Statement of Patrick J. Lawler, Chief Economist
Federal Housing Finance Agency
Before the House Financial Services Committee
Subcommittee on Housing and Community Opportunity
February 24, 2009
Chairman Waters, Ranking Member Capito and members of the Subcommittee, thank you for the opportunity to testify on behalf of the Federal Housing Finance Agency (FHFA). My Name is Patrick Lawler and I am Chief Economist of FHFA.
Today, the country faces an enormous challenge to stabilize the housing market. FHFA and the housing GSEs are actively working on foreclosure prevention to help homeowners in trouble. This is a major component of FHFA’s four-pronged strategy to ensure the housing GSEs fulfill their mission of providing liquidity, stability, and affordability to the housing market. The other crucial components of this strategy are:
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Ensuring that Fannie Mae, Freddie Mac, and the Federal Home Loan Banks support the market in a safe and sound manner, with special emphasis on affordable housing;
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Strengthening confidence in Fannie Mae and Freddie Mac, which should improve mortgage rates; and
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Working with the Enterprises to set best practices for the whole mortgage market.
The housing plan outlined last Wednesday by President Obama highlighted an even more prominent role for Fannie Mae and Freddie Mac. My testimony today will summarize recent initiatives and activities already underway to promote effective loan modifications, and discuss the even larger Enterprise role announced last week.
Since its inception, FHFA has provided supervision and oversight of the Enterprises’ credit risk profile and default management activities including loss mitigation program. During the last 24 months, that oversight heightened with the rise in defaults, serious delinquency rates and foreclosures. During 2008, FHF A worked closely with Treasury, HUD, the FDIC, other regulators, and the Enterprises to enhance and expand loss mitigation activities in general, and loan modifications in particular. FHF A implemented monthly and quarterly Foreclosure Prevention Reports to monitor and publicly disclose the Enterprises’ efforts to assist "at risk" borrower.
As indicated in our Federal Property Manager reports, modifications have been rising steadily since the beginning of 2008. In 2007, loan modifications totaled 34,603 and averaged 2,884 per month. As of November 2008 year-to-date, monthly loan modifications have ranged from 3,971 to 8,291 per month, and averaged 5,311. In addition, Fannie Mae introduced the Home Saver Advance program which allowed borrowers to reinstate their accounts with an unsecured loan on the property. As of November 2008, Home Saver Advance loans reinstated 6l, 671 accounts.
Clearly, modifications can be very effective in reducing foreclosures. To maximize that effectiveness, servicers need to be able to establish meaningful contact with the borrower. Also, borrowers must provide information needed for the servicer to create a payment that is affordable, and that the borrower can consistently pay over time. The likelihood of a successful modification is increased when servicers and borrowers connect very early on—before the account is deeply delinquent.
Since the 1980s, the Enterprise have offered loan modifications as an alternative to foreclosure. A loan modification is simply a change to one or more of the mortgage term—unpaid balance, term or interest rate—that creates a more affordable payment for the borrower. A standard loan modification requires the borrower to submit a personal budget, hardship statement, and verification of income. The servicer pulls an updated credit report. The borrower’s ability to pay is calculated on his or her personal circumstances, and is based on the borrower’s residual cash-flow. The approach is customized to the borrower’s situation, requires extensive communication, and is very labor-intensive. In this environment with rapidly rising delinquencies, servicers are challenged by the sheer volume of borrowers requesting assistance and their ability to effectively and efficiently modify the loans. As a result, new programs have been designed with the goal of reaching more borrowers more quickly, and making it easier and faster to execute a loan modification.
In November, FHF A announced the "Streamlined Modification Program" (SMP) that was rolled out in December. To date, 90,000 letters (solicitations or modification offers) have been mailed to a targeted population of borrowers who had missed three payments. Responses to those letters are just starting to come in. Early indications are that several of the program guidelines should be liberalized to reach a broader population and to create a lower, more affordable payment. This feedback was shared with the Treasury Housing Team working on the Administration’s Homeowner Affordability and Stability Plan.
In addition to the SMP announced in November, the Enterprise have taken many additional steps to help avoid preventable foreclosures. They suspended foreclosures and evictions and developed program to protect renters living in foreclosed properties. They are pulling loan files for a second look before foreclosures, and they are working with credit and housing counselors.
Historically, under individually customized modifications, re-default rates have ranged around 25 - 30 percent. Because the SMP was just recently rolled out, there are no data to calculate re-default rates. It’s important to note that when calculating and analyzing re-default rates, common definitions are required. There is much debate within the industry as to what those definitions are, how re-default rates should be measured and over what timeframes.
Private Label Securities (PLS)
As conservator of the Enterprises, FHF A has not only taken strong action to ensure the maximum effort by the Enterprises to modify loan to prevent foreclosures, but also has taken a leading role in efforts to address the foreclosure crisis in the private-label securities market. While Fane Mae and Freddie Mac own or guarantee almost 31 million mortgages, about 56 percent of all single-family mortgages. The mortgages they own or guarantee represent just 19 percent of serious delinquencies. Private-label mortgage-backed securities (PLS) represent 16 percent of all outstanding mortgages but more than 62 percent of the serious delinquencies.
If we are going to stabilize the housing market, we must address that 62 percent. FHF A believes Fannie Mae and Freddie Mac must be leaders in improving, promoting, and enforcing industry standards and best practices for all mortgages.
The GSEs own the largest position of originally AA-rated private-label residential and commercial mortgage-backed securities. Currently, Fannie Mae, Freddie Mac, and the 12 Federal Home Loan Banks own $255 billion unpaid principal balance in private-label residential mortgage-backed securities or 14 percent of single-family PLS outstanding. Fannie Mae and Freddie Mac have wrapped an additional $13 billion unpaid principal balance of such securities, which they now guarantee for third-party investors. Subprime and Alt-A mortgages constitute the overwhelming majority of mortgages backing these securities for Fannie and Freddie. The Federal Home Loan Banks have very little subprime but a substantial investment in Alt-A securities.
We have heard for almost two years that it is hard to modify PLS because of the constraining trust and pooling and servicing agreements. In December, FHF A convened a meeting with the major trustees and a group of high touch, independent servicers. Director Lockhart has met with American Securitization Forum representatives and private-label MBS servicers, investors, and trustees to strongly encourage rapid adoption of SMP as the industry standard. In light of the GSEs’ large exposure to mortgages in private label MBS, on November 24, 2008, the Director sent to private-label securities servicers and trustees a letter urging their prompt action to support SMP. We have subsequently encouraged the Corporate Trust Committee of the American Bankers Association in the development of its letter encouraging all servicers to consider and pursue appropriate modifications in a proactive and timely manner, and providing information on how to best work within PLS pooling and, servicing agreements. I am pleased to say that the Corporate Trustee Committee recently released a letter doing just that. We and the Enterprises are working with independent mortgage servicers to help them in their efforts to obtain financing of the advances they are required to make to PLS trusts.
FHFA began in September a Foreclosure Prevention Report, which is a transparent review of key performance data on foreclosure prevention efforts. These monthly and quarterly reports present data from more than 3,000 approved servicers on 30.7 million first-lien residential mortgages serviced on behalf of Fannie Mae and Freddie Mac, of which 84 percent are prime. The just released November report showed that for the first full two months of conservatorship, October and November, the number of loan modifications increased 50 percent from the previous two months.
FHFA understands the nation’s deep concern over the personal hardships of the foreclosure crisis. We maintain that significant loan modifications are the best way to help both the people involved and the economy in the long run. Any legislative changes to existing bankruptcy laws should be approached in as careful and considered way as possible to avoid unintended consequences for individuals and for weakened financial institutions. We must do everything we can to give homeowners incentive to achieve an affordable mortgage payment through loan modifications rather than endure the hardships of bankruptcy.
Modification Costs and Process Improvements
The Committee asked about costs of modifications—to the servicer, the investor, and the GSEs and about how the modification process can be improved.
In the absence of any loss mitigation strategy, the delinquency and ultimate foreclosure on a residential property imposes substantial costs on all stakeholders. The borrowers end up with ruined credit records and the loss of their homes. The servicer absorbs the up-front responsibility of covering missed payments and the operational expenses of trying to work with the borrower.’ The investor ultimately absorbs the foregone payments, the process costs of the foreclosure, and the difference between the mortgage balance and the net realized value upon sale of the house. If the mortgage is in a MBS guaranteed by Fannie Mae or Freddie Mac, the Enterprise absorbs these losses instead of the investor as do private mortgage insurers and bond insurers, where applicable.
As the total costs of foreclosure can be sizeable in relation to the mortgage balance, servicers often will pursue less costly outcomes, ranging from loan modifications that reduce the income stream on the mortgage but keep the borrower paying on the mortgage to alternatives to foreclosure that result in the homeowner leaving the property. These alternatives include short-sales—the sale of a house at less than the mortgage balance and deed-in-lieu transfers where the borrower surrenders the property to the lender without going through foreclosure.
The Homeowner Affordability and Stability Plan anticipates the use of a standard net present value (NPV) model. The purpose of that model is to compare the cost of the modification to the cost of foreclosure and to identify the least cost alternative.
Areas where improvements can be made are in borrower education and in servicer capacity. First, borrowers need to be educated to not immediately pack up and vacate the property when they hear the term "foreclosure." Foreclosure is a process that takes anywhere from 4 to 24 plus months to complete. During this period, any borrowers interested in retaining their homes can and should continue to work with the servicer to reinstate the account. Second, serious attention should be placed on assisting servicers in expanding their capacity to reach all borrowers who are in need of help. The Homeowner Affordability and Stability Plan substantially increases servicer incentives to modify loans. However, servicers should be encouraged to hide the required resources to do the job right. In addition, servicers’ capacity can be expanded by leveraging off existing housing counseling agencies. Furthermore, the servicer workforce can be further expanded with training of professionals with a comparable skill set and experience; e.g., tax preparers accustomed to working one-on-one with clients. Finally, technology initiatives are being explored to make the process more accessible, timely and "efficient; e.g., a web-based portal available to all borrowers nationwide.
Before I move on to the pivotal role to be played by the Enterprises in loan modifications under the Homeowner Affordability and Stability Plan announced by President Obama last week, I want to provide a brief update on Enterprise utilization of the support facilities created under the July 2008 HERA legislation, and under more recent Federal" Reserve programs. These important sources of liquidity and financial backing allow the Enterprise to operate in conservatorship and to play a crucial role in helping to restart the housing market.
Government support for the GSEs
HERA gave the Treasury Department authority to support Freddie and Fannie and fund them in a variety of ways. We could not have put Fannie and Freddie into conservatorship without Treasury’s $100 billion Senior Preferred Stock facility; which provides an effective guarantee of the Enterprises’ debt and mortgage-backed securities by ensuring each Enterprise has a positive net worth. The amount of this facility, $100 billion, That is about three times the minimum capital the old law required. In return Treasury received from each Enterprise a billion dollars in senior preferred stock and warrants for 79.9 percent of the common stock. At the same time, we eliminated the dividends on both the common and preferred stock.
This Senior Preferred Stock facility protects not only present senior and subordinated debt holders and MBS holders but also any future debt and MBS holders. It lasts until the facility is fully used or until all debt and mortgage-backed securities are paid off To date, Freddie has accessed about $13.8 billion and indicated it needs another $30 billion to $35 billion to cover fourth quarter losses: Fannie only just recently announced that it will need $11 billion to $16 billion to cover its fourth quarter losses.
As Secretary Geithner and President Obama announced last Wednesday, Treasury has doubled the Senior Preferred Stock Facility to $200 billon each to remove any possible doubt from the minds of investors that the U.S. Government stands behind Fannie Mae and Freddie Mac.
Two additional facilities were also implemented when the conservatorships began. Under the fist, Treasury has purchased $94 billion in mortgage-backed securities and has made it clear it will continue to be an active buyer. The second is an unlimited secured credit facility which acts as a liquidity backstop for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, but this has not been utilized.
In November, the Federal Reserve announced two critically important programs to reduce mortgage rates. In the first, it will purchase $500 billion or more in Fannie Mae, Freddie Mac, and Ginnie Mae MBS over a period of six months. Since the beginning of January, the Fed has purchased $115 billion under this program. The second program is a purchase of up to $100 billion in Fannie Mae, Freddie Mac, and Federal Home Loan Bank debt. To date, the Federal Reserve has purchased $30 billion in Fannie, Freddie, and Federal Home Loan Bank notes. Both of these programs are a significant part of the government’s overall efforts to restart the housing market.
These program have had a very positive impact on mortgage rates, which have fallen more than 100 basis points. Rates on 30-year loans even dropped below 5 percent, but crept back up to 5.04 percent in Freddie Mac’s latest weekly report. These lower rates provide an important opportunity to do two things--refinance and modify mortgages to help stabilize housing prices. If confidence is restored and the present large spread to Treasury rates is reduced, mortgage rates could move lower.
Although I have been concentrating on the single family market, the housing GSEs are very important players in multi-family housing. That market is extremely important in creating affordable housing. Fannie and Freddie remain committed to that market through Delegated Underwriting and Servicing, and Commercial Mortgage-Backed Securities. As the President indicated last week, we are working with the GSEs—and with private sector industry participants—on ideas to better support Housing Finance Agencies, especially in the tax credit and housing bond areas.
Homeowner Affordability and Stability Plan
Let me now turn to the new Homeowner Affordability and Stability Plan announced last week by President Obama, focusing particularly on elements of the plan relevant to the Enterprise. FHF A was pleased to work with the White House, the Treasury Department, and the Enterprise in the development of this plan. It is a major step forward in reducing preventable foreclosures and stabilizing the housing market. It aggressively builds on the FDIC’s and our streamlined mortgage modification program. While the Enterprise will receive less in monthly payments on the modified loan, this should be more than offset by the benefits of having far fewer defaults and foreclosures. The key elements of the plan are:
1)Fannie Mae and Freddie Mac will provide access to low-cost refinancing for loans they own or guarantee. This will help up to 4 to 5 million homeowners avoid foreclosure and reduce their monthly payments. This program is designed for current borrowers who seek to refinance at a lower rate or into a safer mortgage but who have experienced difficulties due to declining home values. They will be eligible for a refinanced mortgage with a current loan-to-value of up to 105 percent.
This refinance initiative covers only mortgages that Fannie Mae and Freddie Mac already hold in their portfolio or guarantee through their MBS. Thus, they already hold the credit risk on the mortgage. For those mortgages that at the time of origination had above 80 percent L TV ratios, there exists some form of credit enhancement, in most cases private mortgage insurance. For those that had LTVs below 80 percent at origination, no additional credit enhancement was needed.
The target beneficiaries of this initiative are those homeowners who are current on their mortgages. The initiative is premised on the unusual and exigent market circumstances that preclude such homeowners from refinancing to a lower rate mortgage because of the combined effects of the decline in house prices and limited availability of mortgage insurance.
The refinance initiative allows a borrower with a mortgage held or guaranteed by Fannie Mae (Freddie Mac) to refinance into a new mortgage that would be held or guaranteed by Fannie Mae (Freddie Mac). The key characteristic of this initiative is that the borrower need not obtain additional credit enhancement (such as private mortgage insurance) on the refinanced loan in excess of what is already in place for that loan. That is, the overall credit exposure of Fannie Mae (Freddie Mac) would not increase after the refinance. In fact, it would be reduced because, after the refinance, the borrower would have a lower monthly mortgage payment and/or a more stable mortgage payment.
There are several important limitations placed on the refinances permitted under this initiative. The refinance will not have a cash-out component, except for closing costs and certain de minimums allowances; the Enterprise will use its best efforts to continue existing mortgage insurance coverage; monthly principal and interest payments will be reduced or the borrower will be refinanced from a more risky loan (such as interest-only or a short term ARM to a more stable product; and this new authority extends only through June 10, 2010.
The refinance initiative is akin to a loan modification as it affects loans for which an Enterprise already holds the credit risk. By creating an avenue for the borrower to reap the benefit of lower mortgage rates in the market, the credit risk of that mortgage to the Enterprise diminishes; thus, this is a loss-mitigation initiative in this very troubled time in housing finance. It has the added benefit of helping many households strengthen their own financial situation and enhance their commitment to their home and community. FHFA will maintain its oversight over the initiative as part of its safety and soundness responsibilities.
2) A $75 billon loan modification plan, called the Homeowner Stability Initiative, will reach up to 3 to 4 million at-risk homeowners. This program will help homeowners stay in their homes and protect neighborhoods. Importantly, there will be a national standard for loan modifications and the Treasury will partner with financial institutions to reduce borrowers’ housing costs to 31 percent of their gross incomes through a combination of interest rate reductions, maturity extensions, principal forbearance, and/or principal forgiveness. The initiative will pay half the cost of the reduction from 38 percent to 31 percent. There will be "pay for success" incentives for servicers, incentives to encourage borrowers stay current, incentives to reach borrowers early, and reserve payments to encourage lenders to modify mortgages even though prices could fall further. For those loans owned or guaranteed by Fannie Mae or Freddie Mac, the Enterprise will bear the full cost of the modification.
3) Treasury will support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac. The Treasury Department has doubled the size of its Preferred Stock Purchase Agreements to $200 billion each. This increase is to provide assurance to the markets that Fannie Mae and Freddie Mac will continue to fulfill their important mission of providing much needed liquidity, stability and affordability to the housing market at this time.
Resetting these agreements from $100 to $200 billion each should remove any possible concerns that investors in debt and mortgage-backed securities have about the strong commitment of the. U.S. Government to support Fannie Mae and Freddie Mac. In addition, the Treasury Department will continue to purchase Fannie and Freddie MBS, and is increasing the size of the GSEs’ allowable mortgage portfolios by $50 billion to $900 billion, along with corresponding increases in the allowable debt outstanding.
Over the next several days, FHF A will be working with the Administration and the Enterprises to finalize the details and implement this program.
Thank you for the opportunity to offer this testimony. I will be happy to answer questions.
Link to Documents:
February 9, 2009 letter to James B Lockhart III
Re: Mortgage Loan Modifications for RMBS Transactions
From Diane Casey-Landry
FHFA Federal Property Managers Report No. 3, February 12, 2009
Contacts:
Corinne Russell (202) 649-3032 / Stefanie Johnson (202) 649-3030