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Testimony of General Deputy Assistant Secretary Ira G. PeppercornJune 2, 1998
Mr. Chairman and members of the Subcommittee, my name is Ira Peppercorn. I am the General Deputy Assistant Secretary for Housing-Federal Housing Commissioner. Thank you for the opportunity to testify today on behalf of Secretary Andrew Cuomo and the US Department of Housing and Urban Development (HUD). With me today is Gary Eisenman, HUD's Deputy General Counsel for Housing and Community Development.
I am pleased to have this opportunity to discuss the current status of the Federal Housing Administration (FHA), its role and mission, the financial status of FHA, and many of the dramatic improvements and reform efforts we are implementing under Secretary Cuomo's direction. I understand Subcommittee members are particularly interested in FHA's single family programs, including our plans to reform and privatize FHA's real estate owned property disposition program. Therefore, my testimony today will focus on these areas of interest to the Subcommittee.
Mr. Chairman, Secretary Cuomo and I believe that FHA's mission remains as clear today as when the Agency was formed in 1934 -- to meet the home mortgage credit needs of American households who are not well served by the private mortgage finance industry, while maintaining the financial integrity of FHA. What has changed though over the last several years, Mr. Chairman, is the environment within which FHA operates.
In 1934, only 44 percent of US households owned their own homes - and the Depression threatened to drive the homeownership rate lower still. Those who could qualify for home loans typically faced sizeable down payments of up to 50 percent of the house value, short mortgage terms of ten years or less, and large balloon payments. Throughout the 1930s, 40s and 50s, FHA pioneered the development of the national housing finance system. It set the underwriting standards for the private mortgage industry and contributed to the quality of housing in America by promoting national minimum building code requirements. With the introduction of FHA-backed mortgage insurance, conventional lenders were able to manage the risk associated with low-down payment (20 to 25 percent), long-term (25- to 30-year) amortizing loans. Following FHA's lead, the entire housing finance industry soon shifted to the new type of mortgage, dramatically expanding access to mortgage capital for millions of middle-income Americans.
As you are aware, a lot has changed in the housing finance industry and within FHA since those early years. Particularly over the last two decades the private mortgage finance industry has been revolutionized. The variety of housing finance organizations has expanded - with private, nonprofit and public entities now active in the market - technology has become more sophisticated, and new financial instruments have been developed. Growth of the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) and the development of the private mortgage insurance industry has further enhanced the liquidity of residential mortgage loan market.
Within this shifting environment, I believe FHA still has an important, although more modest, role to play. Despite the tremendous growth in private home mortgage loan market, hundreds of thousands of Americans continue to be denied access to private mortgage financing. With more flexible underwriting criteria and the ability to take on more risk than private mortgage insurers (PMIs), FHA continues to play a critical role in meeting the mortgage credit needs of hundreds of thousands of American households - including young first-time homebuyers, center city residents and racial and ethnic minorities - who are not presently well served by the private mortgage industry. As PMIs have grown and extended their reach into more markets, FHA's role in the market has appropriately decreased in size and become more focused on those Americans not well served by the private housing finance industry.
FHA has a demonstrated track record of providing mortgage credit to these borrowers who have relatively little savings, minor credit blemishes, or other unique characteristics that create barriers to access private industry home financing. By offering down payments as low as 3 percent, permitting homebuyers to borrow closing costs in their mortgages and use gifts from family members and non-profit groups to make their down payments, FHA offers a very unique mortgage product that reaches American households who are not presently well served by the private housing finance industry.
Please allow me to provide a picture of who FHA serves today:
Taken together, this empirical data indicates that FHA today continues to play a vital role in serving the home mortgage credit needs of young, first-time home buyers, center city residents, racial and ethnic minorities, and other Americans who are not well served by the private mortgage finance industry.
In addition, I'd like to point out another important role FHA continues to play in housing finance markets: safeguarding the flow of capital in regional markets during periods of economic distress. Despite impressive growth over the last two decades, the PMI industry provides uneven coverage across markets, leaving individual regional markets vulnerable during economic downturns. When PMIs and the conventional lenders that rely on their credit enhancements abandon regional markets en masse, they can make economic downturns even worse - as seen in Texas and the Southwest during the 1980s.
FHA counters this trend by serving as a back-stop in regional markets experiencing an economic downturn. Just as in the 1930s when FHA helped stem the flight of mortgage credit from housing and homeownership, FHA prevents capital flight that both destabilizes regional markets and limits the ability of private and nonprofit developers to address unmet housing needs.
FHA IS FINANCIALLY STRONG TODAY
Mr. Chairman, I also am pleased to report to the Subcommittee that FHA today is financially stronger than it has been in more than a decade. The FY 1997 Price Waterhouse actuarial report on FHA indicated that:
Furthermore, the annual FHA actuarial review performed by Price Waterhouse continues to demonstrate that FHA operates at no cost to the taxpayer. FHA's insurance premiums plus recoveries on properties sold from the real estate owned (REO) inventory, exceed the cost of all insurance claims and operations.
Nevertheless, despite these tremendous improvements in the health of the FHA Fund, we recognize that there still is room for improvements. One of the central concerns raised by the various organizations who review FHA's financial integrity, including GAO, is the return FHA receives on the sale of REO properties. GAO and others have noted that FHA takes too long to dispose of properties, and generally does not receive a return that is competitive with private industry returns. That is why Secretary Cuomo and I are committed to fundamental reform and privatization of FHA's property disposition program.
HUD 2020 REFORM: POSITIONING FHA FOR THE 21ST CENTURY
Mr. Chairman, under the leadership of Secretary Cuomo FHA is not only the strongest it has been in decades, but it also is well positioned to become even stronger and to take on new challenges in the future. Secretary Cuomo's Management 2020 Reform effort is creating new and more effective ways for FHA to conduct its business. Instead of working out of 81 small and inefficient field offices, FHA now does business through four state-of-the-art Home Ownership Centers (HOCs). Working with Freddie Mac and Fannie Mae, FHA lenders and borrowers now have access to a state-of-the-art automated underwriting system, reducing from days to a matter of minutes, the time needed to process an application for home financing.
HUD's 2020 Reform is also dramatically restructuring FHA's loan loss mitigation and property disposition activities. In February, FHA opened a new Loss Mitigation Servicing Center in Oklahoma to help boost use of our comprehensive Loss Mitigation Program. And just last Friday, May 29, FHA issued a proposed Real Estate Owned (REO) rule that would revolutionize the way we dispose of foreclosed properties. Using existing authority, this initiative would provide regulatory authority for FHA to shift to large scale privatization of FHA's property disposition program. This rule will allow HUD to manage its single family inventory in accordance with the best private sector practices, to streamline the disposition process and to reduce the time and cost of selling properties, generating significant savings.
Building on accomplishments to date, HUD's FY1999 Budget proposes further dramatic reform of the property disposition process. If enacted, HUD's proposed property disposition legislation would allow HUD to intervene earlier in the loan default cycle and have the option to transfer notes to private real estate professionals prior to foreclosure. The new legislation would not only improve FHA efforts at loan loss mitigation and property disposition, it would also further reduce costs associated with foreclosure and disposition, resulting in $525 million in savings, according to the Office of Management and Budget (OMB).
In short, FHA is streamlining operations, centralizing back-office functions and staff, investing in advanced technology and drawing on private sector expertise wherever possible. Secretary Cuomo is leading FHA into the 21st Century, and turning it into a state-of-the-art mortgage insurance company.
FHA HAS BEGUN SYSTEMIC REFORM
As part of these reform efforts, Secretary Cuomo recently announced a complete package of far-reaching reforms that will strengthen FHA and help more Americans families buy homes while maintaining the financial health of the MMI Fund.
Secretary Cuomo's comprehensive package includes reforms for every aspect of the home buying, loan origination and homeownership continuum. This continuum starts when a family begins to look at prospective homes to purchase, through the information gathering process of appraising and inspecting specific homes, into working with a local lender to weigh alternative financing and arrange for a home loan, and finally the post-acquisition phase when FHA works with borrowers having difficulty making loan payments to try to help them stay in their homes. FHA has developed and is implementing improvements, and in some cases dramatic reforms, for every aspect of this home buying and homeownership continuum. Key components of our FHA reform package include:
Mr. Chairman, I'd like to share some of these reforms with members of the Subcommittee.
Providing Housing Counseling
More Funds to Support Counseling: HUD's FY 1999 budget proposes an increase in the amount of funds for homeownership counseling by 25 percent to $25 million. Secretary Cuomo and I believe that housing counseling is a critical component of any strategy to help American households achieve the dream of homeownership. Pre- and post-purchase counseling assistance helps homebuyers identify potential problems before they buy a home, emphasizes the importance of a full home inspection, helps buyers determine how much they can afford to spend, and teaches negotiating skills that can cut the price of a home purchase. HUD funds about 300 housing counseling agencies and five national nonprofit organizations. This counseling increases the likelihood that FHA home buyers will make a wise decision in purchasing a home and will have a better chance of holding on to their home over the long run.
Strengthening the Appraisal Process and Encouraging Home Inspections
More Thorough Appraisals: HUD will issue new guidelines requiring appraisers to do more detailed examinations of homes, enabling them to discover more potential problems. For example, in conducting the basic physical condition survey, appraisers will have to: report all health and safety problems they find; and, check to make sure the plumbing and electrical systems are working among other new requirements. A detailed guidebook will explain the new appraisal standards.
Stricter Accountability and Tougher Sanctions for Appraisers: FHA also is creating uniform national appraisal standards and plans to impose tough new penalties. HUD also plans to make the appraisal an official submission to the federal government, opening appraisers to legal action under the False Claims Act for the first time if they state falsely that they conducted the appraisal in compliance with FHA guidelines. The False Claims Act makes it illegal to knowingly file a false statement with the federal government.
In addition, for the first time, FHA will issue a list of uniform national penalties for specific violations of FHA's appraisal guidelines. The penalties - consisting of suspensions from FHA appraisal work for up to a year - will standardize and in most cases increase existing penalties used by HUD's field offices.
Increased Review of Appraisals: FHA plans to hire contractors to review 10 percent of the approximately 800,000 appraisals each year. The reviews are an enforcement tool designed to find appraisers violating HUD's appraisal guidelines.
Disclosure of Home Defects to Potential Buyers: For the first time, HUD will require that homebuyers be notified of problems that appraisers find in a home. HUD will continue to require appraisers to notify the seller and lender, and major repairs will still have to be made before an FHA mortgage can be issued.
Mandatory Appraiser Recommendations of Needed Inspections: HUD will require appraisers to recommend to homebuyers that they get a full inspection of a home they are considering purchasing if the appraiser finds significant problems with the home.
Increased FHA Mortgage Financing for Inspections: In order to encourage homebuyers to have independent inspections, FHA will raise the amount that it permits to be financed in the mortgage to $300 from the current $200.
HUD Funding for Inspections: HUD will allow communities
to use funds they receive under HUD's Community Development Block
Grant Program and HOME program to pay for home inspections for
low and moderate income homebuyers.
Developing the Capacity to Use State-of-the-Art Automated Underwriting Technology
Speedy FHA Mortgage Application Review: FHA's comprehensive
reform package also includes adoption of state-of-the-art automated
underwriting systems. HUD will make available its own powerful
new high-speed loan evaluation system to all FHA lenders later
this year. FHA began using Freddie Mac's Loan Prospector computerized
loan evaluation system in March - cutting the time it takes to
evaluate a homebuyer's application for an FHA-insured mortgage
from four weeks to two minutes, dramatically reducing paperwork,
and enabling more families to qualify for FHA mortgages. FHA
is also now using a similar system from Fannie Mae in a pilot
FHA Reforms to Help Families Stay in Their Homes
Early Warning Systems to Help Borrowers Avoid Default: HUD is now exploring the potential for adapting risk assessment tools commonly used by leading private real estate finance organizations for use by FHA. These systems represent state-of-the-art technology for assessing the likelihood that a loan in default will cure (i.e. return to making timely payments) or fall further into arrears. Adopting this types of system, will help FHA and lenders to work with the homebuyer to provide credit counseling and other assistance to help avoid defaults.
FHA's New Loan Loss Mitigation Program: As you are aware, in 1996 Congress authorized a comprehensive new program of loan loss mitigation that protects the interest of homeowners and the financial integrity of the FHA MMI Fund. The program includes several new ways to help families in financial distress stay in their home, including special forbearance periods, modification of loan payments, balance and/or interest rate, as well as pre-foreclosure sales. This new program replaces the ineffective Assignment Program, which often left borrowers deeper in debt and was costly to the Fund. And, perhaps most importantly, the new program shifts the emphasis to early intervention in the default cycle, when there is the greatest potential for the borrower to recover from default and remain in their home.
Mr. Chairman, I'd like to take a few minutes to describe a few critical features of FHA's Loan Loss Mitigation Program. These include:
Mr. Chairman, let me assure you that FHA is working hard to facilitate the transition from the Assignment Program to the new Loss Mitigation Program. As you may know, loan loss mitigation is one material weakness KPMG Peat Marwick noted in FHA's FY 1997 audit. As such, loan loss mitigation has the full attention of senior HUD staff. We have a plan that outlines all of the material weaknesses identified by our auditor (including loan loss mitigation), identifies staff responsible for correcting each weakness, highlights action steps and sets target dates for completion. We take these weaknesses seriously and are working hard to correct them. Toward this end, we are focusing our energy on ensuring a smooth transition to a new loan loss mitigation program and increasing the lenders use of the new loss mitigation tools. HUD's efforts in this area include:
After a somewhat slow start in 1997 when FHA and lenders were transitioning from the Assignment program to the new Loan Loss Mitigation Program, we now are starting to see an increase in lenders' use of the new methods to help families in financial distress stay in their homes. In the first five months of FY 1998, FHA reported nearly 3,100 new Loss Mitigation cases, with the monthly average number of cases increasing each month. Based on this rapid growth, HUD estimates over 10,000 borrowers will participate in the Program by the end of the fiscal year.
As housing counselors, lenders and borrowers become more familiar
with loss mitigation options, HUD expects the number of cases
in FY 1999 to equal or exceed assignment cases in previous years,
which averaged 12,000 annually.
Dramatically Reforming and Privatizing FHA's Property Disposition
After several successful demonstration projects with private partners, HUD recognizes that private real estate professionals, including nonprofit organizations, can often service loans, pursue loan loss mitigation and, if necessary, manage foreclosure and property disposition more efficiently. FHA's current system of property disposition takes far too long, costs too much and sometimes causes substantial disruption to communities and neighborhoods. Secretary Cuomo and I believe that HUD should move out of the retail property disposition business, and instead privatize the entire property disposition process.
The empirical evidence supports HUD's experience. According to a report by Andersen Consulting on behalf of FHA, the private sector industry standard for the average holding period of an REO property is between 120 and 180 days. By comparison, the average holding period for a FHA property is 213 days. Furthermore, FHA incurs more costs than the private sector in the process of managing, marketing and selling properties. While the average disposition costs as a percentage of market value for the private sector averages between 16 and 18 percent of the un-repaired property value, the average for a FHA property is 21 percent.
President Clinton's National Performance Review (NPR) also recognized the need for FHA to privatize its property disposition. NPR's report on HUD recommended that HUD "outsource its property disposition function in order to create higher returns." The report further stated that, "Private companies operating in a competitive market can normally provide a business service more efficiently than a government staff, which is protected from the rigors of competition".
Now we are acting on the empirical evidence, our own experience and the advice of NPR by taking aggressive measures to privatize FHA's property disposition program. We are pursuing this reform through two primary efforts:
The new approach proposed in HUD's FY 1999 Budget Proposal would have numerous advantages:
Both the disposition options included in the REO Rule and the new approach contemplated in HUD's FY 1999 Budget Proposal, will provide additional tools for FHA to perform loan loss mitigation, property management and disposition activities. These new tools will complement existing disposition processes available under existing authority, such as individual competitive sales, direct sales to nonprofit organizations and government agencies, auctions or bulk sales. No single procedure will ever be right for all locations or economic conditions. Availability of a number of different tools will allow FHA to match its disposition program to the local market and maximize the return to the Fund. Further options will enhance FHA's ability to adapt to different market conditions.
Finally, even as HUD moves to streamline and privatize its loan loss mitigation and property disposition procedures, FHA will continue to sell a small number of properties in inventory to local government or nonprofit entities. This transfer of properties to local governments or community based nonprofit organizations may be done either as part of the sale of a future stream of properties or alternatively through another means more similar to the current way HUD disposes of properties.
Mr. Chairman, I want to clearly state that in pursuing these property disposition reforms it is HUD's intention to be very sensitive to the needs and concerns of people in the communities affected by sale of our REO properties. Toward this end, HUD senior staff have been meeting on a regular basis with House and Senate staff, as well as representatives of community organizations from across the nation to hear all interested parties' concerns and to integrate their input into our development of a new, more efficient property disposition process.
HUD'S PROPOSAL TO INCREASE FHA'S LOAN LIMITS
Finally, Mr. Chairman, I'd like to say a word about HUD's proposal to increase FHA's loan limits to one national standard equal to the conforming loan limit. This proposal will raise the FHA limit in 2,000 low-cost areas across the country from $86, 317, which is far below the median home price in many of those areas, and it will enhance FHA's ability to meet the needs of moderate-income Americans in high cost areas, where the current FHA limit is $170,362. Despite record national homeownership rates, many Americans - including young first-time homebuyers, center city residents and racial and ethnic minorities - are shut out of homeownership opportunities due to difficulty accessing mortgage credit.
A recent report by Harvard University's Joint Center for Housing Studies, suggests that:
These differential homeownership rates, which hold across all income groups, are due, in part, to difficulty obtaining home loans from the private mortgage finance industry. Mortgage lending information gathered by the Federal Reserve Board under requirements of the Home Mortgage Disclosure Act (HMDA) shows that minority households of all income levels are nearly twice as likely to be denied home loans as white applicants.
With the proven ability to take on greater risk than PMIs and the GSEs, and a unique mix of flexible, low-down payment mortgage insurance products, FHA is able to reach underserved borrowers and communities across the nation. Today, FHA serves a disproportionate number of young first-time buyers, borrowers making low down payments, households living in urban areas, African-Americans and Hispanics, and lower-income borrowers. Raising the loan limits will permit FHA to serve more of these borrowers, whose mortgage credit needs presently are not met by the private mortgage industry.
Overall, FHA estimates that the higher loan limit would enable approximately 54,000 households each year to purchase homes. CBO scored savings resulting from these new loans at $212 million annually.
Finally, raising loan limits is consistent with FHA's historical mission of meeting the credit needs of households not well served by the private market. Since 1992, even as the loan limit increased from $124,875 to the current $170,362, the share of FHA insured mortgages going to low-income borrowers increased from 15.7 percent to 20.1 percent. Over the same time period, first-time borrowers also have accounted for an increasing share of FHA activity going from 65.4 percent to 78.5 percent.
Members of the Subcommittee I would like to conclude my remarks by reiterating that FHA is heading in the right direction. Our mission remains clear: to meet the mortgage credit needs of American households not well served by the private housing finance industry. We are fulfilling that mission, while improving the fiscal health of FHA.
At the same time, we are working to dramatically reform FHA. We are working to provide more counseling to FHA borrowers, to strengthen the home appraisal process and encourage use of home inspections, to improve our systems of helping families in financial distress stay in their home, and to privatize FHA's property disposition process.
Thank you for this opportunity to testify. Mr. Eisenman and I look forward to answering any questions Subcommittee members may have.
Content Archived: January 20, 2009
Content Archived: January 20, 2009