecessary losses. 
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER 

FROM MATHEW J. SCIRE`

Q.1. Mr. Scire`, in your testimony you recommend that, ‘‘Congress 

should consider establishing a minimum time frame for restoring 

the capital ratio to 2 percent and clarifying a number of statutory 

provisions concerning the FHA’s administration of the Fund.’’ Do 

you think that should be a hard deadline? How much time should 

Congress give the FHA to rebuild the capital ratio once it dips 

below 2 percent? 

A.1. Congress would need to weigh FHA’s financial soundness with 

its public purpose in establishing a time frame for FHA to restore 

the capital ratio to 2 percent. A shorter time frame with a rigid 

deadline would place greater weight on the financial health of 

FHA’s insurance fund. A longer time frame with a more flexible 

deadline would place greater weight on FHA’s role in supporting 

the mortgage market during periods of economic distress. To inform its decision making on this issue, Congress may find it instructive to consider what occurred in 1990, when the 2 percent requirement was enacted. Then, as now, the capital ratio was below 

1 percent and FHA accounted for a significant share of the mortgage market. At that time, Congress gave FHA 10 years to achieve 

a 2 percent capital ratio, and the agency reached it in 5 years. 

Q.2. Please detail which other statutory provisions require clarification and how should they be clarified? 

A.2. We identified three statutory provisions regarding FHA’s management and reporting of the Fund’s condition that Congress 

should consider clarifying. 

• First, a provision in the Omnibus Budget Reconciliation Act of 

1990 defined the capital ratio as the economic value of the 

Fund divided by the ‘‘unamortized insurance-in-force,’’ which is 

generally understood as the initial insured loan balance. (12 

U.S.C. §1711(f)(4)(B)). However, another provision in the Act 

defines unamortized insurance-in-force as the remaining loan 

balance, which is generally understood to describe the amortized insurance-in-force. (12 U.S.C. §1711(f)(4)(D)). To avoid 

confusion about the meaning of these provisions, we believe 

that Congress should consider making them consistent. We believe that the amortized insurance-in-force is the appropriate 

measure of the Fund’s potential liability and should be used for 

purposes of defining the capital ratio. 

• Second, a provision in the Housing and Economic Recovery Act 

of 2008 (HERA) states that if the Secretary of HUD determines 

there is a substantial probability that the Fund will not maintain its ‘‘established target subsidy rate,’’ the Secretary may 

make programmatic or premium adjustments. (12 U.S.C 

§1708(a)(6)). However, neither HUD nor Congress has established a target subsidy rate for the Fund. FHA has interpreted 

the term to mean the capital ratio, but it could also be interpreted as a credit subsidy rate (a budgetary measure of the estimated lifetime cost of each annual loan cohort). While FHA’s 

interpretation is consistent with the legislative language that 
53 

HERA amended, we believe that Congress should replace ‘‘target subsidy rate’’ with a less ambiguous term. 

• Third, HERA requires FHA to provide quarterly reports to 

Congress that include ‘‘updated projections of [the Fund’s] annual subsidy rates to ensure that increases in risk to the Fund 

are identified and mitigated . . . and the financial soundness 

of the Fund is maintained.’’ (12 U.S.C. §1708(a)(5)(E)). Because 

credit subsidy rates generally are only updated annually, FHA 

has reported the same subsidy rate information in multiple reports. If the purpose of the reporting requirement was to provide Congress with current information on factors that may affect subsidy rates, we believe that Congress should specify 

more clearly the nature and extent of the information that it 

is seeking. In our report, we cited cohort-level delinquency 

trends and changes in economic forecasts as examples of the 

types of information that Congress may find useful. 

Q.3. The FHA has asked Congress for the ability to indemnify 

mortgages that are found to be fraudulent. Should the FHA be required to indemnify those mortgages or should it be left to the discretion of the Commissioner whether or not to indemnify fraudulent mortgages? 

A.3. We have not conducted work on FHA’s indemnification authority and therefore have not explored whether or not there are circumstances under which the Commissioner would require discretion to effectively exercise this authority. 

Q.4. What threat do early term delinquencies, those mortgages 

which default in the first eighteen to twenty four months after 

origination, pose to FHA? What do you think about a proposal 

which would require the FHA to establish a program which would 

review all early term delinquencies and require that the FHA indemnify any mortgages that were originated fraudulently and further examine the loans of the company that made those loans? 

A.4. Early default rates are an important gauge of the strength or 

weakness of recent loan cohorts. They are also an indicator of potentially unsound underwriting practices (including fraud) that can 

lead to foreclosures and FHA insurance claims. Therefore, we believe that early defaults and lenders with relatively high proportions of such loans should be subject to close review and oversight. 

Important factors to consider in evaluating a proposal to review all 

early defaults are the capacity of FHA’s workforce to conduct such 

reviews and how the reviews would fit in with FHA’s existing oversight and enforcement efforts, which include onsite examination of 

lender loan records and sanctions against lenders with high early 

default and claim rates. At the request of the Chairman and Ranking Member of the Senate Committee on Banking, Housing, and 

Urban Affairs, we are currently reviewing FHA’s capacity to oversee lenders and other program participants. 

Q.5. Should the FHA continue to allow borrowers to finance mortgage insurance premiums and closing costs? As you state in your 

testimony in some cases this results in a mortgage loan over the 

value of the home. What risk does that expose the taxpayers to 

given that they ultimately stand behind 100 percent of the value 
54 

1GAO, Mortgage Financing: Actions Needed To Help FHA Manage Risks From New Mortgage 

Loan Products, GAO-05-194 (Washington, DC: Feb. 11, 2005). 2GAO, Federal Housing Administration: Modernization Proposals Would Have Program and 

Budget Implications and Require Continued Improvements in Risk Management, GAO-07-708 

(Washington, DC: June 29, 2007). 

of the loan insured—a very real exposure given the FHA is currently below its mandatory 2 percent capital ratio requirement? 

A.5. Although FHA requires borrowers to make a cash investment 

of at least 3.5 percent of the home’s purchase price, FHA’s policy 

of allowing borrowers to finance their upfront insurance premium 

and some closing costs results in an effective loan-to-value (LTV) 

ratio of close to 100 percent for some FHA-insured mortgages. We 

and others have reported on the importance of the LTV ratio as a 

predictor of default. 1 The higher the LTV ratio, the less cash borrowers will have invested in their homes and the more likely it is 

that they may default on mortgage obligations, especially during 

times of economic hardship. Not allowing FHA borrowers to finance 

upfront premiums and closing costs would reduce FHA’s financial 

risk (all other things being equal) but also would make it more difficult for some borrowers to qualify for mortgages. Any changes to 

FHA’s current policy would need to consider this tradeoff. 

Q.6. Should the FHA continue to insure 100 percent of the value 

of the loan? How does this compare to the structure of private 

mortgage insurance? Does the FHA’s structure create an incentive 

for mortgage originators to prefer FHA insurance to private mortgage insurance? 

A.6. In a 2007 report, we discussed a number of options for increasing FHA’s operational flexibility, including authorizing FHA to insure less than 100 percent of the loan value. 2 At that time, private 

mortgage insurers offered several levels of insurance coverage up 

to a maximum of 40 or 42 percent (depending on the company) of 

the value of the loan. Since most FHA insurance claims are offset 

by some degree of loss recovery, some mortgage industry observers 

have suggested that covering 100 percent of the value of the loan 

may not be necessary. While lower coverage could cause a reduction in the volume of FHA-insured loans and a corresponding decline in income from premiums, it could also result in reduced 

losses and ultimately have a beneficial effect on FHA’s insurance 

fund. However, partial FHA coverage may lessen FHA’s ability to 

stabilize local housing markets when regional economies decline 

and may increase the cost of FHA-insured loans as lenders set 

higher prices to cover their risk. We have not examined the extent 

to which FHA’s insurance structure affects incentives for mortgage 

originators. 

Q.7. Have you examined whether or not the solvency of the FHA’s 

fund would benefit from increasing the minimum down payment 

requirement from 3.5 percent to 5 percent? If so, what did you 

learn? 

A.7. We have not examined this particular question. However, our 

prior work indicates that lower LTV ratios (i.e., higher down pay-
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3See, GAO-05-194 and GAO, Mortgage Financing: Additional Action Needed To Manage Risks 

of FHA-Insured Loans With Down Payment Assistance, GAO-06-24 (Washington, DC: Nov. 9, 

2005). 

ments) and the absence of down payment assistance reduces FHA’s 

financial risk, all other things being equal. 3