June 10, 2008

The Solvency of FHA

Filed under: FHA Loan

PREPARED REMARKS BY FHA COMMISSIONER BRIAN D. MONTGOMERY AT  THE NATIONAL PRESS CLUB

Thank you and good afternoon.

Let me begin by congratulating new HUD Secretary Steve Preston.  

All of us at HUD look forward to working with Secretary Preston over the next few months.  And I appreciate the strong interest he has taken in the work of the Federal Housing Administration. 

I also want to recognize our General Deputy Assistant Secretary for Public Affairs DJ Nordquist.  DJ and her team have more than earned their stripes the past few months dealing with a host of contentious issues. 

She was always the consummate professional handling dozens of press queries many of them quite complex and of course all of them with a tight deadline. 

And I also want to recognize Press Secretary Steve O’Halloran and an all-star team of career public affairs specialists including Brian Sullivan, Lemar Wooley, and Jerry Brown among others.

Congratulations to the National Press Club on its 100th anniversary, a centennial of service.

I am honored to be the first Commissioner of the Federal Housing Administration invited to address the Club, appropriately during “National Homeownership Month.”  And I am pleased to be the latest speaker in a line that goes back to Buffalo Bill Cody, your very first speaker in 1908.

Lately, the housing market has been as wild and woolly as those days of the Western frontier.  Sometimes, as commissioner, I feel that it is “High Noon” and order and justice need to be restored. 

I suspect that some of you are students of history.

You probably know that the Press Club was founded during a housing crisis that started at the turn of the twentieth century and continued through the Depression. 

My agency, the Federal Housing Administration, FHA, was created to help end that crisis.

It was established by Congress in 1934 to provide liquidity in the mortgage market, a function that it has ably served for more than 70 years.

FHA’s presence has been solid and sound, but silent. 

In my tenure as Commissioner, no one has ever asked me about where we would be without FHA, but I think about it often.

We have insured more than 34 million loans over this time span.

Currently we have 4.8 million loans in our insurance portfolio – loans that are safe and secure from astronomical rate resets or hidden add-ons or prepayment penalties.  And through our extensive loss mitigation efforts, we have helped about 300,000 FHA-insured families avoid foreclosure in the last four years.

Imagine if just a fraction of those loans were added on to our current difficulties!

I can assure you that our current housing crisis would be exponentially worse without the day-to-day availability and foreclosure prevention efforts of FHA.

That last statement might surprise some people, but that surprise is a relatively recent reaction.  In fact, for decades, FHA was so well-known that it was part of our common culture, a reference everybody understood.

Most people knew about FHA, knew of its mission, and many of our parents and grandparents used it.  It was the gold standard of the housing market.

Public awareness of FHA became lost, forgotten, as housing prices rose beyond the reach of FHA-backed loans.

It became difficult for hard-working Americans living in high-cost housing markets to access FHA loans.

This was especially true in markets like California, New York, Florida, and Nevada – in cities like Las Vegas, Riverside, Phoenix, and Denver.

These are the very markets that are now suffering through a foreclosure crisis, in part fueled by irresponsible subprime mortgages that were nothing but suicide loans for both lender and borrower. 

And the subprime loans cut into our ability to serve minority communities and those with low incomes, people who traditionally relied on FHA financing. 

Historically, one-third of our borrowers are minorities.

In fact, as early as 1981, the New York Times ran a story (“FHA’s Future Under Debate, November 8, 1981) about whether or not FHA should even exist, that maybe it had become a fossil of the New Deal. 

The story discussed a proposal floating in Washington to engineer the demise of the FHA because fixed-rate mortgages were, in their words, “becoming history” and that FHA may be, again, in their words, “a thing of the past.” 

At that time, almost three decades ago, FHA Commissioner Philip Winn rightfully argued that FHA should be modified to allow the products to keep pace with housing inflation and that monthly mortgage payments should be on a level within the means of first-time buyers.

That was in 1981!

Commissioner Winn worried that, in his words, “There are those in the city who are ready to guillotine FHA.”

Instead of elimination, he argued for changes that would ensure FHA’s relevance.

I have echoed his request all these years later, because legislation to modernize FHA could have prevented much of the mess we confront today.  Hobbled by low loan limits and higher downpayment requirements, FHA was literally priced out of some housing markets.

It’s been over two years since we introduced that FHA legislation, it’s now passed both chambers twice, we’re in the middle of a housing crisis, and yet, a final bill still hasn’t made it to the President’s desk.

I feel like one of the characters from the timeless Samuel Beckett play “Waiting for Godot.”  Despite our best efforts, we continue to wait and wait, and wait for Congress to do their work on FHA Reform. 

Today’s housing market is vastly bigger than the 1930s, both in percentages of homeowners and in number of dwellings.

We now have a foreclosure crisis of our own, with 1.5 million foreclosures started in 2007.  We also have about 9 million homeowners underwater as housing prices fall.

The median price of a home has dropped 8.2 percent in the last year.  And there are worries about the future, about when the crisis will end and about how many more people will lose their homes. 

FHA has been an important part of our national response to this crisis.

In late August 2007, President Bush introduced FHASecure to help Americans facing foreclosure refinance into a safer, more secure FHA loan.

Since then, more than 230,000 families have been able to refinance with FHA.

In fact, if you look at the number of single-family mortgages endorsed by FHA in the first quarter of 2008 alone, which includes FHASecure and FHA purchase business, total FHA endorsements increased more than a 100 percent over the same period last year.

The Administration announced this program last year to help more low-to-moderate income families who could not otherwise qualify for prime-rate refinancing.

Our projections show that we are on pace to reach close to 500,000 families by year’s end.  

In addition to helping struggling homeowners, the program has added much-needed liquidity to the real estate market.

Since September 2007, FHA has helped pump more than $76.1 billion of mortgage activity into the housing market; more than $30.3 billion of that investment came through FHASecure.

Two months ago, in early April, I extended the FHASecure product to even more at-risk homeowners.

In response to the shifting market conditions, the program is now serving families in default as a result of temporary economic hardship, as well as those who were affected by payment shock.

With interest rates remaining fairly low, yet with contraction in some local economies, some families have lost overtime pay and second jobs. 

Thankfully, the FHASecure program is now helping many of these families refinance into a more affordable FHA loan.  

Expanding FHASecure in this way is a good idea.  It offers lenders a refinancing alternative that makes voluntary write-downs a viable option.

Appropriately reducing the principal amount owed on subprime mortgages helps both troubled borrowers and lenders.  And avoiding foreclosure is less costly for lenders than foreclosure.

The Joint Economic Committee has estimated that foreclosure avoidance costs a lender about $3,000; while an actual foreclosure costs a lender almost $78,000.

Another helpful action was passage of the Economic Stimulus Package.

The President’s stimulus package has temporarily increased FHA’s loan limits.

For the rest of the year, we can back more mortgages in high-cost states and help homeowners hold on to their houses.

The new loan limits were announced in March. They range from $271,000 to $729,000.

I have spoken with many people in the housing industry who believe that this action instantly assisted many homeowners.

These loan limits make FHA relevant in all markets, but noticeably so in high-priced markets like Nevada, California, New York, Washington, D.C., and Florida. 

We project that the new, temporary loan limits will help approximately 100,000 homeowners obtain safe FHA-backed loans by the end of this year. 

But these loan limits will expire at the end of the year.  So we need to have appropriate and long-term changes to FHA’s loan limits through modernization legislation.

There are two key components that must be part of any final FHA Modernization bill.

First, we must maintain FHA’s ability to offer a fair and equitable mortgage insurance premium structure that is commensurate with the risk presented by the loans it insures.

Any bill must continue to allow FHA to price for additional risk.  That’s how any successful insurance company operates – more risk, higher cost.  Just like an 18-year old gets charged higher car insurance than his dad.

To ensure the solvency and continued operation of FHA’s single family mortgage insurance fund, FHA has already announced implementation of a flexible risk-based premium structure.

It’s the first time in FHA’s 74-year history that we have had different prices for premiums.

The change is very well timed, allowing FHA to reach more troubled families without placing excessive risk on the insurance fund or on taxpayers.

The modernization bill must preserve this authority, consistent with the goal of fiscal solvency.

What’s interesting about risk-based pricing is that it will actually benefit lower-income American families.

We did an analysis of our borrowers and contrary to conventional wisdom, FHA families with the lower incomes have higher FICO scores.  These are hard-working American families who live within their means and pay their bills.

That’s why we need legislation to do risk-based pricing beyond what we’ve done in rule-making.  We need the authority to go beyond the current statutory cap.

Second, legislation must address the risks associated with down-payment assistance that comes from the seller or any other person or entity that stands to benefit from the transaction financially.

The IRS, GAO and our own Inspector General have previously expressed concerns with these circular financing schemes.

Data clearly demonstrates that FHA loans made to borrowers relying on seller-funded downpayment assistance go to foreclosure at three times the rate of loans made to borrowers who make their own downpayments.  No private mortgage insurance companies back these loans.  They now account for one third of our portfolio.

We are concerned about this business because the substantial losses affect FHA’s bottom line and FHA’s ability to serve American citizens who need access to prime-rate home loans. 

Given these concerns, we cannot just stand by – we must make our case again.  So, today, I announce that we are reopening public comment on our proposed rule.

Within hours, we will submit this rule to the Federal Register.  It should be online at FHA.gov soon thereafter.  The Department is eager to review all comments. 

In its entire 74-year history, FHA has been self-sustaining.  That means that our income has exceeded our costs and we have not needed an appropriation of taxpayer dollars to cover FHA’s operations. That’s pretty unique for a federal program.

Currently, FHA is solvent.  In fact, we have a reserve of about $21 billion.

However, as a result of our annual re-estimate, we had to book an additional of $4.6 billion in unanticipated long-term losses, mostly due to the increased number of certain types of seller-funded loans in the FHA portfolio. 

Let me repeat:  FHA is solvent.

However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, FHA will soon either have to shut down or rely on appropriations to operate.

That, I think, would have a far-reaching impact on the economy.

It would severely reduce the number of new homeowners each year.

It would also sharply reduce the need for the services required to build and maintain homes.

In other words, the negative impact goes far beyond the individuals who would not be able to purchase homes, and would likely be felt across the entire economy.

Frankly, we need reasonable solutions to the housing crisis.  And I think there is considerable common ground on confronting it.

There is surely a consensus on a number of actions.  But some in Congress are advancing legislation that, while well intentioned, could be problematic for the economy and the country.

Some of the proposed Congressional actions could actually weaken FHA and endanger the housing market by turning FHA into a less stable, less solvent, more bureaucratic entity.

There are some who want FHA to pick up all the potentially delinquent 2 million subprime loans.

This is a worrisome idea.  FHA is designed to help stabilize the economy, operating within manageable, low-risk loans.

It is not designed to become the federal lender of last resort, a mega-agency to subsidize bad loans.

We don’t want to dramatically enlarge FHA’s portfolio, with a substantial portion of the portfolio problematic, high risk loans that cost homeowners who were careful and bought homes within their means.

So far, I have talked about efforts to find and secure the right mortgage for the right home.  But we also need to make mortgages more understandable and more uniform.

People need to be able to read and understand the fine print of their loans.

A home is easily the largest purchase most people make their entire lives.

Not many people do it repeatedly so they don’t have a lot of experience with the process and it can be pretty scary, especially when you see charges outside the price of your house and your loan that you have never heard of.

A new study by HUD and the Urban Institute found that total loan fees can vary widely from borrower to borrower within a state, and from state to state, even for similar loans.

The variation can be as much as several thousand dollars.

The same study found that members of our minority communities are hit especially hard during the closing process.

African-American families pay an average of $415 more in total loan origination fees than non-minority borrowers, and Hispanic borrowers pay an average of $365 more in total loan origination fees than non-minorities.

The unnecessary complexity of mortgages has actually greatly contributed to our housing crisis.  And we must do something to make mortgages more understandable and the process more transparent.

That’s why we are pushing through new regulations to reform the Real Estate Settlement Procedures Act (RESPA) to require all mortgage lenders and brokers to clearly display an estimate of all settlement services, fees, and charges.

They must not be hidden in the fine print.

This would help to make mortgages more understandable.  Borrowers would know the interest rate and monthly payment amount.

They would know whether or not the rate or principle balance would increase over time.

They will know if there are prepayment penalties or any balloon payments. 

The rule will require a clear statement that would itemize closing costs and lock in certain charges at settlement.

This would offer greater transparency and certainty, allowing Americans to shop and compare.

Frankly, this will help in many ways.

We estimate it will save about $700 per person in closing costs.

It will help avoid changes in the mortgage that contribute to foreclosure.

It will help the lender too, by making sure that the mortgage is affordable and more likely to be paid on time. 

The original comment period on this rule has passed, but we have extended it to this Thursday, June 12th.

We are committed to finalizing this rule before the end of the Administration.  Further delay helps nobody.

The industry should embrace this rule as a best practice that strengthens their business and better serves their customers.

We are doing other commonsensical things.  For example, in 1958, faced with 23 volumes of outmoded and confusing standards for an FHA loan, Commission Norman Mason ordered that a one volume book be written that would update and clarify the regulations. 

That was a good idea then.  Simplicity can be a good thing now.

We have also tried to simplify our internal and external processes. 

Simple things like going to electronic records, which helps streamline and remove typical bureaucratic red tape and makes a more efficient approval process, while still weighing risk.

In the end, the housing crisis happened because of a variety of factors, all of which were solvable and essentially preventable.

Lenders need to be subject to prudent regulation and the financial regulators need to beef up their rules.

Wall Street needs a little less irrational exuberance.  Ratings agencies need to look in the mirror.  And of course lenders themselves have to be more responsible.

Risk must be minimized through common sense actions like checking credit, employment history, and ability to pay.

Seriously, what a concept!!

Mortgages have to be clear and affordable. 

We need to mobilize every segment of the housing industry in an effort to make housing more available, affordable, and sustainable.

I have been very impressed with a voluntary industry effort called HOPE NOW.

By reworking mortgages with homeowners facing foreclosure, the industry has reached 1.6 million homeowners in trouble.  That gets right to the problem and doesn’t cost the taxpayers anything. 

Borrowers themselves must be prudent, avoiding a credit addiction that is epidemic in this country and quickly places people in a position where they can’t pay their bills.

Financial responsibility is an important part of life, of our character, of who we are, and who we will become.

There needs to be a higher standard of responsibility.  That is not an unreasonable expectation.

I realize that I am the first commissioner to speak here because the housing crisis demands our attention.  But I hope I’m not the last.

When this crisis is over we will need to make sure that the American housing market is on a solid foundation for the future.

We will need to make up the lost ground of the last couple of years and forge ahead to higher rates of sustainable homeownership. 

And we have to learn from this crisis, having the wisdom to avoid the high risk, entirely predictable problems we face now. 

As I said earlier, this month is “National Homeownership Month,” and I can think of no more appropriate time to reflect on our housing market and to determine the correct course of action.

Certainly, this is a decisive moment in our economic history.

We have the chance, the opportunity, to set the course for further homeownership, prosperity, and wealth creation.

We will choose wisely if we emphasize responsibility, common sense, transparency, openness, and cooperation.  And FHA can be a cornerstone of our housing recovery, if we give it the right tools to do the job through modernization.

For myself, I thank you for the chance to express these views in this historic venue.

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