Hearing of the US Senate Committee on Banking, Housing, and Urban Affairs - Turmoil in the US Credit Markets: Examining Proposals to Mitigate Foreclosures and Restore Liquidity to the Mortgage Markets

Hearing of the US Senate Committee on Banking, Housing, and Urban Affairs - Turmoil in the US Credit Markets: Examining Proposals to Mitigate Foreclosures and Restore Liquidity to the Mortgage Markets

SEN. DODD: The committee will come to order.

I want to thank witnesses this morning and those who've gathered in the committee room to be here for our hearing this morning entitled "Turmoil in the U.S. Credit Markets: Examining Proposals to Mitigate Foreclosures and Restore Liquidity to the Mortgage Markets."

And again, I want to thank everyone for their participation over the last several weeks. We've had a very busy committee activity, and it will continue as such. We have an awful lot on our plate obviously, and so yesterday's hearing was, I thought, a very good one, and I appreciate immensely the participation of its many members. I know they all -- everyone has conflicting schedules as well, with other committee assignments and responsibilities, but the fact that we've had as much participation by the committee as we've had I think is an indication of how seriously every member of this committee takes these issues that we have in front of us.

And I'm particularly grateful to Senator Shelby and his staff, as well as my own, obviously, for the tremendous work being done and the effort made a week or so ago as we spent a good deal of time on the floor of the Senate grappling with at least our first efforts on trying to deal with the foreclosure issues. And while it wasn't everything that this -- that Senator Shelby wanted or I wanted, or even things that were in there that we would've necessarily written on our own, I think it was a major step in the right direction, and I'm grateful to every member of this committee for their support in that effort.

This morning, we'll continue that discussion, obviously, as we examine furthermore the further questions of how can we mitigate foreclosures, how can we really help unleash the pent up capital that's out there? I mentioned to Senator Shelby that yesterday morning I had the privilege of meeting with a large group of people involved in commercial mortgage-backed securities and heard an earful about their problems. I think -- they won't misquote him -- last year I think that business did some $230 billion worth of business in 2007. As of the middle of April, they've done $5 billion worth of business this year. It has just frozen up entirely.

We heard about 15 percent of lenders no longer involved in the business of student loans, and those numbers could continue to skyrocket over the next several weeks and months. So any debate about whether or not there's a contagion effect in this issue I think has been obviously debunked by anyone who's listening to anybody else in various other sectors of our economy and how this is affecting us. So whether or not we can do something to play a worthwhile and responsible role in trying to bring this to a halt and move in a different direction is the critical question before us: the liquidity, transparency and, most of all, confidence in our markets.

So this morning, the Senate Banking Committee is meeting to hold its second hearing on the Hope for Homeownership Act and other plans to address the historic levels of foreclosures the American people are experiencing. This is Wednesday of this week. By the end of business today, another 24,000 people in this country will have filed for foreclosure and roughly 1,000 a day will be in foreclosure. And every day that we move forward without addressing that underlying question, those problems will continue to grow. There is a growing consensus that the federal government needs to get more aggressively involved in helping American families keep their homes. In addition to my legislation, the Office of Thrift Supervision has put forward a plan, HUD has proposed a plan, Senator McCain has a plan, and these plans embrace the key concepts, I would point out, in the legislation that I have circulated to Barney Frank, and the House side is also working on and holding hearings on, including use of the existing FHA platform to refinance distressed homeowners into new loans.

It's my hope that we can work collectively to bring together the best features of these various ideas and move legislation quickly before we watch any more people have to suffer the loss of losing the most important investment they're ever going to have in their lives. Our failure to act earlier has made the problems we now face more severe. Mark Zandi, a well-known housing economist, put it this way, and let me quote him: "Policymakers'" he said -- "Policymakers' initial response to last summer's subprime financial shock was very tentative, as they misjudged its severity and the extent of its economic fallout. Financial markets and the economy subsequently eroded. Only if more homeowners are able to retain or remain in their homes will the negative cycle of foreclosures begetting house price declines begetting more foreclosures be short-circuited. This in turn is necessary to ending the downdraft in the housing market that is weighing so heavily on the economy and the financial system," end of quote.

Briefly, the legislation that I've proposed creates a new fund at the FHA to ensure new affordable mortgages for distressed homeowners. These FHA mortgages would refinance the old troubled loans at significant discounts. The new loans would be no larger than the borrowers could afford to pay and no more than 90 percent of the current value of the home. This formula is very similar to the one laid out by the Federal Reserve chairman, Bernanke, in his speech several weeks ago when he noted that creating new equity for underwater borrowers may be a more effective way to prevent foreclosures.

The administration has also embraced the concept. Under my proposal, no one -- I repeat no one -- gets what would be described as a bailout. Lenders and investors will have to take a serious haircut to participate in the program, but in return, they will receive more than they would recover through foreclosure. Borrowers get to keep their homes, but they must pay for the FHA insurance and share the newly created equity and future appreciation with the FHA program to help offset any possible losses. Only owner-occupiers would be eligible for this new program and only those who clearly cannot afford their current mortgages. There will be no speculators or investors allowed in this program.

Not only would this initiative help deserving homeowners and the communities in which they live, this program would help stabilize capital markets, put a floor on excessive downward spiral of housing prices, and get capital flowing once again, which is absolutely critical, in my view.

In addition to the witnesses we've heard from at last week's hearing, the staff has been consulting widely with investors, lenders, servicers, economists, securitizers, regulators and other Senate offices to improve the draft legislation, and we continue to seek input in order to make this product as strong as possible and move it forward as soon as possible. It's increasingly difficult to explain to the American people why it is that their government can act so quickly to put taxpayer dollars at risk to bail out, if you will, large financial institutions on Wall Street without making a more robust effort to help Americans keep their homes. In my own view, these efforts must go hand in hand. Before financial institutions can really get back on a steady course, we need to address the subprime and nontraditional mortgages underlying the alphabet soup of complex securities. While not a silver bullet, the Hope Ownership (sic/Hope for Homeowners) Act -- owners' act -- would I think help to do so.

The need for action continues to be acute. Yesterday RealtyTrac released new data which showed that foreclosure filings jumped 57 percent in March from a year ago. This marks the 27th consecutive month of year-over-year increases in national foreclosure filings, and as I've said a moment ago, another 8,000 families today in America will file for foreclosure. Eight thousand roughly did yesterday, the day before, and will tomorrow. At some point, we have to step up and decide we're going to try and do something about that. And allowing it just to hemorrhage day after day after day is not an answer. Inaction is not an answer, and failure is not an answer. And so today we're gathering once again to try and think about ways in which we can make a difference. In America, in our America, this should not be acceptable. If we don't take effective action, we risk being forced to take more dramatic and costlier action to respond to more dire consequences down the road. That is what happened with Bear Stearns, obviously.

As I said last week, I understand that some people oppose this kind of program on the grounds that we should not reward people who in their view acted irresponsibly. Let me respond by quoting Scott Stern, who testified last week on this very subject matter. To remind my colleagues, Mr. Stern is the CEO of Lenders One, a coalition of 110 small and medium-sized mortgage lenders. Mr. Stern explained that he feels that the, quote, "combination" -- "condemnation," rather -- of borrowers who took out risky loans is misplaced because of the going practice of pushing high-risk loans on borrowers who had no reasonable expectation of being able to repay the mortgage. Mr. Stern called this mortgage malpractice.

He went on to say: "In our industry, we have frankly seen too much mortgage malpractice. Curing a loan that had a high risk of failure creates no moral hazard, just the opposite. Modifying a loan which probably shouldn't have been made in the first place is the kind of action that can help restore integrity and trust in the mortgage market," end of quote.

Of course, some borrowers who might benefit from this program might not be deserving, according to some. But if we do nothing, we know for certain that hundreds of thousands of homeowners who need and deserve our help will lose their homes. That is why I believe we should act, and I look forward to working with my colleagues to craft the best possible solution to this problem.

And again, I want to thank Senator Shelby immensely for supporting the idea of these hearings for us to listen to people who can offer some sound advice and counsel on how we move forward.

And with that, let me turn to the ranking member.

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SEN. DODD: Thank you very much.

I am reminded by the committee, we are going to have Chairman Cox here next week to be talking about the role of the SEC and the credit agencies. We've had a series of hearings, and we'll continue, obviously, as Senator Shelby points out, very accurately -- here we have an obligation to know how this all happened, and certainly that's an important role and an ongoing one. I would also suggest we have a commensurate responsibility, of course, to act, to make sure this problem doesn't grow worse, and my concern is, it is.

But now Larry Summers the other day was talking about -- I think, Jack, to pick up on your point -- some 15 million homes now are under water; that is, debt exceeds equity and those numbers are growing. And obviously that's -- you go back to what values were before -- Bob Corker likes to point out, and rightly so -- that, you know, we're looking at values today versus where they were a few years ago in terms of reality and all of that. In the meantime, obviously, a lot of wealth is being lost. So we have two roles: one, to find out what happened, and two, to make sure we take steps to see to it that we bring -- we short-circuit this problem before it gets completely out of hand.

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SEN. DODD: Good question. That was 96 hours, moved pretty fast to put ($)29 billion right on the block pretty fast, and no collateral asked, except hoping the assets there are going to turn out to be worth something down the road. And here we are one year later, (deciding ?) in this very room with all of the stakeholders, trying to get them to do something on this damn thing and nothing happened. According to Moody's, 1 percent maybe workouts -- nothing. And the administration sat back in August, and all they wanted to talk about was the debt ceiling when we had the meeting on this issue, and (usually ?) that language is contained.

So clumsy -- clumsy is what I'm getting from the administration, and not responding to this because failing to address what's going on here, and it's getting worse -- daily getting worse. So my hope is, and we're going to be able to act fairly soon on some of these ideas -- and simultaneously obviously go back and try to figure out as much as we can about what happened. And that's clearly an important function of the committee.

But that isn't going to be -- we're not going to be judged historically by just examining what happened if in fact in the process we don't do something to short-circuit this. And if we don't do that, then history with indict us if we end up with an economic mess on our hands it takes a generation to correct. And I'm worried that's going to be the case. So with that, we welcome our witnesses this morning.

Delighted to welcome the Honorable Brian Montgomery, assistant secretary for the Federal Housing Commission. Mr. Montgomery formerly served as deputy assistant to the president in Cabinet of the -- secretary before coming to HUD; his duties include oversight of FHA's $400 billion insurance portfolio and HUD's various regulatory responsibilities.

Arthur Murton is director of the Division of Insurance and Research for the Federal Deposit Insurance Corporation. Mr. Murton has a Ph.D. in economics at the University of Virginia, served at the FDIC since 1986, 22 years. The Division of Insurance and Research directs the FDIC's efforts in banking research and policy development.

And let me just say, Sheila Bair wanted to be here but there's been a death in her family and we extend, all of us do, our deepest sympathies to Sheila. She's been a wonderful public servant; she's been before this committee many, many times.

We welcome you here today, Mr. Murton, but please extend our condolences to Sheila.

MR. MURTON: Thank you, I'll do that.

SEN. DODD: Scott Polakoff is the senior director -- deputy director and chief operating officer of the Office of Thrift Supervision. He joined OTS in 2005 after serving the FDIC for over two decades. The OTS is the primary regulator of federal and state- chartered savings associations, and we thank all three of them being here this morning.

And we'll begin with you, Brian. Thanks for coming before the committee.

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SEN. DODD: Thank you very, very much.

And thank all three of you for your comments. And I should have said at the outset, if I didn't, any supporting data, materials you want the committee to have as part of your testimony we will certainly include as part of the record. And I'll put seven minutes on here and see if we can't hold to that so we give everyone who's here a chance to raise some of these very important questions that members have.

Let me if I can, just start off quickly with you, Mr. Montgomery, because there's been -- obviously, trying to give as much information as we can about what's working , what's not working. And again, I want to emphasize the point -- I know a lot of people are trying to figure out what best to do in all of this, and I welcome that and I'm deeply appreciative of the various ideas that have been surfaced.

And let me state as clearly as I can, there's no ideological position here. I'm trying to be as practical as I can as to what can work and make a difference, and so I'm less interested in people's ideological framework than recognizing there are moments when an intervention is necessary. Ideally I don't like it; I'd like the market to work. And if the market can work there's no reason for us to act, but when the market's not working, then it becomes incumbent upon us, I think, to try and figure out a responsible way to intervene intelligently, thoughtfully and responsibly.

Obviously understanding the time, you're never quite sure what's going to happen, but you hope you're smart enough that you're going to be a positive influence on it. But to do that, you've got to know what the data is. I'm looking at a report, an article that was entitled, "HUD Acknowledges Inability to Help Many Borrowers." This was an article that appeared about a month ago, and the director of FHA's office of Single Family Program Development said that there had been only 1,500 FHASecure financings from March 1 to the 15th. HUD reported that just 242 loans were made for delinquent borrowers, or just 17 loans per day.

I mentioned earlier we're getting some -- according to TracRealty (sic/RealtyTrac), in the neighborhood of 7(,000) to 8,000 filings a day. And as many of a thousand of those 7(,000) or 8,000 of those are actually going into foreclosure. At least that's the numbers we're getting on all of this.

So instead of 17 today, as opposed to the numbers we're looking at, let me ask, first of all -- the two other witnesses -- do you agree with that general overview here, that we're just -- the program is not -- FHASecure, while a good idea, is not addressing the magnitude of the problem. Is that your conclusion as well, as you look at this issue?

MR. POLAKOFF: Mr. Chairman, I wouldn't be prepared to say that at this point. As we reach out to the servicers, we understand that the servicers themselves are modifying a number of loans in an attempt to do the right thing. Borrowers are using FHASecure as a vehicle. There still seems to be an incredible difficulty to reach a number of borrowers as they approach default and a foreclosure situation, sir.

SEN. DODD: How about you, Mr. Murton?

MR. MURTON: Well, I think as I said in my statement, I think, as Chairman Bair said, we're at the point where we do think more steps are needed. We think the efforts so far have been important, but we do think that more may be needed.

SEN. DODD: Well, in your testimony, Mr. Montgomery, you state that FHASecure and Hope Now initiatives have together helped more than 1.3 million homeowners. And I'd like to get the data, if I can -- or the committee would -- for the record that breaks out exactly how many borrowers are getting repayment loans and modifications, what kind of repayment plans and modifications they are getting.

All of us here have a certain -- too many loans are being reclassified as modifications where no long-term interest rate freezes are involved or other considerations. The word modification is being rather used loosely, and it would be very helpful if we could, at your earliest possible convenience here, to get us the data that supports that conclusion of 1.3 million.

You want to add any comments here in terms of the concerns I have about that?

MR. MONTGOMERY: Absolutely, Mr. Chairman. Thank you. When we announced FHASecure on August 31st --

SEN. DODD: By the way, the industry itself has raised some concerns in the press about what they call "cooking the books" on these numbers. So --

MR. MONTGOMERY: Anybody can look at our books that want to, sir, at any time, any day.

Let me just say that when we rolled that FHASecure -- again, we're an insurance company; we needed to have a measured response backing our actuarial soundness. But we did say going forward that we would make improvements as we saw fit.

There have been 163,000 mostly subprime borrowers who are heading towards the slippery slope of delinquency -- we know this because they tell us -- who have never even heard of the FHA. Remember, for many years -- and your staff will attest to this -- FHA, I think a lot of people thought we were the Federal Highway Administration. We were almost an afterthought for many borrowers. A lot of publicity around the announcement, and again borrowers tell us this, they thought they had no other option.

So I will say this: We way overestimated the number who would come in delinquent. I'll get to that in a second. We way underestimated the numbers that would come in current. By the end of the fiscal year, we believe we will have 400,000 borrowers -- remember, these were not FHA borrowers -- that will refinance through a safe and secure FHA loan.

Now let me fast forward to last week. Moving forward, we wanted to make some more improvements to FHASecure, again coming at it from the sense of delinquencies, keeping our debt-to-income ratios and the like, that we think we'll add another hundred thousand to that number. Remember, a lot of these folks were never going to qualify anyway; they had no-doc loans; they'd stripped out a lot of the equity in their homes. So going forward, I think a lot of those families who refinance would disagree that they have not been helped.

SEN. DODD: Well, again, given the data you would help us get a better picture on all of this.

One of the things being raised a concern about is of course that we're protecting taxpayers. And obviously, all of us want to do that. The idea for this program or something similar was tried years ago; it actually produced a modest amount of income for the federal government in those days, in dollars, in 1920s, 1930s dollars. And we're not looking to make money off this, but obviously we want to avoid having great exposure for the American taxpayers as well, but it's been raised by many, including Senator Shelby and others.

And one of the ways we try to protect the taxpayer in this plan -- three ways we try to do it, and I'd like to know how you feel about these and if there are any other ideas you'd have that we ought to include as part of the proposal.

One, it increases the maximum up-front and annual premiums in the proposal, calls for FHA to share in future appreciation. So you're getting resources back in the program. And it limits the maximum loan-to-value of the new loan to 90 percent of the current value of the property, something Mr. Polakoff addressed.

Do any of you have any other additional factors or reactions to these ideas and is there anything else you'd add?

How about you?

MR. MONTGOMERY: I would say, on the LTV, again, sir, there's some common ground here; I can't stress that enough. We think there needs to be an incentive for the current lien holders -- as part of those agreements that were referenced earlier -- to want to do the write-off down to some certain number. I think a mandatory complete write-off for the FHA re-fi is accepted as payment in full.

I don't know that you would get the participation that you're looking. We think by coming at it a little differently, that FHA steps in, there's a second lien for a part of that charge-off I think we think is a more prudent approach. Ninety percent LTV loans perform very well for FHA.

I will also say on the debt-to-income, I know that you give those authority to a board, which again we -- speaking for our excellent career staff at FHA -- we strongly -- we have that expertise. But we feel very secure in keeping those debt-to-income ratios the same. And I know you would have this board do that, 31 being the front end, 43 being the back end.

On the shared equity component, again, as I mentioned in my oral statement and the written, we were not party to that original transaction. This is not FHA's money. I think we share in the goal that we want to keep that borrower in the home so they don't experience some windfall profit.

We think the 90 percent with a soft second support set, but we could also have some sort of recapture provision, some sort of resale restriction to perhaps (account for ?) same thing.

SEN. DODD: I agree with you. There's no value.

Mr. Murton?

MR. MURTON: Yes, in our written testimony we did mention that perhaps increasing the fee from 3 percent to 5 percent or in that direction may be important. We're concerned about making sure that the government is protected to the extent possible, so I think there may be room for discussion on that. We do recognize that we do have to provide incentives for the investors to participate.

MR. POLAKOFF: Mr. Chairman, we would urge very strongly consideration that the negative equity certificate or the potential share in upside appreciation reside with the original loan holder, potentially also with the second and with the borrower.

Whether 90 LTV, whether that 10 percent cushion is the right amount -- the key here for these FHA refinance, we believe, is insured financial institutions are going to be the ones that underwrite these loans -- should be fully documented, properly underwritten with the 10 percent margin. We believe they should be safe and sound loans.

SEN. DODD: Yeah. I think on the incentive idea, I think there's some real value in that as well, striking that balance, because this is voluntary and to the extent you want both the investor and obviously the borrower, the incentive of the borrower is there; you're set to stay in your home. But the incentive for the investor to step up and say, "I'm willing to take that haircut and do this," I think you've got to have a proper incentive in there.

It gets to the issue of (by the well ?) of the safe harbor provisions, which I'll come back in a later round, since I've already over the time here, but I appreciate your comments.

Senator Shelby?

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