GAO To Look At Foreclosure Incidence and Causes After Hearings

Before we were sidetracked by new and existing home sales reports and falling interest rates we were profiling hearings before the House Committee on Financial Services that featured some of the big wheels of banking regulation and mortgage lending talking about solving problems with subprime mortgages and helping homeowners who are facing foreclosure on their homes.

Fannie Mae President Daniel Mudd had the most to say and we covered his remarks earlier. Also testifying were Freddie Mac CEO Richard F. Syron, Federal Deposit Insurance Corporation Chairperson Sheila C. Bair, and Brian D. Montgomery, Assistant Secretary for Housing and Federal Housing Commissioner, U.S. Department of Housing and Urban Development.

Syron restated his corporation's recent restriction of subprime investments to those that were underwritten at a fully-indexed and amortizing level and elimination of no-income or asset verifications loans and restriction of stated income in mortgage originations.

He said that Freddie is currently working on developing more consumer-friendly subprime mortgages and expected to have ready by mid-summer a 30 and possible a 40-year fixed rate mortgage and ARMS with reduced margins and longer fixed rate periods. The Corporation is also considering modifications to its existing Home Possible� mortgage product which allows very high loan-to-value ratios for borrowers with less than perfect credit or who might be in debt beyond established parameters. "These characteristics overlap with those in the subprime market, providing viable upstreaming opportunities for some segment of subprime borrowers."

Syron stressed that these offers are not a one-stop remedy and that the solution to the expected rise in foreclosures as well as subprime problems are going to take a unified effort by all major players; Congress, the mortgage industry, and GSEs to find viable solutions.

Good regulation, he said would set prudent guidelines on the "socially acceptable" level of defaults. "As a nation, we need to set some limit on the level of risk we are willing to take in order to promote higher levels of homeownership. We need to be honest that there's a major tension between putting as many families into homes as possible � and ensuring they can sustain homeownership over the long term."

And Syron said the system should carefully distinguish between those borrowers who can be "rescued" and those who cannot. Such a triage will not be easy or popular, but widespread "bailouts" or foreclosure moratoriums should be considered only in certain extreme situations. Broad application of such prescriptions could have lasting, unintended consequences that harm the housing finance system in the long term.

Good regulation should also ensure a level playing field. If some institutions have different or no regulatory strictures there will be potential for excess and abuse. It is a broad market and relying on any one set of participants won't work. You cannot, Syron said, expect the GSEs to "regulate" the behavior of other entities because non-GSE investors account for the vast majority of subprime mortgages that have been securitized.

He suggested that regulators resist the impulse to overcorrect this market. Without the ability to get a subprime mortgage, many borrowers would not be homeowners today. Helping this market transition into a more viable, stable source of financing is a desirable policy objective. He cautioned the Committee that as corrective measures begin to take effect, there will be some unfortunate tradeoffs. These could include a possible reversal in homeownership gains and further softening of house prices, particularly in hard-hit communities.

Brian D. Montgomery spoke to the proposed modernization of the FHA. Under the current modernization proposal the agency would be given authority to charge insurance premiums commensurate with risk and to increase maximum loans amounts. This, he said would allow FHA to "dive deeper" into the pool of homeowners who could benefit from refinancing their subprime loans. Such legislation has already been filed in both houses of Congresses.

With such expanded authority FHA could potentially assist tens of thousands of borrowers who cannot be helped under current restricted premium limits and maximum loan amounts. But, even before reform, FHA is seeing an increasing number of borrowers who are refinancing into its loans � a number that increased by 94 percent in the first five months of 2007 over the same period a year earlier. It is safe, he said, to assume that a significant portion of these loans are subprime. FHA cannot, however, help those subprime borrowers who took out their loans because they could not document their income and assets, are involved in speculative investments, or who have such significant debt that they could not sustain payments on new financing.

Ms. Bair pre-released statement was a truly tooth-numbing dissertation on mortgage securitization and offered little in the way of solutions other than that borrowers should contact their lenders or services immediately should they be unable to meet their commitments.

Subsequent to the hearing, Chairman Barney Frank and Ranking Member Spencer Bachus requested that the Government Accountability Office (GAO) conduct a thorough study of the reasons for the recent surge in foreclosures. In a letter to GAO's Comptroller General, Frank and Bachus said that it seems clear that the type of mortgages that have been offered to borrowers in recent years is one such factor, but perhaps not the only one.

The two Congressmen instructed GAO to examine the current state of the problem, its causes, and potential solutions, and seek to provide answers to the following questions, as well as any others that the GAO finds to be relevant.

• The scope and magnitude of the current increase in foreclosures and where they are concentrated.
• How the recent rise in foreclosures compares to previous housing downturns? Are foreclosure rates higher in regions that are also experiencing higher unemployment levels?
• What role has been played by: the rise in subprime lending and risk-based loan pricing; "alternative" or "exotic" mortgages; predatory practices (e.g., loan flipping and deceptive sales practices, among others); and evaluations of borrowers' ability to repay?
• What effect has the increased involvement of secondary markets (securitization, parceling and packaging of risk, etc.) had on foreclosures?
• What impact have the 17 consecutive Federal Reserve interest rate increases had on borrowers with adjustable rate mortgages (ARMs)?
• What role have federal and state regulators played in monitoring and averting foreclosures, and have their actions been adequate and effective?
• What effect have trends in employment both nationally and regionally had on delinquency rates?
• What impact has the slow-down or absence of home price appreciation had on foreclosure rates, particularly in high unemployment regions?
• Have life events, such as job loss, major sickness or death had an impact on current foreclosure rates?
• What constructive role in resolving the problem and averting future foreclosures can be played by: mortgage counseling, financial education, lender forbearance and loan "work-outs," among other tools?
• What role can the Federal Housing Administration (FHA) and the housing Government Sponsored Enterprises (GSEs) play in refinancing failing loans and offering new mortgage products?

A tall order for the GAO; we shall eagerly await its conclusions.