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EXAMINING THE PROPER ROLE OF THE 

FEDERAL HOUSING ADMINISTRATION IN 

OUR MORTGAGE INSURANCE MARKET 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

FEBRUARY 6, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–1 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

February 6, 2013 .............................................................................................. 1 

Appendix: 

February 6, 2013 .............................................................................................. 43 

WITNESSES 

WEDNESDAY, FEBRUARY 6, 2013 

Gordon, Julia, Director, Housing Finance and Policy, Center for American 

Progress Action Fund ........................................................................................... 11 

Petrou, Basil N., Managing Partner, Federal Financial Analytics, Inc. ............. 10 

Pinto, Edward J., Resident Fellow, American Enterprise Institute .................... 8 

Sanders, Anthony B., Distinguished Professor of Real Estate and Finance, 

School of Management, and Senior Scholar at The Mercatus Center, George 

Mason University ................................................................................................. 13 

APPENDIX 

Prepared statements: 

Moore, Hon. Gwen ............................................................................................ 44 

Neugebauer, Hon. Randy ................................................................................. 45 

Wagner, Hon. Ann ............................................................................................ 47 

Gordon, Julia .................................................................................................... 48 

Petrou, Basil N. ................................................................................................ 64 

Pinto, Edward J. ............................................................................................... 82 

Sanders, Anthony B. ........................................................................................ 154 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Capuano, Hon. Michael: 

HUD Summary of FHA Policy Changes under the Current Administration, updated February 2013 ........................................................................ 168 

Maloney, Hon. Carolyn: 

Letter to HUD Secretary Shaun Donovan, dated November 9, 2012 .......... 172 

Waters, Hon. Maxine: 

Written statement of the Local Initiatives Support Corporation (LISC) ..... 173 

Written statement of the National Association of Home Builders (NAHB) 176 

Written statement of the National Council of La Raza (NCLR) .................. 180 

Written statement of Potomac Partners LLC ................................................ 183 

National Association of REALTORS® fact sheet entitled, ‘‘Myths and 

Facts about FHA,’’ dated November 2012 ................................................... 201 

(1) 

EXAMINING THE PROPER ROLE OF THE 

FEDERAL HOUSING ADMINISTRATION IN 

OUR MORTGAGE INSURANCE MARKET 

Wednesday, February 6, 2013 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 9:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Jeb Hensarling [chairman of the committee] presiding. 

Members present: Representatives Hensarling, Miller, Bachus, 

Royce, Capito, Garrett, Neugebauer, McHenry, Campbell, Pearce, 

Posey, Westmoreland, Luetkemeyer, Huizenga, Duffy, Renacci, 

Hurt, Stivers, Fincher, Stutzman, Mulvaney, Hultgren, Ross, 

Pittenger, Wagner, Barr, Cotton; Waters, Maloney, Velazquez, 

Watt, Sherman, Meeks, Capuano, Clay, Green, Cleaver, Himes, 

Carney, Sewell, Foster, Kildee, Murphy, Delaney, Sinema, Beatty, 

and Heck. 

Chairman HENSARLING. The committee will come to order. 

Without objection, the Chair is authorized to declare a recess of 

the committee at any time. 

Opening statements will be limited to 10 minutes per side. At 

this time, I will yield myself 3 minutes for an opening statement. 

Last week, many of us awoke to the news that we had negative 

economic growth in the last quarter. Although one quarter does not 

make a trend, it was not welcome news, and it was not expected 

news. Unfortunately, what has become expected news is subpar 11⁄2

to 2 percent economic growth, when historic trends are above 3 percent, and clearly, the economy is capable of 4 percent or greater. 

Two percent economic growth means that millions of Americans lay 

awake at night pondering insecure financial futures for themselves 

and their families. 

Hardworking Americans demand a healthy economy, and we cannot have a healthy economy until we have a housing finance system that is both sustainable and competitive. In its current form, 

the Federal Housing Administration (FHA) is clearly an impediment to such a system. Because of this, the Financial Services 

Committee today is holding its first in a series of hearings to examine the FHA, now the largest mortgage insurance company in the 

United States. 

Historically, FHA has represented roughly 10 percent of the 

mortgage insurance market and has fulfilled its role of being the 

provider of mortgage credit for certain discrete populations, parVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
2 

ticularly first-time home buyers and low- and moderate-income 

Americans who qualify under stringent tests. 

Today, however, FHA has strayed far from its original mission 

and legislative purpose. It doesn’t just focus on low- and moderateincome Americans; it provides mortgage insurance for expensive 

homes valued as high as $729,000. By offering riskier terms than 

private competitors, the FHA today controls 56 percent, more than 

half of the total mortgage insurance market in terms of numbers 

of loans. Talk about too-big-to-fail. So instead of complementing a 

robust private mortgage market, the FHA’s high-cost loan limits 

and extremely low downpayment requirements put it in direct competition with the private sector. 

In addition, we know that as bad as that is, its single-family insurance fund is flat broke. The independent actuarial study released last November shows that the FHA single-family mutual insurance fund has a negative—I repeat negative—economic value of 

$16.3 billion. If the FHA were a private financial institution, it is 

likely that somebody would be fired, somebody would be fined, or 

the institution would find itself in receivership. Instead, it is merrily on its way to becoming the recipient of the next great taxpayer 

bailout. 

Finally, given their high-loan-to-value, low-credit-score policies 

and high rates of default, it is an open question whether FHA has 

now morphed into Countrywide. Arguably, the FHA has now become the Nation’s largest subprime lender, all with the blessings 

of the Administration. 

FHA’s loan downpayment lures families into having an unrealistic view of homeownership obligations. Their high loan limits encourage people to buy more home than they can possibly afford to 

keep. Putting borrowers in homes where one in eight loans end in 

default, the FHA can make entire communities worse off, trapping 

more and more families as property values fall. You do not help 

families achieve the American dream by putting them into homes 

they cannot afford. This is how you turn the American dream into 

a nightmare. 

I will now yield 3 minutes to the gentleman from Texas, Mr. 

Neugebauer, the chairman of the Subcommittee on Housing and 

Insurance. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman, for holding this important hearing. 

And I want to thank our witnesses for your testimony and for 

your being here today. I think this is an important hearing. 

What we do know is that there is kind of a trend here, that government doesn’t do a good job at pricing risk. We see that manifest 

itself currently at FHA, and that did not evidently set the right 

risk premium because, as the chairman alluded to, there is $16 billion underwater, and the trend is not good. I think we have seen 

another example of that, for example, in the Flood Insurance Program, which is $20 billion in the hole. 

What we are learning, I think, is that the government has a hard 

time being in the insurance business. And in many cases, by the 

government being in the insurance business, we are crowding out 

the private sector. That is not a good trend. I think it detracts from 

the core mission of what government should be doing. 

3 

We have had a number of projections that this fund was going 

to be get healthier each year over the last 3 years’ testimony. But, 

in fact, the fund hasn’t gotten healthier; it has gotten 

unhealthier—$16 billion underwater, almost a negative 1.44 percent. 

I think the other troubling thing, though, is the mission creep 

that has happened at FHA over the years. Basically when—I am 

a homebuilder and I have been in the real estate business for over 

30 years. I know I don’t look that old. But, I think the thing when 

FHA was originally started, it was to help kick-start a certain 

group of people, help them get into homeownership. But now we 

see we have an agency that controls over 50 percent of the mortgage insurance in this country and almost 30 percent of the origination market, with loan limits now of over $700,000. This is not 

your mother’s or your father’s FHA. And, in fact, about 90 percent 

of the portfolio, I believe, that is in FHA now would not qualify 

under the original standards that were set up. 

And so I think it is important that we have a hearing and begin 

to set FHA on the track of its original mission, but also, more importantly, to create some space for the private sector to come back 

into the market. 

So when we have all of these discussions, what is the bottom line 

here, what is the important thing here? The important thing here 

is that homeownership is an important part of the American 

dream, but we don’t, as the chairman said, want to turn it into the 

American nightmare by having policy at the Federal level that infringes not only on the rights of the people trying to get into the 

housing market, but also damaging the people who are already 

homeowners in this country. And I think we have seen over the 

last few years where that has actually been the case, and basically 

then infringes on everyone’s rights by the fact that we are not making the right policies. 

So I look forward to the testimony of the witnesses. And, with 

that, I yield back. Thank you, Mr. Chairman. 

Chairman HENSARLING. The gentleman from Massachusetts is 

recognized for 3 minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman. 

Mr. Chairman, I am glad that we are having this hearing. I am 

glad we are going to be looking at the FHA and hopefully the entire problem of being able to buy and maintain housing in this 

country. But I think that we need to be a little careful with some 

of the rhetoric. I don’t think there are many independent people 

who think we are looking at the next great bailout. 

Yes, the FHA is a little bit of an issue at the moment because 

of its countercyclical mission. By the way, it was part of their original mission to come in during difficult times. They did that, and 

they are in trouble because of it. We all understand that. Everybody here wants to make sure to the best of our ability as quickly 

as possible the housing industry can get back to normal. No one 

likes or enjoys this crisis or any aspect of it, not just in housing, 

but housing is the issue today. 

So as we go forward, for me, I am certainly looking for ways to 

improve the FHA and other lending agencies. I am certainly looking for ways to protect the American taxpayer. We are all looking 

4 

for that. But I also want to make sure in doing that, we don’t 

throw the baby out with the bath water. Because let’s not forget 

that for 80 years, the FHA helped with a critical aspect of building 

the middle class, of building equity. 

I say this as a person who comes from a district that really 

doesn’t benefit much from the FHA. And I say that because my district is a high-cost district. The FHA cannot make many loans in 

my district. In 2011, they made 5,000 loans in my district. In the 

Fifth District in Texas, they made 25,000 loans. And that is just 

typical. I understand that, but I don’t live on an island. My district 

will do fine with or without the FHA, to be perfectly honest. But 

I don’t live on an island, and I want all Americans to enjoy the 

middle class. I want all Americans to have an opportunity to move 

into that middle class by building equity, the same way I did. I 

bought my house 30 years ago. It was not allowed to qualify for the 

FHA. And I had a higher debt-to-income ratio than most people because that house was expensive and my income didn’t match it. 

But we did it, as many Americans do. 

So, yes, we have problems, and, yes, we need to address them, 

and, yes, we need to ask a lot of serious, difficult questions and debate what the right answer is. We also have to understand the 

FHA has taken a lot of actions, some of which I am not even sure 

I support. But it is not like everybody has been sitting on their 

hands or anybody wants to drive this country into bankruptcy. 

The housing crisis happened. The default rates for private mortgages are actually higher than those for the FHA—a lot higher in 

some instances, particularly in subprime. 

So I welcome the discussion. I look forward to the debate. More 

importantly, I look forward to a hopefully thoughtful discussion on 

what things we should do to make sure that the FHA or some 

other agency similar to it is around for the next generation and the 

next generation after that so that the middle class or people trying 

to get into the middle class will still have the hope that we have 

had. 

Thank you, Mr. Chairman. I yield back. 

Chairman HENSARLING. The gentleman from California, Mr. Miller, is recognized for 1 minute. 

Mr. MILLER. Thank you, Mr. Chairman. 

So that the FHA can play a countercyclical role in the future, as 

we have discussed, we must ensure the FHA program better manages the risk it is taking on. To preserve the countercyclical role, 

FHA must lessen taxpayer exposure. This can be accomplished in 

3 ways. 

One, we must take a close look at the business model and management of the FHA. We need to look inside the FHA to ensure its 

policies, management, and technology can handle times of increased pressure. 

Two, we need to ensure appropriate credit quality for those receiving FHA loans. While the current book of business shows the 

FHA has made progress, we need to consider whether these actions 

have been enough. Are current FHA underwriting requirements basically adequate to keep default rates low in the future? 

5 

We should also look at the structure of the FHA mortgage insurance product itself. Is there a way for FHA to preserve its function 

in a way that requires less taxpayer exposure? 

And, finally, we must demand the FHA remain adequately capitalized. We need to be careful not to disrupt the fragile housing 

recovery by abruptly pulling back liquidity. Liquidity right now is, 

above all, important to keep the housing market going and recovering. And so we need to be very cautious about what we do, but 

we do need to require accountability. 

I yield back. 

Chairman HENSARLING. The Chair now recognizes the gentlelady 

from New York for 2 minutes. 

Mrs. MALONEY. I want to thank you for calling this hearing, and 

I welcome all the witnesses. 

Our housing market and recovery is critically important to this 

committee and will probably be one of the main issues that we look 

at over the next 1 or 2 years. Economists have estimated that 

housing’s impact on our economy is 25 percent of our economy. So 

whether or not it is healthy and growing and balanced is critical 

to our economic recovery. And it is important that we, here in this 

hearing, study exactly what went wrong in the housing crisis and 

see what we can do to promote prudent lending and a vibrant secondary market. 

The FHA role in housing is countercyclical. At one point, it was 

as low as 5 percent. But in times of crisis, its portfolio expands, 

and then it contracts in good times. We were fortunate to have 

them there during the financial crisis, as they did come in and help 

finance housing. FHA insured nearly 1.2 million single-family 

mortgage loans in 2012 alone, with a total value of $213 billion. 

And it has continued to play a role for first-time home buyers and 

for home buyers in minority communities and lower income brackets. 

So it is, of course, a logical question to ask in the wake of one 

of the worst financial crises in our lifetime how the Mutual Mortgage Insurance Fund is functioning and whether the stress that 

was placed on the fund will require a credit or a support. 

I wrote to HUD in November of last year and asked this exact 

question. I ask permission to put my letter in the record. 

Chairman HENSARLING. Without objection, it is so ordered. 

Mrs. MALONEY. I have not yet received a response, so I hope I 

will hear some answers today from the witnesses. 

Thank you. My time has expired. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from New Jersey for 11⁄2 minutes. 

Mr. GARRETT. And I thank you, Mr. Chairman. 

So here we are again, another year, another multi-billion-dollar 

taxpayer bailout for the housing market. And so I guess the question is, when are we going to learn? 

The continued oversubsidization of the housing market doesn’t 

help the consumer, it doesn’t help the borrowers, it doesn’t help the 

neighborhoods, and it doesn’t help the economy. You see, this housing bust that triggered the financial crisis was mainly caused by 

a combination of the Federal Government subsidies into the housing market and also by loose money by the Federal Reserve. And 

6 

so you had a dangerous mix here that basically destroyed the economy and left millions upon millions of homeowners underwater. 

So instead of learning from these past mistakes, this Administration has done what? They have doubled down on their failed policy 

of throwing billions of taxpayer dollars at the problem and giving 

almost any individual who wants to buy a home one that is government-financed, with nothing down primarily, and all in the name 

of what? Just like we have heard over here: the name of countercyclicality. 

So instead of ensuring the housing market is put on a more sustainable basis in moving forward, what has the FHA done? They 

have helped literally thousands of borrowers get into homes that 

they can’t afford, and they wind up now finding that they are underwater and undervalued. 

While continuing to spend literally billions of taxpayer dollars to 

reinflate the housing bubble—and this might temporarily help 

some of the market participants, those who financially benefit from 

this in the production and the sales of homes—again, it does nothing to help the consumers, the neighborhoods, the taxpayers, or the 

economy. 

So I look forward to this panel, to drilling down to see how we 

got here, and how it continues now going forward, and how we get 

out of this problem in the future. 

With that, I yield back. 

Chairman HENSARLING. The Chair now recognizes the ranking 

member, the gentlelady from California, for 5 minutes. 

Ms. WATERS. Thank you, Mr. Chairman, for holding this hearing 

today on the role of the Federal Housing Administration and our 

mortgage insurance market. 

FHA has long been a focus for me. In the last two Congresses, 

I worked first with Congresswoman Capito when I was chairwoman of the Housing and Community Opportunity Subcommittee, 

and then with Congresswoman Biggert to pass FHA solvency legislation through the House of Representatives. I was disappointed 

that the Senate did not take up our legislation, but I remain hopeful that this can be an area for constructive collaboration over this 

next congressional term. 

I think all of the Members here today are deeply concerned about 

the health of the FHA’s Mutual Mortgage Insurance Fund, particularly the finding in FHA’s actuarial analysis that the capital reserve ratio of the fund fell below zero in Fiscal Year 2012. So I welcome the opportunity to explore these issues fully in the series of 

hearings you recently announced. 

But along with that concern, I think it is important to acknowledge FHA’s crucial role in our housing finance system. Particularly 

in the last few years, in the aftermath of a housing crisis precipitated by privately funded, poorly underwritten subprime mortgages, FHA stepped up, providing crucial liquidity and access to 

the mortgage market. 

All told, over the course of its 78-year history, FHA has helped 

more than 34 million Americans achieve the dream of homeownership, with a particular focus on first-time home buyers. In fact, 

Mark Zandi of Moody’s Analytics estimates that if it were not for 

FHA, home prices could have fallen an additional 25 percent durVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
7 

ing the most recent economic crisis. So while we all agree that the 

government footprint in our mortgage market must shrink, we 

have to balance that concern with an understanding that the presence of FHA has mitigated the length and severity of the housing 

downturn. 

I would also like to explore more fully the recent actions taken 

by the FHA to address prior problems by tightening up the origination policies and stepping up their lender enforcement efforts. In 

addition to the ending of seller-funded downpayment assistance, 

the FHA has initiated five increases to their mortgage insurance 

premiums, tightened FICO score lending requirements, and reduced allowable seller concessions. 

Just last week, FHA announced four additional changes in policy, 

including raising debt-to-income requirements for borrowers with 

low credit scores, raising annual mortgage insurance premiums for 

new borrowers, initiating a moratorium on full cash-out reverse 

mortgages, and instituting greater oversight of borrowers who are 

trying to obtain FHA loans after foreclosure. 

And it appears that the changes instituted by FHA since 2009 

have helped lead to positive books of business for 3 consecutive 

years, including the 2 strongest books in FHA’s history, in 2011 

and 2012. 

Again, I think that Members and other stakeholders will readily 

see and understand the significant risk management and policy 

changes that FHA has and continues to undertake in response to 

the most recent actuarial review. I look forward to us continuing 

that educational process through our hearing today as well as future hearings. 

And I yield back the balance of my time. 

Chairman HENSARLING. The gentlelady from West Virginia is 

recognized for 11⁄2 minutes for the last word. 

Mrs. CAPITO. Thank you, Mr. Chairman. I would like to thank 

you for convening this morning’s hearing. 

In light of the latest independent actuarial review of FHA’s Mutual Mortgage Insurance Fund, I believe it is a very legitimate concern that FHA will not have sufficient funds to pay the projected 

claims. 

As we have heard, the countercyclical role that the FHA traditionally plays in the mortgage market is an important one. And as 

our ranking member, Ms. Waters, just mentioned, we have worked 

diligently to try to put reforms in legislation in prior Congresses to 

ensure that the agency remains a source of funding for creditworthy borrowers. It is unfortunate that these efforts have not 

been able to make it beyond the House at a time when they are 

most needed. 

While FHA helped fill a gap in liquidity from 2007 to 2009 as 

credit markets contracted and lending standards tightened, the resulting increase in market share continues to impede private insurance mortgage market resurgence. Downpayments, conforming loan 

limits, and premium structures that treat risk differently are all 

examples of FHA’s being able to maintain an advantage in the 

market and make it much more difficult to restore a healthy and 

vibrant private market. 

8 

I believe a mortgage insurance market dominated by FHA 

hinders the ability of our economy to function most effectively. The 

immediate long-term challenges that face the FHA will affect its 

ability to serve in its traditional manner. Moving in a direction 

which encourages private capital is the direction I would like to see 

us go. 

And I thank the chairman for this hearing. Thank you. 

Chairman HENSARLING. At this time, I want to welcome all of 

our panelists. Thank you very much for agreeing to testify today. 

I do want to tell our panelists and all Members that, regrettably, 

votes are expected on the Floor sooner than originally anticipated, 

so the Chair will wield a very tight 5-minute gavel. And although 

we normally provide very lengthy introductions, instead you will 

get abbreviated introductions at the moment. 

Ed Pinto is a resident fellow at the American Enterprise Institute, having previously served as an executive vice president and 

chief credit officer at Fannie Mae. 

Basil Petrou is the managing partner of Federal Financial Analytics. He has been a consultant on mortgage and housing-related 

regulatory issues for 20 years. He previously worked at the Treasury Department. 

Julia Gordon is the director of housing finance and policy at the 

Center for American Progress. She previously managed the singlefamily policy team at FHFA. 

Finally, Dr. Anthony Sanders is the finance area chair and a distinguished professor of real estate and finance at the George Mason 

University School of Management, and is also a senior scholar at 

George Mason’s Mercatus Center. 

Again, each one of you will be recognized for 5 minutes to give 

an oral summary of your testimony. Without objection, each of your 

written statements will be made a part of the record. 

Mr. Pinto, you are now recognized for 5 minutes. And please 

bring the microphone as close to you as possible. 

STATEMENT OF EDWARD J. PINTO, RESIDENT FELLOW, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. PINTO. Thank you, Chairman Hensarling and Ranking Member Waters, for the opportunity to testify today. 

FHA poses a triple threat. It has an extraordinary failure rate 

that, as I will show, has continued for decades. It has insolvency 

on a regulatory and GAAP accounting basis that poses a threat to 

taxpayers. And it has unfair competition with private capital that 

is blocking housing finance reform. 

This is not the first time this has occurred. This is an excerpt 

from testimony by the late Gale Cincotta back in 1998 before a subcommittee of this committee, and it reads as if it were written 

today. It talks about the same issues that we are talking about 

today. Likewise, on October 8, 2009—and I see many of the Members here who were present in 2009—when I indicated in testimony 

that FHA was facing a $54 billion capital shortfall, that has come 

to pass. 

FHA is a continuing threat to working-class neighborhoods and 

families because of the extraordinary failure rate that it experiences year after year. It has an 11 percent average claim rate over 

9 

the last 37 years. That is the weighted average over 37 years. Its 

abusive lending practice have led to over 3 million failed American 

dreams since 1975. People tend to forget how many millions of families have had their dreams dashed by FHA’s abusive lending practices. And this foreclosure pain is concentrated year after year after 

year on working-class families and communities. 

This is a chart that shows year-by-year FHA data. It shows the 

number of claims per year, it shows the average claim rate, and 

that the cumulative amount of claims is over 3 million. 

This shows up very clearly in—just a second. This shows up very 

clearly in—getting out of order here. I am sorry, getting a little out 

of order. 

This shows up clearly in the masking of this pain. When you deal 

with lower FICO scores, you are looking at 20 and 30 percent default rates. When you are looking at higher FICO scores and other 

lower-risk characteristics, you get averages that are below 5 percent. The problem is that averages don’t cut it. The averages end 

up masking the pain. Where that pain shows up is very specifically 

in neighborhoods that end up being the same neighborhoods year 

after year. 

Chicago is an example of that. This chart shows a study that I 

completed last year on 2.4 million FHA loans. The Chicago loans 

are shown here from 2009 and 2010. The highest foreclosure rates 

are in the orange; the lowest foreclosure rates are in the dark blue. 

Loan counts show the size. And you see the concentration in the 

south side of Chicago, part of the west side of Chicago, but there 

are concentrations throughout Chicago. But these are the same 

areas that have been talked about for decades. 

This chart shows what happens in terms of income in the zip 

codes and house prices in the zip codes. The lower quadrant on the 

lower left we call the ‘‘quadrant of doom’’ because that is where the 

foreclosures are concentrated. They are people with below-average 

incomes and below-average house prices. 

The ‘‘enablers of doom’’ are the usual individuals, but they include investors in Ginnie Mae, they include Ginnie Mae itself, they 

include regulators, they include real estate agents and homebuilders and many others that are indifferent to the levels of foreclosure, these 3 million foreclosures that FHA has had over the 

decades. 

The insolvency of FHA puts taxpayers at risk because even 

under very generous accounting rules, FHA now has a negative 

economic value of $14 billion. But that really understates what is 

going on because under today’s low-interest-rate environment, that 

negative economic value is in the mid-$30 billion range. And when 

you add their required capital requirement, you are at the $54 billion number I predicted 31⁄2 years ago. 

By unfairly competing with the private sector, it really delays 

housing finance reform. The FHFA Director said in December that 

FHA is really the path to deciding on housing finance reform; you 

have to start with FHA. 

Turning hope into homes can be done by following four steps, 

and I list them there. You should start with some of the provisions 

from the House-passed bill. You should apply best practices that 

the VA has shown over the years. Needy families need FHA’s full 

10 

attention. FHA should be targeted on where it can help the most. 

And, lastly, they should establish a tolerance for failure; just stop 

making really bad loans. And, finally, I offer to work to with any 

Member here on accomplishing this tolerance for failure. 

Thank you. 

[The prepared statement of Mr. Pinto can be found on page 82 

of the appendix.] 

Chairman HENSARLING. Thank you, Mr. Pinto. 

The Chair will now recognize Mr. Petrou for 5 minutes. 

STATEMENT OF BASIL N. PETROU, MANAGING PARTNER, 

FEDERAL FINANCIAL ANALYTICS, INC. 

Mr. PETROU. Thank you, Chairman Hensarling and Ranking 

Member Waters. It is an honor to appear before this committee 

today to discuss the proper role of the FHA single-family mortgage 

insurance program in the U.S. mortgage finance system. 

FHA plays a vital role. It has an urgent and continuing mission 

to ensure that the Federal Government supports sustainable homeownership for moderate-income borrowers without access to private 

capital. 

However, I believe that taxpayers should take as little risk as 

possible, standing back now that the crisis is ebbing to permit private capital to reenter the market under a new robust regulatory 

framework. With specific regard to FHA, I recommend that Congress should reduce the 100 percent full faith and credit guarantee 

provided by the FHA to parallel the limited coverage of 25 to 50 

percent successfully used by the Veterans Administration. 

There are three simple points that demonstrate that 100 percent 

FHA insurance coverage is self-defeating for FHA and the U.S. taxpayer. First, FHA is exposed to severe losses on every loan that 

goes to claim during a house price decline, such as that experienced 

since 2006. Second, FHA exposes itself to fraud and poor underwriting. That is far less likely to occur if the loan originator had 

skin in the game on every FHA-insured loan it originates. And 

third, reducing the level of insurance coverage on future FHA loans 

while holding the FHA premium at its current level would recapitalize the FHA MMI Fund with positive budget scoring. 

It is simply impossible for there to be real incentive alignment 

between mortgage originators and the taxpayer if originators take 

all the profit and the U.S. taxpayer takes all the risk. Further, the 

FHA should be targeted to borrowers based on income, not home 

price. When the U.S. Government supports mortgage finance for 

higher-income borrowers, it unnecessarily supplants private capital 

otherwise ready to take on this risk. 

Also, since FHA mortgage underwriting is delegated to the lender, the FHA exposes itself to the risk that poor underwriting will 

only be found after a loss occurs. It is important that the taxpayer 

be protected at the front end of the loan origination from poor 

FHA-delegated underwriting. FHA should thus be authorized to engage in risk shares with private providers of credit risk mitigation. 

Importantly, the model used by FHA for accessing the actuarial 

value of its single-family fund is not working. Since 2007, the current model has consistently overestimated its economic value. A 

strict new capital requirement should be set for the FHA’s singleVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
11 

family fund, incorporated through a new actuarial model that accurately predicts losses. 

Additionally, the budget treatment of FHA should be changed to 

reflect the fair-value analysis recommended by the Congressional 

Budget Office as it currently applies to the GSEs. 

FHA is a critical market driver and source of taxpayer risk, but 

it is not the only force redefining U.S. housing finance. If reform 

to FHA or the GSEs is not well-balanced and pending rules are not 

carefully structured, we could well see creation of a set of new perverse Federal policies that force still greater mortgage market reliance on the taxpayer and, thus, still more risk, exacerbating our 

already dangerous fiscal situation. 

Thus, I recommend that Congress should work to ensure that an 

array of pending prudential rules for banks—for example, those implementing the Basel III capital rules—do not so favor U.S. Government-backed mortgages as to block the reentry of private capital. 

A critical pending rule would implement the risk-retention provision of the Dodd-Frank Act, creating a new Qualified Residential 

Mortgage (QRM) criterion that would exempt loans from risk retention. Although downpayment and loan-to-value ratio are key prudential factors, the QRM should not, as proposed, set a simple 

downpayment requirement without regard to the use of regulated, 

capitalized providers of credit risk mitigation like private insurers. 

Doing so would make it extremely difficult to securitize high-LTV 

loans for first-time home buyers and other borrowers who can prudently manage low-downpayment mortgages with careful underwriting backed by private capital at risk. If the QRM advances as 

proposed, these loans will flood into the GSEs and FHA, and once 

the conservatorships are closed, then only into the FHA. 

In conclusion, private capital will only be attracted to the mortgage space when and if it becomes clear that the market has been 

reopened through the retreat of the government. One side of reform 

will only drive still more risk to taxpayers through FHA, an especially dangerous prospect given the many systems and risk management problems that have brought FHA to the perilous condition 

revealed in its most recent actuarial report. 

Again, thank you for inviting me to participate in this vital discussion. I look forward to answering your questions. 

[The prepared statement of Mr. Petrou can be found on page 64 

of the appendix.] 

Chairman HENSARLING. At this time, the Chair will recognize 

Ms. Gordon for 5 minutes. 

STATEMENT OF JULIA GORDON, DIRECTOR, HOUSING FINANCE AND POLICY, CENTER FOR AMERICAN PROGRESS 

ACTION FUND 

Ms. GORDON. Good morning, Chairman Hensarling, Ranking 

Member Waters, and members of the committee. I am honored and 

delighted to be here to testify today about the importance of the 

Federal Housing Administration in our mortgage market. 

Since its creation in 1934, FHA has contributed to broadly 

shared prosperity in this country by helping tens of millions of families access homeownership. FHA doesn’t directly lend money to 

12 

home buyers, but instead insures the loans made by private lenders. In exchange for this protection, the agency charges both upfront fees and annual premiums. 

FHA’s model enables it to serve a crucial macroeconomic role, as 

well, because by providing reliable credit enhancement, it enables 

continued liquidity in severe credit crunches. It is essentially a 

shock absorber. 

This role never been more important than in the wake of the recent housing market meltdown. When the bubble burst, privately 

funded lending essentially came to a halt and the government 

placed Fannie Mae and Freddie Mac into conservatorship. Access 

to credit tightened precipitously, throwing the market into serious 

imbalance. 

In this difficult environment, lenders turned to FHA to help the 

market continue to function. FHA filled a gap left by the private 

market. It did not affirmatively seek market share. It is worth noting that the people who run FHA make the same amount of money 

whether they have a 3 percent market share or a 30 percent market share. 

Since the beginning of the crisis, the agency has insured a historically large percentage of the mortgage market and, in particular, has served the home purchase market at a time when 

many other originations are refinancings. Right now, the housing 

sector is actually one of the brightest spots in the economy, and 

while the recovery does appear to be real, it is very fragile at this 

time. 

FHA’s countercyclical role over the past several years is more 

than a simple convenience for mortgage lenders or a slogan. Economists estimate that the liquidity provided by FHA kept home 

prices from plummeting an additional 25 percent. And remember, 

that is on top of the 30 or so percent that they already did drop. 

That kind of market collapse would have wreaked havoc, not just 

causing an untold number of additional foreclosures and decimating FHA’s insurance fund, but also requiring far bigger taxpayer bailouts of Fannie and Freddie. Even worse, it is likely to 

have sent our economy into a double-dip rescission, costing up to 

3 million jobs and half a trillion dollars in economic output. 

As critical as it was to stabilizing the market, this support did 

not come without cost. FHA’s insurance fund is not in good shape, 

and it is crucial that the agency takes steps to consolidate and improve its financial position as the economy recovers. 

The finances, however, are not a reflection of a flawed business 

model but instead are a consequence of the 100-year flood of the 

great recession. The bulk of the agency’s losses come from loans 

originated between 2007 and 2009, the years just before and after 

the $700 billion government bailout of the Nation’s largest private 

financial institutions. That time period also included a large percentage of loans that used seller-funded downpayment assistance, 

an admittedly flawed program that cost the agency $15 billion in 

losses and without which the economic value of the fund would 

likely not be negative. In contrast, the agency’s more recent books 

of business are likely to be some of its most profitable and safest 

ever. 

13 

FHA has taken a number of steps in the past few years to reduce 

risk and to strengthen the fund. They have raised premiums 5 

times and instituted a variety of other risk management policies. 

In addition, the home price rise over the past year will further 

improve the financial outlook. At this point, it would be prudent to 

hold off on additional price increases or additional changes in the 

credit box to avoid overcorrecting or making mortgages 

unaffordable for too many people. However, as these changes take 

effect, FHA can continue to improve their loss mitigation to avoid 

paying claims whenever possible. It should also continue to crack 

down on lenders who don’t follow the rules. 

But beyond FHA, the time is now to have a larger conversation 

about the future of our housing finance system. Fannie and Freddie 

cannot remain in conservatorship indefinitely, and a vibrant housing market cannot be built simply on refinancing. The market 

needs a steady supply of first-time home buyers who can then become move-up home buyers later. Many of these buyers will be people of color, young people with student debt, and other low-wealth 

but otherwise creditworthy families who don’t have the means to 

put 20 percent down. As we consider what role the government 

should play in the mortgage market, we need to consider closely 

who will serve these borrowers. 

I welcome the opportunity to discuss these important matters 

with you over the coming year. Thank you again for inviting me 

today, and I look forward to your questions. 

[The prepared statement of Ms. Gordon can be found on page 48 

of the appendix.] 

Chairman HENSARLING. Dr. Sanders, you are now recognized for 

5 minutes. 

STATEMENT OF ANTHONY B. SANDERS, DISTINGUISHED PROFESSOR OF REAL ESTATE AND FINANCE, SCHOOL OF MANAGEMENT, AND SENIOR SCHOLAR AT THE MERCATUS CENTER, GEORGE MASON UNIVERSITY 

Mr. SANDERS. Chairman Hensarling and distinguished members 

of the committee, thank you for the invitation to testify today. 

Where do we sit now with the FHA? High-LTV loans, defined as 

95 percent LTV and higher, currently stands at 71.52 percent. The 

FICO score buckets, which means the percentage of low FICO 

scores, which is 680 or below, is at 52.54 percent. These are very, 

very risky loans we are talking about. 

And what I would like to do is point you to the colorful tables 

I have in my presentation. I just want to point something out on 

the risk of high-LTV/low-FICO-score lending or insurance programs. In 2007, in the 620 and lower FICO score and 971⁄2 percent 

and above LTV, the serious delinquency rate was 51.6 percent. 

That means we are putting over half of the households into harm’s 

way. It is like putting them in front of a bus. And a lot of them 

got severely injured. 

But if we want to say, wait a minute, that was just that one 

year, flashback to 2001, before the bubble really hit, et cetera, 620 

and below FICO and 971⁄2 LTV and above was at 22.7 percent serious delinquency rate. That is one in four. 

14 

So, again, what I am saying here is that while the FHA has historically served a very notable presence in the market and has 

helped many American households get housing, it is also, by having 

the FICO score too low, throwing a lot of households under the bus, 

which is not great policy. 

And one thing I just want to point out is that—so if we take a 

look at the FHA loan limit and what we can do to that, FHA of 

course has a higher loan limit than even Fannie and Freddie, their 

cousins. And I would say the first step is to shrink the FHA’s footprint to allow entrance to the private sector by reducing the loan 

limit to 625 and then going at $100,000 a year until this is over. 

According to a study by Robert Van Order, former chief economist at Freddie Mac, and Anthony Yezer at George Washington, 

they find that current FHA policies are unlikely to assist the FHA 

in reaching its historical constituencies—first-time, minority, and 

low-income households: ‘‘We find that FHA’s current market share 

exceeds what is needed to serve these markets. In the wake of significant declines on home prices, we believe FHA could reduce its 

loan limits by approximately 50 percent and still almost entirely 

satisfy its target market,’’ which I just mentioned. That will reduce 

its current market share, which is difficult for the FHA to manage. 

And David Stevens, the former FHA Commissioner, has said that 

exact same thing. 

We need to put a floor on the credit score, as well, again, primarily to protect those households that are actually getting annihilated in default and foreclosure. So I would recommend a floor of 

anywhere from 630 to 660. A maximum LTV of 95 percent, at least, 

should apply. We are not talking 20 percent down; we are talking 

5 percent down at a minimum, or a minimum downpayment of 10 

percent if your credit score is below 680. Maximum debt-to-income 

ratio should be about 31 percent, should be put in there as well. 

In summary, the FHA’s low-downpayment, low-FICO policies 

with 100 percent guarantee, which is way too high, encourages 

risk-taking by working-class households when there is a viable alternative: renting. But simple adjustments to FHA’s policies of a 

FICO score floor, a minimum downpayment of 5 percent, and a 

lower loan limit, going down from 625 down to 350 eventually or 

less, and a lower insurance coverage to, say, 80 percent instead of 

100 percent, can improve the situation. 

These are not draconian measures. These are simple fixes to at 

least help protect the first-time home buyers and minority programs. All these measures can serve to reduce the FHA’s substantial high-risk footprint in the mortgage market and allow competition in the market to come back in. 

Thank you for the opportunity to testify. 

[The prepared statement of Dr. Sanders can be found on page 

154 of the appendix.] 

Chairman HENSARLING. Thank you, Dr. Sanders. 

Thank you to all of our witnesses. 

The Chair now recognizes himself for 5 minutes of questioning. 

As chairman, I will tell you that it is going to be a priority of 

this committee to forge a sustainable housing finance system in 

America. And I mean ‘‘sustainable’’ in two different senses: number 

one, something that can help reduce the severity of the boom-bust 

15 

cycle that has imposed such a cost on our economy and our hardworking families and taxpayers; and number two, something that 

is also sustainable for families. Again, the American dream was not 

to buy a home, it was to buy a home that you can actually afford 

to keep. 

And so I have become concerned—and I think, Ms. Gordon, you 

used the phrase about the recent market meltdown, but I would remind all of us that the great debacle most people would date to 

September of 2008. It is now February of 2013. And I am again 

concerned that what were once extraordinary measures are becoming ordinary measures and becoming barriers to entry. 

I am concerned about FHA having 56 percent of the market. And 

I know that in the February 2011 report to Congress entitled, ‘‘Reforming America’s Housing Finance Market,’’ the Administration 

stated that, ‘‘FHA should be returned to its pre-crisis role—and 

that was 2 years ago the Administration called for this—as a targeted provider of mortgage credit access for low- and moderate-income Americans.’’ 

So we will start with you, Mr. Pinto. How much progress have 

they made? 

Mr. PINTO. Very little progress has been made, Mr. Chairman. 

While FHA says it has shrunk some, you have to realize that there 

are really three agencies that work in concert together under 

Ginnie Mae: FHA; the VA; and the Department of Agriculture. And 

their share has not changed very much because they have very 

large competitive advantages over the private sector. 

So we have made very little progress. And we actually are in a 

situation where that progress could be turned back. Because as the 

FHFA Director increases the guarantee fees for Fannie and 

Freddie—Congress passed a law requiring that they be set at private capital rates—if FHA doesn’t increase their rates in lockstep, 

then the business can just shift in the future over to FHA. So we 

still have a situation where the government has a hammer-hold on 

the market. 

Chairman HENSARLING. Dr. Sanders, what do you see as the impediments for private insurance to fill the market? What are the 

precise practices of FHA that are helping them maintain this 56 

percent market share? 

Mr. SANDERS. I agree with Mr. Pinto. It is the conglomerate of 

not only the FHA but Fannie and Freddie. The market share is 

huge. 

And right now, between Dodd-Frank and the Consumer Financial Protection Bureau and the endless mortgage put-backs by the 

same agencies that were involved in the National Homeownership 

Strategy, which caused the nightmare for American households, 

right now if I was lending or an insurer, I would be scared about 

going to the mortgage market, simply because you are going to get 

blamed for everything, particularly under the Qualified Mortgage 

(QM) rules that say all borrowers are now prime, and if any of 

them default, it has to be your fault. 

So we have created an environment where FHA, Freddie, and 

Fannie, particularly the FHA, are just going to have, as Mr. Petrou 

said, an incredible market share. And we are kind of scaring people 

out of the market. 

16 

Chairman HENSARLING. I am going to try to set a good example 

here and keep myself to 5 minutes. 

I just had my staff do a simple Google search, and I pulled up 

an ad called ‘‘MyFHA: FHA Mortgages.’’ It is a private company, 

but listen to the verbiage here: ‘‘FHA Bad Credit Home Loans. 

Many people don’t realize that FHA loans can help people with bad 

credit. Need a home mortgage but concerned about bad credit? You 

have come to the right place. An FHA mortgage can get you into 

a new home even if you have bad credit because the loans are insured by the Federal Government. If you have had accounts forwarded to collections, filed bankruptcy in the past, or have high 

debt, you still may qualify for an FHA mortgage. These loans can 

work for you even if you don’t have much cash for a downpayment 

or closing costs. And they are a much better choice than the very 

expensive financing that banks call subprime.’’ And the verbiage 

goes on. 

I wish I had time to ask a question regarding that. I hope some 

of the other panelists will explore the serious delinquent rates you 

spoke about earlier. 

At this time, I will yield 5 minutes to the ranking member. 

Ms. WATERS. Thank you very much, Mr. Chairman. 

One of the great things about this process are these hearings 

where we have an opportunity to straighten out the record, to 

present the facts, and to unfold what is really happening in many 

of these issue areas. And while we are in the Minority on this side 

and we only have one witness today, I think it is important that 

we clear up some facts. 

Before I go on to the question, I would like to ask the chairman, 

did you say that the ad that you just read was by some unknown 

private business? 

Chairman HENSARLING. The Chair said ‘‘private.’’ 

Ms. WATERS. I beg your pardon? 

Chairman HENSARLING. The Chair said it was a private company. 

Ms. WATERS. And so this was not an FHA ad soliciting anything; 

is that correct, Mr. Chairman? 

Chairman HENSARLING. That is correct. The Chair— 

Ms. WATERS. Thank you very much— 

Chairman HENSARLING. —said it was a private company. 

Ms. WATERS. —Mr. Chairman. I think we need to be clear about 

this. 

Let me go on to a question that I would like to pose for Ms. Gordon. 

The recent report released by FHA’s independent actuary states 

that FHA’s Mutual Mortgage Insurance Fund has an economic 

value of negative 1.44 percent, or $16.3 billion. But the fund’s negative value is a future projected shortfall, not a current deficit. 

The report also showed that FHA still has more than $30 billion 

of combined capital resources, and the manner in which the FHA’s 

MMIF is calculated does not include future projected income. 

Can you discuss some of the misperceptions about FHA’s economic health and delve into the nuances of FHA’s exact financial 

position and the meaning of the independent actuarial review? 

Ms. GORDON. Sure, I would be happy to. 

17 

The negative economic value number is a number that says, 

okay, if we closed our doors today and didn’t do any more business 

and had to pay out claims for the next 30 years, do we fall short? 

And the answer right now is we fall a little bit short. That is—if 

I had to look at my own balance sheet that way, trust me, I would 

fall short too. 

Right now, FHA has plenty of cash to cover claims certainly for 

the next 7 to 10 years. And these new books of business are going 

to be extremely profitable. As home prices rise, losses decline. High 

foreclosure rates are a problem; I certainly agree with my colleagues on the panel about that. But from the point of view of the 

insurance fund, if in a foreclosure you sell a home and you don’t 

take a loss, that is not a loss to the fund. So I think that is important to recognize. 

It is also important to recognize that in its authorizing statute, 

Congress gave FHA the ability to draw from the Treasury in the 

event that they have to balance their books, as is required. That 

does not require any kind of congressional action. It is not a bailout 

by the taxpayers. You are essentially moving money from one account to another inside the— 

Ms. WATERS. Thank you very much. 

Dr. Sanders, do you realize that FHA does not insure loans over 

$729,750? 

Mr. SANDERS. Yes, that is in my testimony. 

Ms. WATERS. And is that available for the private market to take 

advantage of? They can have all of those loans over $729,750 if 

they want; is that correct, Dr. Sanders? 

Mr. SANDERS. Technically speaking, that is correct. 

Ms. WATERS. Whether it is technical or not, that is a fact. And 

they are not active in the private market while it is wide open to 

them, yet we talk about competition and we talk about them having too big a share of the market. 

Let me also raise another question with you about how the loans 

are performing. Is it not true, Ms. Gordon, that FHA loans have 

been performing very well since 2010? 

Ms. GORDON. Yes, new loans are performing very well. They are 

very safe. Average FICO scores for FHA borrowers right now hover 

around 700. These are certainly the safest books of business they 

have had in a long time. 

Honestly, this is an example of government working for all of us 

to help the housing recovery, which is helping all of our neighborhoods and all of our mortgages, whether or not they are insured 

by FHA. 

Ms. WATERS. Thank you very much. 

I suppose my time is almost up, so I am going to be as generous 

as you were and yield back. 

Chairman HENSARLING. Leading by example, as well. 

The gentleman from California, the vice chairman of the committee, Mr. Miller, is recognized for 5 minutes. 

Mr. MILLER. Thank you, Mr. Chairman. 

I want to say that FHA has played a very important countercyclical role in the process, providing liquidity. We have been in a 

very distressed marketplace. 

18 

Mr. Sanders, I agree with you—I have been a builder for over 40 

years—that the private sector has actually been scared out of the 

marketplace by the Dodd-Frank Act. 

And I probably would disagree with all of you on certain things, 

but, Ms. Gordon, I had some real concerns in your testimony. You 

conclude your written testimony today saying it is important to 

give sufficient time to see the results of internal reforms recently 

instituted by FHA. That is a correct statement? 

Ms. GORDON. Yes. I think a lot— 

Mr. MILLER. Thank you. I appreciate that. But I heard the same 

thing from FHA in 2009, 2010, 2011, and 2012. They said the very 

same thing when they testified before Congress. 

The problem I have is, when I look at the actuarial projections 

that you based your testimony on, in 2009 we were told they were 

0.42 percent-plus at that point in time. We were told that by 2012 

they would be at the congressionally mandated minimum of 2 percent. Is that not a correct statement? 

Ms. GORDON. That is correct. And I think— 

Mr. MILLER. Thank you. And in 2010— 

Ms. GORDON. —there are a lot of things that have not gone— 

Mr. MILLER. That is it. 

Ms. GORDON. —the way we thought. 

Mr. MILLER. I am going to ask you some questions. 

In 2010, they were at 0.59 percent. We were told that by 2011, 

they would be at 1.75 percent. Is that not a correct statement also? 

Ms. GORDON. Correct. 

Mr. MILLER. And in 2011, they were at 0.12 percent, not 1.75 

percent. We were told that by 2012, they would be at 1.5 percent. 

Is that not a correct statement? 

Ms. GORDON. Correct. 

Mr. MILLER. They were actually at 1.28 minus, which means 

there is a 2.75 percent difference in what they projected every year 

based on what they have done and the reforms they have undertaken. 

Now, I agree that FHA has been a shock absorber for the economy, but it has kind of been broken. The shock absorber doesn’t appear to be really working. 

I also agree that real estate is probably one of the bright spots 

in the economy today, because I am doing building in some States 

and I see the market coming back. But that doesn’t change the fact 

that FHA is undercapitalized. Every projection they have made by 

the actuarial and their data that they have, that they have given 

them, has been wrong. 

And the problem I have is, yes, I agree that much of the losses, 

the major losses, occurred in 2007 and 2008, probably in 2009, in 

that era—I think they might have gone back to 2006 when they 

started. But they have not done what is necessary to keep themselves in the plus column, and that is taking in and analyzing the 

risk that they are taking on certain loans and making loans that 

would offset the losses that they know they were going to take. 

And if we would have had any bank in the economy or mortgage 

industry group out there, we would have closed them down and 

taken them over in year one. But by the projections I see by the 

actuary, we are talking about 8 years. We are going to forego what 

19 

we required every private sector lender out there to undergo by the 

Federal Government, being closed down 1 year, we are saying, well, 

that is okay, but we are going to let you go 8 years. 

And so the problem I have, even though I support what they 

have tried to do to stabilize the economy, in your testimony you say 

that we should not be worried because a projection by the FHA actuary is that the capital reserve ratio will be positive by 2014 and 

will reach a statutory minimum of 2 percent by 2017. 

And I am not trying to impugn you, but I am impugning somebody. Because what they are telling us is to sit back and hope— 

hope it is going to happen, hope they are going to be right this time 

even though they haven’t been right in the previous 4 years. Vince 

Lombardi was really great. He said, ‘‘Hope is not a strategy.’’ And 

I am unwilling as a Congressman, as much as I support the housing industry, as much as I love the industry—I have been involved 

over 40 years; I see it recovering—but I can’t sit back here with 

taxpayers’ dollars and say, well, I hope they are right this time. 

From 2011 to 2012—we were told in 2009 they had modified the 

structure of the FHA so you would not face these downturns. And 

we went from 0.12 in the plus to minus 1.28 in the negative in 1 

year. Now, the problem is I don’t know what has happened since 

2012 to 2013. Did we go down another 1.28 percent? 

My time has expired. And I was not attacking you, but I was attacking what you were working under— 

Ms. GORDON. May I briefly respond? 

Chairman HENSARLING. The time of the gentleman has expired. 

The gentlelady from New York is now recognized for 5 minutes. 

Mrs. MALONEY. Thank you. 

During the economic crisis, my constituents were telling me that 

it was impossible to refinance a mortgage, it was impossible to get 

a mortgage. I had distinguished businesses and businesspeople 

come to me and ask, why doesn’t the Federal Government open up 

a bank so that we can get a loan for a home? 

So I would like to ask Ms. Gordon, what economic effects would 

we have witnessed if FHA closed down and stopped insuring new 

loans immediately following our recent economic crisis? 

I would like to add that many members of the panel say that the 

private sector wants to step in. Well, step in. Finance it. FHA came 

in during a crisis and provided a stop-gap support for housing that 

others were not willing to do. 

So, Ms. Gordon, your response, please? 

Ms. GORDON. Thank you for that question. 

The fact is, whether the fund is $1 billion up or $1 billion down, 

this is a bargain price for what the FHA did to stabilize the housing market and the economy. We are talking billions, if not trillions, more that could have been lost if we had not had this liquidity available to us. 

I am very glad to see that Congressman Miller understands the 

role that has been played, but when we think of the $700 billion 

bailout of those private institutions, which clearly were far worse 

at pricing risk than the government has been—in fact, they 

thought they had magically eliminated risk—we have really seen 

government at work here on behalf of all of us. 

20 

Mrs. MALONEY. I would like you to comment on a statement that 

Secretary Donovan made before this committee last year. In it, he 

was quoting findings from Moody’s. And he said that the loss of 

FHA in 2010—if FHA had not been there in 2010, the loss would 

have meant the loss of 3 million American jobs and a 2 percent decrease in our GDP. 

Would you agree with his statement on that and Moody’s statement on that, on their role? 

Ms. GORDON. I would absolutely agree with it. This is FHA playing the role that was intended from the beginning. The Act establishing FHA did not limit FHA just to a particular set of buyers 

or a particular kind of loan. It was there to backstop the housing 

market. 

Mrs. MALONEY. And in your testimony you spoke about this, but 

I would like you to elaborate on the countercyclical role FHA has 

played since the financial crisis began in 2008. You mentioned in 

your testimony that FHA has been as low as 3 percent in times of 

great prosperity, but in times of crisis it steps in to fill the gap because the private sector is not there. 

Could you elaborate on the countercyclical role it plays? 

Ms. GORDON. That is exactly right, that FHA was available to 

provide the liquidity that people needed both to refinance their 

homes and, most importantly, to buy homes. Because when people 

are going through foreclosures or leaving their home, someone has 

to be on the other end to buy that home to keep the neighborhood 

stable and keep the market functioning. So that was so important 

about this role. 

As to the question of market share, there are a variety of steps, 

some of which FHA has already taken and, I agree with my colleagues on the panel, can be taken to maybe help crowd in private 

capital, as people talk about. But at the moment, if you look across 

Fannie, Freddie, and FHA, it is going to take a lot more to ‘‘crowd 

in’’ private capital. 

Private capital is sitting on the sidelines not just because of some 

CFPB rules and not because FHA is so cheap, because it is actually 

not that cheap to get an FHA loan, but because there is enormous 

uncertainty about what the long-term future of housing finance in 

this country looks like. And that is why it is really important that 

we soon have the conversation about the future of Fannie and 

Freddie and the future of FHA and what kind of housing policy we 

want to have. 

Mrs. MALONEY. You have mentioned steps that could be taken. 

What steps is FHA taking in terms of improvements to risk management and fee increases to help mitigate the changes we have 

seen in the market? 

Chairman HENSARLING. I am sorry. If you could summarize. 

There are only 10 seconds left. 

Ms. GORDON. Sure. There have been five premium increases, as 

well as a number of other policy changes. 

Mrs. MALONEY. Thank you. My time has expired. 

Chairman HENSARLING. The Chair now recognizes the chairman 

emeritus, the gentleman from Alabama. 

Mr. BACHUS. Thank you. 

21 

I would say to both the Members and to the panel, Ms. Gordon 

is right when she says the role of FHA originally was different 

from what it is now. In 1934, when it was formed, 60 percent of 

Americans did not own their homes and you could only have a 

mortgage for 3 to 5 years. And then in the 1940s, it was primarily 

used for affordable multifamily housing. So, it has evolved. 

But I don’t think there is any disagreement—I think Ms. Gordon 

would agree—that the present mission, even if you look on the official Web site, is to provide mortgage insurance for low- and middleincome American families for affordable housing and for multifamily housing. Now, we sometimes forget that multifamily housing. And I know Chairman Frank and I have both said that is a 

very important role and it is a profitable role, providing financing 

for private apartments. 

The present mission—and I would ask the panelists—as I understand it, is there is pretty much agreement on low- and middle-income mortgages, other than multifamily, for creditworthy families. 

And we sometimes forget that ‘‘creditworthy.’’ 

Now, having said that, where are these loans being made? They 

are primarily made in two areas. They are primarily made for people of higher incomes. You can look at Mr. Pinto’s and Dr. Sanders’ 

testimony. They are cross-subsidizing and loaning—I think the figure is 54 percent of its activity in 2011 was for 125 percent of an 

area’s median income housing, so above—and, actually, 63 percent 

of FHA borrowers in high-income areas had greater than 150 percent of the average median income. 

So, they are doing that. The reason they are doing that is they 

are making money on that, which is subsidizing another category— 

I read Mr. Pinto’s testimony and what he said earlier. Don’t miss 

this. Forty percent of FHA’s business consists of loans with either 

one or two subprime attributes: a FICO score below 60, below 60— 

that is bad credit—or a debt ratio greater than or equal to 50 percent. Now, those are risky loans. 

So my question for Mr. Pinto, Dr. Sanders, and any of the panel: 

These loans to high-income Americans and to families with FICO 

scores of 60 or below or debt ratios which are subprime category, 

is that the mission of the FHA? 

Mr. PINTO. I think it is not FHA’s mission to serve higher-income 

individuals and higher-priced homes. FHA’s mission should be focused on working-class neighborhoods, first-time home buyers. 

And what I have suggested in my testimony is that if you establish a tolerance for failure of FHA around 5 to 6 percent, you can 

re-target FHA to that group and successfully price those loans and 

still have money left over so it doesn’t negatively impact FHA’s fiscal position, which is poor; we just don’t want to make it any 

worse. 

The reason for this is, as my study has shown, once you get 

around 10 percent—and remember, that is the history of FHA over 

37 years. That is why we have the 3.25 million foreclosures in 37 

years. It is because FHA has been tolerating an 11 percent foreclosure rate year-in and year-out, on average. So if you have that 

11 percent foreclosure rate, you end up having neighborhoods, 

thousands and thousands of them—we found 6,000 zip codes where 

22 

the foreclosure rate averaged 15 percent. And that is financing failure in those zip codes and destroying those neighborhoods. 

Mr. BACHUS. All right. So both of those categories that I talked 

about are really somewhat of a departure from their mission; is 

that correct? 

Mr. PINTO. Absolutely. 

Mr. BACHUS. And Dr. Sanders? 

Mr. SANDERS. Oh, absolutely. I think the FHA has veered dramatically from its original mission. In fact, based on the Web site 

Mr. Hensarling found, I think they ought to put a little asterisk 

there saying, ‘‘Low-FICO, high-LTV loans have between a 25 and 

50 percent chance of serious delinquency. So you might want to 

think twice—’’ 

Chairman HENSARLING. The time of the gentleman has expired. 

Mr. BACHUS. Thank you. 

Chairman HENSARLING. The Chair now recognizes the gentlelady 

from New York for 5 minutes. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Mr. Pinto, isn’t it true that FHA has stringent standards related 

to borrower qualifications and credit scores? 

Mr. PINTO. Than prior? 

Ms. VELAZQUEZ. They are talking about—I believe the previous 

Member asked you if they will provide— 

Mr. PINTO. We have this bifurcation that leads to an average. So, 

on one hand, FHA has very high-income, very high-home-price, and 

relatively high-FICO-score borrowers. And they make loans to 

those borrowers, and they use those moneys to subsidize the borrowers who are below—the subprime borrowers who were mentioned, the 40 percent of borrowers who have FICO scores below 

660 or debt ratios above 50 percent. That is what is going on here. 

Ms. VELAZQUEZ. Yes. 

Ms. Gordon, I would like to hear from you. 

Ms. GORDON. First of all, I think it is interesting that sometimes 

Mr. Pinto likes averages when he is talking about the foreclosure 

rates, but sometimes he doesn’t like averages when he is talking 

about FICO scores. 

But that said, I think what we have to do here is we have to distinguish between what I like to call ‘‘risky borrowers’’ versus ‘‘risky 

loans.’’ 

The reason we had a housing crisis was because of risky loans 

and risky lending practices. People in the neighborhoods that Mr. 

Pinto has identified, those neighborhoods were largely targeted and 

in some sense, terrorized by these exploding ARMs, negative amortization loans, loans that were push-marketed to people without including escrow in the monthly payment. These were terrible products that were designed to fail. 

FHA provides 30-year, fixed-rate, fully underwritten mortgages. 

These are not risky mortgages. 

Ms. VELAZQUEZ. Thank you, Ms. Gordon. 

Mr. Sanders, in your testimony, you suggest reducing FHA’s loan 

limit by 50 percent over the course of the next few years. However, 

the average home prices in high-cost urban markets like New York 

are far above $350,000 and continue to grow. Your recommendation 

will price first-time and low-income buyers out of the market. 

23 

How can FHA fulfill its mission if it cannot provide loans to firsttime home buyers and low-income families in high-cost housing 

areas? 

Mr. SANDERS. Thank you. 

On this score, I agree with Shaun Donovan, the Secretary of 

HUD, who believes that we should be building more multifamily 

projects in the city to help relieve that stress so we have people 

with sensitive credit who can actually live in clean multifamily 

housing. I think that is an excellent public policy goal. 

Ms. VELAZQUEZ. Ms. Gordon, could you please explain to the 

committee that the median home sale price in places like Brooklyn, 

New York, is $565,000. And I suspect in areas like Boston and San 

Francisco, that would also be the case. In Chinatown, the median 

average is about $1 million. 

FHA’s products allow low-income borrowers and first-time home 

buyers to obtain affordable financing options to purchase homes in 

these and other high-cost areas. What will happen in these communities if FHA reduces loan limits, as suggested by some of the other 

panelists? 

Ms. GORDON. It is an anomaly right now that the GSEs have 

lower loan limits than FHA. That is an odd arrangement of the 

world. And I understand Congress made that choice, but I am not 

sure people quite understand that. 

But what is important to understand now is that this housing recovery is both crucially important to us right now and very fragile. 

So to the extent we move, we need to move slowly, and we need 

to move carefully. 

And I would love to see private capital come back into that space. 

They can come back into that space. The reason FHA used to have 

such a low market share is because private capital had no trouble 

competing. FHA mortgages are cumbersome, there is a lot of paperwork, there is a lot of stuff you have to go through. It used to be 

that private mortgages were more attractive to most people when 

they could get them. So if the private market comes in, FHA will 

be able to retreat. 

Ms. VELAZQUEZ. Thank you. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from California, Mr. Royce, for 5 minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. 

I think as we look at the overarching goal here, it is really to get 

private capital back in, right? And at the same time, we are concerned about the bailouts and the likelihood of a major bailout here 

if we go in the wrong direction. 

We had in 2009, and we had in 2011, testimony from the head 

of HUD and from the FHA that they were going to work to improve 

the financial footing. The way they were going to do it was HUD 

decided to allow FHA to expand, rather than to ask it to be recapitalized at that point. 

So we are headed in a direction, but what has the result been? 

The consequences of that expansion has—we have gone from, what, 

a positive $4.7 billion 3 years ago to $2.5 billion in 2011, to a negative $16.3 billion in 2012. 

24 

I was going to ask Mr. Pinto—we talk about the enablers here 

of overleverage in the system. We are all concerned about what 

was done in the past to overleverage. You have heard me argue in 

the past about 10-to-1 leverage being the maximum we should 

allow. We had Bear Stearns at 30 to 1. That is a problem. But in 

November 2011, we had FHA at 422 to 1. I remember when Fannie 

Mae and Freddie Mac were discovered to be 100-to-1 leverage, we 

thought we had a problem. 

So, clearly, going forward, we have something we have to address 

here. And now that the FHA has a negative economic value, I don’t 

know how you even compute leverage. I don’t think you can with 

a negative denominator for capital. 

Are there other accounting means that we can use to compare 

FHA to other public- and private-sector entities? I will ask Mr. Ed 

Pinto on that. And under any mechanism, is the FHA solvent? 

Does this raise the prospects, frankly, for us to be concerned about 

a future bailout here, given the way that this graph shows actual 

versus projected over the last couple of years? 

Mr. PINTO. Okay. Thank you, Mr. Royce. 

I don’t know of any accounting regulatory scheme that would 

lead FHA to have a positive net worth. What is used by the actuarial study is what is known as government accounting principles. 

Back in 1984, when someone who worked for me was talking about 

government accounting principles, they said, ‘‘They are neither accounting nor principles. They are not based on anything that you 

can get your arms around.’’ 

Generally Accepted Accounting Principles (GAAP), which are 

used in the private sector—I have been reviewing FHA every 

month for over a year using generally accepted accounting principles. And based on that, FHA has a negative $25 billion net 

worth today, and it is also short $22 billion in its capital requirement as established by Congress, so for a total negative of over $45 

billion. 

That is where FHA is today. And where it is going to be tomorrow—Ms. Gordon talks about how they would like to count future 

income and things like that, future business. No financial institution in the world gets to count things the way FHA counts them. 

Mr. ROYCE. Let me ask Mr. Sanders, then, because in your testimony you laid out a series of steps that could improve the financial 

soundness and would also reduce the market share, including: improve the credit quality of those receiving insurance; increase the 

minimum downpayment; and reduce loan limits. 

Can some of these steps be taken by the FHA under its current 

authority? And of those requiring congressional action, how would 

you prioritize which we should tackle in Congress? But, first, let’s 

take what could be done under the current authority. 

Mr. SANDERS. Under the current authority, they can do things 

like disclose information better. The FHA is almost like Communist 

China in terms of reporting their loan level data; we just don’t do 

it. That would help us get around the problem that was asked of 

Mr. Pinto on accounting. Just show us your books. The actuarial 

reports are just—whether grossly misleading, I don’t know, but 

they are just— 

Mr. ROYCE. Reducing loan limits? 

25 

Mr. SANDERS. I think reducing loan limits has to be done here. 

I don’t think they can do that themselves. 

Mr. PINTO. Let me just say two things that FHA could do immediately that would be huge. 

Number one is, they threatened a 3 percent limitation on seller 

concessions, David Stevens, 21⁄2 years ago. It has not been done. I 

think one of the Members said it had passed; it has not taken 

place. 

And then, number two, return appraisal panels, just like the VA 

does. Those two things would be huge. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlemen from North Carolina, 

Mr. Watt, for 5 minutes. 

Mr. WATT. Thank you, Mr. Chairman. 

And let me start by thanking the chairman and the ranking 

member for having this hearing. I think it is critically important, 

and it is an important first step to getting to the basis of what we 

need to do in this committee not only about FHA but Fannie and 

Freddie. And if we don’t find some good answers, housing in this 

country is going to be even worse and homeownership is going to 

be an impossibility, I think, over time. 

I assume there is nobody on this panel who believes that we 

don’t need FHA, is there? 

Oh, there is somebody. Mr. Pinto. 

Mr. PINTO. I think that raises the question— 

Mr. WATT. Either you do or you don’t, now. 

Mr. PINTO. Let me just answer it. 

Mr. WATT. Don’t— 

Mr. PINTO. If you don’t take steps to reform FHA, there is an alternative way to get to the kinds of housing assistance— 

Mr. WATT. Okay. But the mission— 

Mr. PINTO. But if you don’t fix it— 

Mr. WATT. Let me rephrase the question. The mission of FHA— 

is there anybody on the panel who believes that we should not have 

the mission of FHA if FHA is operating within that mission? Is 

there anybody who— 

Mr. SANDERS. The original mission? 

Mr. WATT. Yes, the original mission. 

Mr. SANDERS. I have no problems with the original mission. 

Mr. WATT. All right. Okay. So the problems we are having is, it 

sounds to me like you believe that FHA is operating outside the 

mission. And part of that has been as a result of the private market fleeing for whatever reason. So one question I have is, how do 

we get the private market to step back into this space that FHA 

is inappropriately, you believe, in? 

Let’s talk about that for a little bit. And I would love to have Ms. 

Gordon’s opinion about that. I would love to have Mr. Pinto and 

Dr. Sanders’ opinion about it. Because if the private market is not 

going to step into the space, either we are not going to have the 

space occupied or Fannie is going to occupy it or Freddie is going 

to occupy it or FHA is going to occupy it, all of which currently expose, potentially, taxpayers. 

26 

How would you attract the private market into this, Ms. Gordon? 

And then, Mr. Pinto and Dr. Sanders? 

Ms. GORDON. It is going to be important to have the larger conversation all together. You can’t just address FHA in a vacuum, if 

we really want to fix the housing market going forward. 

We have to get serious about what we are doing with Fannie 

Mae and Freddie Mac. They are showing a profit now; they have 

become a convenient piggybank. But the fact is we have to address 

the whole thing together so that we can appropriately— 

Mr. WATT. Okay. All right. 

Mr. Pinto, go ahead. 

Mr. PINTO. I agree with Acting Director DeMarco: ‘‘The road to 

housing finance reform starts with FHA. You have to define the 

role of FHA.’’ If we define— 

Mr. WATT. Well, we have agreed on the mission, the original mission. How do you get— 

Mr. PINTO. Right. So then you— 

Mr. WATT. How do you get the private market to come back in 

beyond that mission? 

Mr. PINTO. The private market is ready, willing, and able. You 

have new mortgage insurance companies that have started. You 

have capital being put in— 

Mr. WATT. What are they waiting for? 

Mr. PINTO. Excuse me? 

Mr. WATT. What are they waiting on? Why are my constituents 

coming to me saying, ‘‘I can’t get the private market to finance a 

loan?’’ What are they waiting on? That is the question I am trying 

to get to. 

Mr. PINTO. You want responsible lending. I think we all want responsible lending. And the private sector is ready, willing, and able 

to do responsible lending. FHA, as I have documented, is not doing 

responsible lending in these areas that are occupied—working-class 

families and neighborhoods. They are not doing responsible lending. You want responsible lending. 

Mr. WATT. Dr. Sanders, go ahead. 

Mr. SANDERS. I agree with Ed. Part of the reason, although Ms. 

Gordon doesn’t agree with me— 

Mr. WATT. I am not looking for reasons. I am asking, how can 

we attract private capital back into this area? I am not looking to 

blame anybody. I know what the blame is. We have been doing 

that for 2 years now. 

Mr. SANDERS. I am not blaming Ms. Gordon. I am just saying 

that—what I think is, if we take a look at the Dodd-Frank Consumer Financial Protection Bureau QM, whereas essentially, as I 

have called it before, is the Fannie-Freddie-FHA protection bills, 

because now most loans are just going to go to FHA once Freddie 

and Fannie come out of conservatorship. And so, we have to lower 

the footprint, raise the premiums even more on FHA, and, again, 

take them out of the subprime end of the market. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from West Virginia for 

5 minutes. 

Mrs. CAPITO. Thank you, Mr. Chairman. 

I want to thank the panel. 

27 

I would like to start on the shortfall at FHA, the $16 billion that 

we have talked about, capital ratios in the negative. And I believe 

I heard Ms. Gordon say—and I haven’t been in the entire hearing, 

so excuse me if I have misconstrued your comments—that basically 

what it would be is, if it was ever called upon, is just shifting from 

one account to the other and that there is really nothing that the 

taxpayers would be liable for. 

Is that your essential statement there? 

Ms. GORDON. No, that is not what I am saying. What I am saying is that right now, there is nothing that is going on that requires what I think people think of as a bailout, where Congress 

has to vote new money to do something that wasn’t contemplated. 

What is happening right now is contemplated, that from time to 

time an agency with a mission like this is going to be in dire 

straights. 

And don’t misunderstand me. These are financial dire straights, 

and it is very important to get the financial house back in order 

through steps such like the ones that FHA has taken and some of 

which they are seeking additional congressional authority so that 

they can take. 

Mrs. CAPITO. Right. But if there is an infusion from the Treasury, that would, in fact, impact taxpayers, because the Treasury is 

and continues to be our tax dollars. Correct? 

Ms. GORDON. Yes. 

Mrs. CAPITO. Okay. 

Then my next question would be to the experts on the panel. Is 

there a mechanism that if an infusion of capital from the Treasury 

becomes necessary, which it looks like it might be, is there a mechanism for FHA in rosier times to repay this as part of the process? 

Mr. PETROU. Yes, there is. The key is to, first of all, change the 

budget accounting, which is what CBO has recommended, to show 

the true risks associated with FHA. All these numbers that you are 

talking about are numbers that are really artificial, and they are 

artificially low in terms of the bailout that we are talking about. 

Mrs. CAPITO. So you think the $16 billion is a low figure? 

Mr. PETROU. It is low in terms of the real risk, and that is— 

Mrs. CAPITO. Okay. 

Mr. PETROU. —what CBO has made clear in its work with respect to fair-value accounting. 

The second thing, the way you want to—if you are going to 

grow—you can’t—I don’t believe in growing FHA’s way out of its 

problem. I think that is really just what the S&Ls thought they 

would do in the early 1990s, and it failed, but now you are playing 

with taxpayer money. 

The answer, really, as I indicate in my testimony, is to cut the 

government insurance down to 30 percent from 100 percent— 

Mrs. CAPITO. I see. 

Mr. PETROU. —so that the lender is on risk, and then keep the 

premiums so that you can recapitalize the fund to 4 or 5 percent. 

And that way, you would start getting yourself into a responsible 

economic program, as opposed to worrying about supporting the 

market—if, in fact, it needs the support, continued support—by inflating home prices. 

Mrs. CAPITO. All right. Thank you. 

28 

I am going to jump to another area here because I only have a 

minute and 45 seconds left. 

I was the ranking member on the Housing Subcommittee with 

Ms. Waters when she was the Chair, and we had more than a few 

meetings of this impending doom. This has been talked about in 

our committee for years, that this is the direction the capital ratio 

is headed. 

The response from the Secretary of HUD and others, the FHA 

administration, has always been that the newer loans, the ones 

that are being entered in now, are going to be the ones that are 

going to sustain the fund going forward and that the past ones are 

the ones that are really messing it up, and that all these loans are 

going to be cycled through. But from what I am hearing from your 

testimony, that is not what is happening here. 

Mr. Pinto, would you have a response to that? 

Mr. PINTO. Yes. You are absolutely correct. What is going on 

here, these projections are made, and they are just not credible. 

The projection itself that was made in November is based on a 

July interest rate projection. In the report, it talks about, if we are 

in a low-interest rate environment—and I think everyone here 

agrees we are in a low-interest rate environment—it is not $16 billion negative or $15 billion negative, it is $31 billion negative. 

Secondly, the last recession ended in mid-2009. It doesn’t feel 

like it ended, but officially that is when it ended. FHA is very vulnerable to a recession, as the chairman said at the beginning, very 

vulnerable to a recession. If there were to be a recession anytime 

in the next 4 or 5 years—and I am not talking about a big one, 

just a normal, run-of-the-mill recession—FHA would suffer catastrophic losses and the taxpayer would be at risk. 

Why? Because not only do they have all these negative economic 

values we have talked about, then they run into some additional 

losses that they never projected. 

Mrs. CAPITO. All right. Thank you. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair now recognizes the gentleman from California, Mr. 

Sherman, for 5 minutes. 

Mr. SHERMAN. Thank you. 

The FHA may have mispriced risk, but I will point out that the 

private sector did worse. S&P stood as the crown jewel of the private sector’s ability to price risk. They were in the business of telling everybody else in the private sector what the risk was. And 

now, a judge or jury will determine only the simple fact: Were they 

negligent in mispricing the risk or fraudulent in mispricing the 

risk? 

In 2010, this committee and the Congress passed legislation that 

pushed the FHA toward higher fees. Now, it appears that they are 

doing a better job of pricing risk—if anything, pricing it high 

enough to make a profit. 

Last December, the Secretary of HUD testified that FHA’s market share was contracting. I want to recognize the gentlelady from 

West Virginia, because she and I worked on a letter that I think 

was important in prodding the regulators to define qualifying mortgage with a safe harbor. Now that they have a safe harbor—and 

29 

let’s hope that concept is made solid—I don’t know why the private 

sector is not playing a more robust role. 

Ms. Gordon, you testified that there would have been another 25 

percent decline in home prices if FHA had not been in the market. 

I think that comes from Moody’s? And you are nodding ‘‘yes.’’ 

In a few sentences, could you tell us what this country would 

have looked like if we had had another 25 percent decline in home 

prices? Or do I have to watch all those post-apocalyptic movies? 

Ms. GORDON. Yes, I would say you have to watch one of those 

movies with all the scary things, because I— 

Mr. SHERMAN. ‘‘Thunderdome?’’ 

Ms. GORDON. —can hardly imagine. There are so many neighborhoods that still are in deep, deep distress because of the private, 

toxic, subprime loans that were made and because of the foreclosures, the subsequent recession, the unemployment. Imagine if 

we had had 3 million fewer jobs—we would not be on a road to recovery today at all. 

Mr. SHERMAN. For the record, I will just define your answer as 

‘‘somewhere between ‘Grease’ and ‘Thunderdome.’’’ 

Ms. GORDON. That works. 

Mr. SHERMAN. I worked with the Vice Chair of this committee to 

allow FHA in high-cost areas to go as high as $729,750. That 

sounds like too much for most of the districts represented here, but 

in the 12 high-cost areas, it was critical. 

Are the FHA’s reserves higher? In effect, are they making a profit, an actuarial profit, on those loans that they are guaranteeing 

between $625,000 and $729,000? 

Ms. Gordon? 

Ms. GORDON. I don’t have the numbers in front of me, but one 

would imagine that is a possibility. Maybe Mr. Petrou has the 

number. 

Mr. SHERMAN. Mr. Petrou? 

Mr. PETROU. I would question whether or not that is the case. 

And the reason I question it is that, while FHA had hoped that its 

2010 book of business, for example, would be performing better, 

hopefully enough to bail out the rest of the fund, in fact, if you look 

at the latest actuarial report, you will find that the present value 

of that book of business is falling. 

Mr. SHERMAN. I would beg to differ with you on a couple of 

points. First, I was asking about loans that make up about onetwentieth of that book of business. 

Mr. PETROU. Yes, and that is where you get— 

Mr. SHERMAN. You are talking about what the temperature was 

in the whole country, and I asked you what the temperature was 

in one county. 

Mr. PETROU. And that is—I said my— 

Mr. SHERMAN. So I am going to reclaim my time and just note 

for the record that in terms of default rates, private-sector loans, 

prime, have been at 5 percent; subprime, 22 percent. Yes, the FHA 

overall is at 9 percent, but for those loans made in 2011, the seriously delinquent loans are only 3 percent. 

So to say that the FHA’s recent loans—first of all, you have the 

actuarial value that says that their book of business for 2010, 2011, 

and 2012 should raise their capital by $22 billion in profit, but then 

30 

you have the actual nonprojected, real-life experience of 2011, a 3 

percent default rate. 

And I believe my time has expired. 

Chairman HENSARLING. It is certainly expiring. 

The Chair will now— 

Mr. SHERMAN. It is clearly expiring. 

Ms. Gordon, do you have any further comment in 5 seconds? 

Ms. GORDON. What we can all agree on is if we do a better job 

of loss mitigation, both at FHA and elsewhere, that will help 

everybody’s books. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from New Jersey, Mr. Garrett. 

Mr. GARRETT. Thank you. 

And before I begin, just to this issue of where the private sector 

is versus these that are basically in the public sector, remember, 

those loans that are in the private sector, if they go bad, the taxpayer is not on the hook. So if they made bad decisions on these 

things, it is not the taxpayer who ultimately has to pay the price 

for it. 

But on to this panel. This panel has been interesting in some of 

the rhetoric that we have heard so far, that we have heard from 

some members, at least Ms. Gordon, using the term ‘‘terrorism’’ in 

the financial sector, that people have been terrorized, areas have 

been targeted, and what have you. I suppose that some of the government policies that also went after the low-income in these certain areas, such as CRA, might be government counterterrorism in 

those same areas, as well. 

But rhetoric aside, I think the other term that we hear from the 

other side, the constant refrain or the mantra of the countercyclical 

role of the FHA is an interesting one. I guess that means that if 

you, individually, would not lend money to your neighbor to help 

them buy a home because of market situation or what have you, 

but you want the government to use taxpayers’ dollars to go in and 

help them out and buy a loan, that is the countercyclical nature of 

the FHA; something that you, individually or personally or investment-wise, you are not willing to do, but you are sure happy to 

have the taxpayer step up and step into that role. And that is the 

role you are suggesting for the taxpayer through the FHA. 

Now, notice that when you do require the FHA to take that countercyclical role, there is a price to pay, not for the prudent borrower, not for the individual who has said, ‘‘During these down 

times, I am going to wait and save up my money to get into the 

market tomorrow or the next day,’’ because when you act in this 

countercyclical manner that the FHA has done, what happens is, 

as this panel has indicated, the rates later on, as they are now, as 

Ms. Gordon has said as well, the costs go up. 

So that prudent individual actually has to pay the price for the 

failed policy of the Federal Government and also for the imprudent 

action of the prior borrower, who now finds himself either out of 

a house or in a house that is underwater. I am not sure why anyone would be advocating for imprudent investments and imprudent 

lending or for penalizing those individuals who do the appropriate 

thing and buy when they are able to afford it. 

31 

Let me turn to Dr. Sanders as to what the appropriate role for 

the FHA is, since you said you approve of the appropriate historical 

role of the FHA. And that was, I believe, to help out first-time 

homeowners and those low-income communities and areas or individuals who could not afford to buy a home, and FHA was created 

in that manner. 

Just as an aside, I know our President has been on TV frequently defining who the rich are in this country, and the rich are 

anybody who makes over $250,000. So those are who are the rich. 

But isn’t that exactly what the FHA has now morphed into, is saying that we are now going to allow and to help facilitate those rich 

people to buy homes? 

Mr. SANDERS. Yes, the FHA has strayed from its original mission: first-time home buyers and minorities. 

And even on the minorities side, you have to be very careful 

about harming. Again, FICO score gets too low, they are actually 

worse off—not all of them, but maybe 50 percent are worse off 

going into this homeownership under the new rule, the revised 

thing. This is not helping; this is hurting. 

Mr. GARRETT. Let’s drill down on that a little bit. What we think, 

on the face of it, is actually helping communities and helping 

homeowners is, what? Is actually hurting them, because it is helping to facilitate people buying houses that they can’t afford in a 

downward market, putting them into houses that are soon going to 

be underwater. And, actually, now, you are also adding the other 

facet that I didn’t think about: That actually gives them a lower 

FICO score going forward if they need to get out of this or buy 

something else. 

Is that what you are saying? 

Mr. SANDERS. Yes. I never think it is proper housing policy, or 

any kind of policy, to encourage households to take on a lot of risk, 

which is exactly what the FHA is doing when they strayed from 

their original mission. And, of course, that ended catastrophically 

in history. 

And, by the way, saying, going forward, the book looks good now 

may be true, but, remember, everyone was saying back in 2002, the 

book looks great, everything is improving. Well, it didn’t. We still 

had for those low-FICO 25 percent serious delinquency rates. 

The problem is that you can’t just look at the current state and 

assume that is the future. We will have other recessions, as Ed 

said. 

Mr. GARRETT. Mr. Pinto, I see you are raising your hand. 

Mr. PINTO. Yes. The NAR—and, in fact, they just took out ads, 

full-page ads today. And they say that FHA provides access for 

credit for millions of Americans exactly the way Congress designed 

it to operate 80 years ago. So I went back and looked. Eighty years 

ago, the maximum LTV was 80 percent; today it is 961⁄2 percent. 

The maximum loan term was 20 years; today it is 30 years. Insurance claim rate, 0.2 percent cumulative over 20 years, versus 11 

percent annual now. The loss rate has increased 400 times—400 

times. 

Mr. GARRETT. Thank you. Those are important points. I appreciate them all. 

Chairman HENSARLING. The time of the gentleman has expired. 

32 

The Chair is going to make an announcement. As you probably 

know, votes are anticipated on the Floor shortly, perhaps as early 

as 11:00. With the agreement of the ranking member, we will clear 

one more Member on each side and adjourn at that point. And I 

understand the Democrats have their retreat today, so we we will 

not be gaveling back in. 

So, at this point, the Chair will recognize the gentleman from 

New York, Mr. Meeks. And with apologies to everybody else, you 

can probably do the math and figure out whether or not you are 

going to be recognized. 

The gentleman from New York? 

Mr. MEEKS. I want to thank the chairman and the ranking member for this time and for this hearing. 

Let me just ask a few quick questions. I know that the ranking 

member of the Housing Subcommittee is champing at the bit over 

here, and so I am going to try give him a couple of minutes, at any 

rate. 

But I just heard—Mr. Sanders, you stated and you have quoted 

in some of your testimony, I guess, this question about the policy 

or the mission of FHA and that it no longer can serve first-time 

buyers or minority and low-income borrowers. 

But isn’t it true that in 2011, over half of all African Americans 

who purchased homes purchased an FHA mortgage and over 49 

percent of Latinos did so with FHA financing, as well as 78 percent 

of all FHA finances were first-time home buyers? Isn’t that the 

mission of what FHA is all about, and, therefore, they are continuing that original mission? 

Mr. SANDERS. Mr. Meeks, thanks for asking me that question. 

First of all, I did not say they are not doing first-time home buyers. But, second, I have that table in my testimony, that, in fact, 

the FHA does serve more Black and Hispanic households. 

My point is that, while that may be true, do we really think, 

again, throwing them in front of a moving bus, where the delinquency rates are so high, is that proper public policy? Or are they 

better off doing what Shaun Donovan, the Secretary of HUD, said? 

Mr. MEEKS. Just what we just said before, under those same 

time periods, if you look at the delinquency rates, it is down. In one 

year, it was 6 percent, and in the other, it was 3 percent. 

And then in your same testimony you talked about the fact 

that—and you used the D.C. area, where you talked about foreclosures. But in the D.C. area, the majority of those foreclosures 

were not FHA; they came from foreclosures from privately funded 

subprime loans that were not insured by FHA. 

And I see Ms. Gordon is champing at the bit. 

Ms. Gordon, do you want to add something? 

Ms. GORDON. Yes, I just want to say, with all due respect, what 

Mr. Sanders and Mr. Pinto are doing is blaming the firemen for 

getting the house wet. FHA did not cause the crisis. FHA was virtually absent from the market when this got started. 

FHA has come into neighborhoods, neighborhoods that have been 

in something of a death spiral with foreclosures and the like, and 

tried to put some kind of floor under that and allowed people in 

those neighborhoods, many of which are neighborhoods with large 

communities of color, to get their feet back under them. 

33 

Mr. MEEKS. In fact, even in Mr. Pinto’s statement, I believe he 

said that FHA is overly concentrated in low- and moderate-income 

communities. But that is FHA’s core mission, to help creditworthy 

low- and moderate-income families. That is what their core mission 

is. 

I am going to yield back the balance of my time. 

They are going to come back? Oh, great. Good. Then I can keep 

going. 

Mr. Pinto, in your answers to Mr. Watt, I think that maybe you 

might want to—your statement clearly seems to me that you are 

not for the mission of FHA; you don’t agree with it. Because you 

are saying in your statement that it was overly concentrated in 

low- and moderate-income communities, which is exactly what 

their mission is. 

I think that you raised your hand and then you put it down, so 

I want to give you a chance to really state—and it is okay. If you 

are not for the mission of FHA, then state it. Because that seems 

to be what your testimony is. 

Mr. PINTO. I appreciate that. 

First, let me say that FHA was not the firemen, they were the 

arsonist. Starting in 1992, Congress ordered FHA, Fannie Mae, 

and Freddie Mac to go down an arms race of weakened lending 

practices that led to the problems that we had, along with the National Homeownership Strategy. 

But on to your point, I am not against FHA’s mission of serving 

working-class families and communities. What I am against is abusive lending practices by FHA in those communities and to those 

families. And that is what I have documented. 

If you go to page 25 of my testimony, you will find an explicit 

way to serve those communities precisely in a way that is not abusive and does not finance failure, which is what FHA has done— 

Mr. MEEKS. All those delinquencies that you say were in private 

industry— 

Mr. PINTO. —for 30-plus years. 

Mr. MEEKS. —so, therefore, the private industry that had all of 

those delinquent loans, that really caused—when they bundled 

them, sold them, they are not the arsonists. They should be exempt 

from what you have been talking about. 

And I see Ms. Gordon is champing at the bit. I am going to give 

Ms. Gordon a chance to say something there. 

Ms. GORDON. I think that it is insane to consider FHA abusive 

lending. This is fixed-rate, long-term, sustainable, underwritten 

mortgages. We know what toxic loan products look like, and they 

don’t look like this. 

UNC has recently done a very in-depth longitudinal study of a 

group of something like 46,000 lower-income, lower-FICO home 

buyers who were given these 30-year, fixed-rate mortgages, sometimes with lower downpayments than FHA requires. And those 

loans have outperformed all but the very— 

Chairman HENSARLING. The time of the gentleman has expired. 

I want to announce that the House is in recess at the moment, 

so several of you need not rush off. 

The Chair now recognizes the gentleman from Texas, Mr. 

Neugebauer. 

34 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

I think one of the questions that was asked is a good question, 

and that was, what does it take to get the private sector back into 

this market? I think a couple of things would help that process. 

One is, if I was a private company and the Federal Government 

would subsidize my operating costs—that is what we do with FHA; 

they do not take any of their operating costs out of the fund revenue—and that I had an unlimited credit line at the United States 

Treasury and I didn’t have to answer to any shareholders, I could 

be very competitive in making loans competing with FHA. 

But the truth of the reality is, in the marketplace today, it is 

very inexpensive to sanitize these mortgages, either running them 

through FHA, Fannie Mae, or Freddie Mac. And so, you have 90 

percent of the market being sanitized there for a very low risk premium. If you want the more private market to come back in, you 

have to level the playing field, and the playing field is not level. 

Comments, Mr. Pinto, Mr. Sanders, Mr. Petrou? 

Mr. PINTO. Yes, absolutely. I think I testified 3 years ago that 

the housing policy in the United States has created a brick wall 

that the government mortgage complex has created. And that complex is impenetrable. It is 10 feet high, very wide, and it goes underground. So you can’t dig under it, you can’t go over it, and you 

can’t go around it. 

The private sector doesn’t like to break through brick walls. They 

like to go into opportunities. As long as the private sector—as long 

as the government mortgage complex, which is Fannie, Freddie, 

the FHA, VA, Ginnie Mae, USDA, all of these entities, are out 

there with their different programs, it is very difficult for the private sector to compete. 

The advantages that Ginnie Mae brings to FHA are not very 

well-understood. Ginnie Mae reduces the rate on FHA loans by a 

substantial amount. It actually almost offsets the amount of some 

of the premium increases that have taken place. And the result is 

that those securities sell at a higher price in the securities market 

than a Fannie Mae security. That is a subsidy, an implicit subsidy, 

that goes to FHA. And, again, it makes it very hard to compete. 

That is why these higher-income loans—you ask, why are those 

loans being made? The reason they are being made is because of 

the Ginnie Mae subsidy. They charged a lot on the FHA side, but 

you then add in the Ginnie Mae subsidy and those loans are able 

to be done. 

So the market is not a level playing field, and we need to get to 

one. 

Mr. NEUGEBAUER. Mr. Petrou? 

Mr. PETROU. I agree completely. Ginnie Mae is pricing right 

through Fannie/Freddie securities, and that is the key factor in 

terms of trying to ‘‘compete.’’ 

In the immortal words of Milton Friedman, we could still have 

a Pony Express, if you want to subsidize something like that, but 

we chose not to. And the reality is that nobody is going to get into 

this market as long as the government is blocking them with this 

cheap pricing. 

Mr. NEUGEBAUER. And before you respond, Mr. Sanders, the 

other thing, too, that I didn’t mention is this new risk that everyVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
35 

body is trying to figure out how to price, and that is called the regulatory risk now that falls onto the private mortgage market that 

doesn’t necessarily fall to those loans being originated through 

FHA and Freddie and Fannie. Is that correct? 

Mr. SANDERS. That is correct. Dodd-Frank and, to a large part, 

the Consumer Financial Protection Bureau omits Freddie and 

Fannie and FHA. So we have for the lenders a very stringent set 

of standards, including prime risk and the associated blame with 

that, but Fannie and Freddie and FHA just seem to have somehow 

waltzed their way out of this. So they are not really under the regulatory supervision of Dodd-Frank. 

That has been pointed out before, but that has to be fixed. We 

have to have rules governing the FHA, Freddie, and Fannie that 

make it a level playing field with the banks, the lenders. 

Mr. NEUGEBAUER. Yes. So we are really comparing apples and 

oranges when we try to compare. And we are going to have a hearing in our subcommittee, and we are going to dive deeper into this 

so that we can begin to contrast these entities from an accounting 

standpoint, from the regulatory standpoint, to try to build a model 

here so we can tell why these entities aren’t able to compete. 

I just had one last question for Ms. Gordon. 

Ms. Gordon, you said that if the money is advanced to FHA, it 

isn’t a bailout because it isn’t the taxpayers’ money, it just comes 

from the Treasury. Do you know where the Treasury gets its 

money? 

Ms. GORDON. No, we have discussed that already. That is not 

what I said. What I said is Congress does not have to vote on some 

kind of bailout. 

Mr. NEUGEBAUER. No— 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Massachusetts, 

Mr. Capuano. 

Mr. CAPUANO. Thank you, Mr. Chairman. 

I want to thank the panel for being here today. As I said, I think 

you raised a lot of good questions. But I want to make a few points. 

First of all, we haven’t publicly stated, though I know it is in your testimony, that at this very moment FHA has $30.4 billion 

worth of cash ready and available to cover it. I understand that 

over the long term they have some concerns; I am not even arguing 

the point. That is why I want to hear some of the things. But this 

is not a crisis that is going to happen tomorrow, at least not right 

away tomorrow. 

I also want to be clear that the FHA has taken—I have a list of 

15 different steps that they have taken over the last several years 

to address these very issues you mention. 

And I would like to submit that list for the record, Mr. Chairman, if I could. 

Chairman HENSARLING. Without objection, it is so ordered. 

Mr. CAPUANO. Thank you. 

But, this list includes increasing the mortgage premium rate at 

least 4 times. It might be 5 times; maybe I counted wrong. I am 

not even sure I like that, but at least it addresses your end of it. 

They increased some of the downpayment requirements for different FICO scores. They changed some of the things for seller conVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
36 

cessions. At least that is pending, as I understand it. The new 

debt-to-income ratios—they have done a whole bunch of the things, 

at least in general, that you have suggested. And they are in the 

middle of doing others. 

Now, I am not suggesting they can’t or shouldn’t do more. But 

I think that needs to be recognized, as well, and that their book 

has gotten better over the last 2 years. I think those things have 

to be recognized. So I just want to put those on the record. 

I also want to state very clearly that if the chairman or anybody 

else wants to put the bill out that this committee put out last cycle, 

we should do it today, get it on the Floor, get it through. We can 

beat up the Senate for the next 2 years, instead of waiting until 

we beat up everybody we want to beat up to put out a bill. Let’s 

put the bill out that this committee voted last cycle. Let’s put it out 

today so that we can get moving on some of the things that the 

FHA says it needs legislatively that I think everybody agrees we 

want to give them the power to do. So let’s do that instead of just 

beating each other up. 

I guess I want to also comment on some of the things that were 

said earlier. 

Prudent lending. Who is against prudent lending? Now, the question is, define ‘‘prudence.’’ Some people would define prudence as 

only lending to Donald Trump. That is prudent. He can pay it back. 

That means there is no middle class. The question on prudence is 

always about the ability to pay. 

And, Mr. Petrou, I want to get to some of your comments. Because the reason is, all of these agencies deal with the amount of 

money that is available for loans, and it doesn’t take into consideration regional differences. The cost of housing in my district is approximately 2 to 3 times the cost of housing in the chairman’s district, but wages are approximately 70 to 100 percent higher, as 

well. 

Mr. CAPUANO. The question shouldn’t be on how much the house 

cost; it should be on whether the borrower can afford to pay. That 

all plays on all different things: downpayment requirements. I 

could not afford to buy any home in any district if you have a 50 

percent downpayment requirement. What should it be? Should it be 

5? Should it be 10? Fair questions. But to simply throw numbers 

out really begs further questions. 

For me, those numbers are fine. FICO scores up, down, over. The 

question is, what does it mean to the middle class? Can FHA actually accomplish its mission based on some of these numbers? And 

the truth is none of these testimonies gives answer to that. They 

raise questions, but they don’t give answers. I need to see answers 

as to what the impact is of some of the things you are suggesting. 

And if we get to there, I don’t think we are going to find ourselves on significantly different pages at the end of the day. Maybe 

we will, but right now we don’t have it. If you have those statistics, 

I would like to get them. 

I read your full testimonies, including your multi-page thing, and 

I didn’t see them. I saw nice, generic comments and studies of what 

happened in poor neighborhoods. FHA belongs in middle-class and 

lower-income neighborhoods. We all agree with that. Was it the 

FHA or wasn’t it? What is the impact to this? 

37 

Even by shifting to some of the things—for instance, the VA coverage of 50 percent versus 100 percent. Conceptually, I like that 

proposal. I don’t know if 50 percent is the right number, I don’t 

know the number, but the concept of somebody having skin in the 

game is a good concept. But I need to know, what does that do to 

rates? If you say we are going to have a 10 percent skin in the 

game, does that mean that my mortgage rate goes up 20 percent? 

And if it does, that means you are kicking out a whole lot of people 

from being able to do it. 

So, for me, I guess I am asking especially those of you who have 

been enjoying kicking the recent history of FHA—I hope you are 

having a good time; that is great. It doesn’t help me move forward. 

It doesn’t help us get back to that mission. 

So, for me, I need you to tell me: What are the impacts on these 

rates? Who are we kicking out of the housing market? And how is 

it going to impact some of these middle-class neighborhoods that 

we claim that we all want to help? 

Mr. PINTO. Page 22 to 25 in my testimony explicitly and precisely 

answers every question you just asked. 

Mr. CAPUANO. Actually, I did read it. I don’t think it did, but we 

will talk about that another time. 

Mr. PINTO. I would be happy to meet with you over it. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from California, Mr. 

Campbell, for 5 minutes. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

What I would like to focus on in this 5 minutes is what FHA 

should look like going forward. Let’s assume that we are developing 

a sustainable housing finance market, which means we have to do 

a lot of things around FHA, granted. Okay, that is going to be a 

lot of the work of this committee coming this year. But assuming 

that happens—and we will all be deciding at some point what that 

looks like—what, ideally, would we like FHA to look like? 

Two things I would like to focus on, and that is, one, in terms 

of the original mission. I am from Orange County, California, a 

very high-cost area. FHA is doing a ton of loans from $400,000 to 

$700,000 in my area. A lot of low-downpayment loans, where people actually have more money for a downpayment but because 

loans are so cheap, interest rates are so cheap, they put as little 

down as they can—all kinds of things that it strikes me are not 

anywhere near—and I take your point, Ms. Gordon, about how we 

have softened what would have otherwise been a worse market. 

But that clearly is not what the original mission of FHA was. 

I heard from you, Mr. Pinto, and you, Dr. Sanders, I think, about 

the original mission. I would like to hear from the other two of you, 

Mr. Petrou and Ms. Gordon, about what sorts of loans should FHA 

be making in this ideal sustainable market in the future. 

Mr. PETROU. I think, as I say in my testimony, they should be 

targeted to the income of the borrower, not the loan amount. And 

that would be by geographic area on median income. And, consequently, if your borrowers in your district are of a certain income 

and they qualify for the loan, then those are the loans that should 

be made. You shouldn’t have builders building up to an $800,000 

38 

limit because they are able to get it from FHA even though the median income in the area isn’t at that level. 

And it also addresses the fact that when interest rates go up, the 

amount of money that qualifies falls for these mortgages. And you 

have to take that into consideration, as well. 

Mr. CAMPBELL. Okay. 

Mr. PETROU. And, finally, on downpayment, it is critical that the 

downpayment be reflective of the risk. 

Mr. CAMPBELL. I am going to get to that. 

Ms. Gordon? 

Ms. GORDON. Mr. Pinto referred to Gale Cincotta before, and I 

think I am fighting for the same thing she was fighting for, which 

is just to make sure that credit is available in all the communities 

of this country and to people of low wealth, people of color, younger 

people. 

And so, in my ideal world, you see both Fannie and Freddie and 

the private market competing for that business. I would far prefer 

to see most creditworthy borrowers served by a private market, 

maybe with some kind of government backstop, so that government 

is not on the hook for the first loss, and see FHA fill in behind that 

for people who otherwise need some assistance. I actually think we 

all share that vision. We may have slightly different views of how 

to get to it. 

And I am not sure how you pull FHA back before you make sure 

there is something coming in behind it so we don’t go into another 

round of home price declines. 

Mr. CAMPBELL. Right. And I get that. But, and to your point, I 

think there is agreement on the panel that we would like to see 

FHA go back to what it was originally designed to do. And as much 

as I get it and it is my district and all that now, they shouldn’t 

be making $700,000 loans on million-dollar houses. There should 

be other accommodations for that sort of loan. 

Let’s talk about whether FHA insures from dollar 1. With a 31⁄2

percent downpayment, effectively, when you sell a house, that 

doesn’t cover the commission. So, essentially, FHA insurance covering from dollar 1 of the potential loss. 

I would like to start with you again, Ms. Gordon, and then work 

back the other way and just see, do you think that FHA should be 

doing that? Or should someone else bear some of the risk, 5 percent, whatever? 

Ms. GORDON. For the role that FHA would ultimately play, this 

is part of the historical mission, that FHA is an insurance program 

which is backed by the U.S. Government. And I think that is an 

appropriate role. But I think that what is important is that we 

make sure there are ample opportunities and avenues, channels for 

credit elsewhere that do not have— 

Mr. CAMPBELL. Okay. Let me give someone else the final 14 seconds. 

Yes? 

Mr. PETROU. I would recommend that you could do a risk-share 

program within FHA so you could have a private risk at the first 

dollar loss, FHA takes the remainder down to 30 percent, and then 

the lender is on the hook for anything deeper. 

Chairman HENSARLING. The time of the gentleman has expired. 

39 

We will call upon two more Members and then adjourn. 

Mr. Green from Texas is recognized for 5 minutes. 

Mr. GREEN. Thank you, Mr. Chairman. I thank you and the 

ranking member for the dinner that we had together to engender 

a degree of civility and friendship. And I want to assure the people 

who are watching at home that we really did have the dinner. 

Let me start by saying to you that I did not come prepared to 

defend FHA today, but I feel compelled to do so. FHA did not create the housing crisis. Some things bear repeating. FHA did not— 

N–O–T—create the housing crisis. 

It started in the 1980s with these so-called exotic products. And 

I am sure you remember some of them, but for fear that some do 

not, let me express to you what some of them were. 

Teaser rates that coincided with prepayment penalties. FHA 

didn’t creates teaser rates that coincide with prepayment penalties, 

such that you are locked into a loan and you can’t get out unless 

you pay some large amount of money. 

Qualifying buyers for teaser rates but not qualifying buyers for 

the adjusted rate. FHA didn’t create that product. By the way, 

Dodd-Frank addresses these products. 

Balloon mortgages. One big payment at the end of some period 

of time, after having maybe an interest-only payment. 

Option ARMs. Underpay, and we will tack what you don’t pay 

onto the principal. 

No-doc loans. 

Rating agencies that—at least one of which is now being prosecuted—rating agencies that were literally giving those who desired an evaluation what they wanted. 

Credit default swaps in the tertiary market so that you could 

kind of gamble together with the taxpayers’ money, in a sense. 

Originators of loans not having to be responsible for the default. 

Probably more than anything else, this was the gravamen of the 

problem. When we allow the originator to care less about whether 

or not there would be a default, just qualify the person as a home 

buyer rather than a homeowner, and send that on to the secondary 

and tertiary market, somebody else will worry about the default, 

this is what it was all about. 

Let’s not kid ourselves and try to blame the CRA and FHA for 

what happened in the—started in the 1980s and ended up with the 

crisis that we had to give some attention to. 

FHA does insure—does not lend a penny, by the way—some 

loans that some would consider high-dollar loans. But would it surprise you to know that in October, the average loan amount for 

FHA was around $180,000, $183,000, less than $200,000? Would it 

surprise you to know that the entire portfolio of FHA has loans 

that average around $150,000? FHA is not a culprit. 

So let me just ask one question, and I will probably then yield 

some time so that others can be heard. But my one question is to 

the entire panel. 

Who among you would end FHA—would end it rather than mend 

it? Which of you would end it? I ask that you acknowledge that you 

would, if this is your position, by kindly raising your hand. Kindly 

raise your hand. 

40 

Now, Mr. Pinto, I don’t see your hand going up, so I am going 

to assume that you would not end FHA. This will require, unfortunately, because time is of the essence, a yes-or-no answer. And perhaps we will get into— 

Mr. PINTO. I can’t—I answered the question earlier not yes-or-no. 

I am sorry, it is just not a yes-or-no question. 

Mr. GREEN. Not a yes-or-no. Then I will conclude, if I may—and 

you can have someone else help you with this, if you would like— 

but I am going to conclude that under certain circumstances, you 

would. And that is all I can conclude. 

Is there anyone else who would end the FHA? 

All right. Let me close with this, dear friends. I came to Congress 

to represent everybody in this country. And in so doing, I understand that there are a good many people who cannot go back to the 

1930s, when you had 3- to 5-year loans, when you had huge balloon 

payments, when the interest rates were exceedingly high. 

FHA has provided middle-income persons with an opportunity to 

engage in homeownership. We have to mend it. There may be some 

problems. But we didn’t end the big banks. We gave them a second 

life. I am going to fight to keep FHA. 

Chairman HENSARLING. The time of the gentleman has expired. 

And I would just let the gentleman know, having paid for half 

of the bipartisan dinner, I certainly recall it. 

The Chair now recognizes the gentleman from Georgia, Mr. 

Westmoreland. 

Mr. WESTMORELAND. Thank you, Mr. Chairman. 

To my colleague from Texas, FHA does not have to meet the 

same QM/QRM standards that the Dodd-Frank requires private 

companies to have. 

And, Ms. Gordon, I just want to clarify one thing. I think the 

gentlelady from California was talking to you about the minus 

1.44, and you were explaining that this does not have to do with 

the $30 billion that they have in the bank but that this was something that, if all of them come due at one time, that the fund would 

be a little bit short. 

Just for clarification so I can kind of get the perspective on it, 

what is a ‘‘little bit short?’’ 

Ms. GORDON. The point I was making is that right now FHA has 

cash on hand, as has been pointed out by several of the Members 

today, and that the measurement that we are talking about is a 

measure of if FHA stopped doing business today and paid out its 

claims, not all at once but over the next 30 years. 

Mr. WESTMORELAND. Yes. But what is a ‘‘little bit?’’ Because my 

numbers say it would be $16 billion. 

Ms. GORDON. We don’t actually know what the number is because this is not the same number as will correspond to— 

Mr. WESTMORELAND. All right. What would your ‘‘little bit’’ be? 

Ms. GORDON. I think what I am trying to look at is what the 

value is that we are getting for our money here. 

Mr. WESTMORELAND. Okay. I don’t think you are going to answer 

the question, or maybe I am not asking it correctly. 

In President Obama’s Fiscal Year 2013 budget, FHA requested about $688 million to cover the expected losses during this fiscal 

year. Ultimately, FHA did receive $1 billion from the DOJ settleVerDate Nov 24 2008 16:42 Jun 10, 2013 Jkt 080867 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 K:\DOCS\80867.TXT TERRI
41 

ment with the banks and averted a taxpayer, what I would term 

a ‘‘bailout.’’ 

And given what you all know about FHA’s current financial situation, could each one of you give me an estimate on how much 

money you think that the FHA will need to cover their losses in 

Fiscal Year 2014? 

Mr. PINTO. I think the number is going to be in the negative $10 billion to $12 billion range. 

Mr. WESTMORELAND. Twelve billion? 

Mr. PINTO. Yes, $10 billion to $12 billion, negative. 

Mr. SANDERS. That is a reasonable estimate, but, again, it all depends on whether we ever actually get out of this super-slow-economic-growth thing or do we have a double dip in the economy, 

which is possible. Then all bets are off. 

Mr. WESTMORELAND. Right. 

Mr. PETROU. FHA has a lot of real estate owned on its books 

right now, and a lot of how much loss is buried in that real estate 

owned. So while I think $10 billion to $12 billion makes sense, it 

could go a lot higher. 

Ms. GORDON. I am not the economist as some other people may 

be, so I can’t give you a number. But I can say it will depend a 

lot on the housing market, and it will depend on how well we continue to engage in loss mitigation, which is an area where I think 

the FHA still has significant room for improvement. 

And some of the efforts they are making in terms of the distressed asset sales and some of the changes they have made to the 

REO process, all of those things work together to determine how 

much money will be lost ultimately. 

Mr. WESTMORELAND. There are approximately, I think, six private mortgage insurance companies that write private mortgage insurance. And if I understand it correctly, they are under regulations by their States as to a capital requirement or whatever you 

want to say, as far as being able to cover their losses. 

And I would like to ask each one of you, how do you think they 

would rate the FHA as compared to some of the private mortgage 

insurance companies in their financial situation? 

Mr. PINTO. If you took away FHA’s government guarantee and 

its access to the Treasury, FHA would be closed down, I believe, 

by every State regulator in the country because they have no capital today, period. What is called this $30 billion in the bank, for a private mortgage insurer you would go through the roughly 700,000 delinquent 

loans, 60 days or more, you would figure out how much money you 

would expect on just those loans you know about, and that exhausts the $30 billion, plus. And so, they have no money on a regulatory basis under private mortgage insurance or under a GAAP 

accounting basis. 

Chairman HENSARLING. Regrettably, the time of the gentlemen 

has expired. 

Votes are being held open. I would like to recognize the ranking 

member for a UC request. 

Ms. WATERS. Mr. Chairman, I ask unanimous consent that the 

following materials from organizations that support the Federal 

Housing Administration be entered into the record: a statement 

42 

from the National Association of Home Builders; a publication by 

the National Association of REALTORS®; a statement from the 

National Council of La Raza; a statement from the Local Initiatives 

Support Corporation; and a statement from Brian Chappelle, a 

partner with Potomac Partners, which specializes in mortgage finance. 

Chairman HENSARLING. Without objection, it is so ordered. 

I would like to thank each of our witnesses for coming to testify 

today. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

The Chair announces that the next full committee hearing will 

take place Wednesday, February 13th, at 10 a.m., with FHA Commissioner Carol Galante. 

Without objection, this hearing is now adjourned. 

[Whereupon, at 11:20 a.m., the hearing was adjourned.] 

(43) 

A P P E N D I X 

February 6, 2013 

44 


80867.001

Statement 

of 

Representative Gwen Moore 

Hearing 

Axamining the Proper Role of the FHA in Our Mortgage Insurance Market 

February 6, 2013 

Chairman and Ranking Member, it is a pleasure to be back. I look forward to continuing to work 

with you both in the J13th Congress. 

I would also like to welcome the new members to the committee. It is a diverse and talented 

group on both sides that I am excited to work with. 

I am pleased that the committee will begin with a hearing on housing. 

There are a variety of opinions on this committee on how to address various housing issues. I am 

interested to see how those views play out and, hopefully, lead to meaningful reforms that 

strengthen the housing sector and fulfill FHA's important mission. 

I endeavor to keep an open mind as we look at these issues and to work with anyone that wants 

to find a reasonable path forward. 

I truly believe the comity that exists on this committee enables us to have tough debates that get 

us to good results. 

One area that I will be following as this debate evolves is the role of the FHA single family 

mortgage insurance program and avenues to bring back the private mortgage insurance sector. I 

really look forward to working with the Chairman and Ranking Member to explore way for the 

private sector mortgage insurers to provide more affordable and responsible housing finance 

options. 

Finally, I would like to call attention to the fact that the President has made half a dozen good 

FHA reforms already. I trust that we can find a way forward to supplement and finish the 

Administration's work. 

We have a lot ofleadership on this issue, including Ranking Members Waters, who has been 

wonderful on housing issues. 

I look forward to hearing from the witnesses and kicking off the 113 Congress. 

Thank you. 
45 


80867.002

Statement of Randy Neugebauer 

Full Committee Hearing 

"FHA: Examining its Proper Role in our Mortgage Insurance Market" 

February 6, 2013 

Thank you, Mr. Chairman, for holding this important hearing examining FHA's role in the 

mortgage insurance market. As you mentioned, this is the first in a series of hearings. I look 

forward to holding similar hearings in my Subcommittee. I also look forward to working with 

you, Ranking Member Waters and Ranking Member Capuano as we seek to reform FHA and 

nurse it back to financial health. 

As we meet today, FHA's financial condition continues to deteriorate. FHA's most recent 

actuarial report showed that it's MMI Fund capital reserve ratio fell to negative 1.44 percent 

well below the Congressional mandated ratio of 2 percent. This means that FHA does not have 

sufficient reserves to cover its expected losses. The report also noted that the MMI Fund's 

economic value was negative $16.3 billion, paving the way for another taxpayer funded bailout. 

This is on top of the roughly $190 billion taxpayer bailout of the GSEs. 

As if the impending bailout were not enough, I am becoming increasingly concerned as FHA 

strays far away from its intended mission. FHA was created in the 1930's with a unique mission 

to serve targeted populations such as first-time homebuyers, communities with little access to 

credit, and other higher-risk borrowers who were still creditworthy. But this isn't your 

grandparents' FHA. In fact, over 90 percent of FHA loans insured today would not have even 

qualified for insurance under the original program. 

Since the onset of the financial crisis, the Agency has morphed from a mortgage insurer of last 

resort to a dominant component of our mortgage finance system. It has done this by expanding 

its insurance to higher income borrowers and houses in thc upper end of the marketplace. For 

example, in my hometown of Lubbock, TX the area median home price is roughly $132,000; 

however FHA can insure loans up to $271,050 - more than double thc mcdian home price. 

As a result, FHA's insurance portfolio has exploded to $1.12 trillion - making it equivalent in 

size to the entire property & casualty and life & health insurance industries combined. Not 

surprisingly, FHA's unwieldy growth has crowded out private mortgage insurers, thereby 

thwarting the ability of private capital to enter the mortgage market. According to the GAO, 

FHA's share of the mortgage insurance market stands at 56% compared to just 19% for the 

private insurers. And given FHA's dire financial condition, it is unlikely that its market share or 

its insurance portfolio will be reduced as the Agency attcmpts to grow its way out of its 

problems. 
46 


80867.003

Finally, it is worth noting that FHA's insatiable desire to "grow out of the problem" has led to an 

aggressive push that could have devastating consequences for the very people FHA is intended to 

help. FHA's expanded role has been fueled by similar tactics employed by subprime lenders at 

the height of the housing boom. While appropriate for some, these practices - including seller 

concessions, small down payments, low credit scores, and cheap upfront pricing - can entice 

others who are unprepared for the obligations of homeownership to overextend themselves. The 

likelihood of enticing such borrowers is heightened as FHA becomes more aggressive in its push 

to ramp up its market share. 

I thank the Chairman for calling this hearing and T look forward to hearing from our witnesses 

today as we address these important issues. 
47 


80867.004

Opening Statement of Rep. Ann Wagner (MO-2) 

Full Committee 

House Committee on Financial Services 

"Examining the Proper Role of the Federal Housing Administration in our Mortgage Insurance Market" 

February 6th, 2013 

I would like to thank Chairman Hensarling for holding this important series of 

hearings on the critical situation at FHA. 

Nearly four and a half years after taxpayers were forced to commence what 

has become a nearly $200 billion dollar bailout of Fannie Mae and Freddie Mac, it 

appears that the worst-kept secret in Washington is now official: The FHA is 

broke, and taxpayers are on the verge of bailing out yet another federal housing 

agency. 

With over $1 trillion in taxpayer liabilities and an alarming default rate of 

nearly 10%, the FHA has caused pain for the very homeowners it is meant to serve, 

and is likely about to cause even more pain for the American taxpayer. It's time to 

end the bailouts of failed policies and put our housing market back on sound 

footing with private capital playing its proper role. I look forward to taking the first 

step today towards bringing real and lasting reform to our housing market. 
48 


80867.005

Center for American Progress Action Fund 

iII§II -

Julia Gordon 

Director, Housing Finance and Policy, 

Center for American Progress Action Fund 

before 

The Committee on Financial Services 

United States House of Representatives 

"Examining the Proper Role of the Federal Housing 

Administration in our Mortgage Insurance Market" 

February 6, 2013 
49 


80867.006

Good morning Chairman Hensarling, Ranking Member Waters, and members of the committee. 

Thank you for the opportunity to testify today about the role of the Federal Housing 

Administration in our mortgage insurance market. 

The Federal Housing Administration is a government-run mortgage insurer. It doesn't actually 

lend money to homebuyers but instead insures the loans made by private lenders, as long as 

the loan does not exceed a certain size and meets strict underwriting standards. In exchange for 

this protection, the agency charges up-front and annual fees, the cost of which is passed on to 

borrowers. 

The FHA was established in 1934 to help promote long-term stability in the U.s. housing 

market. Emerging from the foreclosure crisis that occurred during the Great Depression, FHA 

transformed housing finance by demonstrating how long-term, fixed-rate mortgages can help 

middle-class families build long-term economic security even through uncertain economic 

times. FHA was integral in transforming the standard mortgage from a 50 percent lTV, shortduration loan that required frequent refinancing to a 20 percent down, long-term, fixed-rate 

mortgage. 

In the almost 80 years since, FHA has helped more than 40 million creditworthy families realize 

the benefits of homeownership, and has developed a niche of providing low-down-payment 

loans through its single-family programs to creditworthy, lower- wealth, and otherwise 

underserved borrowers. 

Under normal economic conditions, the agency typically focuses on borrowers that require low 

down-payment loans-namely first-time homebuyers and low- and middle-income families. 

During market downturns, when private investors retract, and it's hard to secure a mortgage, 

lenders often turn to Federal Housing Administration insurance to keep mortgage credit 

flowing, and the agency's business tends to increase. This so-called countercyclical support is 

critical to promoting stability in the U.S. housing market. 

During the recent financial crisis, lenders turned to FHA as private investors retreated from the 

mortgage business in the wake of the worst housing crisis since the Great Depression and as 

Fannie Mae and Freddie Mac entered conservatorship. Fortunately, FHA was able to help keep 

mortgage credit available. Without the agency's support in recent years, it would have been 

much more difficult for middle-class families to access mortgage credit and the housing 

recovery would be much further away. 

Perhaps even more important, the agency's actions prevented home construction from 

plummeting 60 percent from already depressed levels and home prices from dropping an 

additional 25 percent. This would have sent our economy into a double-dip recession, costing 3 

million jobs and half a trillion dollars in economic output. 1 

It is important to note that as a government agency, FHA's mission is not to maximize profits, 

but to provide important capacity in the housing market that may ebb and flow depending on 

1 
50 


80867.007

macroeconomic conditions. Some books of business yield a positive economic value, while 

others have a negative value. In simple terms, FHA's long-term financial health depends on 

building a strong capital cushion from well-performing books so that it can continue to reach 

underserved borrowers and to do business in stressful periods when other credit providers 

withdraw. 

Critics claim that FHA's basic business model is flawed. For evidence, they point to a 

concentration of lending in areas where default rates are high. This criticism is essentially 

blaming the fireman for getting the house wet. Risky subprime lending dominated the market 

in these neighborhoods, with FHA largely standing on the sidelines. As those toxic loans failed, 

FHA lending was available to keep housing market activity alive. Loans made under these 

circumstances naturally have higher loss rates, but as described above, if lenders and borrowers 

had not had access to FHA when other credit dried up, it is likely these neighborhoods would 

have been lost permanently. 

A. FHA Today: Fulfilling its Mission of Providing Access and Countercyclical Capacity 

In the late 1990s and early 2000s, the mortgage market changed dramatically. New subprime 

mortgage products emerged, bundled by private Wall Street investment firms into mortgagebacked securities. These designed-to-fail products featured loan terms such as steep rate 

resets, prepayment penalties, and negative amortization. Underwriting ranged from poor to 

nonexistent. 2 

Yet, these loans required less paperwork and tended to offer far better compensation for their 

originators than FHA-backed loans, in part due to creditor bonuses to brokers for steering 

borrowers into riskier and more expensive loans than they qualified for. 3 As a result, many 

borrowers who would have qualified for FHA loans ended up in the dangerous sub prime loans 

instead.4 

As private subprime lending took over the market for low down-payment borrowers in the mid2000s, the agency saw its market share plummet. In 2001 the Federal Housing Administration 

insured 14 percent of home-purchase loans; by 2006 that number had decreased to less than 4 

percent.5 

All this easy subprime money fueled a steep increase in home prices. The bubble burst in a 

flood of foreclosures, leading to a near collapse of the housing market. Wall Street firms 

stopped providing capital, banks and thrifts pulled back, and subprime lending essentially came 

to a halt. The mortgage giants Fannie Mae and Freddie Mac also faced such large losses that the 

government placed them under conservatorship. As a result, they significantly scaled back 

lending, especially for home-purchase loans with low down payments. 

True to its role to provide countercyclical liquidity, lenders and borrowers turned to FHA to fill 

the gap. By 2009 the agency had taken on its biggest book of business ever, 6 backing roughly 

one-third of all home-purchase loans.7 Since then the agency has insured a historically large 

2 
51 


80867.008

percentage of the mortgage market, and in 2011 backed roughly 40 percent of all homepurchase loans in the United States. 8 

fiGURE 1 

As private investors left the mortgage market, FHA insurance filled the gap 

Share of annual origination volume (home purchases and refinancings), 20()3-2010 

-- fHAIVA market ,ha,,, -- SubprimefAlt·A roOf""t ,hare Total origination volume {S) 

40% $4.000 

E 35% 53,500 

~ c; 30% 53,000 0 

'", 

.5 25% $2,500 

.~ 

52,000 0 20% ;;; 

$1500 8 15% \5 

~ 

'" "" 10% Sl,lloO c 

~ " 5% $500 If. 

0% SO 

2003 2004 200S 2006 2007 2008 2009 2010 

0' 

91. 

!;: 

<is 

~" 

is 

::;; 

~ 

" 3 

'" '-" 

~ 

0-

-~ 

Looking at the borrowers served as part of this massive increase in volume demonstrates the 

unique role of FHA in the housing finance world. In 2012, 78 percent of FHA endorsements 

were for first-time homebuyers.9 According to the National Association of Realtors, FHA 

provided financing for 46 percent of first-time homebuyers that year, while the conventional 

market financed 33 percent of them.lO These first-time homebuyers are important to the 

housing recovery, especially as existing homebuyers remain on the sidelines. In 2011, FHA also 

financed half of the home purchase mortgages obtained by African Americans and Latino 

homebuyers.ll Moreover, in 2012 over 60 percent of FHA's endorsements'2 were for home 

purchase loans whereas only 28 percent of Fannie Mae and Freddie Mac originations were for 

home purchase loans. 13 

B. Without the Federal Housing Administration, the Housing Downturn Would Have 

Been Much Worse. 

Since 2008, the agency has backed more than 3 million home-purchase loans and helped 

another 2.7 million families lower their monthly payments by refinancing.'4 Without the 

agency's insurance, millions of homeowners might not have been able to access mortgage 

credit since the housing crisis began, which would have sent devastating ripples throughout the 

economy. 

3 
52 


80867.009

While it's difficult to know precisely what would have happened to the economy but for the 

liquidity provided by FHA, Moody's Analytics addressed this issue in the fall of 2010. According 

to preliminary estimates using their models, if the Federal Housing Administration had simply 

stopped doing business in October 2010, by the end of 2011, mortgage interest rates would 

have more than doubled. New housing construction would have plunged by more than 60 

percent; new and existing home sales would have dropped by more than a third; and home 

prices would have fallen another 25 percent below the already low numbers seen at this point 

in the crisis.'s 

The analysis goes on to suggest that a second collapse in the housing market would have sent 

the U.S. economy into a double-dip recession. Had FHA closed its doors in October 2010, by the 

end of 2011, gross domestic product would have declined by nearly 2 percent; the economy 

would have shed another 3 million jobs; and the unemployment rate would have increased to 

almost 12 percent. We can only imagine what this additional damage would have meant for 

losses and taxpayer costs at the GSE's and other financial institutions. 

TAblE 1 

Without the Federal Housing Administration, the housing market would have 

collapsed in 2011, sending the U.S. economy into a double-dip recession 

Projected year-to-year changes in key economic indicators had the agency stopped insuring mortgages 

in October 201 0 

Indlcat<>' 

fixed Mo't9Gge Rate 

llesidential/1Q<iSj"!r St.,t~ 

New and Existing Home Sal .. 

Total Employment 

Gros, Doolestic Product 

Perc"n! <h.nge 

According to Mark Zandi, chief economist for Moody's Analytics, "[The administration] 

empowered the Federal Housing Administration to ensure that households could find 

mortgages at low interest rates even during the worst phase of the financial panic. Without 

4 
53 


80867.010

such credit, the housing market would have completely shut down, taking the economy with 

it. u16 

C. Current Financial Condition: The Crisis has Taken a Toll 

The breadth and depth of the 2008 financial collapse and FHA's shock absorption role exposed 

the FHA to significant risk. As a result, FHA today faces mounting losses on loans originated as 

part of its countercyclical role. 

According to data from the FHA actuarial report, in fiscal year 2012 the capital reserve ratio of 

the agency's primary insurance fund fell below zero to negative 1.44 percent, and the Fund's 

economic value stands at negative $16.3 billion.'7 (The "capital reserve ratio" is a measure 

devised by Congress in 1990 to improve oversight of FHA and to safeguard the MMI Fund in the 

case of economic hardship. If the ratio is below two percent, the agency is required to present 

Congress with a plan to restore the capital reserves.'S The "economic value" refers to the 

amount that would be needed for FHA to meet all its expected claims over the next 30 years if 

FHA closed its doors tomorrow and had no new business to offset those claims.) 

It is important to put FHA's current capital ratio challenges in context. Immediately prior to the 

financial crisis in 2007, FHA's capital ratio was 6.4 percent - more than triple the required 

level.'9 This buffer, designed to support FHA through difficult economic times, served its 

purpose and allowed FHA to respond to the 2008 financial collapse and subsequent economic 

downturn without the assistance sought by some over-leveraged private firms20 

As dire as these numbers sound, the fact is that the Federal Housing Administration is not 

running out of cash anytime soon. The agency still has $30.4 billion in its coffers to settle 

insurance claims as they come in, estimating that it has enough cash for at least 7-10 years.21 

However, under federal budgeting rules, if FHA does not have enough in its capital account to 

cover the 30 years' worth of claims, it must draw from an account at the Treasury Department 

to fill the gap. We will not know for certain until September whether that draw will occur. 

If FHA does require a draw, it is important to understand what such a move does and does not 

mean. Most important, it does not mean a congressional bailout. Since its creation in the 

1930s, the agency has been backed by the full faith and credit of the U.S. government, meaning 

it has full authority to tap into a standing line of credit with the U.S. Treasury in times of 

extreme economic duress-with no act of Congress necessary.22 (Note that if the capital fund 

does need to be replenished, no money actually leaves the Treasury; it is simply moved from 

one account to another.) 

In addition, mortgages insured by the Federal Housing Administration in more recent years are 

likely to be some of its most profitable ever, generating surpluses as these loans mature. The 

actuary projects that the MMI Fund capital reserve ratio will be positive by FY 2014 and reach 

2.0 percent during FY 2017 under its base-case estimate. These forecasts assume no changes in 

5 
54 


80867.011

policy or other actions by FHA, so the package of changes recently announced23 will likely 

accelerate the time to recovery. 

Today is not the first time FHA has faced a negative economic value. Most recently it faced a 

negative economic value in 1990 but by 1997 was capitalized at three times the required 

levels. 24 Frankly, what is remarkable is not that FHA is facing hard times but rather that it 

continued operating without assistance in the midst of the greatest housing catastrophe in 

generations. 

Notably, one should carefully dissect calls to make FHA function "like the private sector." The 

private mortgage insurance industry has been significantly weakened by the crisis,25 with some 

private mortgage insurers seeking bankruptcy or being taken over by regulators. 26 Moreover, 

FHA has a different mission, much of which acts as a complement to the private sector. 

D. FHA Losses are Due to Post-Crisis Business and Seller-Funded Down-Payment 

Programs, Not Normal Insurance Activity. 

To understand whether the current condition of the agency's mortgage insurance fund is due to 

the recent crisis or to a fundamental problem with its model, consider where the current losses 

are coming from. The agency is currently facing massive losses on loans insured in the later 

years of the housing bubble and the early years of the financial crisis, when lenders started 

turning to the agency after other sources of credit dried up. These losses are the result of a 

higher-than-expected number of insurance claims, resulting from unprecedented levels of 

foreclosure during the crisis. 

According to recent estimates from the FHA's recent actuarial report, loans originated between 

2005 and 2009 are expected to result in $30 billion in losses for the Federal Housing 

Administration. 27 The 2008 book of business - the year that the crisis culminated - accounts for 

about $13 billion of those losses, making it the worst book in the agency's history by just about 

any metric. 28 

6 
55 


80867.012

FIGURE~ 

A high percentage of FHA-insured loans originated in 2006,2007, and 2008 

are expected to go to claim in the near future 

Percentage of fHA-backed mortgage~ that have missed at least three consecutive payment~ or are in 

bankruptcy/foreclosure processing 

30'* 

26% 25.2% 25% 

20% 195% 

15.9% I 15% 135% I 125% 

lQ.6% I 10% 

5% 

0% 

Pre-2004 FY 2004 FY 2005 FY 2006 fY2oo7 FY 2000 FY2oo9 

But as a whole, FHA's delinquency rates are much lower than riskier 

mortgage products 

5.4% 

II 2% 

FY 2010 

-

FY2011 

Percentage of mortgages that have missed at least three consecutive payments or are in bankrupc)';' 

foreclosure processing by type of loan 

35% 32.9% 

3()% 

25% 

20% 18.4% 

15% 13.4% 

10% 9% 

5% 4% 

0% 

FHA 

-

Pr;m~-fix<'d Prime-ARM StJbpom,,·fix<'d StJbprime-ARM 

One of the reasons for the outsize losses from those years is that these books of business have 

a high concentration of loans under a special program to provide seller-funded down-payment 

assistance. This particular brand of seller-funded loans was often riddled with fraud and 

defaulted at a much higher rate than traditional FHA-insured loans. These loans made up about 

7 
56 


80867.013

19 percent of the total origination volume between 2001 and 2008, but account for 41 percent 

of the agency's accrued losses on those books of business. 29 

FHA unsuccessfully had tried to eliminate this seller-funded down-payment-assistance program 

from its programs, but it was not until 2008 that Congress finally banned it in the Housing and 

Economic Recovery Act (which didn't take effect until the second fiscal quarter of 2009). If such 

a ban had been in place from the start, the agency could have avoided more than $15 billion in 

losses, which would have put it in a much better capital position going into the crisis, according 

to the latest actuarial report 30 

Vet while the losses from loans originated between 2005 and 2009 will likely continue to appear 

on the agency's books for several years, the Federal Housing Administration's more recent 

books of business are expected to be very profitable. 

Some of the improvement going forward will result from the dramatic decline in loan 

delinquencies and defaults. The single-family portfolio's ninety-day delinquency rate, often the 

first indication of strength or weakness of new insurance commitments, was approximately 0.3 

percent in early 201231 . As a comparison, that so-called "early-period" delinquency rate was 

more than eight times higher at the peak of the foreclosure crisis in 2007.32 

The portfolio's "serious" delinquency rate, which tracks delinquencies after 90 days, has also 

declined over the past two years, from 9.44 percent in early 2010 to 8.54 percent in the third 

quarter of 2012.33 And the quality of FHA's loan portfolio seems to have improved since the 

crisis: serious delinquency rates for the 2009-2011 books of business are substantially lower 

rates than the 2006-2008 books34 

Improvements are also due to changes that FHA has already implemented to reduce risk, such 

as eliminating seller-funded down-payments, improving monitoring and oversight of lenders 

(which has improved compliance and resulted in the termination of bad lenders), and 

increasing down payment requirements for borrowers with credit scores below 580. 35 FHA also 

has begun a more aggressive program to sell distressed assets in bulk, and has improved its REO 

disposition processes generally.36 The agency also now requires FHA-approved lenders to have 

a net worth of at least $1 million. Last but certainly not least, FHA has now increased mortgage 

insurance premiums five times since 2009. 

Since the actuarial report was released, FHA has announced several other significant changes 

that will strengthen its finances going forward. 37 These include yet another increase in the 

annual mortgage insurance premium and a new policy that will require borrowers to pay 

annual premiums for the life of the loan rather than to cancel them after the outstanding 

principal balance reaches 78 percent of the original principal balance. FHA will also now require 

lenders to manually underwrite loans of borrowers that have a credit score below 620 as well 

as a total debt-to-income ratio greater than 43 percent, and it will be issuing a proposal for 

public comment regarding increasing down payment requirements for mortgages that have 

original principal balances above $625,000 from 3.5 percent to 5 percent. 

8 
57 


80867.014

Economic :\et Worth Book-of-Business 

Policy Changes H:ne Led to Impl'oYelIlents in Fund Tmjeetol':r 

15% 

10% 

5% 

0% 

-5% 

-10% 

-15% 

.. Book Value [loss} ($ bit) _Seok Vafue i$ bll) -Book Vafue (as a % of Endorsement Volume) 

Source: FY 2012 Acr:uarial ReI'iews of the }vfM] Fund; analysis ~v U.S, Deparrment ofm7J!FH~, 

As a result of these and other changes enacted since 2009, the newer books of business, 

especially 2011 and 2012, are together expected to bolster the agency's reserves by over $19 

billion, according to recent estimates from the recent FHA actuarial review. 38 

E. Recent Attacks on the FHA model are Inconsistent with the Facts 

As noted above, FHA appears to be returning to "normal" profitability, just as it has after 

playing a countercyclical role in the past. New business is significantly less risky and will likely 

perform better than any books of business in the agency's history. If anything, FHA's insurance 

activities have become more conservative than ever before. 

However, critics continue to attack FHA's basic business model. For example, in December 

2012, the American Enterprise Institute released a report written by Ed Pinto entitled "How the 

FHA Hurts Working-Class Families and Communities." The author seizes on reported losses at 

FHA in the wake of the crisis to portray FHA as a destabilizing force while omitting the context 

9 
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surrounding the loss and the way in which FHA stabilized the U.S. housing market during the 

housing and financial crisis. 

Pinto has come up with projected losses that far exceed those predicted by other analysts; a 

major reason for this is that his analysis fails to take into account both the superior 

performance of FHA loans vis-a-vis PlS loans, and changes made to FHA's business meant to 

improve its bottom line. Furthermore, the report fails to take into account any of the policy 

changes that FHA has made to improve its financial position, ranging from the elimination of 

the seller-funded down-payment program to the numerous increases in insurance premiums. 

In addition, the Pinto report examines the 2009-2010 book years, which Pinto considers as 

"well after the market's collapse," and therefore (presumably) a neutral period of time in which 

to evaluate FHA's lending39 In fact, the dataset begins just months after the government bailed 

out the nation's major financial institutions, Fannie Mae and Freddie Mac entered 

conservatorship, credit markets froze, unemployment spiked, and housing prices were in free 

fall. The 2009 book also still includes a sizable chunk of seller-funded down-payment-assistance 

loans. 

Perhaps most misleadingly, Pinto presents a correlation between FHA and high foreclosure 

rates in distressed communities as if to imply that the FHA is responsible for the high 

foreclosure rate. The concentration of FHA loans and the high rates these communities are 

largely a result of the unsustainable private subprime mortgages pushed in these communities 

during the housing bubble. FHA was one of the only lenders supporting the housing market in 

these distressed communities at the height of the foreclosure crisis because most private 

lenders had fled the credit risk of such neighborhoods. FHA's presence helped to stabilize the 

neighborhood-not a cause but a consequence of the neighborhood's financial distress. 

Although Pinto characterizes FHA's loans as inherently risky because of borrower 

characteristics, the trigger for the housing crisis was not risky borrowers, but risky loans.4o FHA 

loans are fully amortized, fixed-rate loans, a stark contrast to interest-only or even negativeamortization mortgages that were available during the housing bubble. This higher loan quality 

is reflected in the relative default rates of FHA loans and subprime mortgages. While the 

serious delinquency rate on subprime loans reached over 30 percent in 2009, the serious 

delinquency rate of FHA-insured loans has hovered around 9 percent since 2009. 4J 

As Pinto pointed out in the recent report, average interest rates were higher for African 

American and Hispanic borrowers in the lead-up to the financial crisis. This fact is not surprising, 

though, since privately funded predatory lending targeted communities of color, often upselling 

those families into higher-cost and riskier loans than they otherwise would have qualified for.42 

Indeed, had FHA followed Pinto's ill-supported advice and refrained from lending in distressed 

neighborhoods, the agency would not have been able to play its critical countercyclical role 

following the crisis. Many of the neighborhoods that are now entering a recovery period likely 

would have been lost for good. 

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F. A Few Recommendations Going Forward 

As the housing market recovers, FHA's share should and will return to its historical norms. But 

as long as the GSEs are in conservatorship and private mortgage lenders continue to stay on the 

sidelines, FHA will remain a crucially important option for ensuring that affordable mortgage 

capital remains available for potential homebuyers. 

It is now important to give sufficient time to see the results of the significant improvements 

made by FHA before adding still more changes to the mix. If too many changes are made at 

once, there is a serious risk of overcorrection that will have negative repercussions in the 

housing market. In particular, further tightening underwriting standards at this time will likely 

reduce both FHA's volume and the overall size of the mortgage market and put downward 

pressure on home values -limiting FHA's ability to play the countercyclical role. Such a move 

could negatively affect FHA's financial health in the long run, as the agency is so dependent on 

the health of the housing market. 

FHA does need to continue to explore how to improve risk estimates on FHA insurance, a 

problem that they have been grappling with for years. But it would be a mistake to approach 

this problem by intentionally inflating the cost of that risk through so-called "fair-value budget 

reporting." Instead of improving the accuracy of cost estimates for credit programs, it actually 

makes them less accurate by biasing apparent costs upward, and distorts the government's 

true fiscal position.43 It could cause serious harm to programs such as FHA while doing nothing 

to actually reduce taxpayer exposure to loss. Instead, it is largely a back-door way to scale back 

the government's footprint under the guise of "responsible" budgeting.44 

FHA also can take additional steps to improve its loss mitigation efforts, since providing 

borrowers with alternatives to foreclosure helps homeowners, the FHA insurance fund, and 

home values in neighborhoods - a win-win-win proposition. FHA has recently updated its loss 

mitigation requirements, including a revised set of alternatives to foreclosure that every 

servicer must consider before completing a foreclosure, but to increase compliance, FHA should 

require that a servicer provide clear proof that it complied with these new guidelines before it 

pays out an insurance claim. 

Also, FHA should require that its loan servicers give homeowners notice describing FHA's loss 

mitigation option and develop an effective mechanism through which homeowners can address 

a servicer's non-compliance with FHA's loss mitigation requirements. In addition, since FHA's 

loss mitigation guidelines are embodied in a disorganized series of bulletins and letters that 

neither homeowners nor servicers can access easily, it would help for FHA to develop a concise 

handbook describing FHA's loss mitigation options that is available to the public and easily 

understood. 

Finally, there are some areas in which FHA needs additional authority from Congress to manage 

its risk as effectively as possible. These areas include revised indemnification authority, greater 

flexibility related to the Compare Ratio requirement, and additional servicing transfer 

11 
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authority." It is our understanding that FHA will provide more information about these 

requests in this Committee's hearing on February 13, 2012. 

Conclusion 

FHA plays a key role in helping creditworthy homebuyers - especially those of modest means 

obtain access to credit to purchase a home. Owning a home provides economic and social 

stability for middle-class families, builds wealth that can be leveraged and transferred across 

generations, and encourages residents to maintain their properties and invest in their 

communities. 

Because of FHA's importance to the market, the agency should take prudent and targeted steps 

to restore the financial health of the insurance fund. But even if the agency does require 

support from the U.S. Treasury in the coming months, it will still have saved taxpayers billions 

of dollars by preventing massive home-price declines, another wave of foreclosures, and 

millions of terminated jobs. Considering the strength of the agency's recent books of business, 

any temporary assistance would almost certainly be paid back over a reasonable time frame. 

Beyond FHA, the time is now to have a larger conversation about the future of housing finance 

in America. Fannie and Freddie cannot remain in conservatorship indefinitely, and a vibrant 

housing market cannot be built simply on refinancing. The market needs a steady supply of 

first-time homebuyers who can then become move-up homebuyers. Many of these buyers will 

be people of color or young people shouldering student debt, and they may not have the 

means to put twenty percent down. Important questions must be resolved about how to bring 

private capital back into the market, how to minimize government and taxpayer support while 

still providing long-term, sustainable lending, and how to serve the buyers of the future. 

f welcome the opportunity to discuss these important matters with you over the coming year. 

Thank you again for inviting me today, and flook forward to your questions. 

12 
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ENDNOTES 

1 Unpublished data estimates from Moody's Analytics, October 2010. Data provided to Center for American 

Progress from Moody's Analytics. 

2 Julia Gordon, Testimony before the Financial Crisis Inquiry Commission, January 13, 2010, available at 

http:/(www.responsiblelending.org(mortgage-Iending(policy-legislation(Gordon-FClC-testimony-final.pdf. 

3 Eric Stein, Testimony before the House of Representatives Subcommittee on Financial Institutions and Consumer 

Credit, "The Impact of Dodd-Frank's Home Mortgage Reforms: Consumer Market Perspectives," July 11, 2011, 

ava ila ble at http://financialservices.house.gov(uploadedfiles(hh rg -112 -ba15-wstate-estei n-20 120711. pdf. 

'Ibid. 

S U.S. Department of Housing and Urban Development, "FHA Single Family Activity in the Home-Purchase Market 

through June 2012" (2012), available at http:/(portal.hud.gov(hudportal(documents(huddoc?id=fhamkt0612.pdf. 

6 U.s. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2011" (2011), available at 

http://portal.hud.gov(hudportal/documents(huddoc?id=FHAMMIFundAnnRptFY11N02.pdf. 

7 U.S. Department of Housing and Urban Development, "FHA-Insured Single-Family Mortgage Originations and 

Market Share Report 2011 - Q3" (2011), available at 

http://portal. h ud .gov (h u dportal (documents(h uddoc ?id=fhamktq3 11. pdf. 

8 U.S. Department of Housing and Urban Development, "FHA Issues Annual Financial Status Report to Congress," 

Press release, November 15, 2011, available at 

http://portal.hud.gov(hudportal(HUD?src=(press(press releases media advisories(2012{HUDNo.12-171. 

9 U.S. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

10 National Association of Realtors, "Profile of Home Buyers and Sellers 2012" (2012). 

11 U.s. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

12 Calculations from U.S. Department of Housing and Urban Development, "Annual Report to Congress Regarding 

the Financial Status of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

13 U.s. Federal Housing Finance Agency, "Conservator's Report of the Enterprises' Financial Performance, Third 

Quarter 2012" (2012), available at http://www.fhfa.gov{webfiles{24861{Conservator'sReport3Q2012F.pd!. 

14 U.s. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

15 Unpublished data estimates from Moody's Analytics, October 2010. 

16 Mark Zandi, "Obama policies ended housing free fall," The Washington Post, September 28, 2012, available at 

http:{{articles.washingtonpost.com{2012-09-28/news{35495982_1_house-prices-home-buyers-tax-credits. 

17 U.s. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

18 Omnibus Budget Reconciliation Act of 1990, Public Law 101-508, 101" Congress, (November 5, 1990). Note that 

FHA need not regenerate its capital reserves in one fell swoop. By law, the HUD secretary is required only to come 

up with a viable recapitalization plan. When Congress instituted the capital ratio requirement in 1990, it gave HUD 

ten years to increase its capital from zero to 2 percent. It took only three years for FHA to reach the threshold, 

thanks in part to increased insurance premiums. 

19 Robert Quercia and Kevin Park, "Sustaining and Expanding the Market: The Public Purpose of the Federal 

Housing Administration," (Chapel Hill, NC: UNC Center for Community Capital, 2012), available at 

http://ccc.unc.edu{documents(Dec2012 FHASustainingAndExpandingMarket.pdf. 

20 Sarah Rosen Wartell and John Griffith, "Too Early to Sound the FHA Alarm," (Washington: Center for American 

Progress, 2011), figure 1, available at: 

http://www.americanprogress.org(issu es(housi ng(report{2011{12 (12(10787 (too-ea rly-to-sound-the-fha-ala rm! 

21 Integrated Financial Engineering, Inc, "Actuarial Review of the Federal Housing Administration Mutual Mortgage 

Insurance Fund Forward Loans for Fiscal Year 2012" (2012), available at 

http://portal.hud.gov(hudportal{documents(huddoc?id=ar2012 forward loans. pdf. See also U.S. Department of 

13 
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Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status of the FHA Mutual 

Mortgage Insurance Fund Fiscal Year 2012." 

"National Housing Act of 1934, Public law 84-345, 73,d Congress, (June 28, 1934). 

23 Shaun Donovan, Testimony before the Senate Banking Committee, "Status of FHA Programs and the FY 2012 

Annual Review of the Mutual Mortgage Insurance Fund," December 6, 2012, available at 

http:!(portal.hud.gov(hudportal(HUD?src=(press(testimonies(2012(2012-12-06. 

24 Quercia and Park, "Sustaining and Expanding the Market." 

" Moody's Investors Service, "US Mortgage Insurers: Negative Outlook" (2012), available at 

http://www.radian.biz(sfc(servlet.shepherd(version/download(068COOOOOOOS19KIAS. 

26 See, for example, Dawn McCarty and Steven Church, "PMI Group Seeks Bankruptcy After Regulators Take Over 

Main Unit" Businessweek, November 28,2011, available at http://www.businessweek.com(news/2011-11-28/pmigroup-seeks-bankruptcy-after-regulators-take-over-main-unithtm! and Weiss Ratings, "Mortgage insurer Triad 

Guaranty placed into rehabilitation" December 18, 2012, available at http://www.weissratings.com(news(newsbriefs/mortgage-insurer-triad-guaranty-p!aced-into-rehabi!itation. 

27 U.S. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

"Ibid 

29 Integrated Financial Engineering, Inc, "Actuarial Review of the Federal Housing Administration Mutual Mortgage 

Insurance Fund Forward loans for Fiscal Year 2012" (2012), available at 

http://portal.hud.gov/hudportal/documents/huddoc?id=ar2012 forward loans.pdf. 

30 Ibid. 

31 U.S. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

32 U.S. Department of Housing and Urban Development, "FHA Single-Family Mutual Mortgage Insurance Fund 

Programs" (2012), available at http://portal.hud.gov/hudportal/documents(huddoc?id=fhartc 93 2012.pdf. 

33 Mortgage Bankers Association, "National Delinquency Survey," available at 

http://www.mbaa.org(ResearchandForecasts(ProductsandSurveys!NationaIDelinquencySurvey.htm. 

34 U.S. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

of the FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

35 Donovan, Testimony before the Senate Banking Committee. 

36 Ibid. 

37 Christina Mlynski, "FHA raises mortgage insurance, for life of loan," HousingWire, January 30, 2013, available at 

http://www.housingwire.com!news!2013!Ol/30/fha-raises-mortgage-insurance-life-Ioan. 

38 U.s. Department of Housing and Urban Development, "Annual Report to Congress Regarding the Financial Status 

olthe FHA Mutual Mortgage Insurance Fund Fiscal Year 2012." 

39 Edward Pinto, "How the FHA Hurts Working-Class Families and Communities," (Washington: American 

Enterprise Institute, 2013), available at http:(/www.aei.org/files/2013/01/29/-edward-pinto-fhapresentation 124146786409.pdf. 

40 Julia Gordon, Testimony before the House of Representatives Subcommittee on Insurance, Housing and 

Community Opportunity, "Are There Government Barriers to the Housing Market Recovery?" February 16, 2011, 

available at http://www.responsiblelending.org/mortgage-Iending/policy-legislation!congress!Gordon-HFSBiggert-testimony-final.pdf. 

41 Mortgage Bankers Association, National Delinquency Survey 

42 United States v. Wells Fargo Bank, 1:12-cv-OllSO-JDB (D.D.C. 2012), available at: 

http://www.justice.gov/crt/about/hce/documents!wellsfargocd.pdf; see also Janet Paskin, "Higher Rates for 

Blacks and Hispanics?" The Wall Street Journal: Total Return Blog, July 12, 2012, available at 

http://blogs.wsj.com/totalreturn!2012/07/12!higher-rates-for-blacks-and-hispanics( 

43 Jim Horney, Richard Kogan and Paul Van de Water, "House Bill Would Artificially Inflate Cost of Federal Credit 

Programs," (Washington: Center on Budget and Policy Priorities, 2012), available at 

http://www . cbpp.org/ cms!i ndex. cfm ?fa-view&id-3661. 

14 
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80867.020

44 For more information about fair-value budget reporting, see John Griffith, "An Unfair Value for Taxpayers," 

(Washington: Center for American Progress, 2012), available at 

http:((www.americanprogress.org(issues(budget(report(2012(02(09(l1094(an-unfair-value-foHaxpayers( 

45 Donovan, Testimony before the Senate Banking Committee 

15 
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80867.021

TESTIMONY 

Establishing the Proper Role 

of the Federal Housing Administration 

in The U.S. Mortgage -Finance System 

Basil N. Petrou 

Managing Partner 

Federal Financial Analytics, Inc. 

Before the 

Committee on Financial Services 

United States House of Representatives 

February 6, 2013 
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80867.022

It is an honor to appear before this Committee today at its first hearing of the 

113th Congress under the leadership of Chairn1an Hensarling and Ranking Member 

Waters to testify on the proper role of the ,Federal Housing Administration (FHA) singlefamily mortgage insurance program in the U,S. mortgage-finance system, FHA plays a 

vital role, but it may well supplant private capital that can and should be deployed to 

reduce taxpayer risk in a vital sector: low down-payment mortgage loans for first-time 

home buyers and others without the equity to purchase a home, refinance an existing loan 

that is now high loan-to-value or "move up" in a prudent fashion, Further, FHA is just 

one element in the U,S. Government's role and its risk related to residential mortgage 

finance, In your request for testimony today, the Committee rightly made clear that 

setting the right role for FHA must be done with a clear vision of the overall stand the 

federal government will play in residential mortgage finance. Like I think most if not all 

Members of this Committee, r believe the taxpayer should take as little risk in this sector 

as possible, standing back now that the crisis is cbbing to permit private capital to rcentcr this sector under a new regulatory framework robust enough to prevent past abuse 

of borrowers and investors. 

I am Basil N. Petrou, managing partner of Federal Financial Analytics, a firm that 

provides consulting services on, among other things, the array of policy issues affecting 
66 


80867.023

single-family residential mortgage finance.' As the Committee has requested, I will focus 

my remarks today on whether FHA's 100 percent federal guarantee distorts mortgages in 

the U.S. financial system, if high-income borrowers who otherwise would be eligible for 

privately-insured loans should still avail themselves of FHA-insured loans and on 

policies that thwart efforts by the private sector to revive and strengthen their role in this 

vital arena. 

Because the Committee has rightly noted that FHA reform is only one element of 

urgently-needed broader housing-finance reform, I will briefly summarize the 

relationship of FHA not just to the future of Fannie Mae and Freddie Mac, but also to 

many pending changes to financial-market regulation in the wake of the 2008 crisis and 

the passage of the Dodd-Frank Act. FHA is a critical market driver and source of 

taxpayer risk, but it is not the only force redefining U.S. housing finance. To consider it 

in a "silo" may lead to neglect of other pending policies that - even if FHA reform is 

speedily enacted in meaningful fashion - still may not fully support a vibrant mortgagefinance system largely reliant not on taxpayers, but rather on private capital. 

With specific regard to FHA, I recommend that: 

I Since 1985, Federal Financial Analytics, Inc. has provided analytical and proprietary advisory services to 

private corporations and government agencies in the U. S. and other major financial centers. The firm's 

practice includes a focus on U. S. residential-mortgage finance, including analysis oflegislative, regulatory 

and policy matters governing issues such as the role of the FHA, the structure ofthe GSEs, pending efforts 

to reform asset-backed securities, U. S. and global regulatory-capital regulation and similar matters. The 

firm has frequently testified before the U. S. Congress on these matters (see WWW.FEDFIN.COM) and 

has otherwise been honored to participate in the public debate on these vital matters. Federal Financial 

Analytics, Inc. does not lobby on behalf of any clients. 

2 
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• Congress should reduce the 100 percent full-faith-and-credit guarantee provided 

by the FHA to parallel the limited coverage of 25% to 50% successfully used by 

thc Veterans Administration (VA) for the mortgages it has guaranteed 

for several decades. Reducing coverage levels will effectively cap the severity of 

loss on FHA loans and improve their underwriting by putting the lender at risk. It 

is simply impossible for there to be real incentive alignment between mortgage 

originators and the taxpayer if originators take all the profit and the U. S. taxpayer 

takes all the risk. Further, expansion of housing programs with the full-faith-andcredit backstop distorts the U. S. financial system and global capital markets 

because capital regulations and many other requirements strongly favor 

obligations of this sort over those backed by private capital, creating a high barrier 

to the re-entry of private capital to U. S. residential-mortgage finance. 

• The FHA should be targeted to borrowers based on income, not home price. 

Currently, high-income low down payment borrowers are often eligible for fullfaith-and-credit U.S.-backed mortgages even though the private market for their 

mortgages would otherwise be deep, liquid and efficient. When the U. S. 

Government (USG) supports mortgage finance for higher-income borrowers, it 

supplants private capital otherwise ready to take on this risk and creates market 

distortions because of the lack of market discipline applicable to these larger 

loans. 

3 
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• Current FHA policy should be significantly revised with regard to delegating 

underwriting to the loan originator and reviewing underwriter performance only 

aftcr the fact. Instead, FHA should be authorized to share risk with regulated. 

capitalized providers of private credit -risk enhancement for mortgages (if 

unaffiliated with the originator). This deep source of private capital would 

conduct a second underwriting prior to loan origination. applying discipline 

derived from the incentive alignmcnt between the FHA and private providers of 

credit-risk mitigation bascd on shared risk. 

• A strict capital requirement should be set for the FHA single-family fund 

incorporated through a new actuarial model that accurately predicts losses. 

Additionally, the budgetary treatment of FHA should be changed to reflect the 

fair value analysis recommended by the Congressional Budget Office (CBO) 

currently applies to the budget treatment of the GSEs. 

Reflecting the above recommendations for FHA in the broader framework of U.S. 

mortgage-finance regulation and government intervention, I recommend that: 

• Congress should work to ensure that an array of pending prudential rules for 

banks (e.g., those implementing the Basel IfI capital and liquidity rules) do not so 

favor USG-backed mortgages as first to block the re-entry of private capital and, 

second, to prevent constructive reform of Fannie Mac and Freddie Mac. 

Although many pending rules would exempt the GSEs in conservatorship, 

4 
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treating them essentially the same as FHA, the conservatorships should end as 

quickly as possible. Once that occurs, if the U.S. financial-market regulatory 

framework creates only strong incentives for reliance on USG obligations, then 

mortgage risk will flood into the FHA, putting taxpayers at acute risk even if all 

of the reforms outlined above are in place. 

• A critical pending rule would implement the risk-retention provisions of the 

Dodd-Frank Act, creating a new "qualified residential mortgage" (QRM) criterion 

that would exempt loans from costly risk retention. Although down-payment and 

loan-to-value (LTV) requirements are a key prudential factor, the QRM should 

not (as proposed) set a simple down-payment requirement without regard to the 

use of regulated, capitalized providers of credit-risk mitigation like private 

mortgage insurers. Doing so would make it extremely difficult to securitize highLTV loans for first-time home-buyers and other borrowers who can prudently 

manage low down-payment mortgages demonstrated by careful underwriting 

backed by private capital at risk. If the QRM advances as proposed, these loans 

will flood into the GSEs and FHA and, once the conservatorships arc closed,then 

only into the FHA. 

The Risks Covered by Mortgage Insurance 

When providing credit-risk mitigation (CRM) against default by a borrower, 

insurers face two key risks: first, the probability that a loan will go into default and, 

5 
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second, the severity ofloss - that is, the amount the insurer will have to pay based on 

factors such as house-price depreciation, foreclosure costs and property damage. While 

much attention has been paid to the probability of default on the loans FHA insures, the 

severity of default risk to which FHA is exposed with its 100% coverage is at least as 

important when considering taxpayer risk. 

FHA's 100% Guaranty 

The FHA complete guaranty of mortgage risk distorts the incentive structure for 

lenderlservicers and puts the taxpayer at unneccssary risk. There are three simple points 

that demonstrate that 100% FHA insurance coverage is self·defeating for FHA and the 

U.S. taxpayer: 

I. FHA is exposed to severe losses on every loan that goes to claim during a houseprice decline such as that experienced since 2006; 

2. FHA exposes itself to fraud and poor underwriting that would not otherwise 

occur if the loan originator had "skin in the game" on every FHA-insured loan it 

originates; and 

3. Reducing the level of insurance coverage on future FHA loans while holding the 

FHA premium at its current level would recapitalize the FHA MMI fund with 

positive budget scoring. 

6 
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As noted by the Department of Housing and Urban Development (HUD) 

Inspector General, "[aJs a mortgage insurer, FHA pays the ultimate cost of loans that go 

bad. Lenders arc made whole, but FHA seldom recovers that cost in reselling the 

properties to the public.',2 When the HUD IG made this statement in 2007, he noted that 

"FHA loses an average of 30% of each insurance claim it pays, when sales costs are 

netted against the payout to the lender/claimant." 3 By 2008 the loss severity rate for 

non-HECM FHA-insured loans that went to claim in that year had soared to over 62% 

and, by 2010, the loss-severity rate had stabilized at 48%. That is, by insuring 100% of 

the loan amount, FHA is now losing 50% of its insured amount. 4 

There is no market or policy reason why FHA has to expose itself to this level of 

loss severity on insured loans. Indeed, the experience of the V A-guaranteed mortgage 

program demonstrates that lowering the level of insurance coverage reduces both the 

severity of loss and the probability of default. 

FHA. VA and Ginnie Mae 

The FHA and its government securitizer, the Government National Mortgage 

Association (Ginnie Mae), provide investors in single-family mortgage backed securities 

(MBS) with a security that is completely backed by the U.S. taxpayer. Ginnie Mae does 

not issue MBS, but approves the private lenders who issue MBS for which it provides the 

2 Statement of Kenneth M. Donohue, Inspector General, Department of Housing and Urban Development 

Before the Senate Committee on Banking, Housing, and Urban Affairs, July J 8,2007. 

lIbido 

4 Actuarial Review ofthe Federal Housing Administration Mutual Mortgage Insurance Fund Forward 

Loans for Fiscal Year 2012, November 5, 2012, p. E-3. 

7 
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backstop guaranty. The issuers advance payments of principal and interest to the MBS 

investor when a loan underlying the MBS defaults. It is then that the government 

insurance (primarily FHA and VA) repays the issuers. However, the investor in the 

Ginnie Mae MBS does not worry about the ability of the issuer to make a payment 

because Ginnie Mae insures the performance of the issuers and provides the MBS 

investor with a complete and explicit government guaranty on the timely payment of 

principal and interest. Private entities cannot provide investors with a similar taxpayerbacked guaranty and consequently Ginnie Mae securities are better priced than even 

MBS backed by the GSEs. 

In the marketplace, this favored position for Ginnie Mae-backed securities should 

be passed through to the mortgage borrower in the form of the lowest interest rate 

available given the prepayment risk associated with the mortgages underpinning the 

MBS. To the extent this is the ease, the U.S. taxpayer is providing both the MBS 

investor and the homeowner utilizing the government-baeked mortgage significant 

benefits at a potential cost to the taxpayer that will be reduced by lowering the FHA 

coverage level so as to cap potential losses while targeting FHA only to borrowers who 

cannot achieve sustainable homeownership without government support. 

VA Coverage Levels Adequately Support Ginnie Mae 

As Ginnie Mae notes in its annual report, it "absorbs losses only after all other 

mortgage safeguards (homeowner equity, mortgage insurance, and lender resources) are 

8 
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exhausted, thus minimizing risk to the taxpayer.") In the case of FHA-insured loans, Fl-IA 

provides Ginnie Mae with a complete government guarantee in the event the issuer fails 

in its obligation to make a payment, but the same is not the case for VA-guaranteed 

mOltgages that back Ginnie Mae MBS. The VA guaranty varies from 25% to 50% of the 

mortgage loan amount with the coverage falling as the loan amount increases.6 However, 

from the MBS investor's point of view, the explicit U. S. guarantee of timely payment of 

principal and interest backed by Ginnie Mae remains the same for the MBS composed of 

FHA and VA loans. So, when an issuer fails to meet its obligations, Ginnie Mae steps in 

to provide the MBS investor with the timely payment of principal and interest. Ginnie 

Mae then acquires control of the issuer's mortgage servicing rights and places the 

portfolio with a financially-sound master subservicer. As Ginnie Mae notes, "it is 

through investors' confidence in this sustaining model that Ginnie Mae ensures that 

capital continues to flow to the Nation's housing finance system." 7 

What is clear, however, is that 100% insurance coverage by FHA is not necessary 

to facilitate investor confidence in the ability of Ginnie Mae to guarantee the timely 

payment of principal and interest. Indeed, the much more limited VA guarantee 

combined with Ginnie Mae's power to acquire an issuer's mortgage servicing rights is a 

superior structure to the 100% FHA guarantee since it protects the U.S. taxpayer from 

both a high probability of default and high severity of loss on defaulted mortgages. 

5 Government National Mortgage Association Annual Report 2012, November 13, 2012 letter from 

Theodore Tozer to HUD Secretary Shaun Donovan (p.2). 

6 Under 38 USC Sec. 3703 the guaranty amount for a borrower with full entitlement is 50% for loans of 

$45,000 or less; $22,500 for loans greater than $45,000, but no more than $56,250; the lesser of$36,000 or 

40% of the loan amount for loans greater than $56,250, but no more than $144,000 or; 25% of the loan 

amount for loans 0[$144,000 to $417,000; or for certain loans in excess of$417.000, the guarantee will be 

the lesser of:25% of the county loan limit or 25% of the loan. 

9 
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80867.031

VA Loans Perform Better Than FHA Loans 

Clearly. the limited coverage of VA-guaranteed loans puts the issuer's capital at 

risk instead of the US taxpayer's in the event the loss severity of a loan exceeds the VA 

insured amount. However, the fact that the issuer is placed at potential risk on each and 

every V A-guaranteed loan means that the issuer is inevitably going to perfOlm a thorough 

underwriting to protect its own capital. This is critical in programs such as VA and FHA, 

where the underwriting is delegated to the lender/issuer. 

The default data for VA and FHA loans validates this point. Data collected by the 

Mortgage Banker's Association (MBA) show that VA-guarantced loans have 

experienced serious delinquencies at a rate that ranges from 50% to 60% of the 

comparable rate for FHA-insured loans. 8 In fact, since 2009, the serious delinquency 

rates for VA-guaranteed loans have been lower than the comparable rate for prime loans. 9 

The significantly better performance of VA-guaranteed loans as compared to FHAinsured loans has been consistent for ycars and generally holds regardless of the 

geographic location of the loan. 10 

Importantly, the better performance of V A-guaranteed loans is not an aberration 

and cannot be attributed to the size of the program. Atthe end of FY 2012, V Aguaranteed loans accounted for 32% of all outstanding Ginnie Mae guaranteed 

7 Ginnie Mae 2012 Annual Report, p.7. 

8 See for example The National Delinqueney Survey for the Third Quarter of20 12, published by the 

Mortgage Banker's Association of America, pp.!1. 

9 Ibid., p.lO. 

10 
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80867.032

issuances. I I With $384 billion of outstanding V A-guaranteed mortgages underpinning 

Ginnie Mae MBS, the V A program and its default experience has become a major factor 

in the mortgage market. Indeed, V A-guaranteed mortgage originations in calendar year 

2012 totaled $129 billion, equivalent to 53% of the total FHA single family 

•. . 12 ongmatlons. 

While other factors might contribute to the better performance of V A loans, 

limited insurance coverage and the lender's exposure to loss on every loan inevitably 

means that better underwriting occurs. 

Applying Reduced Coverage Levels to FHA 

As noted, VA coverage levels fall as the loan amount increases but only range 

between 50% and 25% of the loan amount, with the average coverage in the 25% to 30% 

range. Coverage by private MIs varics by initial LTV, with the GSE charter requirements 

bringing the initial LTV down to below 80%. Currently, this generally means coverage 

lcvels of25% to 30%, although in the past deeper MI coverage to 35% has been required 

by the GSEs. 

In order to facilitate a smooth transition to reduced coverage levels, it is 

appropriate for FHA to set a single coverage level of 30%, with the only exceptions made 

for loans in inner-city, low-income areas or other geographic areas where the value of the 

underlying property is uncertain. For these areas, a coverage level above 30% might bc 

10Ibid.,p.6. 

II Ginnie Mae 2012 Annual Report, p. 10 

12 See fnside Mortgage Finance, February 1,2013, pA 

11 
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80867.033

appropriate, but it should not exceed the 50% coverage level that applies to lower dollar 

amount V A-guaranteed loans. 

As Ginnie Mae starts to deal in FHA-insured mortgages with less than 100% 

coverage, it should be given the authority to increase its guarantee fee to the issuer. The 

guarantee fee has been fixed in law at 6 basis points for decades, but, this may no longer 

be sufficient to deal with a program where all loans backing a Ginnie Mae security have 

less than 100 percent insurance coverage. If a higher guarantee fee is needed to 

compensate Ginnie Mae for any new risk, Ginnie Mae will have to be granted the 

flexibility to increase its guarantee fee. 

Other Reforms to FHA 

Reducing the coverage level of FHA-insured loans will be the most positive step 

that Congress could take to improve the performance ofthc FHA single-family program. 

However, below are several other changes that would assure that the taxpayer backstop in 

FHA is only targeted to qualified borrowers who do not have access to other financing 

sources. 

I. Target the FHA Using Borrower Income and Not House Prices 

The current system of setting FHA eligibility by loan size, not borrower 

income, contradicts the purpose of government intervention: serving only 

those whose needs cannot be met by markets when these needs meet agreedupon policy goals. A government program must focus on the people it serves. 

12 
77 


80867.034

This is best determined by looking at the actual individuals using a program, 

not at abstract indicators, proxies, or substitute factors. It is time that FHA 

becomes an income-targeted - rather than a loan amount targeted - housing 

program. The current system for setting FHA area loan limits raises them 

above true median house prices, never lowering them even ifhouse prices fall. 

Indeed, the current FHA nationwide base limit of $271 ,050 is significantly 

higher than the national median existing house price of $176,600 13 which 

means that entire states where house prices are comparatively low now have 

an FHA loan limit that greatly exceeds the median house price anywhere in 

the state. Income targeting FHA's single-family program will assure that lowand moderate-income borrowers become the primary focus of the program 

and not borrowers who can afford large loans even when interest rates 

increase. 

2. Fix the FHA MMI Fund Actuarial Review Process 

The model used by FHA for assessing the actuarial value of its single-family 

insurance fund is not working. Since 2007, the current model--even with the 

changes made over the years-has consistently over-estimated the economic 

value of the MMI Fund and the economic value of each new year's book of 

business. As the HUD Inspector General noted last year, "FHA continues to 

project that the current and future year's books of business will be profitable 

and make up for these past years losses. However, what we have seen in the 

past three years is a troubling trend whereby the point at which the Fund is 

13 See National Association of Realtors Report on Existing Home Sales, January 22, 2013 available at: 

http://www.realtor.orgitopics/existing-home-sales/data 

13 
78 


80867.035

expected to reach its mandated capital level is pushed farther into the future." 14 

Similarly, in 2010, the outside finn hired by the BUD IG to review the 

independent actuary's report on the MMI Fund concluded that the "design of 

the current model does not provide an effective way to communicate risks.,,15 

Finally, the most recent report of the BUD fG on FHA finances noted that as of 

the end of FY 2012 the capital reserve account of the single family fund had 

insufficient funds to cover the re-estimate of expected higher losses. 16 Every 

year, FHA sends to Congress a re-estimate of the perfonnance of its books of 

business and. every year. the re-estimate has been adverse to the Fund. Clearly, 

changes have to be made for Congress to receive a correct and timely update as 

to whether or not FHA will require a taxpayer bailout. 

3. Correct the Budget Accounting for the FHA Program 

The Congressional Budget Office prepared a report in 2011 17 that noted the 

differences between the current budget accounting methodology for FHA and 

fair-value estimate which incorporates a market-based risk premium that 

recognizes the financial risk that the government assumes when issuing credit 

guarantees. This fair-value estimate is more costly to U.S. taxpayers but it 

shows the true cost of government guarantee program. The fair-value approach 

14 Testimony of the Honorable David A. Montoya, Inspector General, U.S. Department of Housing and 

Urban Development, Before the U.S. House of Representatives Committee on Appropriations, 

Subcommittee on Transportation, Housing and Urban Development, and Related Agencies, March 29, 

2012, pA. 

J5 Independent Auditor's Report to the HUD IG, 2011-FO-0002,Audit of Financial Statements for FY 201 0 

and FY 2009, dated November 5, 20 I Oattached to letter from HUD IG to David Stevens, FHA 

Commissioner, Appendix A, p.l4. 

16 Independent Auditor's Report to the HUD IG, 20 13-FO-0002,Audit of Financial Statements for FY 2012 

and FY 2011, dated November 9, 2012 attached to letter from HUD IG to Carol Galante, Acting FHA 

Commissioner, p.7 (referencing Note 6). 

14 
79 


80867.036

is used by CBO to assess the GSEs and it should be used to assess the 

operations of FHA. As CBO noted, the application of a fair-value approach to 

FIlA increases the estimated subsidy rate of the single-family program to such 

a degree that the program would show a cost rather than savings. 

Importantly, the fact that the GSEs are accounted for under CBO's budget on a 

fair-value basis, while FHA's is scored under FCRA accounting, distorts 

incentives to expand the FHA program without recognizing its true cost. As 

CBO noted, '"because costs recorded on a FCRA basis are generally below fair 

value, if legislation would cause mortgage borrowers who would otherwise 

obtain a guarantee from Fannie Mae and Freddie Mac to instead use an FHA 

program on the same terms, the legislation could appear to produce budgetary 

savings, even though the government's exposure to losses from defaults would 

be identical.,,18 

4. Authorize FHA to Develop a Risk Share Program with Private Providers of 

CRM for Residential Mortgages 

As a program where the mortgage underwriting is delegated to the 

lender/issuer, the FHA exposes itself to the risk that poor underwriting will 

only be found after a loss occurs. It is important that the taxpayer be protected 

at the front end of loan origination from poor FHA-delegated underwriting. 

FHA should thus be authorize to engage in risk shares with private providers of 

credit-risk mitigation for residential mortgages. Eligible CRM providers here 

should be: 

17 Report from Douglas W. Elmendorf to Congressman Paul Ryan, May 18,2011, Accounting for FHA'~ 

Single Family Mortgage Insurance Program on a Fair Value Basis. 

15 
80 


80867.037

o regulated under either state or federal standards acceptable to HUD as 

established by rule; 

o expressly subject to rules that bar correlation of risk between the CRM 

provided for FHA and other mortgage-finance activities; and 

o unaffiliated with any loan originator making use of FHA. 

Eligible private CRM providers would then separately underwrite eaeh insured loan 

to verify that the lender/issuer is following the jointly agreed upon proeess of loan 

underwriting and verifieation of borrower ineome, credit, debt service and other key 

underwriting criteria. By putting the private insurer on the same risk with FHA, the 

taxpayer will be protected by both its private capital and its private loan underwriting 

expertise. 

Conclusion 

At the outset of this statement, I indicated that FHA reform couldn't be viewed in 

isolation from pending regulatory developments or - even more importantly the need 

quickly to determine a course for Fannie Mae and Freddie Mac that brings them out of 

conservatorship. Together, FHA, Fannie Mae and Freddie Mac now dominate the U.S. 

residential-mortgage market. Private capital will only be attracted to the mortgage space 

when and if it beeomes clear that market has been reopened through the retreat of the 

government. Today, a combination of regulatory uncertainty and the crushing impact of 

"lbid.,p.6. 

16 
81 


80867.038

a U.S. Government guarantee quash the ability of private capital to invest in the new 

systems and develop the new products necessary to originate. service and securitize loans 

to advanee credit availability without sowing the seeds of another systemic crisis. 

The huge role of the U.S. Government in mortgage finance means that Congress should 

advance FHA reform in tandem with other changes. For example. putting Fannie Mae 

and Freddie Mac into a new form that terminates the conservatorship might promote 

private capital, but not if FIlA continues its 100% guarantee at current loan levels 

without appropriate originator discipline or risk-sharing with appropriate sources of 

private capital. One-sided GSE reform will only drive still more risk to taxpayers 

through FHA, an especially dangerous prospect given the many systems and riskmanagement problems that have brought FHA to the parlous eondition revealed in its 

most recent actuarial report. 

17 
82 


80867.039

Statement before the Committee on Financial Services 

U.S. House of Representatives 

On "Examining the Proper Role of the Federal Housing Administration in 

our Mortgage Insurance Market" 

Edward J. Pinto 

Resident Fellow 

American Enterprise Institute 

February 6, 201~~ 

The views e.Tpressed in tIll:' testimony are those of the author alone and do not necessari(y represent those ~f 

the American Enterprise Institute. 

1 
83 


80867.040

Hearing before Committee on Oversight and Government Reform 

U.S. House of Representatives 

Submitted testimony by Edward Pinto, resident fellow of the American Enterprise Institute. 

Chairman Hensarling and Ranking Member Waters, thank you for the opportunity to testilY 

today. 

Introduction 

I recently completed a comprehensive study that shows the FHA is engaging in practices 

resulting in a high proportion oflow- and moderate-income families losing their homes. Based 

on an analysis of the FHA's FY 2009 and 2010 books of business, the FHA's lending practices 

are inconsistent with its mission and represent a disservice to American working-class families 

and communities. 

The findings of this study indicate: 

• An estimated 40 percent of the FHA's business consists ofloans with either one or 

two subprime attributes-a FICO score below 660 or a debt ratio greater than or 

equal to 50 percent (based on loans insured during FY 2012). The FHA's 

underwriting policies encourage low- and moderate-income families with low credit 

scores or high debt burdens to make risky financing decisions-combining a low 

credit score andlor a high debt ratio with a 30-year loan term and a low down 

payment. A substantial portion of these loans have an expected failure rate 

exceeding 10 percent. 

• Across the country, 9,000 zip codes with a median family income below the metro 

area median have projected foreclosure rates equal to or greater than 10 percent. 

These zips have an average projected foreclosure rate of 15 percent and account for 

44 percent of all FHA loans in the low- and moderate-income zips. 

The study found the direct and indirect costs associated with a foreclosure rate greater than 10 

percent, particularly in working-class communities, are unacceptably high. Risk layering, 

combined with high FHA loan volumes, has a substantial impact on these communities. The 

resulting reduced or declining home values impact FHA and non-FHA low- and moderateincome families diligently making their payments. These families may be denied the 

opportunity to build equity, provide security for their family, and have the down payment for 

their next home as their family grows. Foreclosures also result in increased blight and crime 

and the larger community suffers from a reduced tax base and higher costs for providing 

municipal services. 

The study identified specific reforms to focus the FHA on responsible lending and return it to 

its traditional mission: 

Step 1: Do not knowingly insure a loan with a projected claim termination rate greater than 10 

percent, assuming no house price appreciation or depreciation. 

2 
84 


80867.041

Step 2: Target an average 5 percent projected claim termination rate, assuming no house price 

appreciation or depreciation. 

Step 3: Stop guaranteeing lower-risk loans and high-dollar-balance borrowers, as this allows 

for cross-subsidization of those loans with excessive risk. This will also let the FHA step back 

from markets that can be served by the private sector and allow it to concentrate on home 

buyers who truly need help. 

Step 4: Price for risk, since not doing so deprives the borrower of the price information needed 

to understand the true risk of the loan. Until this is done, the FHA should disclose to the 

borrower his or her expected claim rate, assuming no house price appreciation or depreciation. 

Step 5: Implement underwriting that results in the extension of responsible mortgage credit, by 

balancing down payment, loan term, FICO score, and debt-to-income ratio to achieve 

meaningful equity. 

The Problem: 

Given FHA's mission, allowing the continuation C!ipractices that reslIlt in ... a high 

proportion offamilies losing their homes represents a disservice to American families 

and communities. I 

Based on an extensive analysis of the Federal Housing Administration's (FHA's) FY 2009 and 

2010 books ofbusiness,2 it is violating its own standard. 

Most can agree with the FHA's mission to help creditworthy low- and moderate-income 

Americans and first-time home buyers by providing responsible mortgage credit that leads to 

homeownership success and neighborhood stability. That said, the real question is: what is the 

tolerance for failure? All lending entails risk. At what level offailure does lending become 

abusive because the direct and indirect costs associated with a high foreclosure rate are 

unacceptably high for FHA borrowers and the affected community? 

The findings of this study indicate: 

• An estimated 40 percent of the FHA's business consists ofloans with either one or 

two subprime attributes-a FICO score below 660 or a debt ratio greater than or 

equal to 50 percent (based on loans insured during FY 2012). 

• The FHA's underwriting policies encourage low- and moderate-income families 

with low credit scores3 or high debt burdens to make risky financing decisions1 US Housing and Uiban Development Department "Federal Housing Administration Risk Management 

Initiatives: Reduction of Seller Concessions and New Loan-to-Value and Credit Score Re(luil-ement:s" 

of proposed rulemaking). July 15.2010. 

request by Data provided with respect to 2.4 million loans. which 

represent 75 percent of 3.45 milliou loans insured by the FHA for these two book years. 

3 The median FICO score is about 720. Twenty-one percent of individuals Imve a score below 620. The 

remaining 79 percent have a score between 620 and 800+. the effective score range for prospective home 

3 
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80867.042

one combining one or both a low credit score or a high debt ratio with a 30-year 

loan term and a low down payment. 

o A substantial portion of these loans have an expected failure rate exceeding 

10 percent. 

o Once the expected failure rate exceeds 10 percent, the resulting direct and 

indirect costs to low- and moderate-income families and communities are a 

disservice to the very families and communities it is the FHA's mission to 

help. 

Background 

By the mid-1950s FHA had demonstrated the feasibility ()f [relatively high LTVj 

lending, given the sound underwriting and appraisal standardl· it pioneered. 4 

Many look at today' s FHA and nostalgically recall their great-grandmother's Depression-era 

FHA. Set up in 1934, it insured fully amortizing 20-year term loans combined with a minimum 

20 percent down payment. As late as 1954, down payments and terms on FHA loans still 

averaged about 20 percent and 20 lears, respectively.5 As a result, home buyers accumulated 

nearly 30 percent in earned equity after four years. Additionally, housing debt and total 

housing expense ratios 7 averaged 15 percent and 19.5 percent, respectively, helping to cushion 

any adverse income shocks8 This helps explain why, over its first 20 years, the FHA paid only 

5,712 claims out of2.9 million insured mortgages for a cumulative claims rate of 0.2 percent. 

At the same time, claim loss severity was only 9.percent of the original insured mortgage 

balance, or a total of $3 million on 5,712 claims. 

By the mid-1950s, the FHA had demonstrated the benefits of sound underwriting principles 

built upon 30 percent earned equity build-up over four years and a modest mortgage debt 

burden of 15 percent. The FHA began to abandon those principles in the late 1950s. Since 

ownership today since the FHA insnres few loans where the borrower has a score below 620. The 620 to 659 

score group is served almost entirely by the FHA and accounts for about 15 perccnt of prospective 

homeowners with scores above 620. [ndividuals with a score between 620 and 659 hm·e a much higher risk 

of default than borrowers with higher scores. Source for FICO score distribution information: Board of 

Governors of the Federal Reserve System, Report to the Congress on Credit Scoring and Its Effects on the 

Availability andAjjiJrdahilify ofCredil, August 2007. 

vnvw. fcdcra lrcservc. govlboarddocslIptco ngrcss/crcditscorcl creditscore. pdf. 

4 Department of Housing and Urban Developmcnt The FfL4 Single-Family Insurance Program. Performing a 

Needed Role in the Housing Finance Market, November 2012, 

WWW.llUduser.orgiportal/publications/llsgfin/flla sillglcfanlilY2012.hlml, 

5 John P. Herzog and James S. Earley. Home ,\fortgage Delinquencv and Foreclosure (Cambridge. MA: National 

Bureau of Economic Research. 1970), VI"" .l1bcr.orglbooks/hcrz70- L 

(; The combination of down payment and scheduled amortization. 

7 Herzog and Earley, Home M;>rlgage Delinquencv and Foreclosure. Housing debt is the total of principal, 

interest taxes, and insurance (PITI). Total housing e"'Pense (a concept no longer in use) includes PIT! plus 

utilities. maintenance, and repair costs. It generally added about 5 percent to the housing debt ratio. 

'Ibid. 

9Thomas N. Herzog, with an Emphasis on of 

Actuaries, 2009, 

4 
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80867.043

then, the FHA's role has been that of the leverage leader, spurring the housing finance industry 

and borrowers to multiple forms of increasing leverage. 

Borrower leverage takes six forms, and the FHA has promoted the simultaneous and excessive 

use of each, particularly with respect to low- and moderate-income families and communities. 

Two types of asset leverage: 

1. As the down payment percentage decreases, the asset price of the home it can 

leverage increases. 

2. As the loan amortization term increases, asset leverage remains high because of 

slower earned equity buildup from amortization during a loan's early years. 

Three types of income leverage: 

3. As the debt-to-income ratio increases, so does the loan that may be serviced with 

the same amount of income. 

4. As the loan amortization term increases, so does the loan that may be serviced with 

the same amount of income. 

5. As the rate of interest declines, the size of the loan that may be serviced with the 

same amount of income rises. While the Federal Reserve is responsible for this 

increase in leverage, the FHA's underwriting policies turn virtually all of this 

additional buying power into increased buyer leverage. 

One type of credit leverage: 

6. The lower the acceptable credit score, the larger the pool of buyers. Data are not 

available to track this expansion back to the 1950s. 

Lulled by its early success, encouraged by a housing lobby grown dependent on increasing 

leverage, and faced with private-sector competition for the first time,10 the FHA, at the behest 

of Congress, moved further and further out the risk curve until a down payment ofless than 5 

percent, a loan term of 30 years, and a mortgage debt burden more than double the level in 

1954 became the norm. For a borrower at the maximum loan-to-value (LTV) ratio and loan 

term, earned equity after four years now totals 8 percent, about enough to cover the cost of 

selling the home and not nearly enough to protect the FHA from substantial claim payments. In 

terms of mortgage debt capacity, today the FHA considers a 29 percent housing debt ratio 

normal, with 41 percent acceptable if a borrower has no other debt,l1 yet even these levels are 

routinely exceeded. 

While the FHA utilized all forms of leverage over the period of 1954 to 2012, data are only 

available to track the progress of growing asset and income leverage for 1954 to 1966, picking 

up again in the "00" years. 

10 In 1957. the Mortgage Guaranty Insurance Corporation was founded, the first private mortgage insurer to 

operate in over 20 years. The FHA's immediate response to competition was to move out the risk curve-by 

1959, its average down payment had declined to 10 percent and its average terrn had extended to 27 years. See 

Herzog, IIistOl:V olMortgage Finance. 

11 US Department of Housing and Uroan Development, The HUD Home Buying Guide, Augnst 2004. 

http://po[13] . hud. gOY Ihudporlall doculllellts/huddoc')id~DOC 1216:1. pdf. 

5 
87 


80867.044

• Asset leverage increased by a factor of 5 as the average down payment declined 

from 20 percent to 4 percent. 

• Household income leverage increased by a factor of nearly 3.5 as: 

o The average loan term increased from 21 years to 30 years, expanding 

buying power by about 12 percent. 

o The average housing debt ratio increased from 15 percent to 35 percent, 

expanding buying power by 133 percent. 

o Interest rates declined. The above comparisons are all based on a constant 

interest rate of 6 percent. Today, interest rates are about 3 percent, or half 

this rate, allowing buying power to increase by a further 30 percent. 

With asset and household income leverage compounding each other, as figure 1 demonstrates, 

from 1954 to 2012 the average leverage on an FHA loan increased by a factor of 17 while the 

FHA's foreclosure start rate increased by a factor of 19. Foreclosure starts were elevated even 

during the boom years of the 1990s and 2000s. Today, 1 in 20 FHA borrowers enters 

foreclosure every year. 

Figure 1. The FHA's Growiug Leverage Spurs a Burgeoning Foreclosure Rate 

20,00 

18,00 

16,00 

14,00 

12,00 

10.00 

8.00 

6,00 

4,00 

2,00 

~~Compound (income 

x down payment) 

leverage (1954=1) 

Foreclosure start 

rate (annualized) 

(1954 =1) 

* In calculating leverage factors for 1954-67,2006, and 2012, interest rates were assumed to be a constant 6 

percent for each year. Leverage was calculated a second time for 2012 using the current rate of 3 percent. 

Sources: Mortgage Bankers Association's National Delinquency Smvey and Peter 1. Elmer and Steven A Seelig, "The 

Rising Long-Term Trend of Single-Family Mortgage Foreclosure Rates," 1998, FDIC Working Paper 98-2, 

http://167,176, 17,84/bank/anah"tical/\yorking/98-2.pdf (foreclosure start rate data): Herzog and Earley, Home Mortgage 

J)elinqllen~)' and F()rec/osure (1954-67Ieveragc factors) and FHA Actuarial Review or the Federal Housing 

Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 20 II. October 12, 20 II, 

6 
88 


80867.045

The FHA's excessive use of compound leverage led to borrower and the FHA's increased 

dependence on unearned equity (equity accruing from house price appreciation as a result of 

leverage), rather than earned equity and responsible lending. Leverage is a double-edged 

sword. It creates a windfall of unearned equity for home buyers and reduced losses for the 

FHA when home prices are increasing rapidly. When prices rise more slowly or decline or 

when income drops, it exposes home buyers to foreclosure. Add in refinances to lower the rate 

and taking cash out, and burning one's mortgage by age 60 or 65 became a distant memory. 

As shown in figure 1, the FHA began expanding compound leverage in 1957, followed four 

years later by a burgeoning foreclosure start rate. By 1962, mounting foreclosures had caught 

the attention of lime magazine: 12 

Homeowners of a new and unattractive breed are plagning the Federal Housing Administration 

these days. Known as "the walkaways," they are people who find themselves unable to meet 

their mortgage payments-and to solve the problem simply move out their belongings at night, 

drop their house key in the mailbox and disappear. 

The risks that the FHA's policies present to borrowers, lenders, and the market should come as 

no surprise. As far back as 1970, a multi decade study on postwar lending trends and their 

impact on mortgage delinquency and foreclosure noted the risks posed by reduced down 

payments, longer loan terms, high debt ratios, and cash-out refinances. The study made 

numerous prescient observations, including 

There have been numerous warnings that continued liberalization of mortgage terms 

was creating riskier loans. . A second effect ofliberalized terms is to magnify the 

borrower's resources .... If lenders were to throw all caution to the winds and require 

little or no equity buildup on a property which is declining in value, defaults would 

almost certainly ensue. 1. 

The point about magnifying a borrower's resources is particularly pertinent to today's 

artificially low interest rate environment provided by the Federal Reserve. The Fed's purpose 

is precisely that-"to magnify the borrower's resources." This poses potential risk to families, 

particularly low- and moderate-income ones; their communities; and the FHA itself. A family 

with an income of $30,000 taking out a loan with a 4 percent down payment and a 32 percent 

housing debt ratio is able to purchase a $110,000 home at an interest rate of 6 percent. At 

today's rate of 3 percent, the same borrower is able to buy a home for $146,000. This 

additional buying power is being built into home sale prices. If rates were to return to a still 

historically low 6 percent, this same family (and others like it) would see its buying power 

return to $110,000, a decline of nearly 25 percent. The seeds of the next crisis are being sown 

by the FHA (and the Fed) today. 

12 "Credit: BewafC ofthe Walkaways," Time, Julv 27, 

13 Her.lOg and Earley. . -
89 


80867.046

The FHA Today 

Today, the FHA has 7.7 million loans outstanding and pays 12,000 claims per month, as 

opposed to the 5,000 it paid over its first 20 years of existence. Two of its more recent books 

are experiencing serious delinquency rates that are 8 (FY 2009 book) and 11 (FY 2010 book) 

times those of the Mortgage Guaranty Insurance Corporation's (MGIC's) 2009 and 2010 books 

of privately insured loans, respectively. 14 

Figure 2 shows continuing growth in the serious delinquency rate for the FHA's FY 2010 book 

compared to Fannie Mae and MGIC's rates, which have tapered off. 

Figure 2. FHA, Fannie, and MGIC's 2010 Books: Serious Delinquency Trends 

6% 

1% +---------~~---~.--.----.. --.. -----

o%L~~~-~-~~~~~~~~~ Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10Q11 

-~FHA FY 2010 book 

·············Fannie 2010 book 

,,~~ MGIC 2010 book 

Note: Number or elapsed quarters since (he beginning ofFY 20 to. There lmve been only 10 elapsed quartcrs for 

calendar year 2010. 

Sourees: FHA Single-Family Mutual Mortgage Insurance Fund Programs Quartcrly Report to Congress FY 2012 Q3, 

miscellaneous Fa1mie Mae Credit Supplements, and miscellaneous MGIC Portfolio Supplements. 

As a result, the following description of the FHA of the 1960s and 1970s applies to the FHA 

today: "Frequently working with local Realtors, [FHA] lenders would solicit home purchases 

from families who could not, in fact, afford the acquisition.,,15 

The FHA's flawed policies in the 1960s and 1970S16 were the impetus for much legislation 

over the years: the Home Mortgage Disclosure Act of 1975, the Community Reinvestment Act 

of 1977, and the Federal Housing Enterprises Financial Safety and Soundness Act 1992 (the 

GSE Act), to name but a few. These were largely aimed at the conventional market, not at 

reforming the FHA 

11 Since the FHA's and MGIC's books of business are reported on a fiscal- and calendar-year basis respectively, 

FHA delinquency data was lagged by one quarter so that cumulative seasoning is the same. 

l5 Gregory Squires, cd., Organizing Access to ('a pita!: Advoc([c:v and the Democratization (?fFinancial 

Institutions (Philadelphia: Temple University Press, 2003), 4. 

10 Ibid. Also see Brian D. Boyer, Cities Destroyed For Cash: The FHA Scandal at [HiD (Chicago: Follett, 1973) 

8 
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80867.047

The problems caused by the FHA did not abate in the 1990s. Gail Cincotta, a longtime 

community activist critic of the FHA had this to say in 1998: 

We have been fighting abuse, fraud, and neglect of the FHA program that has destroyed 

too many neighborhoods and too many families' dreams of homeowners hip for more 

than 25 years .... The FHA program has a national default rate 3 to 4 times the 

conventional market, and in many urban neighborhoods it routinely exceeds 10 times. 

In addition, the FHA program is hemorrhaging money. 17 

As a result of the Community Reinvestment Act, the GSE Act, HUD, FHA, and other policy 

and program initiatives, trillions of dollars of private-sector capital were directed into financing 

low- and moderate-income housing. The resulting housing boom and bust repeated the FHA's 

earlier failure: once again harming the very families and communities these policies were 

intended to help. 

Much legislation has also been enacted in an attempt to address deceptive, abusive, and 

predatory lending: the Home Ownership and Equity Protection Act of 1994 and the DoddFrank Act of 2009, to name two. Predatory lending was viewed as "exerting the same adverse 

impact on urban communities as the FHA scandals did in the 1960s and 1970s." 18 Once again, 

this legislation was aimed at the conventional market and ignored the FHA. So now we have 

come full circle, with the FHA acting as the primary source oflending in many communities 

and again setting up for failure the very families and communities it is tasked with helping. 

Some would argue that the FHA saved the housing market because without it, the market 

would have collapsed. 19 Beyond the fact of the FHA's decades-long role as the home lending 

leverage leader, this statement also sets up a false choice. Many could agree that the FHA has 

played a countercyclical role, but the real choice is between responsible and irresponsible 

underwriting polices targeted at low- and moderate-income families. 

Consider the last four years: 

• The lowest home prices since 2002 in nominal prices and 1997 in real prices. 

• The lowest interest rates in generations. 

• Affordability at an historic high. 

Had the FHA made two changes to its underwriting and program policies, the result would 

have been materially improved outcomes for low- and moderate-income families and 

communities, and the FHA itself: 

• On rate and term refinances, use the benefit of a lower rate to shorten loan term and 

speed equity buildup. 

17 Gale Cincotta, Statement before the Subcommittee on Housing and Connnunity Opportunity of the House 

Financial Services Committee. April!. 1998. hltp:/larchiycs.fillallcialscrl'iccs.housc.govlbankingl~198cinc.shrml. 

18 Squires, Orgal1izil1g Access to Capital. 

19 Jolm Griffith. "The Federal Housing Administration Saved the Housing Market," Center [or American 

Progress. October 2012, "ww.amcricanprogress.orgjwp-content/llploadsl20 12/10lGliffith FHA.pdf. 

9 
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80867.048

• On home purchase loans, offer buyers either a lower down payment or a 30-year loan 

term, but not both-this reduction in risk layering would greatly enhance equity 

buildup. 

Instead, the FHA's underwriting policies and practices have knowingly placed a high 

percentage of I ow- and moderate-income families and communities at risk of excessively high 

foreclosure rates. This study identified 9,000 zip codes with a median family income below the 

applicable metro area median, where the zips also have a projected foreclosure rate20 equal to 

or greater than 10 percent These high foreclosure rate zips account for 44 percent of all FHA 

loans that are in the low- and moderate-income zips, and they have an average projected 

foreclosure rate of IS percent. 

The FHA's 2011 Actuarial Study projects that 9.6 percent, or 330,000, of the 3.45 million 

loans it insured during FY 2009 and 20 I 0 will ultimately be foreclosed upon or otherwise 

result in a claim against FHA's insurance fund. 21 With an annual foreclosure start rate 19 times 

the rate in 1954 and a loss severity rate 7 times the level over its first 20 years, this is not your 

great-grandmother's FHA. 

The Government's Subprime Lender 

As I have described and shown in figure 1, starting in the late-1950s the FHA began to 

encourage higher-risk lending. Today, the FHA operates as the government's subprime lender. 

To be clear, the FHA's loans are subprime because of their credit attributes-for example, 

borrowers with impaired credit (a FICO score below 660) or a total debt ratio of 50 percent or 

greater. These high-risk attributes are then generally layered with the additional risks related to 

a low down payment and a slowly amortizing 30-year loan term. 

HUD has historically defined subprime by loan rate (self-serving, since government subsidies 

allow FHA mortgage rates to be at or below prime loan rates) or by the use of an identified 

abusive product like a 2128 adjustable rate mortgage (ARM). However, federal banking 

regulators define subprime by credit characteristics-typically, borrowers with weakened or 

20 The FHA uses the term "cumulative claim rate" (CCR) to describe the cumulative rate of foreclosures, short 

sales, decds-in-lieu of foreclosure, or other actions resulting in the payment of a claim on its insurance over the 

life of a given book of insured loans. In this paper, the terms "projected foreclosure rate" or "foreclosure rate" will 

bc used. 

21 Projccted cumulative claim rates (CCRs) for the FY 2009 and 2010 book years were estimated at lIAS and 

7.80 percent, respectively, resulting in a weighted average of 9.6 percent. The CCRs for fixed-rate 30-year 

mOltgages were used so as to exclude streamline refinances (FHA-to-FHA refinances) pertaining to loans made in 

earlier years. Sec Appendix G-7 in US Department of Housing and U roan Development Actuarial Review of/he 

FederallIousing Administration kIu/ual Mortgage Insurance Fund Fonl'ard Loansfor Fiscal Year 2011 

(excludes HECM) (Washington, DC: Author. October 12,2(11). On November 16, 2012, HUD released the 

Actuarial Review afthe Federal Housing Administration J.\,futua! A1artgage Insurance fund Fonvard LOaJ15;for 

Fiscal Year 2012 (excludes HECM) (Washington, DC: Author. October 12, 2011). This review updated the 

projected CCRs for FY 2009 and 20lO to 11.89 percent (up 0.45 percent from 11,45 percent in the FY 20 II 

Review) and 7.29 percent (dowu 0.51 percent from 7.80 percent in the FY 2011 Review). Since these changes 

effcctively cancelled each other out. no change was made to the CCRs from the FY 20 II Review used for the 

study. The weighted average CCR of9.6 percent for FY 2009 and 2010 as noted above is equal to the FHA's 

average CCR over the period 1982-2003. 

10 
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80867.049

incomplete credit histories or reduced repayment capacity as measured by credit scores, debtto-income ratios, or other criteria. Two specific attributes relevant to the FHA are a FICO score 

below 660 and a total debt ratio equal to or greater than 50 percent. 22 

Today, 40 percent of the FHA's business consists ofloans with either one or two subprime 

attributes-a FICO score below 660 or a debt ratio greater than or equal to 50 percent (loans 

insured during FY 2012):23 

• 24 percent had a FICO score <660 and a debt ratio <50 percent 

• 4 percent had a FICO score <660 and a debt ratio :::50 percent 

• 12 percent had a debt ratio :::50 percent and a FICO score >660 

These attributes are generally combined with a high LTV ratio (81 percent of the FY Quarter 

1 :2012 loans have an LTV ratio equal to or greater than 95 percent) and a slowly amortizing 

loan term (an estimated 90 percent have a loan term of30 years). 

For the FHA to knowingly place a high percentage oflow- and moderate-income families and 

communities at risk of excessively high foreclosure and delinquency rates is unfair and 

deceptive and constitutes an abusive practice. 

The FHA's Mission 

Historically, the FHA's mission was to be "a targeted provider of mortgage credit for low- and 

moderate-income Americans and first-time home buyers.,,24 As noted in their 2011 report to 

Congress, the Departments of Treasury and Housing and Urban Development recommended 

that "FHA should return to [this] ... pre-crisis role.,,25 

Democrats and Republicans alike can agree on this mission going forward. They should also 

agree with the benchmark HOD itself set for evaluating the FHA's performance: "Given 

FHA's mission, allowing the continuation of practices that result in ... a high proportion of 

families losing their homes represents a disservice to American families and communities.,,26 

Does the FHA meet this standard with respect to its mission of being a targeted provider of 

responsible mortgage credit that leads to homeownership success for low- and moderateincome Americans and first-time home buyers? Based an analysis of the FHA's FY 2009 and 

2010 books of business, the answer is no. 

Office of Comptroller of the Currency, Board of Governors of the Fcdeml Reserve System, Federal Deposit Insumnce 

Corporation, and Office of Thrift Supervision, 200 L W\\ w.oec. gov/ncws-issnances/bullctins/200 [/bulletin-ZOO 1-6a.pdf. 

23 HUD confirmed in a private email tloot 39 percent of its loans in FY 2012 had a FICO score of less than 660. a 

debt ratio greater than 50 percent, or both. 

"US Dcpartment of the Treasury and US Department of Housing and Urban Development, Reforming America's 

Housing Finance Market: A Report to Congress, Febrnmy 2011. 

\\",vw.lrcasuf\'.govlinitiflti\'cs/documcnts!rcfonning%20amcrica(Yo27s%12011onsing%20financc%20markct.pdf. 

"Ibid. 

2& US Housing and Urban Development Department, "Fedeml Housing Administration Risk Management 

Initiatives: Rednction of Seller Concessions and New Loan-to-Value and Credit Score (notice of 

July 15,2010, 

11 
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80867.050

The FHA's underwriting policies encourage low- and moderate-income families with low 

credit scores27 to make a risky financing decision-one combining a low score with a 30-year 

loan term and a low down payment This sets up for failure the very families and communities 

it is the FHA's mission to help. As a result, too many low- and moderate-income borrowers see 

their hope for the American dream turned into a nightmare. 

Fignre 3 shows that as a zip's median income declines in relation to the area median, the 

projected foreclosure rate increases (blue bars) and increases even more for the 50 percent of 

zips that are the most risky (red bars). For the riskiest zips with median income ofless than 60 

percent of the area median (red bar), the average projected foreclosure rate is over 17 percent. 

Yet this average masks shocking levels offailure in individual zip codes. In Chicago and 

Atlanta, the five zip codes with the highest projected foreclosure levels ranged from 35 to 73 

percent and 24 to 30 percent, respectively. Contrast this to the five zips in Chicago and Atlanta 

with the lowest projected foreclosure levels. These ranged from 0 to 4 percent and 2 to 4 

percent, respectively. 

Figure 3. Projected Cumulative Foreclosure Rate (PCFR) by Percent of Median Area 

Income (FY 2009-10) 

20% 

18% +------------------

16% 

14% 

12% 

10% 

8% 

6% 

4% 

2% 

0% 

<60% ;0:60% & ~80% & ;:0:100% ~110% 

<80% <100% & 

<110% 

Source: Author's data. 

9 PCFR all zip codes 

PCFR for zip codes with 

highest PCFRs accounting 

for 500/0 of loans 

The FHA's low- and moderate-income families in zips where the median income is below the 

applicable metro area median also suffered substantially larger home price declines than in zips 

above the area median income. For example, zips with less than 60 percent of the median 

income had a 13.3 percent home price decline; the average zip had a 9.4 percent decline (FHA 

loans), while the average decline across the United States (all homes) was 7.2 percent. 

As fignre 4 demonstrates, many of these families are substantially underwater on their 

mortgages. Even if these families do not lose their homes to foreclosure, they are unlikely to 

have the opportunity to accumulate equity for many years. 

See footuote 3. 

12 
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80867.051

Figure 4. Home Price Decline, June 2009-August 2012 by Zip Income as a Percent of 

Area Median (FY 2009-2010) 

2':60% & 2':80% & 2':100% & 

<60% <80% <100% <110% 2':110% 

0.00% 

-5.00% 

-10.000/0 

·25.00% -'----.-............... --.... - ....... --

Source: Author's data. 

II! PCFR all zip codes 

PCFR for zip codes with 

highest PCFRs accounting for 

50% of loans 

Some might argue that an expected foreclosure rate of 10, 20, or even 30 percent is a small 

price to pay, as it means that 90,80, or 70 percent of the loans are performing. Angelo Mozilo 

espoused this view in 2003: 

From my point of view, if80% of the sub-prime borrowers are managing to make ends 

meet and make the mortgage payments on time, then, shouldn't we as a Nation, be 

justifiably proud that we are dramatically increasing homeownership opportunities for 

those who have been traditionally left behind. 28 

But strong reasons exist to dismiss the view that these levels of foreclosure are acceptable. 

The collateral impact on neighbors and the surrounding community these foreclosure levels 

cause is substantial. These foreclosures are concentrated in low- and moderate-income 

neighborhoods. The resulting reduced or declining home values impact FHA and non-FHA 

low- and moderate-income families diligently making their payments. These families may be 

denied the opportunity to build equity, provide security for their family, and have the down 

payment for their next home as their family grows. 

Foreclosures result in increased blight and crime, and the larger community suffers from a 

reduced tax base and higher costs for providing municipal services. 

The impact of abusive lending on borrowers extends beyond excessive foreclosures. For every 

FHA borrower in foreclosure, another four are at an earlier stage of delinquency. Table la 

shows the impact of financial duress on FICO scores. A consumer with a 680 FICO score who 

Angelo Mozilo, "The American Dream of Homeowners hip: From Cliche to Mission," John T. Dunlop Lecture, 

Joiul Center of Housing Studies, Harvard University, Febmary 4, 2003, 

www.jchs.harvard.edu/sites/jchs.harvard.edu/files/m03-1 mozilo.pdf. 

13 
95 


80867.052

experiences a new 30-day mortgage delinquency will see his or her score drop by an average of 

60-80 points 29 

Table lao Impact of Financial Distress on FICO Scores 

Mortgage Oelmquency Impact To FICQ® Score Fica 

Sfa~flCO~· 

FICO® Score alter these events: 

Bankruptcy 530-550 525-545 540-500 

Sourre: FICO!!) Bankmg Analylics Slog. Fair Isaac CorporatIon 

This impact on families is troubling because the FHA's abusive lending practices lead to 

excessive levels of delinquency. Today, one in six FHA loans is delinquent 30 days or more, 

• At a projected foreclosure rate averaging 10 percent, nearly 1 in 5 FHA loans is 

delinquent 30 days or more at least once in a two year period, 

• In a working class neighborhood with a projected foreclosure rate averaging 17 percent, 

nearly 1 in 3 FHA loans is delinquent 30 days or more at least once in a two year 

period. 

Table Ib shows the estimated time for FICO Score to fully recover from a delinquency or other 

adverse credit event. It takes 9 months for a consumer with a 680 FICO score who experiences 

a new 30-day mortgage delinquency to get recover back to a 680 score (assuming no other 

changes)3o 

19 http://www.philadelphiafed.org/community-development/events!2011/impact-of-workout-options-oncredit-reports-and-scores!frbp-fico-impacts,pdf 

30 Ibid, 

14 
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80867.053

Table lb. Estimated time for FICO Score to fully recover 

The FHA financing path keeps families in a cycle of delinquency, foreclosure, and 

dependency. 

This abusive practice is all the more unfair and deceptive since, as I will explain more 

extensively below, the FHA does not price for risk. As a result, unsuspecting borrowers are 

offered government financing where a high-risk FHA loan is as much as 24 times more likely 

to experience a serious delinquency than a low-risk one. 

Even if one were to take the extreme position that a failure rate in excess of 10 percent and the 

adverse neighborhood impacts are acceptable, there would appear to be no justification for 

denying prospective borrowers the facts they need to make an informed decision about the 

deleterious impacts of a higher-risk FHA loan. 

A one-in-five chance oflosing one's home and entire investment, along with being denied 

access to most forms of credit for three to five years and, likely, restrictions on the ability to 

rent a new place to live. 

Even if a borrower avoids the 20 percent chance of foreclosure, he or she is substantially likely 

to experience a mortgage delinquency that will negatively impact his or her FICO score for 

years, severely limit access to credit, and greatly increase the cost of whatever credit might be 

available. 

Equally troubling is that the FHA projects that by 2015 its median FICO score will decline 

from 700 to 685. Unless the FHA takes steps to reduce risk layering as it moves out the credit 

risk curve, its lending standards represent an even greater disservice to low- and moderateincome families and communities. 

15 
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80867.054

These results collectively demonstrate that the FHA is financing failure in working-class 

communities on a level that is a national scandal. 

Credit Scores as an Objective Means of Evaluatiug Credit Risk 

In 2007, the Federal Reserve submitted a comprehensive report to Congress on credit scores3l The 

Fed broadly concluded: 

(1) The credit history scores evaluated here are predictive of credit risk for the population 

as a whole and for all major demographic groups. That is, over any credit-score range, the 

higher (better) the credit score, tbe lower the observed incidence of default. These 

conclusions are limited to credit history scores, tbat is, scores calculated exclusively on the 

basis of individuals' credit records as assembled by the three national credit-reporting 

agencies (Equifax, Experian, and TransUnion). Otber kinds of credit scores were not 

studied here. 

(2) Results obtained with tbe model estimated especially for this study suggest tbat the credit 

characteristics included in credit history scoring models do not serve as substitutes, or proxies, for 

race, ethnicity, or sex. 

(3) Different demographic groups bave substantially different credit scores, on average. For 

example, on average, blacks and Hispanics have lower credit scores than non-Hispanic 

whites and Asians, and individuals younger than age 30 have lower credit scores than older 

individuals. 

Table 2 is derived from the Federal Reserve study and quantifies the Fed's observation 

regarding different credit scores for different demographic groups. 

Table 2. Credit Score Distribution by Demographic G,'oups 

Fed study Fed study Fed study FHA serious 

interest credit score default delinquency Non-Hispanic 

rate distribution rate rate white Black Hispanic 

Credit score 

band 

<580 9.56% 11% 30% 30% 8% 33% 17% 

580-619 8.94% 8.50"/0 18% 20% 7% 20% 13% 

620-659 7.30"/0 10.50"/0 14% 11% 9% 15% 16% 

660-719 6.40"/0 19% 5% 2% 20"/0 17% 24% 

>719 6.10"/0 51% 1% 55% 16% 30"/0 

ISome results interpolated to standardize across credit score bands 

Source: Federal Reserve, Reporl 10 Ihe C. ,. 011 Credil Scoril1K and lis FJfixls on . and 

" Federal Ihe Availability l111dAffbrdabilitv o[Credil. 

May 2007. l.DllUi;Qgjrill.!:<=ITJ='lllli!.ll:!QlQg;Im1ffi!lg!ljilil£ffiill1li<;llL£6~liill=Jlli.[. 

16 
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80867.055

The study also found: 

Credit scoring likely increases the consistency and objectivity of credit evaluation and thus 

may help diminish the possibility that credit decisions will be influenced by personal 

characteristics or other factors prohibited by law, including race or ethnicity. 

The analysis conducted for this study finds that credit scores consistently predict relative 

loan performance within all population groups; that is, for all populations, the percentage 

of individuals experiencing a serious delinquency on one or more of their credit accounts 

consistently declines as credit scores increase. The analysis also finds that some groups 

perform worse (experience higher rates of serious delinquency) on their credit accounts, on 

average, than would be predicted by the performance of individuals in the broader 

population with similar credit scores. For example, on average, blacks perform worse than 

other racial and ethnic groups with similar credit scores. Similarly, single individuals and 

those residing in predominantly black or low-income census tracts perform worse on their 

loans than do their complementary demographic groups with similar credit scores32 

Financing Failure: Homing in on the FHA's Problems 

The FHA Does Not Price for Risk 

Two examples demonstrate this: 

• The FHA charges virtually the same mortgage insurance premium for a borrower with 

a 3.5 percent down payment, a 580 FICO score, and a 50 percent total-debt-to-income 

ratio (loan A in table 2 below) as for one with a 20 percent down payment and a 720+ 

FICO score and a 25 percent total-debt-to-income ratio (loan G below)33 Yet the first 

loan will experience a serious delinquency rate 24 times higher than the second. 

• The FHA charges the same mortgage insurance premium for a borrower with a 3.5 

percent down payment, a 580 FICO score, and a 50 percent total-debt-to-income ratio 

(loan A in table 2 below) as the same down payment and total-debt-to-income ratio, but 

with a 720+ FICO score (loan F below). Yet the first loan will experience a serious 

delinquency rate eight times higher than the second. 

3: Ibid. 

33 The upfront premium is the same for both loans (1.75 percent). The mmual premium is 1.35 percent and 1.30 

percent for loans A and G, respectively. On a present-vahle basis, tlris is an inconsequential difference. 

17 
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80867.056

Table 3. Regardless of the Risk, the Mortgage Insurance Premium Is Essentially the 

Same 

Loan A anC LoanD Loan E Loan F LoanG 

Te,·m 30-yr 30-yr 13O-yr 30-yr 30-yr 30-yr 30-yr 

LTV 96.50% 96.50% 96.5% 96.5% 96.5% 96.5% 80"/0 

nco 580-599 600-619 620-659 660-679 680-719 720+ 720+ 

Total debt-ineome- >50% >50% >50% >500/0 >50% >50% <=25% ratio 

Serious 

delinQueneV!"ate 24% 21% 14% 8%1 60/0 3(Yo 1% 

1.75% 1.75% 

Mortgage upfront Same Same Same Same Same upfront 

insunmce premium 1.35% 1.30% 

annuallv annuallv 

Source: Author. 

When pricing is risk based, a higher rate signals to the borrower that his or her risk profile is 

higher. Flat pricing by the government encourages adverse selection, promotes moral hazard, 

distorts market competition, and leads to higher levels of foreclosure that impose personal as 

well as social costs. 

Adverse selection. The Federal Reserve, in its Report to Congress on Credit Scoring, found: 

When the interest rate charged by a lender is appropriate for the average risk pool of 

prospective borrowers but is either to low or too high for some of the individual 

borrowers, the pool can suffer adverse selection, that is, a rise in the relative number of 

high risk borrowers.>4 

High-risk borrowers have incentives to take on more risk. The Federal Reserve also 

observed: 

High risk borrowers-those for whom the correct individual interest rate would be 

higher than the average rate-will perceive the single-rate offer as a good deal and 

accept the terms, perhaps borrowing more than they would if charged a rate more 

consistent with their risk profile. 35 

Stronger horrowers have incentives to take on more risk. If borrowers with good credit can 

make a smaller down payment or take out a larger loan relative to their income without having 

to pay higher mortgage insurance premiums or a higher rate, they will. This is demonstrated on 

home purchase loans where the FHA's minimum down payment is 3.5 percent and the average 

34 Federal Reserve. Report to the Congress. 

35 Ibid. 

18 
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80867.057

is 4 percent36 Those borrowers now have a higher likelihood of default than less-leveraged 

borrowers. They benefit from the private gains benefits accruing from rising home prices and 

are able to socialize their losses arising from defaults, with the risk being borne by the federal 

government. This results in moral hazard and attendant unintended consequences. 

High-risk behavior is promoted with subsidies. Borrowers have little incentive to exercise 

discipline to save for a down payment, improve their credit profile, or keep debt levels 

moderate, since these actions do not result in a lower mortgage insurance premium or interest 

rate. Instead, borrowers are motivated to take on more risk through subsidies. The combined 

FHNGinnie Mae subsidy on an FHA loan may be estimated by comparing pricing for a 

similar Fannie Mae loan with private mortgage insurance37 

• High-risk loan: A $] 00,000 FHA loan with a 30-year term, a 3.5 percent down 

payment, and a FICO score between 620 and 639 benefits from a subsidy of$5,250 

compared to a similar Fannie loan. 

About one-third of this subsidy results from the pricing advantage Ginnie Mae provides 

when an FHA loan is securitized. 

The rest results from the various subsidies and cross-subsidies that the FHA itself 

receives or creates. 

The FHA's ability to cross-subsidize high-risk loans like this one with premium income 

from lower-risk loans (generally those with FICO scores above 700) enables it to mask 

the concentrated pain inflicted on low- and moderate-income families and 

communities. It also enables the FHA to absorb catastrophic losses in low- and 

moderate-income communities. 

At the same time, the FHA's so-called lower-risk loans seem that way only when 

compared to its higher-risk loans. While these are the loans providing the previously 

mentioned cross-subsidy, they themselves are high-risk loans when compared to lowdown-payment, privately insured conventional loans. The serious delinquency rate on 

the portion of the FHA's FY 2010 book with an LTV ratio greater than 85 percent and 

less than or equal to 95 percent, combined with a FICO score greater than 720, was 

nearly four times the rate on MGIC's entire 2010 book with similar seasoning. For 

example, FHA loans with a balance of $500,000-625,000 and a debt ratio greater than 

or equal to 50 percent had a serious delinquency rate of 9.4 percent compared to 3.8 

percent on loans with a 30-40 percent debt ratio. 

Unless you are a real estate agent, it makes no sense from a policy perspective for the 

government to subsidize this much debt on $500,000-plus loans when the solution is 

'6 US Department of Housing and Urban Development, Quarterlv Report to Congress on FHA Single-Family 

Mutual ivfortgage Insurance Fund Programs, Quarter 3,2012, Exhibit A-7, 

http://porlal.lmd. gov/i1udportaliHUD"src=/program officcs/housingirmra/oelJ]?1 sirtc/J11artcqtrlv. 

3' A Fannie loan with private mortgage insurance incorporates a substantial degree of risk-based pricing. 

However. it is widely recognized that it is still below market -based pricing because of inadequate capital levels 

and return thereon. 

19 
101 


80867.058

for buyers to purchase a somewhat less-expensive home. 

• Medium-risk loan: A $100,000 FHA loan with a 30-year term, a 5 percent down 

payment, and a FICO score between 700 and 719 benefits from a subsidy of $1,695 

compared to a similar Fannie loan. 

Housing finance participants that price for risk cannot comEete with government 

programs that do not. Today, the FHA and the other agencies 8 using the Ginnie Mae 

guarantee account for about half of all home purchase loans. The failure to price for risk, along 

with other advantages the government bestows on the agencies, crowds out competitors since 

they do price for risk. This can be seen by comparing FHA FY Quarter I :2012 and Freddie 

Mac CY Quarter 2:2012 loans: 39 

Figure 5 shows there is little FICO credit score overlap, given 65 percent versus 13 percent of 

the FHA and Freddie's volumes, respectively, have credit scores below 720. 

Figure 5. FHA's Subsidy and Underwriting Advantages Crowd Out Freddie Mac 

100% 

90% 

80% 

70% 

60% 

50% 

40% 

30% 

20% 

10% 

0% 

<580 580 600 620 660 680 720+ 

Source: Inside Mortgage Finance and this study. 

II! FHA Total By FICO (FY 

Q1:12) 

Freddie Total By FICO 

(CY Q.2:12) 

Figure 6 demonstrates there is also little LTV ratio overlap given that 81 percent versus 19 

percent of the FHA and Freddie's volumes, respectively, have an LTV ratio of95 percent or 

greater. 

38 The FHA, the USDA, and the VA are called "agencies" since they arc agencies ofille federal government. 

39 Freddie loan-Iewl detail file from luside Mortgage Finance. There are minimal distribntion differences between 

FY Qnarter I :12 FHA volume and CY Quarter 2:12 Freddie volume. 

20 
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80867.059

Figure 6. FHA's Subsidy Advantages Crowd Out Freddie Mac 

50% +-~-----------~-------;~ 

40% '1-'---"-'-'-----'-"---,,---"'--"-""--'-'---"--"--"11,----, 

30% +-------'-~l'"-----------I~ 

20% +"-~"'"'--------i\~,-·---,-·-,-,-,--,--""--~I----

0% 

Source: Inside Mortgage Finance and this study. 

1\1 FHA Total by LTV (FY 

0_1:12) 

Freddie Total by LTV (CY 

0.2:12) 

Higher levels of foreclosure have an adverse impact on neighborhoods. Abundant research 

documents the adverse impacts on neighborhoods, including reducing neighboring property 

values,4o higher levels of crime,41 impact on children,42 older citizens,43 and an adverse impact 

on health,44 and a disproportionate impact on minorities45 

With respect to the direct adverse impact of foreclosures on nearby families, the Center for 

Responsible Lending found: "On average, families affected by nearby foreclosures have 

already lost or will lose $21,077 in household wealth, representing 72 percent of their home 

value, by virtue of being in close proximity to foreclosures. Families impacted in minority 

neighborhoods have lost or will lose, on average, $37,084 or 13.1 percent of their home 

value.,,46 

40 See W. Scott Frame, "Estimating the Effect of Mortgage Foreclosures on Nearby Property Values: A Critical 

Review of the Literature," Economic Review No_ 3. 2010, 

www.frballanla_orgfdoclllllcntsfpllbsfcconomicrcvicwferlOno3frame_pdf;JohnYCampbellet.aL. "Forced Sales 

and House Prices." December 2009. htlp:ffccollomics.mit.ednffilcs/1914; and Debbie Gmenstein Bocian et. aI., 

"Collateral Damage: The Spillover Costs of Foreclosures," October 2-1,2012, 

www.rcsponsiblelclldillg.orgfmortgage-Icndingfrcscarch-analysisfeollateral-damagc.html. 

41 Sec Dan lmmergluck and Geoff Smith, "The Impact of Single-family Mortgage Foreclosures on Neighborhood 

Crime;' November 2006, www_prismgatcch_eduf-diI7fHousingStudics.pdf: and Ingrid Gould Ellen et. aI., "Do 

Foreclosures Cause Crime"" June 23, 2011, 

http://funnanceuter.org/filcs/publicationsfEllen Lacoc SIl111'Ygin ForeclosuresCrimc .lune27_pdL 

42 Philipp Loyell and Julia Isaacs. "The Impact of tile Mortgage Crisis on Children, April IS, 2008, 

,yww.brookings_cduf"lmediafresearch/filcslpapersf20()8!5f04'%20mortgage%20crisis'%20isaacsf(H nlortgagc cris 

is isaacs.pdf: and Joanue Wood et. aL "Local Macroeconomic Trends and Hospital Admissions for Child Abuse, 

2000-2009;' July 16, 2012, http://pcdialrics.aappublications.orgfcol1tclltfearlvf20 12f07fllfpeds.20 II3 755,abstract"sid=aba 13d57 -drrc-.! 71d-SHc-5d U7cc2bc9d. 

'B Lori Trawinski, Nightmare on Main Street Older Americans and the Mortgage Market Crisis, AARP Public 

Policy Institute, July 2012, 

www.aam.orgfeolltcn!ldamf<lam!researchfpublic po !icv institutefcons prolf20 12fnight m<l re-o n-main-strcctAARP-ppi-eons-prot.pdf. 

44 Sec Janet Currie aud Erdal Tckin, "Is the Foreclosure Crisis Making Us Sick?" NBER Working Paper No. 

17310, August 2~OO~I.:I;'I=~~~~~Q9];;bIITUQ ,15 Bocian et a1.. ". 

46 Ibid. 

21 
103 


80867.060

Conclusions: 

• The FHA not pricing for risk leads to a variant of Gresham's Law: high risk lending 

drives out low risk lending. 

• The FHA's high risk lending policies sell hope and deliver harm, making them a 

disservice to low- and-moderate-income families and communities. 

The FHA Does Not Underwrite for Risk 

Based on an analysis of the characteristics of FHA loans, it is apparent that the FHA does not 

adequately evaluate the various risk factors present in a loan in a holistic manner. See appendix 

A for additional detail on these risk relationships. 

Consider the FHA's underwriting of home purchase loans: 

Down Payment: While the FHA's minimum down payment on a home purchase loan is 3.5 

percent, the average is 4 percent. This indicates that down payment is not being used as a 

factor to offset other risks present on an individual loan. 

• As indicated in appendix A, LTV ratio is generally a moderately effective indicator 

of default for FHA loans with FICO scores below 660. 

• Loan term: 92 percent of all fully underwritten fixed rate loans (purchase and 

refinance) have a 30-year term. This indicates that loan term is not used as a factor 

to offset other risks. As indicated in appendix A, loan term is generally a 

moderately effective indicator of default for FHA loans, although less so for FICO 

scores below 620. 

Total debt ratio: A slightly higher percentage of borrowers with a 620-659 scores had a total 

debt ratio greater than 50 percent than did borrowers with a 720+ FICO score. This indicates 

that total debt ratio was not used as a factor to offset other risks present on an individual loan. 

• As indicated in appendix A, total debt ratio is generally a moderately effective 

indicator of default for FHA loans, although its effectiveness declines as FICO 

score declines. 

Having eliminated underwriting variation based on down payment, loan term, and total debt 

ratio, only FICO score remains. 

• As the Federal Reserve found, "Credit scores consistently predict relative loan 

performance within all population groups.,,47 

• The performance of FHA loans indicates that that FICO score is a strong indicator 

of default for FHA loans. 

The FHA's underwriting policies largely ignore the fact that a 30-year term loan with a 95 

percent LTV, a FICO score of 580-599, and a debt ratio of>50 percent has a serious 

delinquency rate of24 percent, which is 24 times the 1 percent serious delinquency rate on a 

30-year term loan with 95 percent LTV, a FICO score of >720, and a debt ratio of <25 percent. 

17 Federal Reserve. Report to the Congress. 

22 
104 


80867.061

Likewise, it ignores that a 30-year term loan with a 95 percent LTV, a FICO score of 580-599, 

and a debt ratio of>50 percent has a serious delinquency rate of 24 percent, 8 times the serious 

delinquency level of3 percent on a 30-year term loan with 95 percent LTV, a FICO score of 

>720, and a debt ratio of>50 percent. 

However, a 20-year loan term can be used effectively to mitigate risk across all FICO bands. 

Figure 7 compares delinquency rates for 15-, 20-, and 30-year term mortgages. Mortgages with 

15- and 20-year terms perform similarly and have far lower delinquency rates than 30-year 

mortgages. 

Figure 7. FHA Home Purchase Mortgage Performance by Term 

7.0% T----.--.-~··----·-------··-- -----~---

6.0% 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

Source: 

2010 2011 2012 

l1li15 year term 60 day+ 

delinquency 

20 year term 60 day+ 

delinquency 

Wi 30 year term 60 day+ 

delinquency 

Figure 8 shows that shorter-term mortgages effectively to mitigate risk across all FICO bands. 

Figure 8 is limited to 15- and 30-year term mortgages as FHA's 20-year is insufficient for this 

level of detaiL 

Figure 8. FHA Home Purchase and Refinance Mortgage Performance by Loan Term 

across FICO Bands (60-day-plus delinqueucy) 

18% 

Q)16% 

~14% 

:.-12% 

g10% 

~ 8% 

.~ 6% 

~ 4% 

:.- 2% 

~ 0% 

+ o 

CD 

<620 

Source: Author's data. 

15-.. . 

11130-.. . 

620-659 660-679 680-719 720+ 

FICO 

23 
105 


80867.062

Conclusions: 

• The FHA's failure to underwrite in a responsible manner leads it to largely ignore 

risk layering on individual loans, 

• This leads to unnecessarily high foreclosure and delinquency rates that are a 

disservice to low- and moderate-income families and communities, 

• Reducing loan term is highly effective as a risk mitigant 

The FHA's Irresponsible Underwriting Policies and Abusive Lending Practices 

As shown in figure 9, a high percentage of the home purchase loans made to low- and 

moderate-income and minority borrowers are backed by the government. 48 

Figure 9. Share of Home Purchase Loans with Federal Backing in 2010 (Percent) 

Virtually all of these loans combine a 30-year loan term with a low or no down payment, and 

many are to borrowers with low credit scores andlor high debt ratios, This intentional risk 

layering places a high percentage of low- and moderate-income families and communities at 

risk of excessively high foreclosure and delinquency rates, Combined with the FHA's failure to 

price or underwrite for risk and the fact that low-price-tier neighborhoods have historically had 

more volatile price movement, this policy results in disproportionate impact on low- and 

moderate-income families and communities, Since failing to price and underwrite for risk is 

done knowingly, the FHA's underwriting policies and practices are unfair and deceptive and 

constitute an abusive practice. 

More Volatile Price Movement 

More volatile home price movement for lower-price-tier homes was generally the case during 

the Great BoomlBust of the 1990s12000s, The lowest price tier had the largest percentage price 

increases followed by the steepest declines, Figure 10 provides a representative example: 

·18 Joint Center for Housing Studies of Harvard The State ofrhe Nation 's IIousil1g~2012, 

24 
106 


80867.063

Figure 10. S&P/Case-Shiller Chicago Tiered Home Price Indices 

Source: S&P Indices and Fiserv. 

A study of 16 large metro areas found that in every case, the prices of homes in the lower price 

tier have fallen more from the peak than homes in the median and high price tiers 49 

This trend has continued since mid-2009 as lower-price-tier homes insured by the FHA in FY 

2009-10 have also seen greater price declines or smaller price increases than higher-priced 

homes. 

The combination of the FHA's underwriting policies and practices and low-tier home price 

volatility results in a disproportionately high level oflow- and moderate-income families 

losing their homes. 

As previously noted, this study found 9,000 zip codes where the median income is below the 

applicable metro area median and where the projected foreclosure rate is equal to or greater 

than 10 percent. These zips account for 44 percent of all loans in the low- and moderate 

income zips. The average projected foreclosure rate for these zips is 15 percent. 

However the impact extends well beyond the 10 percent or more that may lose their homes. 

• Another 20 to 30 percent will have their credit scores impacted by one or more 

delinquent payments. 

• All homeowners in the neighborhood will be impacted as these FHA loans become 

delinquent and go into in foreclosure. 

19 Ibid. 

25 
107 


80867.064

How the Study ofthe FHA's FY 2009 and 2010 Books Supports This 

Analysis 

In this study, I undertook a detailed examination of the FY 2009 and 2010 books to identify 

which loans are most likely to suffer a foreclosure, I also sought to identify which zip codes 

will bear the brunt of the 330,000 foreclosures forecast to result from the FY 2009 and 2010 

books of insurance50 

Data included loan risk factors such as LTV, FICO score, loan term, and debt-to-income ratio 

along with delinquency status, Based on delinquency data along with projections from the 

FHA's Actuarial Study, I calculated a projected cumulative foreclosure and other insurance 

claim rate ("projected cumulative foreclosure rate") for each zip code51 Additional 

demographic data was appended at the zip code level, including median family income, house 

price change, and percent of mortgages underwater. 

An analysis of the entire database revealed that while LTV, FICO score, loan term, and debtto-income ratio are captured as part of the insurance process, the FHA did not appear to be use 

these risk factors in any significant way in deciding whether to insure a given loan or under 

what terms, 

I then analyzed the results at a zip code level within individual large metropolitan (metro) 

areas52 , with a particular focus on zip codes where the median family income was below the 

median family income for the metro area, The results were striking in that most metro areas 

showed an extremely wide dispersion of projected cumulative foreclosure rates, typically from 

a low of3-5 percent to a high of 20-30 percent or higher across a broad range of incomes 

below the median for the metro area, 

Further analysis was undertaken to determine what might explain this result, The study found: 

1, A wide disparity in projected cumulative foreclosure rates among metro areas; 

50 The study used a database cousisting ofloan perfOfll1anCe data [or 2.4 million FHA loans from the FY 2009 and 

20]() books, estimated to represent 70 percent o[ the 3.45 million loans insured by the FHA for these two book 

years, To be conservative, the CCR for fixed-rate 30-year mortgages was used to calculate the estimated number 

offoreclosures expected to result from these 3.45 million loans, FY 2009 and FY 2010 have CCRs of 11.-15 

percent and 7,80 percent respectively, The all mortgages rates are higher (12,98 and 8,75 percent, respectively), 

primarily because of the impact o[ streamlined refinances. CCRs arc from US Department of Housing and Urban 

Development, 2011 Ac/uaria/ Review, Appendix G-7. 

51 FY 2009 and FY 2010 had CCRs of 11.45 percent and 7,80 percent, respectively, A FY 2009 and FY 2010 

serious delinquency rate was calculated for each zip, Each of these rates was multiplied by the applicable CCR for 

FY 2009 or 2010, This yielded a zip-level CCR for each fiscal ycar. A weighted average CCR was thcn calculated 

for each zip. 

"Metropolitan areas arc officially called Core Based Statistical Areas (CBSAs). Portions of the CBSAs of 

Chicago; New York; Boston; Washington, DC; Miami; Philadelphia; Detroit; Dallas-Ft. Worth; Seattle; San 

Francisco; and Los Angeles are further segmented into divisions. For example, the Chicago CBSA (formally 

named "Chicago-Naperville-Joliet. IL-IN-WI") cousists oftlrree divisions: Chicago-Joliet-Naperville. IL; Gary, 

IN; and Lake County-Kenosha County, IL-Wl. TIns distinction comes into play when analyzing mcdian family 

income versus median area home price, While area median family income is available at the CBSA/CBSA 

division leveL area median home price is available [or the cntire CBSA only and is not further divided by 

division. 

26 
108 


80867.065

2. An even wider disparity among zip codes within metro areas. 

3. At the metropolitan statistical area (metro area) level, FICO scores largely accounted 

for the wide dispersion of projected cumulative foreclosure rates among zip codes that 

had a median family income below the metro area median. 

4. Many areas with heavy concentrations of FHA loans suffered declining home prices 

since mid-2009. Home price declines had a disproportionate impact on low-and 

moderate-income families and communities, the groups traditionally served under the 

FHA's mission. 

Implications 

These results raise serious policy issues: 

1. The lending policies that FHA has in place today promote the financing of failnre 

for too many families and too many communities: The study found 9,000 low- and 

moderate-income zip codes with projected cumulative foreclosure rates of 10 percent or 

greater, with an average 15 percent projected cumulate foreclosure rate. These zips 

accounted for 38 percent of the study's 23,800 low- and moderate-income zip codes 

and for 44 percent of all FHA loans studied in these same zip codes. 

2. The FHA's lending policies are putting borrowers in low- and moderate-income 

communities in a negative equity hole that will be difficult to escape from. As 

noted in Figure 12 below families in zips where the median family income is below the 

applicable metro area median suffered substantially larger home price declines than 

those in zips above the area median. 

3. Although many agree the FHA's activity needs to be refocused on its traditional 

mission of serving low-income borrowers, if this occurs and the FHA continues its 

irresponsible lending policies, it will be financing failure on an even larger scale. 

The FHA plans to continue its underwriting policies with one notable change: reducing 

its median FICO score from 700 to a projected score of 660. This higher level of risklayered loans will result in a substantial increase in expected foreclosure rate. Unless 

reduced, we face the prospect of the FHA performing a further disservice to American 

families living in low- and moderate-income communities. 

4. The guarantee of the taxpayer is used to put low- and moderate-income families 

and communities at risk. The FHA's pricing advantages and lending policies entice 

many low- and moderate-income families into loans that finance failure. The enablers 

of the FHA rely on this backstop to encourage, originate, securitize, and guarantee 

these risky loans. 

What Is the Impact of the FHA's Lending Policies at the Individual Zip 

Code and Metropolitan Area Levels? 

A review at the zip code and metropolitan area levels confirmed that risk layering, combined 

with high FHA loan volumes, leads to a concentration of high foreclosure and delinquency 

rates in low- and moderate-income communities. 53 

53 All study results are based 011 the performance of loans from the FHA's FY 2009 and FY 20 I 0 books. While 

the books were analyzed separalely. the results are reported for the combined books on a weighled average basis. 

National results arc based on all relevanl zip codes with alleast one FHA loan. Metro area map results are based 

27 
109 


80867.066

This section contains an overview of the case study for Chicago, which is generally 

representative of the metropolitan areas studied. The full results for Chicago and additional 

metropolitan areas may be found on an interactive website for my project: 

www.NightmareAtFHA.com. 

The zip boundaries are color coded based on a scale of a projected cumulative foreclosure rate 

of percent for the FHA's combined FY 2009 and 2010 books. 

on all relevant zip codes with at least one FHA loan. Metro area scatter plot results are based on all relevant zip 

codes with at least 50 FHA loans. 

28 
110 


80867.067

Figure 11. Chicago Metro Area: Map Showing Projected Foreclosure Rate by Zip Code 

and Loan Count 

The summary of the Chicago stud/4 begins with a metropolitan area map at the zip code level. 

The projected cumulative foreclosure rate is shown for each zip. The zip is represented by a 

dot, with the color of the dot representing a rate of 0 to <5 percent,S to <10 percent, 10 to <15 

percent and:::: 15 percent The size of the dot represents the volume of loans insured in the FY 

2009 and 2010 books. 

54 Consisting of Cook Connty (lL), DeKalb Connty (lL), DnPagc Counly (IL), Gmndy County (IL), Kane Counly 

(IL), Kendall County (ILl, McHenry County (ILl, and Will County (IL). 

29 
111 


80867.068

Figure 12. Chicago Metro Area: Scatter Plot Showing a Zip Code's Relationship with Respect to 

Relationship ofIllcome, Home Price Declines, and Foreclosure Rates 

g 

g -10% 

~ 

'l -15% 

'" ~ ~20% 

~ 

u. -25% 

~ ·30% 

~ 

~ -35% 

'" l' 

~ -40% 

e 

c:: -45% 

-50% 

0% 20% 40% 60% 80% 100% 120% 140% 160% 180.% 200% 

Median Zip Home Price as Percent of Area Home PrICe 

The x-axis represents a zip code's median home price as a percent of the area's median home 

price. 

The y-axis represents a zip code's median home price change since June 2009. 

• The US median home price change was 7 percent since June 2009. 

• Chicago's median home price declined 22 percent since June 2009. 

• Median home prices declined 26.7 percent in those Chicago zip codes where the 

median family income was below the area media 

The color of the dot represents the zip's foreclosure rate. 

The size of the dot represents a zip's loan count of FHA loans in 2009-2010. 

What this scatter plot tells us: 

• Price declines were greatest in lower-income areas, which would also have had lowerpriced homes. In this instance, the preponderance of zips with a median family income 

of less than 100 percent of the area median had price declines greater than 22 percent 

for the area (average was -26.7 percent for zips less than 100 percent of area median). 

30 

220% 
112 


80867.069

o These same zips tend to have very high expected foreclosure rates and higherthan-average loan counts. 

• The lower-right portion gridded area of the scatter plot highlights the problem. Rather 

than helping low- and moderate-income families build meaningful equity along v·lith 

stable communities, the FHA's underwriting policies are leading to equity destruction. 

• Beyond the direct impact on families in terms of being likely to experience excessive 

foreclosure and delinquency rates, other FHA borrowers and the overall community 

suffer from equity destruction as a result of larger-than-average price declines. 

FHA reform principles supported: 

• Principle 1: Step back from markets that can be served by the private sector. 

• Principle 2: Stop knowingly lending to people who cannot afford to repay their loans. 

• Principle 3: Set loan terms that help homeowners establish meaningful equity in their 

homes with the goal of ending their dependence on FHA lending. 

• Principle 4: Concentrate on those home buyers who truly need help purchasing their 

first home. 

Figure 13. Chicago Metro Area: Scatter Plot Showing a Zip Code's Relationship with Respect to 

Relatiouship of Income, Home Prices, Low Credit Quality Borrowers, and Foreclosure Rates 

180% 

E 160% 

-~ -'" 

~ 140% 

i " 120% 

t; 

e 

(E 100% --:.::---------

j 80% 

~ E 

if. 

40% 

20% 

0% 

Projected Fqreclosure Rate 

11)% 

20% 40% £0% 

• 

80% 100% 120% 140% 160% 180% 20.0% 220% 

MedJaD Zip Horne Pnce as Percent of Area Horne Pnne 

31 
113 


80867.070

The x-axis represents a zip code's median home plice as a percent of the area's median home 

price. 

The y-axis represents a zip code's median family income as a percent of the area's median 

family income. 

The color of the dot represents a zip's foreclosure rate. 

The size of the dot represents a zip's percentage ofloans with a low FICO score (less than 

660). 

What this scatter plot tells us: 

• The lower-left quadrant (representing zips with both a median family income and a 

median home price below Chicago's $73,000 median family income and $161,000 

median home price, respectively) contains more than half of the loans. 

o The zip codes in the lower-left quadrant account for 53 percent of the loans in 

all the zip codes shown. 

o This quadrant showed a higher percentage ofloans with a low FICO score and a 

high foreclosure rate. 

o Rather than providing responsible mortgage credit that leads to homeownership 

success for low- and moderate-income families and communities, the FHA's 

loans perform a disservice to the very families and communities it is tasked to 

serve. 

FHA reform principles supported: 

o Principle 1: Step back from markets that can be served by the private sector. 

o Principle 2: Stop knowingly lending to people who cannot afford to repay their 

loans. 

o Principle 3: Set loan terms that help homeowners establish meaningful equity in 

their homes with the goal of ending their dependence on FHA lending. 

o Principle 4: Concentrate on those home buyers who truly need help purchasing 

their first home. 

Table 4 sets forth the foreclosure rate, percent of purchase loans that were government loans55 in 2009, 

and other data for the 10 Chicago zip codes with the lowest and 10 with the highest projected 

foreclosure rates. Each zip had at least 50 FHA loans. As I have noted, FHA and other governmentbacked loans are much more predominant among low- and moderate-income home buyers. 

The chart demonstrates the strong correlation among foreclosure rate, FICO score, income, and 

home price. It also demonstrates the harmful effects of the FHA's policies that promote layered 

risk. This negative impact is magnified because zip codes with the highest foreclosure rates 

also have the highest incidence of home purchase lending guaranteed by a government agency 

(FHA, US Department of Veterans Affairs [V A], and US Department of Agriculture 

[USDA]lRural Housing Service). This concentrates the FHA's abusive lending practices on 

"Gov·emment loans arc those insured by the FHA US Department of Veterans Affairs, and the Rural Housing 

Administration of the US Department of Agriculture. Virtually all goyernment--insured home purchase loans have 

a loan-to-value ratio in excess of 98 percent. 

32 
114 


80867.071

those low- and moderate-income families and communities least able to withstand the impact 

of high-risk lending and resulting foreclosures. 

Table 4. Chicago-Joliet-Naperville: 10 Zip Codes with Lowest and Highest Projected 

Foreclosure Rates alon~ with Demo~raphic Data 

HMDA 

Data: FHA. Median 

FSA/RHS & Family 

Median 

family 

income 

(zip)/media 

VA loans as Income for n family 

Percent of CBSA Median income Aug 2012 

Percent of Total Home division or family (CBSA!divis Zillow ZHPI as % 

Property 

ZipGNW 

loan Count Average FICOs <660 Purchase CBSA income ($) ion) - Horne Price Aug 2012 of area 

GNW erR GNW GNW Loans (FFIEC) (census) derived Index CBSA ZHPI home price 

Lowest 

60661 

60070 

60657 

60642 

60463 

60610 

60607 

60613 

60187 

Property 

ZipGNW 

Highest 

60621 

60636 

60609 

60624 

60637 

60428 

121 

60 

207 

78 

64 

148 

227 

223 

175 

Loan Count 

GNW 

142 

209 

212 

134 

174 

110 

60456 66 

60827 177 

60422 137 

1.6% 

3.8% 

4.2% 

5.1% 

5.4% 

5.4% 

5.4% 

5.5% 

5.6% 

5.9% 

13.2% 

40.0% 

14.6% 

12,6% 

2L8% 

28.1% 

15.5% 

19.8% 

17.9% 

28.0% 

133% 

28.0% 

9,8% 

13.8% 

NfA 

26.5% 

13.2% 

19.2% 

16.9% 

32.6% 

HMDA 

$72,747 

$72,747 

$72.747 

$72,747 

$72,747 

$72,747 

$72,747 

$72,747 

$72,747 

$72,747 

Data: FHA, Median 

FSA/RHS & Family 

VA Loans as Income for 

Percent of CBSA 

Percent of Total Home division or 

Average FICOs <660 Purchase CBSA 

CTR GNW GNW Loans (FFIEC) 

72.6% 54.2% 41.49% $72,747 

60.1% 56.5% 49.72% $72,747 

45.5% 43.9% 24.70% $72,747 

41.4% 59.0% 35.22% $72,747 

35.3% 56.3% 37.60% $72,747 

33.2% 59.1% N/A $72,747 

31.7% 57.6% 70.2% $72,747 

31.6% 54.2% 65.4% $72,747 

31.6% 47.4% 60.6% $72,747 

60426 140 30.1% 60.7% 69.6% $72,747 

Sources. Author's data and Cl1y-Data.com 

83527 

60866 

131700 

91886 

91382 

67057 

58349 

71979 

77654 

115% 

84% 

181% 

126% 

126% 

92% 

80% 

99% 

107% 

Median 

family 

income 

(zipl/media 

nfamily 

218,700 

163,000 

317,100 

276,900 

281,200 

236,000 

179,100 

204,200 

227,100 

218,000 

Median income Aug 2012 

family (CBSA/divis Zillow 

160,768 

160,768 

160,768 

160,768 

160,768 

160,768 

160,768 

160,768 

160,768 

136% 

101% 

197% 

172% 

175% 

147% 

111% 

127% 

141% 

136% 

ZHPlas% 

income ($) ion) ~ Home Price Aug 2012 of area 

(census} derived Index CBSA ZHPI home price 

22243 31% 78,400 160,768 49% 

30278 42% 67,000 160,768 42% 

27184 37% 115,400 160,768 72% 

25265 35% 99,300 160,768 62% 

27095 37% 114,500 160,768 71% 

57,700 160,768 36% 

48512 67% 82,000 160,768 51% 

36059 50% 61,600 160,768 I 38% 

103477 142% 185,200 160,768 115% 

37529 52% 50,800 160,768 32% 

Figure 12 above shows the strong correlation among a zip's relative home price, its home price 

decline since June 2009, its projected foreclosure rate, and FHA loan volume (all for the 

Chicago metro area). While Chicago had an average price decline of22 percent since June 

2009 (well exceeding the US average of 7 percent), the lower-left quadrant (representing zips 

with a median home price below Chicago's median of $161,000 and a home price decline 

exceeding the US average of7 percent) generally experienced larger price declines than the 

Chicago median decline of 22 percent, much higher foreclosure rates, and higher levels of 

FHA lending. 

33 
115 


80867.072

Conclusions: 

• The FHA's risk-layered approach is irresponsible. 

• The approach is a disservice to the very families and communities it is its mission to 

serve. 

• FHA's underwriting policies are unfair and deceptive and constitute an abusive lending 

practice. The Consumer Financial Protection Agency should determine whether the 

FHA's underwriting policies are unfair, deceptive, and abusive under the Dodd-Frank 

Act 

The Adverse Financial Impact of These Foreclosures on the Nearby Community 

The FHA projects that its FY 2009 and 20 I 0 books will result in 330,000 foreclosures 56 This 

study found that an estimated 85 percent of these foreclosures will occur in zip codes with a 

median income below the metropolitan area median. There are two distinct, direct adverse 

financial impacts of these foreclosures: 

First, the FHA's losses on the 280,000 foreclosures (85 percent of330,000) equals $20 billion 

(280,000 foreclosures times an estimated $70,000 per foreclosure claim). 

Second is the impact on the price of nearby homes owned by families located in these working 

class zip codes with high expected foreclosure rates. The methodology developed by Harding, 

Rosenblatt, and Yao in 200857 is used to estimate the loss associated with each foreclosure. 

They found each foreclosure results in an average estimated I percent home price reduction on 

every home within a 600 foot radius (0.04 square miles) of a foreclosure. Assuming a housing 

density of2,500 homes per square mile, each foreclosure results in a I percent home reduction 

on each of 100 neighboring homes. At an average home price of $133,000, the impact is 

$1,333 per affected home. 

The FHA's 280,000 foreclosures results in 28 million homes suffering total price 

depreciation of $37 billion 58 

The combined total of these direct impacts is $57 billion. 

56 This analysis focuses solely on the FHA's FY 2009 and 2010 books using a database consisting of loan 

performance data for 2,4 lnillion FHA loans from these years. This is estimated to represent 70 pereent ofthe 3,45 

million loans insured by the FHA for these two book years. To be conservative. the CCR for fixed-rate 30-year 

mortgages was used to calculate the estimated number of foreclosures expected to result from these 3.45 million 

loans. FY 2009 and FY 20JO have CCRs of 11,45 percent and 7.80 percent, respectively (weighted average of 9.6 

percent). The all mortgages rates arc higher (12.98 and 8.75 percent. respectively), primarily because of the 

impact of streamlined refinances. Tn terms of national impact. the MBA's delinquency data indicates that the 

FHA's 2003-10 books arc projected to result in over 1.7 lnillion foreclosure starts, with the preponderance almost 

certainly in zip codes with a median income below the metropolitan area median. 

57 John P. Harding, Eric Rosenblatt. and Vincent W. Yao. "The Contagion Effect of Foreclosed Properties:' 

Journal ofUrhon Economics. 66, no. 3 (July 28. 2008): 164-78, 

http://papers.ssmcomlsol3lpapers.cfm''abstract id~ 1160354. 

58 This is considered to be a low dollar estimate, as the FHA's foreclosures are concentrated geographically, and 

the Harding et aL research indicates that multiple foreclosures in the same vicinity magnify the price decline 

impact in surrounding homes. 

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Who Are the FHA's Enablers? 

How is it that the FHA is able to continue its irresponsible and abusive lending practices 

targeted at low- and moderate-income families and communities? 

Why is there little concern over the fact that the FHA's overall delinquency rate is habitually 

around one in six loans? 

The FHA, as part of the Government Mortgage Complex (consisting of Fannie Mae, Freddie 

Mac, the FHA, the USDA, the VA, and Ginnie Mae), benefits from a web of subsidies, 

benefits, and mandates-all of which stem from the presence of an unlimited full faith and 

credit government guarantee. Mortgage-backed securities (MBS) investors, real estate agents, 

home builders, and bureaucrats are all able to profit from the FHA program and act as enablers 

precisely because of the influence they exert on Congress. Their goal is to continue these 

profitable, but unfair, deceptive, and abusive lending practices, notwithstanding the negative 

outcomes for many low- and moderate-income families and neighborhoods. The presence of a 

government guarantee causes Congress and regulators to be indifferent to the quality of the 

underlying mortgages even while expressing nominal opposition to these abusive practices. 

Investors in Ginnie Mae mortgage-backed securities (Ginnie MBS) are indifferent to the 

quality of the underlying mortgages since Ginnie MBS are backed by the full faith and credit 

of the US government. 

Congress and regulators are indifferent to the quality of the underlying mortgages since Ginnie 

MBS and FHA loans are backed by the full faith and credit of the US government. As a result 

Ginnie MBS are given a zero risk-based capital weighting, compared to a 20 percent weight for 

government-sponsored enterprises (GSE) MBS and even higher weights for home mortgages. 

This encourages investment by domestic and foreign bank buyers. Foreign buyers -central 

banks and commercial banks-hold an estimated 30 percent of outstanding Ginnie securities. 

Additionally, Ginnie MBS get preferential treatment when used to meet bank liquidity 

requirements and are exempt by law from the risk-retention requirements of the Dodd-Frank 

Act. Finally, banks holding FHA loans with subprime attributes are not counted as subprime, 

since the banks have minimal credit exposure. 

Ginnie Mae is largely indifferent because it is insured against loss by the FHA, an agency 

backed by the full faith and credit of the US government. 

Real estate agents and home builders (and the associations that represent them) are largely 

indifferent since they take their profits at the loan closing. 

Originators continue to originate these risky loans because they are insured against loss by the 

FHA 59 

Borrowers are indifferent since they are charged the same insurance premium regardless of 

whether it is a 30-year term loan with 96.5 percent LTV ratio, a 580 FICO credit score, and a 

50 percent debt ratio or a 96.5 percent LTV ratio, a 740 FICO credit score, and a 50 percent 

59 Originators have attempted to protect themselves from excessive liability related to loan repnrchase reqnests by 

imposing higher credit requirements (credit overlays) than required by the FHA The FHA is considering a 

complaint charging that such credit overlays are illegal. 

35 
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debt ratio. This policy leaves borrowers in the dark with respect to risk. A substantial 

percentage of FHA loans can be fairly characterized as irresponsible, even toxic loan products. 

But the FHA does not disclose these extraordinarily high levels of risk to borrowers and FHA 

is able to cover the outsized losses on these risky loans through the use of cross-subsidies. 

The combination of not pricing or underwriting for risk and government guarantees allows all 

the above participants to ignore or be ignorant of the risks that result from the FHA's policies. 

In short, the FHA is built around moral hazard60 where no one has real skin in the game. 

Take real estate agents and home builders. They continually call for looser lending to qualify 

more marginal buyers61 

Consider the Community Reinvestment Act where layered risks are termed "flexible" 

underwriting standards. 

Finally, this is a result that could not continue without the tacit support of Congress, the FHA's 

regulator. 

The NAR as Enabler: Real Estate Agents Gain Even as Low- and Moderate-Income 

Borrowers Lose 

Real estate agents get their profits at the time a home is sold, leaving them with no "skin in the 

game" of housing finance. Thus, it comes as no surprise that the National Association of 

Realtors (NAR) has a long history of promoting looser lending-meaning more marginal 

buyers, meaning more sales, meaning higher prices, meaning more commissions. 

In a NAR news release, the organization's chief economist, Lawrence Yun predicted that a 

return to normal lending conditions would greatly help the US economy. According to Yun, 

"Sensible lending standards would permit 500,000 to 700,000 additional home sales in the 

coming year." 62 Yun then turned to FICO scores on denied FHA loans: "The Office of the 

Comptroller of the Currency has defined a prime loan as having a FICO score of 660 and 

above. However, the average FICO score for denied applications on FHA loans was 669 in 

May of this year, well above the 656 average for loans actually originated in 2001,,63 

The NAR's definition of "sensible lending standards" is driven by what serves its selfinterest-more agent commissions-rather than the adverse impact on low- and moderateincome families and communities. If the FHA were to follow the NAR's advice and lower its 

FICO average but continue using its current risk layering, this would have disastrous 

60 Where one or more participating parties have a tendency to take risk because some other party is bearing the 

cost of that risk. 

61 See National Association ofHomc Builders. "Builder Confidence Continues to Gain Momentum in 

September." press release, September 18. 2012. 

www.nahb.orgillews dClails.asp,,"scclionJD= 13~&ncwslD= 15515: "In particular. mmecessarily tight credit 

conditions are preventing many builders [rom putting crews back to work-which would create necdedjobs-and 

discouraging consumers from pursuing a uew-home purchase." And National Association of Realtors, "Home 

Sales and Job Creation Would Rise with Sensible Lending Standards:' press release. September J 7.2012. 

ww'w .realtor. orglnews-rcleasesl20 12!09Ihomc-salcs-and -job-crca lion-would-rise-with-scnsiblc-lcndi llg-standards. 

62 National Association of Realtors. "Home Sales and Job Creation." 

63 Ibid. 

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consequences for additional low- and moderate-income families that would now be receiving 

FHA-insured loans. 

The NAR's push for looser underwriting is neither news nor a policy change. Near the height 

of the housing and mortgage bubble in 2006, then-NAR president Thomas Stevens was asked 

whether he was concerned about the group's survey finding that 43 percent of first-time home 

buyers put no money down. He answered that he wasn't, but would be "if the number was 

higher than that.,,6-l 

There is no need to recount how disastrous this was for homeowners, particularly low- and 

moderate-income communities in the 2000s. But what does the NAR's perennial push for risk 

layering mean for FHA families living in low- and moderate-income communities today? The 

FHA insured an estimated 1.8 million home purchase loans during FY 2009 and 2010 that 

were in zip codes where the median family income was below the median for the metro area65 

• The estimated average sales price was $150,000. 

• The average real estate commission in America is approximately 5.1 percent,66 for total 

commissions of$14 billion. 

• These FHA home buyers have accumulated estimated earned equity of 8. 5 percent (4 

percent down payment plus 4.5 percent from scheduled loan amortization over three 

years), resulting in total earned equity of $23 billion. 

• These FHA home buyers have had an estimated 10.5 percent home price decline since 

June 2009 resulting in a negative equity total because of price decline: $28 billion. 

The result is a current gross equity position of these FHA home buyers of -S5 and a 

current net equity position (net of7 percent seller transaction costs) 

The winners are real estate agents at +$14 billion and the losers are FHA home buyers in 

below-median-income zips at (gross) and (net). 

The estimated FHA foreclosure rate for all home buyers in below-median-income zips is 10 

percent. For those home buyers in zips with highest foreclosure rates representing 50 percent 

of the loan volume in these below median income zips is 14 percent. 

Conclusions: 

• Realtors' advantage in the housing market is not surprising given that real estate 

agents do not have 'skin-in-the-game' and the FHA entices higher-risk home buyers 

with its irresponsible lending practices. 

~~:~~~:~Ti~~~~~~::~~~~~~~~:'5;;~;";'l1ent FHA OUflook. FY 

2010. This study indicates 85 percent of these would be in lips where the median family was below the 

median for the area. 

66 "What Is an Average Real Estate Commission for This Area?" Zillow, July 18. 2009. wmv.zillow.com!adviccI hrcad/Wlml-is-an-averagc-rcal-cstatc-co Illmissioll-for-this-arcaJ25 77 I 7/. 

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• Yet again, the NAR is more concerned about financial gains for its members than 

the hannful impact the underwriting changes that they espouse will have on lowand moderate-income families and communities. 

The Consequences of the FHA's Excessive Leverage 

The FHA's failure to apply risk-based pricing and underwriting standards guarantees failure 

for many low- and moderate-income families 67 The FHA's experience demonstrates that 

insuring highly leveraged loans to lower-income borrowers with very low down payments and 

a 30-year loan term combined with impaired credit and high debt ratios results in excessive 

foreclosure and delinquency rates that are a disservice to these families and their communities. 

Conclusions: 

• It is time for the FHA to stop knowingly lending to people who cannot afford to 

repay their loans. 

• It is time to return to what has worked in the past for FHA: insuring reducedleverage loans for families who have impaired credit. 

Reforming the FHA 

Social policies that help low- and moderate-income families become homeowners have an 

important place, but they must balance the interest in low- and moderate-income lending 

against the risks to the borrowers and the interests of the taxpayers. In the past, "affordable 

housing" and similar policies have sought to produce certain outcomes-such as an increase in 

homeownership-which turned out to escalate the risks for both borrowers and taxpayers. The 

mortgages made in pursuance of social policies can be lower than prime quality-taxpayers 

may be willing to take risks to attain some social goods-but quality and budgetary limits must 

be placed on riskier lending to keep taxpayer losses within known and reasonable bounds. 

Consistent with these policies, the FHA needs to return to its traditional mission of being a 

targeted provider of mortgage credit for low- and moderate-income Americans and first-time 

home buyers. The FHA perfonns a disservice to American families and communities by 

undertaking practices that result in a high proportion of families losing their homes. 

Families looking for help from the FHA in buying a home want responsible lending solutions 

that do not finance failure and foster continued dependency. These include: 

o A well-underwritten loan they can afford. 

o Tenns that will not expose them and their community to a high risk of default. 

o The opportunity to build equity, provide security for their family, and have the down 

payment for their next home as their family grows. 

"For purposes of this study. low and modemte incomc was defined at the zip code level. Within a metropolitan 

area: those zip codes with a median family income below the median family incomc for area. For non-metro 

areas: those zip codes below the statewide non-metro median family income. 

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o A financing path that does not force them into a cycle of delinquency, default, and 

foreclosure. 

It is obvious that far too many families who took out FHA and other high-risk loans have seen 

their wealth destroyed, their credit severely damaged for many years into the future, and their 

neighborhoods sent into severe decline. This is particularly so for lower-income and minority 

families. As this study demonstrates, the FHA is now the prime mover in perpetuating such 

effects. Although one could focus on treating the symptoms (foreclosures, negative equity,68 or 

insufficient income to support the mortgage payment), that will perpetuate the FHA's 

irresponsible lending practices. Focusing the FHA on responsible lending addresses the root 

causes: the FHA's ongoing underwriting practices that set borrowers up for failure and ensure 

continuing decline of neighborhoods while allowing the market and the judicial system to more 

rapidly correct existing problems in the housing market. 

Four Principles for Responsible FHA Lending Reform 

Principle I: Step back from markets that can be served by the private sector. The FHA 

has significant advantages that allow it to offer much lower rates than the private sector. These 

include a free explicit federal guarantee and no need to earn a return on capital, pay taxes, or 

cover administrative costs. Unless these substantial advantages are narrowly targeted, they lead 

to unfair and dangerous competition with the prime and subprime private sector, political 

interference, and the muting of pricing signals. Over a period of three to five years, the FHA 

should return to a purchase market share of 10-15 percent rather than today's 30 percent. 

Principle 2: Stop knowingly lending to people who cannot afford to repay their loans. 

Although the loans the FHA insured in 2009-11 are called its good books of business, its 2011 

Actuarial Study projects that even under a rosy scenario, these guaranty books will experience 

an average cumulative foreclosure rate of8.5 per 100 loans, or about 1 in 1210ans69 But 

averages can be deceiving. As this study has demonstrated, these foreclosures 

disproportionally impact low- and moderate-income families and communities. The FHA 

should target an average foreclosure rate of 5 percent, assuming no house price appreciation or 

depreciation, and limit the worst credit risk categories to a maximum claim rate of 10. It should 

also price for risk, since not doing so deprives the borrower of price information needed to 

understand the true risk. Until it does so, it should disclose to the borrower his or her expected 

claim rate, assuming no house price appreciation or depreciation. 

Principle 3: Set loan terms that help homeowners establish meaningful equity in their 

homes with the goal of ending their dependence on FHA lending. FHA should balance the 

layering of risk factors such as high LTV ratio, low FICO score, 30-year loan term, and high 

08 Principal forgiveness wonld amonnt to resetting borrower equity from neg'dtive to zero or near zero. This equity 

reset (from a severe negative equity position to oue that is merely bad) would be done mostly for a population of 

borrowers whose credit quality (FICO score) says the odds of failure arc even greater now than when the loan was 

made. Thus. principal forgiveness perpetuates and extends the cycle of neighborhood decline. Also. any principal 

forgiveness program conditioned on delinquency will unquestionably lead to a skyrocketing delinqnency rate as 

borrowers stand to improve their net worth by tens or hundreds of thousands of dollars if tlley stop making 

mortgage payments. The altcmative is an unconditional principal forgiveness program that essentially reduces 

principal balances [or all underwater FHA loans. The magnitude of negative equity iu the FHA portfolio and the 

associated cost of forgiving principal are enormons. 

69 US Department of Housing and Urban Development, 2011 Actuarial Review, Appendix G-7. 

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debt-to-income (DTl) ratio so as to allow borrowers to achieve meaningful equity and build 

wealth. It should limit its insurance to refinance loans where the lower rate is used enable a 

reduction in loan term so as to speed amortization and builds meaningful equity. FHA 

insurance should not be used to enable cash-out refinances, since those work against 

meaningful equity buildup and reduce the overall equity cushion vital to reducing price 

volatility in low- and moderate-income communities. 

Principle 4: Concentrate on those home buyers who truly need help purchasing their first 

home. In FY 2011,54 percent of FHA's dollar volume went to finance homes that were 

greater than 125 percent of an area's median house price, up from 22 percent in 2009. Given 

the FHA's mission is to help low- and moderate-income home buyers, the homes it finances 

should cost less than the median home price for an area. Additionally, first-time home buyers 

should be limited to an income of less than 100 percent of area median income and repeat 

home buyers to an income of less than 80 percent of area median income. 

Adopting these four principles would return the FHA to its traditional mission of being a 

targeted provider of responsible mortgage credit to low- and moderate-income Americans and 

first-time home buyers. 

Specific Reforms to Implement These Fonr Principles 

The following sets forth a series of steps designed to implement the four principles. 

Implementing all of these steps will enable the FHA to return to its traditional mission of being 

a targeted provider of responsible mortgage credit to low- and moderate-income Americans 

and first-time home buyers. 

Step 1: FHA will not knowingly insure a loan with a projected claim termination rate greater 

than 10 percent, assuming no house price appreciation or depreciation. This should be a central 

part of the FHA's definition of "qualified mortgage" and will demonstrate the FHA's 

"reasonable and good faith determination" that "the consumer has a reasonable ability to repay 

the loan.,,7o To allow loans where the rate exceeds 10 percent would be a disservice to low- and 

moderate-income communities since these loans would be concentrated in working class 

neighborhoods. 

Step 2: FHA will target an average 5 percent projected claim termination rate, assuming no 

house price appreciation or depreciation. This is well over five times the historic default level 

for prime loans and two times the historic default rate for 90 percent LTV ratio loans with 

private mortgage insurance. In addition to the underwriting changes noted in Step 5, the FHA 

should limit seller concessions to 3 percent of a home's value. 

Step 3: Stop guaranteeing lower-risk loans and high-dollar-balance borrowers, as this allows 

for cross-subsidization of those loans with excessive risk. This will also let the FHA step back 

from markets that can be served by the private sector and allow it to concentrate on home 

buyers who truly need help. Start by limiting loans to 100 percent of county median house 

price. Additionally limit first-time home buyers to less than 100 percent of area median income 

and repeat buyers to less than 80 percent of area median income. Returning the FHA to its 

Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, I1lth Congo (July 15, 2010), 

Section 1411. 

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mission as a targeted provider of mortgage credit for low- and moderate-income Americans 

and first-time home buyers has obvious benefits. It will return higher-income borrowers to the 

conventional lenders and private insurers market, resulting in a substantial reduction in 

foreclosure rate for higher income borrowers. 

Step 4: Price for risk since not doing so deprives the borrower of the price information needed 

to understand the true risk of the loan. Until this is done, the FHA should disclose to the 

borrower his or her expected claim rate, assuming no house price appreciation or depreciation. 

Step 5: lmplement underwriting that results in the extension of responsible mortgage credit. 

Accomplish by balancing down payment, loan term, FICO score, and DTI ratio in a manner to 

achieve meaningful equity. Table 5 sets forth an approach for accomplishing this goal 

Table 5. Balance Down Payment, Loan Term, FICO, and Debt-to-Income Ratio to 

Achieve Meaningful Equity 

580+ 97.25% 30 years 

30yeafs 

8% 

<50% 10% 

30yr.: 1%/1.10-1.15% 

15yr.: 1%/0.25-0.50% 

1%/1.50% 

26%/25% 

years 20yr.: 1%/1.50% 

Note: For ease of comparison. all examples are based on the pnrchase ofa $100,000 home at the maximum LTV 

and term with a 30-year interest rate of 6 percent, a 20-year interest rate of 5. 75 percent. and a 15-year interest 

rate of 5.5 percent. Maximum LTV with upfmnt mortgage insurance premium financed. 

Source: Author. 

The goal of the above underwriting policies is to reduce risk layering, particularly for 

borrowers with FICO scores below 660, by providing a trade-off between a lower down 

payment and a 30-year loan term. Home buyers would be offered one, not both. In each case, 

the earned equity from combination of down payment and scheduled loan amortization during 

the first four years is the same. 

This approach places a greater reliance on reduced loan term than reduced debt ratio, since the 

reduced term has a greater positive impact. For the 620-659 FICO borrower, the additional 

payment (forced savings) on a 20-year term loan would account for about 6 percent of the debt 

ratio and would likely reduce the foreclosure rate by about 40 percent7 ! As a result earned 

This estimate is based on the FHA's actuarial estimates for the period 1997-2010. The FHA estimates its 15-

year loan term claim terminatiou rate is 29 percent of that for 30-year term loans (sec various FH A Actnarial 

41 
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equity from scheduled loan amortization doubles from from 8 percent (30-year term) to 16 

percent (20-year term) over the first four years. 

Contrast this with the same 620-659 FICO borrower where a 6 percent reduction in debt ratio 

would reduce the foreclosure rate by only about 10 percent and aarned equity from scheduled 

loan amortization would be unchanged at 8 percent (30-year term) over the first four years. 

The Positive Policy Effects of More Responsible Underwriting 

Responsible underwriting for the 580 to 675 FICO score band has many positive policy 

impacts. 

It reinforces the FHA's traditional mission as a targeted provider of responsible mortgage 

credit for low- and moderate-income Americans and first-time home buyers. The 580-675 

FICO score band contains about 23 percent of all individuals with a scoreable credit record, but 

as table 6 demonstrates, it is heavily weighted with low- and moderate-income Americans, 

minorities, and first-time home buyers. (These weights are underlined in table 6.) 

Table 6. Responsible Underwriting Expands FHA's Targeted Mission, with Positive 

Policy Impacts 

Source: Estimates based on Federal Reserve, Report to {he Congress. 

Because of lender FICO score overlays 72 and to bolster its deteriorating financial condition, the 

FHA reduced the percentage of its insured loans with a FICO score below 660. Increased loan 

limits and pricing advantages compared to a private mortgage insurance execution through the 

GSEs allowed the FHA to expand into the prime category (primarily in the FICO score band of 

675-740). As a result, the FHA's average FICO score for FY 2012 (through August) was 695, 

up from 660 in 2007. 

Studies). This rate conservatively estimated at 60 percent for a 20-year rate. This results in a 20-year loan having a 

40 percent lower foreclosure ratc than a 30-year loan. 

'2 A lender FICO score overlay is when the originating lender has a higher minimnm FICO score for borrowers 

than the FHA's minimnm. This was largely a defensive measnre to protect customers from extremely high 

expected foreclosure levels if they have low FICO scores aud other risks, and to reduce the poteutial for 

indemnification requests. 

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Responsible underwriting policies designed around the 580-675 FICO score band would have 

positive policy effects: 

• 23 percent of all individuals with a scoreable credit record are in this band. 

• 38 percent of blacks have a FICO score in this band73 

• 30 percent of Hispanics have a FICO score in this band74 

• 32 percent of the residents oflow- and moderate-income zips (less than 80 percent of 

median) have a FICO score in this band. 

• 30 percent of those 39 years of age or younger have a FICO score in this band. 

The FHA's minority purchase loan volume was 32 percent of the FHA's total purchase volume 

in FY 2012 (through August), the same as for FY 2011. 

FHA's estimated FY 2012 purchase loan volume (based on FY 2011 results) is as follows: 

• Black: 9.5 percent or 69,000 out of a total purchase loan volume of 727,000. 

• Hispanic: 16.1 percent or 117,000 out of a total purchase loan volume of 727,000. 

FY 2007 purchase loan volume: 

• Black: 14.1 percent or 40,113 out of total purchase loan volume of283,639. 

• Hispanic: 12.7 percent or 36,089 out of total purchase loan volume of283,634. 

The FHA's home purchase loan market share has been 30-35 percent since 200975 A 2011 

white paper by the Treasury and HUD recommended: 

The FHA should return to its pre-crisis role as a targeted provider of mortgage credit 

access to low- and moderate-income Americans and first-time home buyers. (Today's 

FHA market share is nearly 30 percent, compared to its historic role of 10-15 percent) 

As Fannie Mae and Freddie Mac's presence in the market shrinks, the Administration 

will coordinate program changes at FHA to insure the private market-not FHApicks up that new market share76 

Assuming the FHA's purchase market loan share returned to, for example, 15 percent by 2015 

and overall purchase loan volume was 25 percent higher than in 2012. The FHA's total 

purchase volume would be about 450,000 loans: 

• Estimated purchase loan volume for blacks would be at least 14 percent (the percentage 

in FY 2007), or 63,000 loans. 

• Estimated purchase loan volume for Hispanics would be at least 13 percent (the 

percentage in FY 2007), or 59,000 loans. 

Another 33 percent have a FICO score below 580. 

74 Another 17 percent have a FICO score below 580. 

75 US Department of Housing and Urban Development, Annual Report 10 Congress. Fiscal Year 2011 Financial 

Stalus, FHA j\lutual }vforlgage Insurance Fund. November 15. 2011. 

http://portaL hud.govli1lldportalldocumcntslhuddoc')id~111ammifal1nrptfv 20 il.pdf. figure II. 

76 US Department of the Treasury and US Department of Housing and Urban Development, Reforming America '.I' 

Housing Finance j\larket. 

43 
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80867.082

Additionally, as the FHA returns to its traditional focus, a more normal conventional market 

will develop, with expanded volume in the 675-720 FICO band. 

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Appendix A. Risk Factors 

90+ Factor 

Sum (90+ Sum Risk (risk bucket 90+ 

Risk factor: LTV FICO Delq (Loan Bucket rate divided by Times More 

LTV Bucket Category Debt Ratio Count) Count) 90+ Rate total 90+ rate) Likely To Be 90+ 

li~~10J 580 - 599 (50,99J 412 1,705 24.2% 3.38 1,62 

580 - 599 (50,99J 24 161 14.9% 2.08 

i~~101 620 - 659 (50,99J 5,046 37,260 13.5% 1.89 1.42 

620 - 659 (50,99J 152 1,591 9.6% 1.34 

i;~~iol 720+ (50,99J 1,176 39,243 3.0% 0,42 1.09 

720+ (50.99J 26 949 2.7% 0.38 

Sum (90+ Sum 

Risk factor: LTV FICO Loan Delq (Loan Risk Bucket 90+ Times More 

Loan term Bucket Category Debt Ratio Term Count) Count) Rate Likely To Be 90+ 

(95+J 580 - 599 (50,99J >15 412 1.705 24.2% 1.21 

(95+J 580 - 599 (50,99J <=15 5 25 20.0% 

(95+J 620 - 659 (50,99J >15 5,046 37,260 13.5% 1,62 

(95+J 620 - 659 (50,99J <=15 16 191 8,4% 

(95+J 720+ (50,99J >15 1,176 39,243 3.0% 2.04 

(95+J 720+ (50,99J <=15 5 341 1.5% 

!::1U+ aeer 

Sum (90+ Sum Risk (risk bucket 90+ 

Risk factor: LTV FICO Deb! Delq (Loan Bucket rate divided by Times More 

Debt ratio Bucket Category Ratio Count) Count) 90+ Rate total 90+ rate) Likely To Be 90+ 

(95+J 580 - 599 (~~~~I 412 1,705 24.2% 3.38 1.66 

(95+J 580 599 121 831 14.6% 2.04 

(95+J 620 - 659 (~~~~J 5,046 37,260 13.5% 1.89 1,86 

(95+J 620 - 659 837 11,515 7.3% 1.02 

(95+J 720+ 

(~~i~J 1,176 39,243 3.0% 0.42 2.86 

(95+J 720+ 228 21,777 1.0% 0.15 

~U' ae or 

Risk factor: Sum (90+ Sum Risk (risk bucket 90+ 

FICO LTV FICO Delq (Loan Bucket rate divided by Times More 

category Bucket Calegory Debt Ratio Counl) Count) 90+ Rate lotal90+ rate) Likely To Be 90+ 

(95+J 580 - 599 (50,991 412 1,705 24.2% 3.38 8.06 

(95+J 720+ (50,99J 1,176 39,243 3.0% 0,42 

(95+J 620 - 659 (50,99J 5,046 37,260 13,5% 1.89 4.52 

(95+J 720+ (50,991 1.176 39,243 3.0% 0.42 

, About 4916 of loans are missing total-debt-to-mcome data, The senous dehquency rate for these loans tend to sillier to 

loan categories with debt ratios greater than 45 percent. 

45 

80867.084

Examining the Proper Role of the 

Federal Housing Administration in O

Mortgage Insurance Market 

, 

80867.085

FHA Poses a Triple Threat 

• An extraordinary failure rate is a continuing th

to working-class families and communities 

• Insolvency on an Regulatory Accounting Princi

basis (so called economic value) and GAAP bas

exposes taxpayers to bailout risk 

• Unfair competition with private capital blocks 

Housing Finance Reform 

80867.086

This Is Not the First Time 

"We have been fighting abuse, fraud, and negl

of the FHA program that has destroyed too ma

neighborhoods and too many families' dreams 

homeownership for more than 25 years .... The 

program has a national default rate 3 to 4 time

the conventional market, and in many urban 

neighborhoods it routinely exceeds 10 times. In 

addition, the FHA program is hemorrhaging 

money .... " 

Statement by the late-Gale Cincotta (founder of National Peoples Ac

made before the Subcommittee on Housing and Community Oppor

of the House Financial Services Committee, April 1, 1998 

80867.087

Likewise, on October 8, 2009 

• In testimony before the Subcommittee on Hous

and Community Opportunity of the Financial 

Services Committee, I noted that the FHA had a 

billion hole in its balance sheet, not the positive 

$2.7 billion as estimated by FHA's actuary: 

1/ Based on my analysis FHA is short $40 billion in its 

Financing Account as of 9.30.09 ... [plus} an additional $

billion [necessary to cover its 2% Capital Reserve 

Requirement]." 

• As I will elaborate on momentarily, it has taken 

three years for the FHA to acknowledge it faces 

massive capital shortfall on the order of $54 bill

80867.088

Continuing Threat to Posed by an 

Extraordinary Failure Rate 

• Financing failure for working-class families an

communities 

• 11%: weighted average claim (foreclosure) rate-1975-

• Abusive lending practices has led to over 3 million fail

American Dreams. 

• Foreclosure pain concentrated year after year on wor

class families and communities 

80867.089

FHA Claims and Claim Rate by Book Ye

35.00% 400,000 30.00% 

25.00% 

20.00% 

15.00% 10.00% 

5.00% 

0.00% 

350,000 

300,000 

250,000 

200,000 

150,000 100,000 

50,000 

o 

Number of FHA claims (right axis) 

-+-FHA projected cumulative claim ra

Weighted average claim rate: 

Over 36 years (1975-2010 ): 10.83% 

Over 30 years (1975-2004 ): 8.89% 

Actual and projected claims (foreclo

over 36 book years: 3.14 million fa

Sources: 

FHA loan count: HUD PD &R historical data FHA projected cumulative claim ra

Annual FHA Actuarial Studies 

Number of FHA claims: 

Loan count x claim rate 

80867.090

Chicago: Projected Foreclosure Rat

loan 

21}1} 

400 

600 

Highest foreclosure 

rates and greatest loan 

volumes are 

concentrated in 

working-class zips. 

80867.091

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Chicago's Quadrant of Doom 

.. 

20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 220%1 

Median lip Home Price as Percent of Area Home Price 

P'''jected F",ed

% L"an; with Fl

1lJ% 

20% 

30% 

4Wk 

5!l% 

"60% 

80867.092

Who Are the Enablers of Doom? 

• Investors in Ginnie Mae MBS) are indifferent to loan qualit

since they are backed by the full faith and credit of the US 

Government. 

• Regulators are indifferent since Ginnie MBS and FHA loans 

backed by the full faith and credit of the US Government. 

- A "a" risk-based capital weighting (compared to a 20 percent fo

GSE MBS). 

• This encourages investment by domestic and foreign buyers. Foreign 

buyers hold an estimated 30 percent of outstanding Ginnie securities

- Ginnie MBS get a free pass under the QM provisions and are ex

by law from the risk retention provisions of the Dodd-Frank Act

• Ginnie Mae is largely indifferent as it is insured against 100

loss by the FHA (not the case with the VA). 

- Ginnie Mae provides a valuable subsidy to FHA that enables it to better 

compete for lower risk loans; loans that subsidize higher risk loans. 

• Real estate agents and home builders (and the NAR and N

which represent them) are largely indifferent since they tak

their profits at loan closing. 

80867.093

Who Are the Enablers of Doom-cont'd

• Originators make these risky loans because they are insure

against loss by the FHA. 

• Borrowers are indifferent since they are charged the same 

insurance premium regardless of whether it is a 30 year te

loan with 96.5 percent LTV with a 580 FICO credit score and 

50 percent debt ratio or a 96.5 percent LTV with a 740 FICO 

credit score and a 50 percent debt ratio. 

• By not pricing for risk, FHA (at the behest of Congress) kee

homebuyers in the dark with respect to loan risk. 

- A substantial percentage of FHA loans can be fairly characterize

abusive, even toxic loan products. 

- Normally risk based pricing would inform borrowers as to risk. 

• FHA does not disclose these extraordinarily high levels of risk to borr

- FHA is able to cover the outsized losses on these risky loans thr

the use of cross-subsidies funded by lower risk loans. 

• Congress, the FHA's regulator, has been largely indifferen

thanks to the convoluted "Federal Credit Reform Act./I 
137 


80867.094

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80867.095

FHA's Insolvency Puts Taxpayers at Risk 

• Even under generous accounting rules that no other financia

entity gets to use, the FHA's FY 2012 actuarial study reported 

that its main single-family insurance program has an econom

value (EV) of negative $13.5 billion. 

• However, on the date submitted to Congress, the base case w

already obsolete, since it ignores the Fed's September QE 3 

announcement. 

- The projection of negative $13.5 billion was based on Moody's 

2012 forecast projecting 10 Year Treasuries in CY Ql:13 to be a

3.25% and climbing to 4.59% by 2014. Under that same foreca

mortgage rates are projected to double to 6.58% by CY Q3:14. 

- Today the 10-year is at 2.02%. 

- If the study's low interest rate scenario is substituted, FY 2012

is a negative $31 billion. Add the $22 billion shortfall in requir

capital buffer and FHA is short over $50 billion. The SEC would 

all over a public company that played by FHA's rules. 

80867.096

FHA's Insolvency Puts Taxpayers at Risk 

• Each year you get the same report saying: don't worry

next year will be better. 

- Contrary to FHA's assertions, the FHA will be not be ba

to a near zero EV at the end of FY2013 or at anytime so

- Of greater concern is that FHA is a recession away from 

catastrophic taxpayer losses. 

• What do we know for sure about the FHA's fiscal 

condition? 

- Under Generally Accepted Accounting Principles (GAAP

FHA's net worth is estimated at negative $26 billion, w

total capital shortfall of $47 billion based on its 2% cap

requirement. 

- Its cash is dwindling fast and may be exhausted within 

next 12-18 months. 

- One in six FHA loans is delinquent 30-days or more and 

rate has been growing. 

80867.097

By Unfairly Competing with Private Capita

Housing Finance Reform Is Blocked 

• FHFA acting director Edward Demarco had this to 

about the future of housing finance reform: 

"One potential place to start is by clearly defining 

the role of the traditional government mortgage 

guarantee programs like the Federal Housing 

Administration {FHA)." 

• As FHFA continues to implement Congress' 

appropriate mandate to align the GSEs' guarante

fees to appropriately reflect the risk of loss, as we

the cost of capital allocated to similar assets held 

other fully private regulated financial institutions

volume might instead shift to the Ginnie Mae 

agencies: FHA, VA, and USDA. 

80867.098

By Unfairly Competing with Private Capi

Housing Finance Reform Is Blocked 

• Over the last five years, private mortgage 

insurers have added $11 billion in private 

capital. 

- Two new insurers have been capitalized: 

• Essent and National 

• Redwood Trust has issued 11 private 

securitizations totaling $3.9bil and retained 

risk bearing tranches. 

80867.099

Turning Hope Into Homes 

• Step back from markets that can be served by 

private sector; take steps to return to a traditio

10-15 percent home purchase market share. 

• Stop knowingly lending to people who cannot 

afford to repay their loans. 

• Help homeowners establish meaningful equity 

their homes. 

• Concentrate on homebuyers who truly need h

purchasing their first home. 

80867.100

QM Continues the Same Policies th

Led to the Financial Crisis 

• Loans with 580 FICOs, 50% OTis and 3% 

down payments will be called prime loans 

instead of subprime 

- FHA insures loans like this today, and there is n

reason that the GSEs will not in the future 

• The 1.5% cap will restrain risky private lend

but channel it through the GSEs and FHA 

80867.101

Step 1: Incorporate Provisions from 

House-passed FHA Bill 

• Sec. 2: Establish minimum upfront and annual premiu

• Sec. 3: Indemnification by FHA mortgagees 

• Sec. 4 Early period delinquencies-amend to automa

buy-back for defaults within 6-months 

• Section 5: Semiannual actuarial studies-amend to 

quarterly updates as part of existing quarterly report 

Congress. 

• Section 7: Authority to terminate FHA Mortgagees 

• Section 15: Require an independent safety and sound

review under GAAP and statutory regulatory account

applicable to the private sector. 

• Section 16: Apply an SEC-style disclosure standard to 

80867.102

Step 2: Apply proven VA best practic

to FHA 

• Reduce maximum claim coverage to 80 perc

from the current 100 percent, with an ultima

goal of 25 percent. 

• Reinstate the use of an appraisal board. 

- This would replace the current system where th

lender chooses the appraiser. 

- This would help assure the quality of homes bou

by working class families. 

• Require the use of residual income. 

- This is consistent with CFPB advice on higher de

to-income loans 

80867.103

Step 3: Needy Families Need FHA's Full Attention 

• Focus on working class families & neighborhood

by replacing a mortgage limit with an income te

• Set maximum FICO score at 675 (580-675 range 

=25% of all households and 40% of Blacks, >675 

64% of all households and 28% of Blacks). 

• Eliminate specific risks that are difficult to offse

with lower-risk features: 

- FICO scores below 580 (11% of all households, 33% of Bla

- Adjustable rate mortgages. 

- Seller concessions greater than 3 percent. 

80867.104

Step 3: Needy Families Need FHA's Full Attention 

Credit Score Distribution by Demographic Groups 

Fed study Fed study Fed study FHA serious 

interest credit score default delinquency Non-Hispanic 

rate distribution rate rate white Black His

Credit score 

band 

<580 9.56% 11% 30% 30% 8% 33% 

580-619 8.94% 8.50% 18% 20% 7% 20% 

620-659 7.30% 10.50% 14% 11% 9% 15% 

660-719 6.40% 19% 5% 

2% 

20% 17% 

>719 6.10% 51% 1% 55% 16% 

Some results interpolated to standardize across credit score bands 

Source: Federal Reserve, Report to the Congress on Credit Scoring and Its Effects on the Availability and 

Afforda bility of Credit, May 2007, 

80867.105

Step 3: Needy Families Need FHA's Full Attention 

Responsible Underwriting Expands FHA's Targeted Mission, w

Positive Policy Impacts 

1.9:1 

Source: Estimates based on Federal Reserve, Report to the Congress. 

80867.106

Step 4: Establish a Tolerance for Failure 

• Key policy question: what is the tolerance for 

financing failure? 

- What is the tolerance given the concentration of 

failure that occurs with respect to working class families and neighborhoods? 

- Limit/adjust risk layering to meet target projecte

average claim rates of 5-6 per 100 insured loans 

under normal circumstances and 10 per 100 insu

loans under stress circumstances. 

- Risk balance down payment, loan term, and deb

income when FICO <660. 

80867.107

Step 4: Establish a Tolerance for Failure 

Down Payment, Loan Term, 3ind Debt-to-Income Ratio to Ach.ieve 

:\1e'liDiugfol Equity 

Not€: For ar€oa8€d atth€maximur

andt€m1witha rat€of6perc€nt,a rat€of5.i5percent,ancia 

of 5.5 percent. M.aximurn L 1'\' ','lith up front mortgag€ insmanc€ D!€mlUn1 financ€d. 

Somc€: Author. 

80867.108

Step 4: Establish a Tolerance for Failure (2

• A 5-6% FHA claim rate is both desirable and feasible 

- It is not true that only lending to high-risk borrowers (Iowincome and first-time borrowers with less than 680 FICO sc

would inevitably force up FHA claim rates and make FHA ev

more insolvent. 

- About 24% of all households (not homeowners) have a FICO 

580-675. This market segment provides plenty of potential 

borrowers for FHA to responsibly insure. 

• Implementing the risk mitigation steps outlined on the 

previous slide, along with sensible process reforms such 

a return to appraisal panels, the use of residual income, 

and a limit seller concessions to 3%, would result in: 

- An average FICO of about 640 (FHA is at 700 today), which 

would not compete with the private sector. 

- Loans with a weighted average claim rate of 5-6%. 

80867.109

Step 5: Fiscal Reform 

• Use of generally accepted accounting principles (GAAP) 

applicable for private mortgage insurers with respect to 

quarterly examinations of the FHA's financial condition

• Require the maintenance of a minimum capital level of 

calculated in accordance with GAAP as applied to priva

mortgage insurers. 

• Set FHA's premium structure where 50 percent of the 

premium is sufficient to meet normal claim expectationinsured loans. 

- Unused portions would accumulate in the capital reserve 

account. 

- The remaining 50 percent would accumulate in a separate 

countercyclical catastrophic premium reserve for a is-year 

period and would be available to pay catastrophic losses fr

periodic but unpredictable general economic risks. 

80867.110

Reform Merits Bi-partisan Support 

• Positive impact of FHA providing responsible lending to 

borrowers with 580-675 FICO scores: 

- Refocuses FHA to its core mission of responsibly serving workin

class families and communities. 

- 580-675 FICO score band has 24 percent of individuals with a 

scoreable credit record, but contains: 

• 34 percent of low- and moderate-income Americans, 

• 38 and 30 percent of Blacks and Hispanics, and 

• 31 percent of under age 30 individuals. 

- Responsible reforms can serve this group, cut FHA's historic fai

rate in half, and not increase FHA's fiscal challenges. 

• These steps will go a long way in eliminating the Quadrant

Doom. 

• FHA's primary mission must be to serve working class fami

and communities, not the interests of the NAR and other l

groups. 

• I pledge to work with any member to make this a reality. 
154 


80867.111

I. Introduction 

"FHA: The Need to Scale Back Their Market Share" 

Prepared for 

HEARING ON FEBRUARY 6, 2013 

BEFORE 

THE COMMITTEE FINANCIAL SERVICES, 

U.S. HOUSE OF REPRESENTATIVES 

WRITTEN TESTIMONY OF ANTHONY B. SANDERS 

Senior Scholar, The Mercatus Center 

Professor of Real Estate and Finance, School of Management 

George Mason University, Fairfax, Virginia 

Chairman Hensarling and distinguished members of the committee, thank you for the invitation to 

testify at today's hearing on "Examining the Proper Role of the Federal Housing Administration in our 

Mortgage Insurance Market" and to provide my perspective on the ongoing mortgage debacle, the 

resulting decline in the private mortgage insurance market and the need to return the FHA's share of 

the insurance market back to pre-bubble levels. I am Anthony B. Sanders, Senior Scholar at George 

Mason University. 

The Federal Housing Administration (FHA) has seen its conforming loan limit surge to $729,750 (1 unit) 

for high balance loans while mortgage giants Fannie Mae and Freddie Mac have seen their conforming 

loan limits for high balance loans fall to $625,500 (1 unit). When this artificially high conforming loan 

limit is combined with the FHA's high loan-to-value (LTV) and low credit score polices, we have a recipe 

for inordinate harm to fragile households. 

II. FHA's Market Share and Risky-lending Profile 

The FHA's market share surged from below 5% during the housing bubble to over 30% in 2008 (see 

Figure 1). To be sure, the decline in FHA share during the housing bubble was in part due to the rise of 

private-label securitizations (see Figure 2). As the FHA's share of mortgage originations (insured) is at 

over 25%, it is time for the footprint of the FHA to shrink back to previous market shares such as in 2003 

when it was around 10%. 

In terms of loan-to-value ratio, the FHA insures a large percentage of low down payment, high LTV loans 

(see Figure 3). The percentage of FHA's book that was high LTV (>= 5% down payment) was around 33% 

in 1990. That percentage almost double by 1995 to 62.36% as the Clinton Administration adopted "The 

National Homeownership Strategy: Partners in the American Dream" calling for lower down payments 

1 
155 


80867.112

and streamlined financing. ' The share of high LTV loans has risen to 71.52% in 2012 (although it peaked 

in 2000 at 84.61%. 

In terms of credit (or FICO) scores, the FHA's data is very spotty prior to 2005. But from 2005 to 2012, 

the percentage of borrowers with low FICO scores (defined as 680 or below) peaked in 2007 at 80.58% 

(see Figure 4). The percentage of low FICO borrowers has declined to 42.54% in 2012, a noticeable 

improvement. 

What is the result of the FHA's low down payment and low FICO policies? The FHA's book of loans in 

2008 has been nothing short of disastrous (see Figure 5). To be sure, unemployment rose dramatically 

in 2008 as house prices declined rapidly (see Figure 6) which contributed to poor loan performance on 

most mortgages, particularly low FICO and low down payment loans. 

To observe the dangers to households (and taxpayers) of low down payment loan coupled with low FICO 

scores, see the loan performance of Enterprise (e.g., Fannie Mae and Freddie Mac) purchased fixed-rate 

mortgages. The low risk loans are defined in each year as FICO score >= 660 and LTV <= 80% and are in 

the upper right hand corner. The high risk loans are defined as FICO score < 660 and LTV> 80%. These 

high risk loans are found in the lower left had corner. The coloring of yellow and orange signify 

excessively high 90% delinquency rates. 

For example, for the 2007 vintage of Enterprise-purchase mortgages, the serious delinquency rate for 

FICO scores < 620 and LTVs >= 97.5 and <= 104.9 was 51.6%. 

The typical domain of the FHA is the lower left hand corner: the high risk loans. 

III. Does FHA Help or Harm American Households? 

In President Thomas Jefferson's inaugural address of 1801, he stated: 

"Still one thing more, fellow citizens, a wise and frugal government, which shall restrain men from 

injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and 

improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of 

good government; and this is necessary to close the circle of our felicities." 

Jefferson's statement applies to the FHA which has harmed American households through insuring risky 

(low FICO) loans with minimal down payments. This is very poor public policy. 

An example of harming American households can be seen in Figure 7 (courtesy of Ed Pinto at the 

American Enterprise Institute). 2 Expected foreclosure rates in the Greater Washington DC are clustered 

1 http://conlouodedinterest.files,wordpress.com/20 131011n hsd rea m2.pdf 

2 http://www.aei. org/files/2013!Ol!07!-how-the-fha-h u rts-workingclass-fa m ilies-a ndcommunities 133838366627.pdf 

2 
156 


80867.113

almost exclusively in working class neighborhoods in Maryland. While homeownership may be the 

American dream, insuring high risk borrowers increases the likelihood of a disaster. 

III. Reducing Loan limits 

The FHA's loan limit is now higher than the conforming loan limits for Fannie Mae and Freddie Mac. But 

both the conforming loan limits and the FHA's loan limit rose dramatically in 2008 as house prices 

collapsed. The first step towards shrinking the FHA's footprint is to reduce the loan limit to $625,000 

and by another $100,000 per year. 

According to a study by Robert Van Order and Anthony Yezer of George Washington University3 they 

find that current FHA policies are unlikely to assist the FHA in reaching its historical constituenciesfirst-time, minority and low-income homebuyers. 

"We find that FHA's current market share exceeds what is needed to serve these markets," Van Order 

continued. "In the wake of significant declines in home prices, we believe FHA could reduce its loan 

limits by approximately 50 percent and still almost entirely satisfy its target market. That would reduce 

its currently large market share, which is difficult for FHA to manage." 

IV. Installing a Credit Score Floor and DTI and LTV Ceilings 

In order to protect households (and taxpayers), a floor should be installed for FHA insured loans at 660. 

As you can see in Table 1, loan performance deteriorates rapidly with FICO scores below 660. 

In addition, a maximum lTV of 95% should be applied. And if the FICO score if below 680, a 10% 

minimum down payment should be required. 

A maximum mortgage debt to income of 31 percent should be established as well. 

V. FHA 30 Year Spread 

The FHA has the highest spread of FHA 30 mortgage rates to GNMA 30 year current coupon rate (the 

rate paid to GNMA investors) of any of the government finance entities, including Fannie Mae and 

Freddie Mac. (see Figure 9). The spread is considerably above levels prior to 2008. In other words, the 

Federal Reserve's manic pushing of interest rates and mortgage rates downwards is NOT getting passed 

through to borrowers as had been hoped. 

VI. Summary 

The FHA's low down payment, low FICO score policies with a 100% guarantee encourages risk taking by 

working class households when there is a viable alternative: renting. But simple adjustments to FHA's 

policies of 1) FICO score floor of 660,2) minimum down payment of 5%, 3) lower loan limit to $625,000 

3 http://business.gwu.edu(creua(research-papers(files(FHA2011Q2.pdf 

3 
157 


80867.114

and eventually to $350,000 (or less), and 4) lower the insurance coverage to 80%. All these measures 

can serve to reduce the FHA's substantial, high-risk footprint in the mortgage market. 

Thank you for the opportunity to testify. 

4 
158 


80867.115

Figure 1. FHA as a Percentage of Mortgage Originations By Type 

FHA As 11 Per<:ent or Mortg.age Originations By Type 

a:::J Purchase 

Sources: MilA and !iUO. 

_Refinance -Combined 

Figure 2. Market Shares of GSE, FHA and Private Label Securitizations 

5 
159 


80867.116

Figure 3. FHA Concentration of High Loan-to-Value Loans 

FHA Concentrations of High LTV Loans 

90.00 

~ 

I '" - BCtOO 

I '\ r 

/ - - ( 

I 

60.00 

503)0 

40.00 

30.00 

20.00 

10.00 

0.00 

'" ,..; N '" :s,t; '" '" "- ro '" "" .-\ N m g '" "' '" ro '" '" rl N 

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--Percentage of>95% LTV 

Source: Mortgage Bankers Association 

6 
160 


80867.117

Figure 4. Percentage of FHA Book with Credit Scores Less Than 680 

Percentage of FHA Book with FICO Score less than 680 

90.00 

150 .. 00 

v 

?fi 40.00 

. ._---

--- ~ ''', ~ -

&100 

70.00 

60.00 

30.00 

20.00 

1 Cl.OO 

0.00 

2005 2005 2007 2008 

68Q FiCO 

Source: Mortgage Bankers Association 

7 
161 


80867.118

Figure 5. Trend in Serious Delinquency Rate for FHA Loans 

fHAloans: Trend in Seriously Delinquent Rate 

Source: Mortgage Bankers Association 

8 
162 


80867.119

Figure 6. Case-Shiller 10 HPI and U6 Unemployment 

9 
163 


80867.120

Table 1. Enterprise-acquired Fixed-rate Mortgages, 90+ Day Delinquent, 2001-2004. 

10 
164 


80867.121

Table la. Enterprise-acquired Fixed-rate Mortgages, 90+ Day Delinquent, 2005-2008. 

11 
165 


80867.122

Figure 7. Projected Foreclosures Rate in the Greater Washington DC Area 

Highest foreclosure 

and greatest 

loan volumes are 

concentrated in 

12 
166 


80867.123

Figure 8. Conforming Loan Limits and Home Prices 

Conforming loan limits and Case-Shiller 20 Metro Home Prices 

SO(J,COO F~':A 

700,COO 

500,000 

SOO.COO 

i 

'if 400,000 

"* 

Ii ..• \ ...••........... 

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30(J,COO :;;~; ....... 200.000 

100000 

2000 2001 2002 2000 2004 2005 2005 ZOO] 200!! 2000 2010 2011 2012 

--Genera~ 

13 
167 


80867.124

Figure 9. FHA 30 Year Mortgage Rates - Ginnie Mae 30 Year Current Coupon Rate 

15 
168 


80867.125

U.S. Department of Housing and Urban Development 

r. Appendix A: Summary of FHA Policy Changes under 

the Current Administration 

1. Changes implemented via mortgagee letter with an implementation date of Jannary 

1,2010: 

a. Modifications to streamline refinance documentation requirements 

b. New appraisal standards 

c. Submission of audited financial statements required for supervised lenders 

2. Mortgage insurance premium (MIP) increase and adjustments to upfront/annual 

MIP relationship 

a. 1112/2010 - Increased Upfront MlP to 2.25% 

b. 10/4/2010 

i. Lowered up front MIP to 1% 

ii. Raised annual MIP to 85 to 90 basis points 

c. 4/18/20 II - Increased annual MIP by 25 basis points 

d. 4/9/2012-

i. Increased upfrontMIP from I%to 1.75% 

ii. Increased annual MIP by 10 basis points 

e. 6111/2012 -Increased annual MIP for loans in excess of $625,500 by 25 basis 

points 

f. 4/112013 - Increased annual MIP by 5-10 basis points, depending on loan amount 

and LTV. 

3. New down payment reqnirements 

a. Mortgagee Letter effective October 4, 2010 

i. Loans to borrowers with a FICO of 579 or lower require a minimum 10% 

down payment 

ii. Loans to borrowers with a FICO of 580 or above require current minimum 

3.5% downpayment 

iii. Minimum FICO 0[500 

b. Federal Register Notice published February 6, 2013 

i. Loans to borrowers seeking loans above $625.500 require a 5% 

down payment 

4. Enhanced underwriting requirements 

a. Mortgagee Letter effective April 1, 2012 

i. Updated documentation requirements for self-employed borrowers 

ii. Offered new guidance on disputed accounts 

111. Expanded the definition of family members for identity of interest 

transactions 

b. Mortgagee Letter published January 31,2013 

1. Borrowers with credit scores below 620 and debt to income ratios over 

43% subject to manual underwriting 

Financial Status of the FHA Mutual Mortgage Insurance Fund FY 2012 - updated FebruGfY 2013 Page 1 
169 


80867.126

U.S. Department of Housing and Urban Development 

5. Changes to the HECM Program 

a. Mortgagee Letter effective October 4, 2010 

i. Introduced HECM Saver, which provides a lower upfront premium 

(.01 %) and a lower max principal limit 

ii. Increased annual MIP to 1.25% 

iii. Adjusted the HECM Principal Limit Factors, resulting in lower maximum 

principal limits 

b. Mortgagee Letter published January 3, 2011 

i. Provided detailed guidance regarding the property charge loss 

mitigation requirements for HECM loans 

c. Mortgagee Letter published January 30, 2012 

i. Consolidated Fixed Rate Standard and Fixed Rate Saver programs 

6. Inereased enforcement for FHA-approved lenders 

a. Enforcement actions taken against lenders 

I. Heightened enforcement of HUD requirements for FHA-approved 

lenders has yielded over: 

I. 1,780 lenders withdrawn from FHA's program as a result of 

violations of FHA approval, origination, or servicing 

requirements. 

2. Imposition of more than $14.26 million dollars in civil 

money penalties and administrative payments for FHAapproved lenders 

ii. Issued notice to lending community that FHA will pursue directly 

or through Federal partners those who advertise access to FHA, 

particularly after foreclosure or other credit impacting event, does 

not require satisfaction of all FHA loan origination and 

underwriting criteria 

b. Mortgagee Letter effective January 21, 20 10 

i. Enhanced monitoring of lender performance and compliance with 

FHA guidelines and standards. 

ii. Expanded the Credit Watch Termination Initiative to include 

evaluation of lender underwriting performance in addition to 

origination performance 

c. Implementation of statutory authority through regulation of section 256 of the 

National Housing Act to enforce indemnification provisions for lender's using 

delegated insuring process 

i. Final rule published January 25, 2012, with an effective date of February 

24,2012 

ii. A Mortgagee letter and Lender Insurance guide will soon be issued to 

implement this new rule. 

d. Additional authority sought by FHA through legislation: 

i. Amendment of section 256 of the National Housing Aet to apply 

indemnification provisions to all Direct Endorsement lenders. This 

would require all approved underwriting mortgagees to assume liability 

for all of the loans that they underwrite 

Financial Status of the FHA Mutual Mortgage Insurance Fund FY 2012- updated FebruQly 2013 Page 2 
170 


80867.127

U.S. Department onlousing and Urban Development 

ii. Legislative authority permitting HUD maximum flexibility (0 establish 

separate "areas" for purposes of review and termination under the 

Credit Watch initiative. This would provide authority to withdraw 

originating and underwriting approval for a lender nationwide or in a 

specific area on the basis of the performance of its regional branches 

7. Changes to FHA lender approval requirements 

a. Final rule published week of April 20, 20 I 0 

i. Increased net worth requirements for approved mortgagees. All new 

lender applicants for FHA programs must possess a minimum net 

worth of$l million. Effective one year from enactment of the rule, 

current FHA approved lenders, with the exception of small 

businesses, must possess a minimum net worth 0[$1 million. Current 

FHA-approved small business lenders must possess a minimum net 

worth of $500,000. Effective three years after enactment of the rule, 

approved lenders and applicants to FHA single-family programs, 

regardless of size, must have a net worth of $1 million plus I % of 

total loan volume in excess of $25 million 

ii. Eliminated independent FHA approval of mortgage brokers who 

originate but do not underwrite loans. FHA-approved mortgagees who 

underwrite loans retain strict liability for all loans, regardless of 

origination via their retail operations or through their sponsored 

mortgage brokers 

iii. Codified requirements for submission of audited financial statements 

by supervised mortgagees 

b. Mortgagee Letter published on January 5, 2011 

i. Required mortgagees that possess NMLS IDs to provide those to FHA 

for both lender approval and loan origination processes 

c. Mortgagee Letter effective July 28, 2011, provided alternative financial 

reporting requirements for small supervised lenders to decrease burdens 

associated with FHA's lender approval and renewal processes 

8. Updated Quality Control Requirements for Direct Endorsement Lenders 

a. Mortgagee Letter effective January 5, 2011 

i. Updated FHA's quality control requirements to include new 

requirements related to Sponsored Third Party Originators, reporting of 

fraud and material deficiencies, and recording of sales or transfers of 

FHA mortgages 

9. Refinance Program Policy 

a. Mortgagee Letter published February 14,2011 

i. Extensive guidance regarding requirements and changes for FHA 

Standard and Streamlined refinance programs 

b. Mortgagee Letter published March 6, 2012 

i. For borrowers who are current on their loans, FHA reduced the upfront 

and annual MIPs for Streamline refinances of FHA-insured loans 

Financial Status of the FilA Mutual Mortgage Insurance Fund FY 2012-" updated February 2013 Page 3 
171 


80867.128

U.S. Department of Housing and Urban Development 

endorsed on or before May 31, 2009 to permit these borrowers to take 

advantage of historically low interest rates, reducing their payments and 

decreasing risk to FHA 

10. Consolidated and updated FHA condominium policy 

a. Mortgagee Letter issued June 30, 2011, and effective August 29, 2011 

i. Consolidate guidelines published in 2009; 

ii. Provide a single source of information for the Condominium 

Approval and Recertification Process; 

iii. Update, consolidate and clarify existing condominium policy 

guidance; and 

iv. Expand FHA's flexibility to consider exceptions at the individual project 

level 

b. Mortgagee Letter issued in summer 2012 to revise updated guidance 

11. Reduction in allowable seller concessions 

a. Proposed policy change published in June of2010 

i. Received over 1,000 comments, prompting extensive additional analysis 

which led to substantial revisions to the rule 

ii. New proposed rule published February 23, 20]2 

iii. Final Rule Expected in 2013 

12. Enhanced and expanded loan sale program 

a. Effective with the quarterly sale that took place in September 2012, FHA 

expanded the 601 Note Sales Program, now known as the Distressed Asset 

Stabilization Program, providing the opportunity for better outcomes for 

borrowers, communities and FHA on non-performing loans. 

Financial Status of the FHA Mutual i'-'fortgage Insurance Fund FY 2012- updated February 2013 Page 4 
172 


80867.129

CAROLYN B. MALONEY 

14TH OlSTf'iICl, N~wYoRl( 

RNANC1ALSERVICES 

OVERS!GHT AND 

GOVERNMENT REFORM 

JOf~T ECONOMIC COMMITTEE 

QL:ongress of tbe ~niteb ~tates 

J,!,loU%C of l\epre%entatibe% 

llmimJ!)ington, lll( 20515-3214 

November 9, 2012 

The Honorable Shaun Donovan 

Secretary 

U.S. Department of Housing and Urban Development 

451 7th Street SW 

Washington, DC 20410 

Dear Secretary Donovan, 

N~w YOI't><:, NY 10128 

1Z11) 860··0606 

W(osm:http://rna!oney.hcuse.g.ov 

[have read several press reports over the last week concerning the health of the Mutual Mortgage 

Insuranee Fund (MMI Fund) which included projections that the FHA may need to draw down funds 

from the Department of Treasury to cover expected claims over the next 30 years. Accordingly, I am 

writing to request information conceming the FH}\ 's ability to cover expected losses based on the :M:MI 

Fund's current levels. 

The foreclosure crisis of the last four years has put enormous stress on the housing market and its ability 

to recover from the losses we experienced starting in 2007. I understand that losses from loans originated 

between 2005 and 2008 will likely continue to be a drag on the Fund. However, the FHA insures a much 

larger share of the market than it did before the crisis and, as a resul~ several steps have been taken since 

2009 to help sure up the Fillld. These include increases in insurance premiums, new rules requiring higher 

risk borrowers to make higher down payments and efforts to mitigate losses on delinquent loans. The 

FHA has also reportedJy recovered approximately $900 million as part of the mortgage servicing 

settlement. These actions will likely bolster the agency's reserves, however, I believe it is important to 

know whether they will ward off the need for temporary support from the U.S. Treasury. 

I am hoping you can provide my office infonnation about the capital reserves in the MMI Fund which are 

dangerously low and only slightly above the 2% level that is required by law. Specifically, to what extent 

are you concerned that the Fund is operating so close to the 2% level? In addition, what is the likelihood 

that FHA will need to access funds from the U.S. Treasury and what additional steps will the FHA take to 

ensure it does not need to access those funds? Finally~ please advise my office as to the efforts by the 

FHA to enforce the nIles that are designed to stem foreclosures and decrease further losses. 

Thank you for your assistance with this request. I look forward to working with you to address the 

housing crisis that has been holding back economic growth in our country. 

s:&y, / ~J:t~~:4-- Member of Congress U 
173 


80867.130

LIse 

"- ~eIpi;;g neighbors 

build communities 

February 5,2013 

The Honorable Jeb Hensarling 

Chainnan, House Financial Services Committee 

U.S. House of Representatives 

Washington, DC 20515 

The Honorable Maxine Waters 

Ranking Member, House Financial Services Committee 

U.S. House of Representatives 

Washington, DC 20515 

RE: February 6, 2013 House Financial ServieesCommittee Hearing on "The Role 

of the Federal Housing Administration in Housing Finance" 

Dear Chainnan Hensarling and Ranking Member Waters: 

Thank you for the opportunity to comment on role of the Federal Housing Administration 

(FHA) in financing the nation's homeownership. This is an important topic regarding an 

essential element of our communities' stability and that of the entire economy. 

The Locallnitiatives Support Corporation (USC) is dedicated to helping community 

residents transfonn distressed neighborhoods into healthy and sustainable communities of 

choice and opportunity - good places to work, do business and raise children. LISC 

mobilizes corporate, government and philanthropic support to provide local community 

development organizations with financial, technical and policy resources. We are a 

national organization with a community focus, with local LISC offices in 30 different 

cities and partnerships with a network of 60 rural organizations. Our program staff in the 

cities and the rural areas where we work collaborate actively with local community 

development groups, to help identify priorities and challenges, and to deliver the most 

appropriate support to meet local needs - whether it's in the area of housing, economic 

development, education, healtheare, community safety, or building family income and 

wealth. 

Our perspective on FHA is based on our long history of supporting urban and rural 

homeownership in the communities we serve. We have supported the creation of over 

30,000 units for single-family homeownership and recognize the importance of this stock 

to our communities. We have seen the best and the worst of how the housing finance 

system affect low-income metropolitan and rural communities and their residents. 

Our message today is basically that while lessons are still being learned from the effects 

of the Great Recession on the FHA, and vice versa, we continue to have confidence in the 

FHA and the ongoing importance of its mission. 

LOCAL INITlATlVES SUPPORT CORPORATION 

1825 K Street, NW, Suite 1100 • Washington, DC 20006 • Phone 202.785.2908. Fax 202.835,8931 

w\VW.f.1Sr. ORr. 
174 


80867.131

In our March 23, 2010 testimony to this Committee, we stated that an important lesson 

from the recent historic downturn is that the long-term interests of consumers and lenders, 

and of communities and the financial system, are and must fundamentally align rathcr 

than conflict. Further, we must ensure that all communities and their residents are 

included within the financial mainstream, consistent with safety and soundness. 

Anything less would only undermine opportunity and prosperity. Many of the problems 

of the recent past resulted when short-term expediencies in the private market 

unfortunately overtook long-term prudence. The resulting collapse of private home 

mortgage financing underscores the significance of the FHA as a public anchor for 

community sustainability. 

We also stressed that: 

• FHA (as well as private capital markets that are aggregated through any future 

GSE structure) should provide low- and moderate-income people with full and 

equitable access to mainstream capital markets. 

• Capital access for all communities, including economically distressed, lowincome, rural, and minority communities, on a fair, equitable and sustainable 

basis, is essential to the economic and social viability of these communities. 

• Liquidity is necessary in all economic eonditions, and FHA is an essential part of 

ensuring that continuity. 

We do not address here differing interpretations of the FHA's safety and soundness in the 

wake of the recent GAO report, except to note that, despite a negative capital ratio at this 

time, the Fund is not illiquid. Further, HUD projects material improvements in the 

Fund's capital position in 2013. 

The FHA mortgage insurance fund serves several critical purposes: 

It is a countercyclical anchor to spatial, temporal and credit risk weaknesses. Even 

as its market share decreases towards more historically typicalleve1s, this role will 

remain important, as the housing finance system undergoes further transformation and 

while major demographic shifts play out. 

Rather than crowding out private lending activity, FHA has provided a stable and 

responsible source of mortgage lending capital after the collapse of the market for private 

originations. This has helped to prevent further price deterioration and loss of credit 

availability, especially in hard-hit locations. Arguably, this stability has also protected 

the nation against another recession. 

Although the delinquency rate on FHA-insured loans increased to over 25 percent on 

loans originated in 2007 and 2008, that rate has dropped substantially and FHA's overall 

delinquency rate today remains hcalthier than that of subprime fixed-rate mortgages, and 

both prime and subprime Adjustable Rate Mortgages (ARMs). 

The full faith and credit of the federal government has been an important component of 

the FHA's ability to provide this stability, and any proposals to modify this policy should 
175 


80867.132

be carefully assessed to avoid unintended consequences that could include loss of FHA's 

ability to fill the gaps it was intended to address. 

The Fund also provides access to credit for homeowners with a wide range of 

economic circumstances. Low down payments remain an essential component of access 

to homeownershlp for families oflimited means. This does not mean that FHA's 

underwriting is unsound. In fact, even as subprime default rates soared to over 30 

percent during thc downturn, FHA default rates were less than half that level. 

The FHA has been a leader in innovation and standardization. The 30 year fixedrate mortgage, GNMA securitization of FHA-insured mortgages, and research leading to 

the development of credit scoring are examples of instances in which the FHA has led the 

way in developing new industry standards. The Administration's HUD team combines 

innovation with prudence in the administration of FHA. We recognize that some product 

features have contributed to Fund losses, such as seller-financed down payments. 

However, HUD made attempts to curb this practice, and the Housing and Economic 

Recovery Act of 2008 (HERA) finally prohibited it. The essential public purpose of 

responsible FHA innovation ~houl:! b;; ::ncouraged and continued. 

We believe that a healthy housing market is necessary not only to meet household shelter 

needs, but also to support the economy as a whole. FHA has a key role in that market, 

and its continued flexible administration should be commended and continued, even as 

we work together to seek continued improvements. 

LISC commends Chairman Hensarling and Ranking Member Waters for bringing 

attention to the role of the FHA and the importance of the FHA Insurance Fund. We look 

forward to working with you on any efforts designed to promote affordable housing 

solutions. For further information, please contact Barbara Burnham, Vice President for 

Federal Policy, at 202-739-0896 or bburnham@lisc.org. 

Sincerely, 

~~;~~ Vincent O'Donnell 

Vice President, Affordable Housing Preservation Initiative 
176 


80867.133

Introduction 

Statement of the National Association of Home Builders 

Hearing on 

"The Role ofthe Federal Housing Administration in Housing Finance" 

House Committee on Financial Services 

February 6, 2013 

The National Association of Home Builders (NAHB) appreciates the opportunity to submit a 

statement in support of the single family and multifamily mortgage insurance programs of the 

Federal Housing Administration (FHA). NAHB represents over 140,000 members who are 

involved in building single family and multifamily housing, remodeling, and other aspects of 

residential and light commercial construction. NAHB's builder members construct 

approximately 80 percent of all new housing in America each year, and many of our builders 

rely on the use of the programs of the Department of Housing and Urban Development (HUD) 

(largely FHA's) in order to help provide decent, safe, and affordable housing to many of our 

fellow citizens. 

NAHB supports efforts to reform FHA, and we understand that this is not a simple undertaking, 

yet we want reform to be approached with a certain degree of caution. Reform of these 

programs cannot be separated from the larger discussion of reforming the complex housing 

finance system, including future reforms to Fannie Mae and Freddie Mac. While the recent FHA 

actuarial report is troubling, and certainly deserving of congressional oversight, NAHB urges 

Congress to proceed cautiously and not significantly alter the structure or role of FHA programs. 

The FHA was created in 1934 during the Great Depression to promote stability in the housing 

marketplace and has been viewed as a housing finance innovator by insuring millions of 

mortgage loans since its inception. In its nearly 80 year history, the agency has successfully 

achieved its mission at no cost to taxpayers. The fact that the FHA finds itself in this position 

now, as opposed to four years ago during the height of the financial meltdown, is testament to 

its ability to meet its mission in these difficult economic times. 

While there is no doubt that the housing finance system needs to be reformed, the contributions 

that the FHA has made during this economic downturn underscore the need for a government 

backstop for both the primary and secondary mortgage markets. In times of crisis, private 

financial institutions have been unable or unwilling to meet housing capital needs. Without 

government support for home purchasing and refinancing, the nation's mortgage markets will 

grind to a halt in times of economic stress and uncertainty, throwing the economy back into 

recession. 

Given the significant role that housing plays in the economy, Congress needs to take a longterm, holistic approach to housing finance reform. NAHB stands ready to work with the House 

Financial Services Committee to achieve such reforms and provide much-needed stability for 

this critical sector of the economy. 
177 


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Statement of the National Association of Home Builders 

February 6, 2013 

Page 2 

Importance of the Federal Housing Administration for Single Family and Multifamily 

Mortgage Financing 

Since the creation of the FHA, it has had a long track record of achievement in insuring loans for 

over 37 million American families, many of whom would not otherwise have been able to own a 

home. FHA pioneered the concept of a 30 year fixed-rate mortgage and low down payments, 

and the nation still benefits from that program today. FHA maintains strong underwriting criteria 

to protect the tax payers and is intended to be self-funded through the upfront and annual 

mortgage insurance premiums that borrowers pay. 

Contrary to the belief of some, FHA is not a subprime lender and has never required a federal 

bailout. Although the single family mortgage insurance program is experiencing shortfalls in its 

excess reserves due to the effects of the worst economic downturn since the Great Depression, 

FHA remains an integral part of our nation's economic recovery. Housing has led America out 

of every economic downturn and can do so again if the future policies regarding housing finance 

reform are addressed in a manner that provides liquidity for the entire housing sector in all 

markets. 

Looking at the dramatic increase of FHA's market share of single-family mortgages over the 

past few years, it is clear how essential the program is for our nation's economic recovery. 

Since the downturn in the housing market, FHA has become the primary source of mortgage 

credit for first-time home buyers, minorities and those with limited down payment capabilities as 

other sources of mortgage credit have disappeared. During this time, FHA's share of the market 

jumped from 3 percent during the housing boom to a high of almost 30 percent early in the 

cnSIS. Nearly 80 percent of FHA's purchase loans have been to first-time home buyers. This 

dramatic shift is evidence that FHA is performing its mission of providing the federal backstop to 

ensure that every American has access to a stable mortgage product. While NAHB believes 

that the private market should be the primary source of mortgage financing, that market is 

extremely limited; until it returns, FHA and other federally backed programs are needed to keep 

our economy afloat. 

FHA historically also has played an important role in the financing of multifamily rental housing, 

and it is especially important now during the current economic crisis. In 2008, FHA endorsed 

just over $2 billion in multifamily loans (excluding health care programs), which grew to $14.6 

billion in FY2012. The FHA multifamily mortgage insurance programs are fulfilling the function 

and mission for which Congress originally intended. 

FHA Single Family Mortgage Insurance Programs 

The FHA single-family mortgage programs are a unique and vital component of the housing 

finance system, providing access to homeownership for underserved communities, primarily 

first-time homebuyers, minorities and those with limited down payment capabilities. During the 

recent mortgage crisis FHA demonstrated how invaluable their counter-cyclical role was in 

providing mortgage market liquidity during the country's unstable housing market system. This 
178 


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Statement of the National Association of Home Builders 

February 6, 2013 

Page 3 

role has not been without costs to the FHA program as evidenced by the recent actuarial 

studies of the FHA's Mutual Mortgage Insurance Fund (MMIF). 

FHA has implemented a series of policy changes over the last couple of years, including higher 

mortgage insurance premiums, tighter underwriting requirements, stricter mortgage lender 

enforcement, and improved risk assessment all intended to strengthen the performance of the 

Mutual Mortgage Insurance Fund (MMIF) and rebuild the capital reserve ratio. These changes 

are the most sweeping combination of reforms to credit policy, risk management, and lender 

enforcement in FHA history. 

NAHB generally has been supportive of FHA's changes to bolster the MMIF. However, NAHB 

strongly believes that such changes must be balanced to ensure the ability of FHA to maintain 

its critical mission of providing support for homebuyers. 

FHA reform must modernize FHA's operations allowing the agency to operate more efficiently 

and effectively. FHA should be provided the necessary tools that reflect its importance to 

housing finance. Reform must be implemented in a structured process to ensure access to 

responsible credit and support for home buyers during this tenuous juncture in the economic 

recovery. 

FHA Multifamily Mortgage Insurance Programs 

NAHB has long-supported the FHA multifamily mortgage insurance programs. These 

programs, notably Section 221 (d)(4) and Section 223(f), have enabled the construction of 

needed affordable and market rate rental housing units over the years, as well as contributed to 

the ability of property owners to acquire, refinance, rehabilitate and preserve the nation's 

existing stock of rental housing. Of importance, FHA financing is often used in smaller markets 

where the government-sponsored enterprises (GSEs) and other market participants are less 

active, and FHA has filled the niche that local banks and thrifts have retreated from in recent 

years. 

It is important to note that over the last two years, HUD has instituted new risk management 

protocols for the FHA multifamily mortgage insurance programs. The new protocols tightened 

underwriting requirements and created a national loan review committee. New policies were 

implemented for large loans, including higher standards for sponsor creditworthiness and 

experience. Processes and procedures throughout the field offices have been strengthened 

and standardized. There is closer scrutiny on market strength and FHA presence than before 

the economic crisis struck. 

In addition, HUD revised and tightened lender capitalization, licenSing and monitoring 

requirements, made significant changes as part of the update of the loan closing documents, 

and finalized several changes to the multifamily mortgage insurance program regulations. The 

most recent step taken was raising the mortgage insurance premiums for programs in the 

General Insurance/Special Risk Insurance fund (GI/SRI). This was the first premium increase in 

10 years for these programs. 
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Statement of the National Association of Home Builders 

February 6, 2013 

Page 4 

All of these actions were intended to strengthen risk management practices related to the FHA 

multifamily mortgage insurance programs, ensure the health of the GI/SRI fund, and attract high 

quality borrowers, without taking market share from the private sector or endangering taxpayers. 

NAHB has been actively engaged in working with the department as these requirements have 

been implemented. Although NAHB has not agreed with every action taken, overall we have 

supported HUD's objectives and have worked to ensure that borrowers and lenders understand 

the changes. 

Conclusion 

Few things are more important to Americans than their homes. Whether they rent or own, 

Americans want to choose where they live and the type of home that best meets their needs. 

Rental housing is the choice for millions, from all ages and walks of life. For many others, the 

opportunity to own a home is the cherished ideal. Today, even though the housing market is 

still suffering from the effects of the worst housing market downturn since the Great Depression, 

Americans still believe in homeowners hip, which is why NAHB appreCiates the key role FHA 

has played in keeping our housing market liquid, stable and affordable. 

Given the significant role that housing plays in the economy, we urge Congress to take a longterm, holistic approach to housing finance reform. NAHB stands ready to work with you to 

achieve such reforms and provide much-needed stability for this critical sector of the economy. 
180 


80867.137

NCLR 

NATlmm COUNCil OF LA RAZA 

FHA REFORM FOR TOMORROW'S LATINO HOMEOWNER 

Statement for the Record 

"Examining the Proper Role of the Federal Housing Administration in our Mortgage 

Insurance Market" 

Submitted to 

The Committee on Financial Services 

Submitted by 

Janet Murguia 

President and CEO 

National Council of La Raza 

February 6,2013 
181 


80867.138

On behalf ofNCLR (the National Conncil of La Raza), please accept this statement for the 

record in response to the hearing entitled "Examining the Proper Role of the Federal Housing 

Administration in our Mortgage Insurance Market." NCLR is the largest national Hispanic civil 

rights and advocacy organization in the United States_ It has been committed to improving 

opportunities for the nation's millions of Latinos since 1968_ To this cnd, NCLR conducts 

research, policy analysis, and advocacy on a variety of financial services issnes that impact the 

ability of Latinos to build and maintain assets and wealth_ NCLR thanks Chaimlan Hensarling 

and Ranking Member Waters for the opportunity to share our perspcctive on the role ofthe 

Federal I-lousing Administration (FHA)_ 

NCLR is uniquely positioned to understand FHA's role. For more than 20 years, we have 

worked in the community development field on bchalf of low-income families. Through its 

more than 50 HUD-certificd comrmmity-based providers, the NCLR Homcownership Network 

(NI-IN) provides first-time homcbuyer and foreclosure prevention counseling to more than 

60,000 families a year. NHN counselors work closely with FHA borrowers to ensure that they 

are prepared for homeownership and 10 help them avoid foreclosure and predatory scams. 

FHA has long provided essential mortgage credit to first-time homebuyers and it is critical that 

this American institution is strengthened and not abandoned or allowed to dwindle, especially in 

today's economy. In this statement, NCLR highlights three important areas to strengthen FHA. 

1. FHA is a lifeline for many families throughout the United States. It has long 

provided safe and sound baseline products to Latinos and has filled a wlique role with 

proven success that no other entity often fills. While FHA insurance was used for 

approximately 27% of all home purchase mortgages in 2011, FHA accounted for 50% of 

home purchase mortgages for Black borrowers and 49% for Hispanic bOlTowers. It is 

vital that such programs continue to ensure that a fair product is accessible and affordable 

to those working to move into the middle-class. 

2. FHA must be modernized with a focus on mitigating abuse and fraud. The federal 

govemmcnt is obligated to promote nondiscrimination, residential integration, and equal 

access to the benefits of decent and safe housing and ownership opportunities. However, 

clear standards for implementation have not been applied to our housing finance system. 

This lack of clarity has opened the door for a persisting dual credit system-that is, a 

two-tiered financial system. Communities of color, the elderly, and women borrowers 

have been routinely steered into substandard mortgages, even when their credit warranted 

a prime loan. Such loans are more expcnsive and more likely to go into foreelosure, 

costing Black and Latino families alone billions of dollars in lost wealth. The dual credit 

market is a real challenge but FHA can be part of the solution through modemization. Tn 

addition, much of the uncxpected spikcs in FHA delinquencies can be attributed to 

impmdent originator behaviors or economic conditions rather than 1l1e design of the FHA 

loan product. In fact, according to the FHA's Annual Management Report: Fiscal Year 

2009, had loans not been made using seller down payment assistance programs, knoVl'1l 

for being fraught with fraud and abuse, its capital reserve ratio would still be at the 

recommended 2%. Limited program oversight has opened the door to a variety of 

abuses, including inflated appraisals, property flipping, and other fraudulent or sloppy 

2 
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80867.139

origination practices. These challenges can be overcome with a resolve to modernize 

FilA's standards and framework. 

3. FHA must not arbitrarily stille credit access. FHA is well positioned to generate 

healthy competition in segments of the housing market but it mustn't tighten credit as a 

knee-jerk response to the housing crisis. Indeed, it must fine-tunc its processes but not 

overshoot with restrictive credit for the sake of restricting credit. When fully functioning, 

FHA can serve as the "conscience of the market." Government-backed entities like FHA 

emerged as the dominant providers of housing credit while private capital fled the 

market. Analysts, decision-makers, and media pundits pointed fingers at govenmlent 

programs but they were not to blame. While FHA is in need of refonn, it must not 

relinquish a pillar in its mission for which it was created and has appreciated vast success 

historically. 

Looking toward el1cctive refonn of the housing market, FHA, D.;](( hkc clltIIi", must keep in mind 

the new characteristics of the millions of current homeowners affected by the crisis and the 

makeup of future homeowners throughout the nation. Latinos are projected to account for nearly 

50% of new households fonned in 2010-20, suggesting that a failure to incorporate the needs of 

Hispanics and other communities of color into the nation's federal housing policy will have 

negative consequences for alL FHA continues to provide a critical platfonn through which 

Congress and the administratioJl can directly help families rebuild their financial future. 

Nationwide, millions offamilies are relying on FHA to help them purchase their first borne or 

avoid foreclosure. As the housing finance system proceeds toward much needed refonn and 

modemization, we must not disregard FHA's nearly SO years of positive influence on building 

up the middle class. Before the creation of such critical government programs, our families had 

few to no options. The benefits of a govemmcnt-supporlcd housing finance system should be 

broadly available to all crcditw0I1hy borrowers, not channeled just to the affluent segments. We 

know from experience that left to its own devices, tbe market will deliver these benefits where it 

is easiest to do so and where the profit margins are highest. Such cherry-picking practices result 

in the benefits tlowing primarily to private shareholders and to tbe narrow group of borrowers 

who least need them as opposed to the economy as a whole. Rather than clipping FHA's wings, 

the government should lead the market in safe and sound innovation to embrace the future 

homebuyer. 

3 
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80867.140

POTOMAC PARTNERS LtC 

The Power of l'artl1ership ill Washingtoll 

Statement of Brian Chappelle 

Partner, Potomac Partners LLC 

Washington D.C. 

Hearing before the U.S. House of Representatives 

Committee on Financial Services 

on 

"Examining The Proper Role of the Federal Housing Administration in Our Mortgage 

Insurance Market" 

Wednesday, February 6, 2013 

Chairman Hensarling, Ranking Member Waters, and Members of the Committee, thank 

you for the opportunity to submit this statement on the proper role of the Federal 

Housing Administration. 

At its core, FHA is an insurance company. Like any private insurer, FHA must be able to 

spread its risk. Just like an automobile insurer cannot be limited to drivers under the 

age of 2S, FHA should not be limited to loans that have higher risk characteristics. Doing 

so would either require FHA to raise premiums significantly on borrowers who can least 

afford them or require taxpayer asslstar;cc. !'!"ither is an attractive option. 

FHA has an even more daunting task than your typical insurer. Its d;Jal mission is: 

1) To serve borrowers not adequately served by the private sector 

2) To operate at no expense to the American taxpayer. 

As a former Division Director in the Office of Single Family at FHA during the mid-1980's, 

I saw first-hand how FHA carried out its mission by backstopping the housing market in 

the "oil patch" states after the private sector pulled back when the economies in these 

states weakened and house prices dropped. Much like FHA has done for the entire 

country after the housing market collapsed in 2007, FHA played an instrumental role in 

the supporting the housing market in these states. 

FHA incurred steep losses in those markets that ultimately resulted in the 1990 FHA 

reform legislation that raised insurance premiums and increased down payments. 

However, as the Fund recovered more quickly than was projected, both down payments 

and insurance premiums were lowered in 1992 (and premiums were lowered three 
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more times in the 1990s) and the Fund exceeded the newly mandated 2 percent capital 

ratio by 1995. 

As the Committee looks into the appropriate role for the FHA in light of its current 

challenges, I encourage the members to consider the very favorable FHA performance 

data that is discussed below. Afterwards, I offer some perspectives on FHA's role in the 

mortgage market going forward. 

The main points of my statement are: 

FHA's recent originations (FY 2010 -2012), which comprise 58% of FHA's 

portfolio, are performing better than in any three-year period in more than 30 

years. 

This record low claim rate has been projected even though the FY 2012 audit 

includes over $28 billion of negative adjustments. 

FHA's credit quality has improved dramatically since the housing crisis. 

FHA is insuring a record high percentage of loans with higher credit scores (680 

& above). 

o Over 50 percent of FHA's fully underwritten loans insured since FY 2009 

have credit scores of 680 and above. Only 22% of FHA's loans in FY 2005 

- FY 2008 had credit scores of this level. 

FHA is insuring many fewer loans with lower credit scores (below 620). 

o Less than 7% of FHA's volume since FY 2009 has credit scores below 620. 

38% of FHA's volume in FY 2005 - FY 2008 had credit scores under 620. 

FHA's March 2010 Congressional testimony documented the correlation 

between credit quality and loan performance. The testimony stated: 

"FHA low downpayment loans (LTVs above 95% with credit scores of 680 

and above perform better than loans with 10% downpayment and credit 

scores between 620-679." 

Congress has already addressed FHA's primary problem when it terminated the 

seller funded downpayment assistance (5FDPA) loan program in September 

2008. 

The FY 2012 actuarial review estimates that SFDPA loans have cost the Fund over 

$15 billion. These loans are now only 4 percent of FHA's portfolio. 
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FHA leadership has moved to strengthen the insurance fund by increasing 

insurance premiums, tightening underwriting requirements, expanding quality 

control activities, and more aggressively enforcing lender performance 

standards to remove poor performing lenders. 

Starting in August 2009 when FHA terminated one of the largest FHA lenders 

(Taylor, Bean & Whitaker), FHA sent a clear message to the industry that it will 

not tolerate unacceptable lending practices. 

The fundamental problem with the mortgage market today is not that FHA is 

making too many purchase loans, but that the total purchase mortgage market 

is not making enough loans. 

FHA's FY 2012 purchase volume is now 13 percent below FHA purchase activity 

in FY 2000 when FHA's share was in line with historical norms. FHA purchase 

activity has fallen steadily since FY 2010 and its FY 2012 volume of 733,864 

purchase loans is now 34 percent below FY 2010 levels when FHA insured 1.1 

million purchase loans. 

Home Mortgage Disclosure Act (HMDA) data shows that U.S. total purchase 

transactions have almost declined SO percent from 4.79 million loans in 2000 to 

2.42 million loans in 2011 (latest year available). 

Add it all up and the mortgage market and the broader economy would be in much 

worse shape without FHA's involvement. More important to this discussion, the FHA 

Mutual Mortgage Insurance Fund would be in far worse financial condition without the 

loans FHA has made since the housing market collapsed. 

That being said, no one can dispute that FHA has incurred significant losses in the last 

several years. The sharp decline in home prices and the recession hurt many 

homeowners regardless of the type of financing. Home prices have fallen over 30% 

from their peak in 2006 according to S&P/Case-Shiller home price data. The impact of 

this decline, coupled with the weak economy, affected many homeowners. 

In a February 2012 speech, Federal Reserve Chairman Bernanke said the following about 

the adverse affect of the housing crisis on prime mortgages: 

"an increasing share of losses have arisen from prime mortgages that were 

originally fully documented with significant downpayments, but that have 

defaulted due to the weak economy and housing market." 

If prime mortgages with "significant down payments" have defaulted, it was inevitable 

that FHA mortgages with much smaller downpayments would face even greater 

challenges in light of the Nation's housing and broader economic problems. 
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In assessing FHA's role, the critical qu'estion is: 

"Are FHA's recent financial problems caused by systemic issues in the program 

(e.g. low down payment), or are they the result of a unique event (i.e, worst 

recession since the Depression)?" 

FHA performance data and the FY 2012 actuarial review prepared by an independent 

auditor support the conclusion that FHA's problems are not systemic in nature, but 

rather are the result of a unique event (i.e. the recession) since there is a sharp 

dichotomy in the performance of older and newer books of FHA business. FHA's 

problems are concentrated in its older books tied to the worst recession since the 

Depression and the SFDPA program that Congress terminated more than four years ago. 

These points are discussed in greater detail below, 

I. FHA Mortgage Performance 

Both the FY 2012 Actuarial Rev:;c,'; ;]no ~l ~,I\, ;:::::;-+0rr.~;:;i1ce data underscore the dramatic 

improvement in FHA loan performance since the housing crisis. 

While the audit's headline number of negative $13.48 billion (for the FHA forward 

program) raises questions about the solvency of the Fund, a closer look at the 

independent actuary's analysis confirms that FHA's problems are concentrated in older 

books (primarily FY 2005 - FY 2008 originations) and that recent books (FY 2010 FY 

2012) are performing better than any three-year period of FHA loans in more than 30 

years. 

Below is a chart documenting the projected cumulative claim rates for these books. 

FY 2010 - FY 2012 Books 

Projected Cumulative (Uf"time) Claim Rate 

FY 2010 - FY 2012 Actuarial Re.'iip~~s 

Actuarial Cumulative 

Review Claim Rate 

FY 2010 7.8% 

FY 2011 7.2% 

FY 2012 6.3% 

The combined cumulative claim rate for the FY 2010 -2012 books has fallen steadily in 

the last three audits and the FY 2012 audit projects a 19 percent decline in the 

4 
187 


80867.144

combined claim rate for these books compared to the projections in the FY 2010 audit. 

This improved claim rate translates into over 60,000 fewer claims for these books. 

These books would be performing even better if streamline refinance loans (with higher 

risk characteristics from the original loans) were excluded from this analysis. FHA 

permits loans already insured to be "streamlined" to lower the interest rate on the 

original loan. While these "streamline" actions help the homeowner and reduce risk for 

the portfolio, they do have the effect of making newer books look worse then they 

really are. (See the Appendix for the impact of FHA streamline refinance loans on recent 

books.) 

FHA's Performance Problems Are Intensifying In Older Books of Business 

The combined cumulative claim rate for the FY 2005 - FY 2008 books has increased 

steadily in the last three audits. 

Below is a chart documenting the projected performance data for the FY 2005 - FY 2008 

books. 

FY 2005 - FY 2008 Books 

Projected Cumulative (lifetime) Claim Rate 

FY 2010 - FY 2012 Actuarial Reviews 

Actuarial Cumulative 

Review Claim Rate 

FY 2010 17.1% 

FY 2011 21.3% 

FY 2012 25.2% 

The FY 2012 audit now projects a 47 percent increase in the combined cumulative claim 

rate for these books compared with the 2010 audit. This deterioration in the combined 

claim rate means another 185,000 claims are projected for these older books in the FY 

2012 audit compared with the FY 2010 study. These four books are only 13 percent of 

FHA's portfolio. 

To summarize, while the projections about the FHA Fund's ability to cover future losses 

keep getting worse, the audit also shows that the performance of new FHA loans (FY 

2010 - FY 2012 books). which comprise 58 percent of its portfolio, keeps getting better. 

In fact, the combined cumulative claim rate for the FY 2010 - FY 2012 books is now four 

times lower than the rate for FY 2005 - FY 2008 books. 
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FHA Mortgage Data 

FHA performance data has also improving significantly. 

FHA's early period delinquency rate has declined significantly for loans insured since FY 

2009 as compared to loans insured in FY 2007 & FY 2008. 

Early period delinquency measures performance (seriously delinquent) within the first 

six payments. This is the first indicator of the quality of new books of business. High 

early period delinquency rates are indicative of possible fraud, poor underwriting and 

generally poor loan quality (e.g. seller funded downpayment assistance loans). 

The following chart breaks out the early period delinquency performance of FHA activity 

for FY 2007 FY 2011. In addition, as will f,c; discussed later in this statement, FHA's 

credit quality improved Significantly during FY 2009. Accordingly, to examine the impact 

of this change in credit quality, subtotals are also provided for FY 2007 - FY 2008 and for 

FY 2009 and later. 

Early Period Delinquency (EPD) Rates by Origination Year 

Fiscal Early Period Total Originations Early Period 

Year Delinquencies Delinquency (EPD) Rate 

2007 8,811 402,343 2.19% 

2008 20,637 1,031,584 2.00% 

2007 & 2008 

Subtotal 29,448 1,433,927 2.05% 

2009 19,462 1,831,312 1.06% 

2010 7,252 1,666,886 .44% 

2011 4,165 1,196,606 35% 

2009 & later 30,879 4,694,804 .66% 

Subtotal 

*HUD Quarterly Reports to Congress 

The early period delinquency rate has dropped sharply since FY 2007 - FY 2008. The FY 

2009 - FY 2011 books performed 67% better than the FY 2007 - FY 2008 books. While 

not included in the chart, FHA's FY 2009 - FY 2011 books also had a 42% lower EPO rate 

than the FY 2004 and FY 2005 books, which had a combined early period delinquency 

rate of 1.17%. FHA's FY 2005 - FY 2008 books account for about 15% of its portfolio. 
189 


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FY 2009 was a transitional year in FHA performance. 

The chart above also points out the significant improvement that occurred during FY 

2009 and then in FY 2010 and FY 2011. FHA's FY 2009 EPD rate was almost 50% better 

than the FY 2007 FY 2008 rate, and the FY 2010 - FY 2011 EPD rate is 50% better than 

FY 2009. The combined FY 2010 - FY 2011 books performed five times better than the 

FY 2007 - FY 2008 books. 

The following chart shows the quarterly breakdown for FY 2009 early period 

delinquency rates with subtotals for the first two quarters and the last two quarters of 

the fiscal year. 

FY 2009 Early Period Delinquency Data By Quarter 

2009 

Fiscal Early Period Total Originations Early Period 

Year Delinquencies Delinquency Rate 

Quarter 

1 5,849 409,025 1.43% 

2 5,045 400,424 1.26% 

Subtotal 10,894 809,449 1.35% 

(Ql& Q2) 

3 4,956 490,646 1.01% 

4 3,612 531,217 .68% 

Subtotal 8,568 1,021,863 .84% 

(Q3&Q4) 

There was steady improvement in FHA's early period delinquency rate for each quarter 

of FY 2009. The early period delinquency rate for the last two quarters of FY 2009 is 

38% below the rate for the first half of FY 2009. Moreover, although the FHA volume 

increased more than 25% in the second half of the fiscal year, the number of early 

delinquencies declined 20 percent. 

The continued improvement reflects the higher quality FHA originations that were 

insured later in 2009. Congress terminated the seller funded down payment assistance 

program in August 2008 and affected loans had to be closed by September 30th to be 

eligible for FHA insurance. Some loans were not insured until FY 2009 {approximately 

40,000 loans}. 

Another reason for better loan quality in FY 2009 is that lenders expanded their own 

credit overlays (underwriting restrictions) in addition to FHA requirements. These 

overlays demonstrate that lenders have been concerned about their liability in the FHA 

7 
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80867.147

program, FHA also took several high profile enforcement actions in 2009 that 

reinforced the industry's concern about their potential risk in the program. 

The performance of FHA's loans originated in the last two years is excellent. 

FHA's Neighborhood Watch system presents another view of early loan performance. It 

pr~vides a snapshot of the performance of FHA loans originated in the most recent twoyear period as of a particular point in time, Neighborhood Watch was implemented in 

1999. The following chart displays seriously delinquent data for loans originated in the 

most recent two years as of the end of each calendar year from 2005 2011. (August is 

the latest available period in 2012 since HUD removed streamline refinance transactions 

in September.) (Link to Neighborhood Watch httjJ~jh:ntjJ,hLJ(LgovjsfnVII/plLbJli:.L) 

For example, for the two-year period ending December 2005, it includes the early 

default performance of FHA originations in 2004 and 2005 as of December 31,2005. 

For the two-year period ending December 2011, it includes the early default 

performance of originations for 2010 and 2011 as of December 31,2011 and so on, 

The following chart includes total FHA originations for the two-year periods, the number 

of seriously delinquent (SID) loans and the percentage of seriously delinquent loans 

originated in each of the two-year periods. 

Performance of FHA loans Originated in Two-Year Periods By Calendar Year End Date 

Two year SID loans Total FHA loans % of FHA loans 

period for last two years originated in twoyear period that are SID 

ending 

Dec 2005 41,516 1,161,710 3,57% 

Dec 2006 28,362 860,627 3,30% 

Dec 2007 35,373 864,323 4,09% 

Dec 2008 77,019 1,788,355 4.31% 

Dec 2009 162,149 3,212,363 5.05% 

Dec 2010 96,953 3,430,615 2.83% 

Dec 2011 47,180 2,546,532 1.85% 

August 2012* 32,642 2,358,646 1.38% 

FHA changed criteria in September to remove streamline refinances. To ensure consistency, August 2012 data IS used. 

R 
191 


80867.148

FHA's seriously delinquent rate for loans originated in the most recent two years 

(1.38%) is at the lowest rate in the 13-year history of the Neighborhood Watch system. 

It has declined 73% since it peaked in December 2009. There are now fewer seriously 

delinquent loans than there were in December 2005, even though FHA's volume for the 

two··year period ending April 2012 was more than double the December 2005 volume. 

This improving rate has also occurred even though FHA's volume in the two-year period 

has declined 31% since December 2010. This means, on a relative basis, that there were 

more seasoned loans in the August 2012 period than in December 2010 making the 

record low seriously delinquent rate even more impressive. 

II. FHA credit quality has improved markedly since the mortgage market 

collapsed. 

When the subprime mortgage market collapsed in 2007, there was widespread concern 

that the FHA program would be flooded with subprime loans. Below is a chart that 

provides the number and percentage of FHA loans for each fiscal year from FY 2005 to 

FY 2011 broken down by two major credit score risk categories (Le. loans with credit 

scores of 680 and above and loans with credit scores below 620). These breakouts 

represent the cut points for low risk and high-risk loans in the FHA portfolio. 

FHA Activity By Key Credit Score Tranches 

Fiscal Year Credit Scores <! 680 Credit Scores < 620 

# of loans % of total # of loans % of Total 

2005 84,000 23% 142,000 39% 

2006 87,000 24% 138,000 44% 

2007 77,000 20% 169,000 44% 

2008 273,000 28% 333,000 34% 

2009 710,000 47% 215,000 14% 

2010 829,000 57% 56,000 4% 

2011 607,000 60% 29,000 3% 

2012 554,000 57% 29,000 3% 

FHA has experienced a remarkable turnaround in the credit characteristics of recent 

originations. FHA credit quality has improved steadily since its volume began increasing 

CJ 
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80867.149

in 2008. In FY 2005 FY 2008, there were more loans with credit scores below 620 

(782,000 loans) than there were loans with credit scores of 680 and above (521,000 

loans). In fact, in FY 2005 - FY 2007, there were almost twice as many loans with credit 

scores below 620 as there were loans with credit scores of 680 and above. 

Starting in FY 2009, that trend has been completely reversed. FHA has insured over 2.7 

million loans with credit scores of 680 and above and only 329,000 loans with credit 

scores under 620, of which 67% were insured in FY 2009. In addition to the elimination 

of the seller funded downpayment assistance program, there was also an appreciable 

increase in FHA credit quality. Below is a chart that breaks down FHA's FY 2009 

quarterly data by the same credit score risk categories for low risk (680 and above) and 

high risk (below 620). 

FHA FY 2009 Activity By Key Credit Score Tranches* 

Fiscal Year Credit Scores ~ 680 Credit Scores < 620 

2009 # of loans % of total It of loans % ofTotal 

10 148,000 38% 94,000 24% 

20 136,000' 43% 59,000 19% 

30 182,000 51% 36,000 10% 

4Q 244,000 56% 26,000 6% 

In FY 2009, the loans with credit scores of 680 and above jumped 65% from the first to 

the fourth quarter and the loans with credit scores below 620 fell almost 75% during the 

same period. 

Importance of credit score on FHA loan performance 

FHA loans with higher credit scores perform much better than loans with lower scores 

even with higher downpayments. For example, FHA loans with credit scores of 680 and 

above and low down payments (LTVs above 95%) perform better than loans with 10% 

down payments and credit scores between 620-679. 

Below is an excerpt from FHA's March 2010 testimony on the importance of credit 

scores in the FHA program. 

"Furthermore, downpayment alone is not the only factor that influences loan 

performance. The combination of down payment and FICO score is a much better 

predictor of loan performance than just one of those components alone." (See 

the following chart.) 

10 
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80867.150

FHA Single Family Insured Loan Claim Rates 

Relative Experience by loan~to~Value and Cr~9~~~.?~~~"ues --- Ratios of each Combination's Claim Rate to that of the lowest Risk Cell 

lo,Jn-to-Value Ratio Ranges ---~-

Credit Score Ranges -- r--- 500-579 580-619 620-679 680-850 

Up to 90% 2_6 25 1.9 1.0 

90.1 95% 5.9 4-7 3_8 1.7 

Above 95% B-2 5_6 35 1.5 

III. Congress has addressed the significant problem when it terminated the seller 

funded down payment assistance program in September 2008. 

-

The FY 2012 Actuarial Review projects that seller funded downpayment assistance loans 

will cost the FHA MMI Fund over $15 billion. According to HUD's Annual Report to 

Congress on the Fund, these loans have a "disproportionate share" of FHA loans that are 

seriously delinquent. SFDPA loans represent 4 percent of FHA's outstanding mortgages 

but are 13 percent of all seriously delinquent loans. 

The independent actuary estimates that without SFDPA loans, the MMI Fund would be a 

positive $1.77 billion. 

IV. FHA has moved swiftly to enforce FHA rules and to hold poor performing 

lenders accountable for their unsatisfactory performance. 

Starting in August 2009 with the termination of Taylor, Bean & Whitaker (TBW), FHA 

took several high profile enforcement actions that have reverberated throughout the 

industry. To demonstrate the impact of these actions, mortgage lenders increased 

credit overlays (underwriting restrictions) on top of FHA requirements. 

FHA has also strengthened lender approval requirements by increasing minimum net 

worth requirements to $ 1 million (that will increase to $2.5 million in 2013). With this 

change, mortgage lenders have more "skin in the game" in the FHA program. FHA also 

has increased accountability of approved lenders for the actions of mortgage brokers. 

FHA has also raised premiums numerous times in an effort to bolster the Fund. 

V. The fundamental problem with the mortgage market today is not that FHA is 

making too many purchase loans, but that the total purchase mortgage market 

is not making enough loans. 

Much has been written about FHA's dominant role in the mortgage market. A closer 

look at the data shows, however, that FHA purchase activity is now lower than it was in 

2000. Below is a chart with FHA purchase activity from 2000 - 2012. (Source: HUD 

Annual Report to Congress) 

11 
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80867.151

FHA Purchase Activity 

{FY ZOOO-FY ZOlz} 

Year Mortgages 

2000 839,869 

2001 806,818 

2002 862,898 

2003 658,640 

2004 586,110 

2005 353,844 

2006 313,998 

2007 278,394 

2008 631,655 

2009 995,551 

2010 1,109,581 

2011 777,427 

2012 733,864 

At the same time, Home Mortgage Disclosure Act data shows that home purchase 

activity still is falling and is now almost one-half of 2000 levels. 

U.S. Total Home Purchase Activity 

2000 4,787,356 

2001 4,938,809 

2002 5,124,767 

2003 5,596,292 

2004 6,429,988 

2005 7,382,012 

2006 6,740,322 

2007 4,663,267 

2008 3,119,692 

2009 2,792,939 

2010 2,546,590 

2011 2,416,854 

*Federal Reserve Bulletin December 2012 "The Mortgage Market in 2011: Highiieht5 

from the Data Reported under the Home Mortgage Disclosure Act" 

Despite the government's dominant role in the mortgage market, the Federal Housing 

Administration, Fannie Mae and Freddie Mac only backed about 1.7 million purchase 

loans last year, which is comparable to 2011 and about 14 percent below 2010. 
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80867.152

The private sector has returned to the housing market, just not the martgage market. 

Of course, the major contributor to the housing rebound has been the explosive growth 

in "all cash" sales. Instead of obtaining mortgages, many wealthy homebuyers/investors 

have the option of simply paying cash to take advantage of the lower home prices. In 

the latest National Association of Realtors (NAR) report on existing home sales, cash 

sales are hovering near 30 percent (historically they were about 5 - 10 percent) of all 

transactions. For 2012, this translates into about 1.5 million cash sales. 

At the opposite end of the housing market are younger, lower income and minority 

homebuyers who rely on mortgage financing to purchase homes. You only need to look 

at the latest Harvard Joint Center of Housing Studies report (The State of the Nation's 

Housing 2012) and Home Mortgage Disclosure Act (HMDA) data to see the impact of the 

weak mortgage origination numbers on these groups. According to the Harvard study, 

first-time homebuyers' share of the market has declined from 39 percent to 33 percent 

and all age groups under the age of 55 saw sharp declines in home purchase activity. 

The Federal Reserve's annual HMDA article ("The Mortgage Market in 2011") 

demonstrates the adverse impact of the current mortgage market on lower income and 

minority homebuyers. While all homebuyer groups saw a decline in purchase mortgage 

activity, lower income and African American homebuyers were particularly hard hit with 

declines that were double other segments. 

Examining FHA's Proper Role in the Mortgage Insurance Market 

FHA has been criticized for straying from its mission because of the increasing 

percentage of high credit borrowers in the FHA program. What the critics do not 

appreciate is that mortgage lenders on their own have tightened guidelines on FHA 

lending 

There are several factors not readily apparent about the FHA program that combine as 

effective checks and balances on lender actions. The impact is exemplified by the fact 

that lenders put their own underwriting restrictions (called credit overlays) on top of 

government restrictions. With credit overlays, lenders in effect are saying they are 

unwilling to originate certain loans that meet government underwriting criteria. 

The good news in the FHA (and Fannie Mae and Freddie Mac) performance numbers is 

that the borrowers being approved today have the highest credit quality as their 

remarkably low early-default rates demonstrate. Consequently, our current mortgage 

dilemma does not stem from the approval of homebuyers with poor credit 

characteristics, but rather, from the inability of many creditworthy borrowers to obtain 

mortgages. 
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FHA's role & the private mortgage insurers 

It should pointed out at the outset that the private mortgage insurers benefited from 

FHA's participation in the mortgage market in 2008 -2009. Without FHA to backstop 

home prices, private mortgage insurer losses would have been even higher during those 

years. 

Some have also criticized FHA for having higher default rates than the private insurers. 

While the credit characteristics have improved dramatically, the credit profile of 

privately insured loans is even better. 

I believe that the private mortgage insurers should playa vital role in our Nation's 

housing finance system and it should be expanded. However, their impediment is not 

the policies of the Federal Housing Administration but rather, the pricing policies of the 

Government Sponsored Enterprises (GSEs). 

As noted above, FHA has already taken significant steps to facilitate the recovery of the 

private sector by raising its insurance premiums five times in recent years. The FHA 

premium is now the highest in its history and more than 60 percent higher than it was in 

May 2008. If FHA raised premiums further, it would place another hurdle in the way of 

future homebuyers at a time when the housing market needs every homebuyer it can 

find. 

The private mortgage insurers' lack of volume is tied directly to the pricing policies of 

the Federal Housing Finance Agency and the GSEs. Starting in March 2008, the GSEs 

added an "adverse market fee" and "loan-level price adjustments" that raised 

homebuyers' costs for almost all mortgage transactions 

The principal reason for the difference in costs associated with an FHA loan and a 

private Mlloan is not the cost of mortgage insurance. FHA and private mortgage 

insurance premiums are roughly comparable depending on the LTV and credit score. 

The pricing disparity is the result of the additional GSE fees since Ginnie Mae, the 

primary secondary market outlet for government loans, only charges a guaranty fee 

(which the GSEs also charge). 

While some would argue that these fees have enabled the GSEs to become profitable, 

there has been a cost for both homebuyers and the private insurers. 

Conclusion 

Just as FHA did in the "oil patch" states in the 1980's, FHA has played an invaluable role 

in supporting the housing market in the aftermath of the housing crisis. It has provided 

liquidity to the mortgage market when the private sector retreated. 

14 
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The performance of FHA loans insured since the private mortgage market shows that 

FHA officials have acted responsibly in balancing FHA's dual mission of serving those not 

able to find financing from other sources and avoiding risk for the American taxpayer. 

Based on the available data, I question whether further changes are necessary to 

resolve problems that have already been addressed (e.g. seller funded downpayment 

assistance loans). HUD officials are rightly concerned about "over-correcting" and 

penalizing future homebuyers. 

As the above data also shows, there is still more work to be done to ensure that all 

creditworthy Americans are able to buy a home. Placing more restrictions on FHA at this 

time will only make it more difficult for many families to qualify for a mortgage. Equally 

important, they could increase financial risk for the FHA program and the American 

taxpayer. 

In conclusion, FHA's fundamental challenge has always been to balance the risk 

associated with serving those not adequately served by the private sector with prudent 

credit management. I believe the recent performance data demonstrate that FHA is 

managing this "balance" in a very effective manner. 
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80867.155

Appendix 

-~ 

POTOMAC PARTNERS llC 

The Power of Fartnership in IVashington November 2012 

Analysis of FHA Streamline Refinance Performance 

As the debate "heats up" about the Federal Housing Administration's (FHA) financial condition, 

it is important to evaluate the impact of various products on FHA loan performance. While the 

excellent credit quality and performance of FHA loans originated since 2009 is well-documented, 

FHA streamline refinance (SIR) mortgages have performed much worse than the rest of FHA's 

originations according to FHA's Neighborhood Watch database. The highlights are: 

Streamline refinances had early default and claim rates up to three times higher than 

the rest of FHA's recent originations. 

FHA streamline refinance loans had an early default and claim rate that was up to three 

times higher than the rate for the rest of FHA's originations. Despite being only 13-18 

percent of FHA's originations during this period, streamline refinances were up to 40 

percent of FHA's early defaults and claims. 

While streamline refinance transactions reduce risk for the FHA Fund, they can distort 

analysis of individual books of business. 

Streamline refinance transactions reduce risk for the FHA Fund by lowering the interest 

rate on an existing FHA loan. However, FHA streamline refinance loans also have the 

effect of making older books look better than they are and making newer books (i.e. 

those that include streamline refinances of older loans) look worse than would be 

expected of newly originated loans (based on the improved credit quality of these 

recent loans). 

For example, assume a homebuyer with a 620 credit score purchased a home in 2007 

with an FHA insured mortgage. (In 2007, over 40% of FHA loans had credit scores below 

620.) If that borrower refinanced his/her loan in 2009 or 2010 and the streamline 

refinance became seriously delinquent within two years of origination (i.e. 

Neighborhood Watch criteria), the appearance would be that the original loan 

performed and the refinance originated in 2009 or 2010 was indicative of performance 

issues with those books of business. Credit characteristics of loans made in 2009 and 

2010 had much better credit quality than earlier originations. (Contrary to 2007, less 

than 10% of FHA's loans in those two years had credit scores below 620). 

To sum up, the following data substantiates the view that FHA's newer books have record low 

levels of early default and claim. However, these books are performing even better when the 

streamline refinance loans (with their higher risk characteristics from the older loans) are 

excluded from the analysis. 

Hi 
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80867.156

Impact of Streamline Refinance (SIR) Performance of FHA's Recent Originations 

Below are several charts that provide data on the performance of streamline refinances and 

their effect on FHA's total performance. The first chart shows Neighborhood Watch 

performance data for streamline refinances insured in two-year periods starting with an end 

date of 2009Q3 (i.e. streamline refinance volume, total SjR early defaults and claims (Dje) and 

the percentage of streamline refinances that are seriously delinquent). In addition, to provide 

perspective, the seriously delinquent (SjD) rate for non-streamline loans is provided in bold. 

Neighborhood Watch 

FHA Streamline Refinances (SIR) Performance for Two-Year Periods By Quarter End Date 

SjR 

Quarter Early Total SjR % Seriously Non SIR 

DjC# Originations Delinquent 5/D% 

2009 Q3 16,625 393,746 4.2% 5.1% 

2009 Q4 24,059 475,307 5.1% 5.1% 

2010 Q1 26,251 509,418 5.2% 4.3% 

2010 Q2 27,489 504,984 5.4% 3.4% 

2010 Q3 33,901 539,175 6.3% 2.7% 

2010 Q4 38,742 617,401 6.3% 2.1% 

2011 Q1 30,764 570,695 5.4% 1.6% 

2011 Q2 19,877 452,358 4.4% 1.5% 

2011 Q3 15,572 . 383,987 4.1% 1.5% 

2011 Q4 10,069 326,978 3.1% 1.7% 

2012 Ql 8,135 341,278 2.4% 1.5% 

2012 Q2 8,855 391,401 2.3% 1.4% 

Starting in 2010, streamline refinance loans have performed much worse than non-streamline 

refinance transactions (i.e. the rest of FHA's originations during those periods). The SjR early 

default and claim rate peaked at 6.3% for the two-year periods ending in the last two quarters 

of 2010. As FHA's over-all credit quality has improved, the SjR early default rate has fallen 

steadily since 2010. 

The last column (bold) of the chart shows that the early default performance of FHA's nonstreamline refinance loans improved steadily since 2009. The data shows that FHA's total 

originations for the two-year period ending in December 2009 were performing comparably to 

streamline refinances. However, while streamline refinances deteriorated throughout 2010, the 

performance of FHA's non-streamline business improved steadily and now has the lowest levels 

of early default in the 13-year history of the Neighborhood Watch database. 

Streamline Refinance Mortgages Comprise a Significant Percentage of FHA's Early Defaults 

and Claims. 

Below is a chart that analyzes the share of streamline refinances as a percentage of FHA's total 

early payment default and claims and total origination volume. 

17 
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80867.157

Neighborhood Watch 

Streamline Refinances Early Defaults as a Percentage of FHA Early 

Defaults and Total Volume 

Quarter 

2009 Q3 

2009 Q4 

2010 Q1 

2010 Q2 

2010 Q3 

2010Q4 

2011 Ql 

2011 Q2 

2011 Q3 

2011 Q4 

2012 Q1 

2012 Q2 

Total Early 

D/C 

# 

142,129 

162,149 

151,810 

126,140 

110,951 

96,953 

74,920 

58,284 

52,809 

47,180 

40,253 

36,084 

SIR Early 

D/C 

# 

16,625 

24,059 

26,251 

27,489 

33,901 

38,742 

30,764 

19,877 

15,572 

10,069 

8,135 

8,855 

SIR as SIR as 

% ofTotal % of Total 

Defaults Originations 

12% 14% 

15% 15% 

17% 15% 

22% 15% 

31% 16% 

40% 18% 

39% 17% 

34% 15% 

29% 14% 

21% 13% 

20% 14% 

24% 16% 

As can be seen in the chart above, starting in 2010, streamline refinances began comprising a 

much higher percentage of FHA's early defaults and claims than of FHA's total originations. 

Streamline refinance transactions peaked at 40% of FHA's early defaults in 2010 4th 

Quarter. Streamline refinance loans comprised from 13% to 18% of FHA's total volume. 

Assessment 

This data shows that the poor performance of FHA's older books of business has crept into its 

newer books through the streamline refinance program. While the FHA program benefits when 

loans are "streamlined", these loans can distort the analysis of the performance of the newer 

books since the credit characteristics of the original loan likely have higher risk characteristics 

than other new originations, which make up over 80 percent of FHA's recent books. 

The good news is that FHA's recent books of business, even with streamlines, are performing at 

record low levels of default. Excluding streamlines, FHA recent books would be performing even 

better. Accordingly, any analysis of recent books of business should consider the differences in 

the credit characteristics of streamline refinances loans and the rest of FHA's originations, which 

are over 80% of FHA's recent originations. 

1R 
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Myths and Facts about FHA 

(November 2012) 

F lIA's single family was created in 1934 to provide access to safe, 

affordable mortt.;age 

Tnste(ld, FJ"L\ insures 

FHA docs not lend money to homeowners. 

Since 1934 FT 11\ has made 

During the economic recession and housing dO"\\Ttturn, FHA has been one of the 

finance available, and have weathered the srorm well. \-X/hilc hanks, 

or FHA bas been there. 

Today, Fl1/\ continues to insurance and pay claims. t:"or tJ1C first rime in its history the 

program does a fuJl30 worth of expected claim But as our 

economy continues to improve, and continue to rise, financial health. 

FHA has been the shining light in our cr1sis, and \\'C beHcyc they wjll continue to be;m 

integral force our recovery. 

MYTH: 1'"HA IS BANKRUPT 

FACT: FHA is not bankrupt. PI fA'$ current cash reserves total $30.4 billion. 

undercapitalized because their independent actuary estimates that they do not 

claims over the next 30 years. FHA is one of the few enttics 

over a 30 By the Financial Accounting 

financial institutions to over the next 12 months. 

FHA is said to be 

have sufficient reserves 

law to hold reserves 

commentators do not mention is the fact that the FY12 Actuarial Review shows FHA will be fully 

again in J<"Y2014, and \vill reach the desired 2% capital reserves ratio by 2017, wbch is above and 

the required of reserves. FHA also reports that "it is possible to return the "MI'vll Fund 

MYTH: FHA IS EXPERIENCING HIGH DEFAULTS AND ;'URRCL08URE8 

FACT: PHA, like risk, has incurred unanda} losses as a result of overall 

market conJitions that led to incre.ased An analy;;;js of FHA data indicates FI-IA's 

problem is concentrated in older PI lA loans that \\Tete significantly' affected by the 33% decline in house 

prices since 2006. There has been improvement in the of FIlA loans since the 

market collapsed in 2008, But the from 2007 2009 are burden on the fund. 

Seventy (70) billion dollars in claims arc of business, 

It must be noted that the more recent book is performing 

high quality and are expected to continue to perfonn very 

at 2.6% and are now at 0.3%. Li-)e most recent """~~,,""" •• 

1'fortgagc Bankers Association, "the past due rate for FIlA now at its in over 

10 years, and FHA's post-2010 hooks are performing much better than loans origina1ed prior to 2010. n 

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80867.159

MYTH: FHA's lJ4ARKE'T SHARE IS TOO HIGH 

FACT: wben \r1CWCO ia tb.e- historical context. 

it was lenders flee fbe 

~ ~IT 

market share peaked at 19.3% in is no,v returning to traditionalleve1s and stands at 

As housing markets stabiJize and new reguiations arc finalized, markets \vill 

once have some certainty and the private market will return, will allow PHA's 

even 

MYTH: FHA IS SQUEEZING OliT THE PRIVATE MARKET 

FACT: FHi\ does not lend money. FI--IA insures loans made hy the 

the \vhen the private market abandoned housing tlnancc. 

out the m;J.rket, \ve would 

j\1.VTH: FHA IS NOT SERVING ITS MISSION 

market. FHA has been critical in 

market for 

market unable or 

.FACT: [<HA \vas created in 1934 a similarly difficult rime in finance markets when there 'waS 

lending. Today, the agency filling just the role it \\'3S for - to provide safe, affordable 

the pri-vate market cannot or will In over half of aU African Americans 

a home and of Hispanics so with FHA fmandng. ;vloreover, 78% of 

M'YTEL- FHA BORROWERS ARE POOR RISKS 

FACT: FI-I/\' borrowers have credit scores 

loans was f"Y12, compared to 696 in borrowers in 

credit scores ahove 720. 

MYTH: P'HA BORROWERS ARE HIGHLY SUBSIDIZED 

premiums to 

four rimes. 1n fact, 

- are higher than they have ever been. Today's premiums a upfront premium, and 1.25% in an 

annual prcrniurn, that is pajd monthly. furthermore, the PHA has also announced moving forward that they will 

increase the annual fee to 1.3S(Yo. 

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ASSOCIATION of REALTORS'