Today, the Senate Banking, Housing and Urban Affairs Committee held a hearing entitled “The Federal Housing Administration—Current Condition and Future Challenges” to assess the adequacy of the capital reserve fund of the Federal Housing Administration (FHA) following its decline below the statutorily-imposed limit, and to discuss proposals for reform within the FHA.

Testifying before the Committee were the following witnesses:

Panel 1

  • David H. Stevens, FHA Commissioner and Assistant Secretary for Housing, U.S. Department of Housing and Urban Development
  • Matthew Scire, Director, Financial Markets and Community Investment, Government Accountability Office (GAO)

Chairman Christopher J. Dodd (D-CT) opening the hearing by discussing the widespread presence of the FHA in the housing and home financing markets, noting that assistance by the FHA loans accounted for half of all recent home purchases and half of refinancing activity. “The federal government now stands behind 90% of all mortgages in the country,” he stated.

The FHA currently is required to maintain secondary reserves of at least 2% of the total amount of the outstanding U.S. home mortgages it insures. The capital reserve fund is a secondary, surplus fund created by Congress in 1990 to provide an additional capital cushion for the FHA in times of economic turmoil. Mr. Stevens began his testimony by discussing this reserve requirement and noting last year’s decline in FHA’s capital reserve ratio below the statutory threshold. He also noted that although net budgetary actual performance is in line with the President’s budget presented in February, “our actual performance to date has been significantly better than predicted by the actuary.” He attributed this better-than-expected performance to the policy changes adopted by the FHA during 2010. He explained that the increased presence of the FHA in the housing and home financing market noted by Chairman Dodd came at a price—namely the capital reserve fund shortfall. Mr. Stevens reiterated the two- to three-year estimate made last year of when the required 2% capital reserve ratio would be reached. “2007 and 2008 were terrible books that were originated with limited scrutiny,” he noted, warning “we are absolutely not out of the woods.” He also warned against adopting a rigid timeline for compliance with the statutory reserve requirement. “I believe a timeline would be the wrong way of approaching the FHA reform. To be clear, we shall do everything he can to get it back to 2%. Those steps are in process,” Mr. Stevens said.

Mr. Stevens also stated that certain proposals adopted by FHA, including increased down payment requirements for borrowers with lower credit scores and tightening the minimum credit score for borrowers with lower down payments, had resulted in the average credit score for FHA-insured mortgages rising from 634 in 2007 to nearly 700 today. He also voiced support for a Senate bill designed to strengthen FHA’s tools to manage risk and protect the FHA capital reserve fund. The bill would allow third-party FHA loan originators to close those loans in their name and would allow the FHA to hold them accountable for any detected misrepresentation or fraud. “FHA remains committed to working with Congress to enact the full breadth of reforms” proposed by the bill, Mr. Stevens said.

Mr. Scire opened his testimony by referring the Committee to a report entitled “Mortgage Financing: Opportunities to Enhance Management and Oversight of FHA’s Financial Condition.” This report explains in greater detail how estimates of the FHA’s capital reserve ratio have changed in recent years, how FHA and its actuary review FHA’s financial condition, the steps FHA has taken to improve its financial condition and changes in the performance and characteristics of FHA-insured mortgages in recent years. He noted that recent declines in FHA’s capital reserve ratio resulted from a combination of economic and market developments. More pessimistic forecasts of economic conditions increased the number of predicted insurance claims and losses associated with those claims, reducing the reserve funds' economic value. In addition, while FHA and its actuarial review have improved the methodology behind assessing the capital reserve fund’s condition, he noted that previous reviews relied on a single economic forecast to produce the estimate of the capital ratio that is used to determine whether the capital reserve ratio is met. “This approach does not fully account for the variability in future housing prices and interest rates” that the capital reserve fund may face. He applauded the recent reforms adopted by FHA but warned that certain legislative requirements concerning FHA’s administration of its reserve fund provide limited direction to FHA, most notably the lack of a timeframe for restoring the capital reserve ratio to its required minimum level or the information FHA provides to Congress in its quarterly reports. He acknowledged the poor performance of FHA-insured mortgages in 2008 and 2009, but stated that the recent improvements in credit quality at loan origination suggested better recent performance, though it was still too soon to tell whether the FHA-insured mortgages would perform to expectations.