FINANCIAL CONDITION OF THE FHA'S MUTUAL

MORTGAGE INSURANCE FUND

FRIDAY, APRIL 3, 1992

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, SUBCOMMITTEE ON Housing and Urban Affairs, Washington, DC.

The subcommittee met at 10:15 a.m., in room SD-538 of the Dirksen Senate Office Building, Senator Alan Cranston (chairman of the subcommittee) presiding.

OPENING STATEMENT OF SENATOR CRANSTON

Senator CRANSTON. The hearing will please come to order. thank each and all of you for your presence, and the panel members for your participation.

Today's hearing will focus on the status of the single and multifamily mortgage insurance programs of the FHA.

This hearing comes at a critical time, as the subcommittee begins reauthorization of the National Affordable Housing Act.

For some 50 years now, FHA helped families fulfill the American dream of home ownership, and helped to expand and preserve the supply of affordable rental housing. It was a partnership which worked exceedingly well, marrying the creditworthiness of the Federal Government with the innovation and creativity of the private

sector.

Then came the 1980's. A decade of privatization schemes, imprudent underwriting and insider favors led to billions of dollars of losses, and the dismantling of a once proud and effective agency. Congressional actions in 1989 and 1990, actions taken at the behest of the administration, have reformed but not yet rebuilt FHA. Flawed programs have been terminated and the worst abuses have been corrected, yet FHA remains crippled in its efforts to expand home ownership and rental opportunities for low- and moderate-income families.

I am particularly troubled by five signs of FHA's decline.

First, I am concerned about the impact that the 1990 FHA reforms have had on the availability of affordable housing for lowand moderate-income home buyers. Housing advocates and industry representatives contend that the new FHA rules have prolonged the recession and kept 100,000 families from becoming homeowners. The impact is particularly hard on minority home buyers who are more likely to rely upon FHA and VA programs.

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We must ask ourselves the fundamental question: Have our efforts to ensure financial soundness come at the expense of expanding housing opportunities for lower income families?

Second, I am worried about the long-term health of the single family insurance fund. Existing loan limits have essentially rendered FHA irrelevant in entire markets. The 1990 reforms contributed to an exodus of low risk borrowers from participation in FHA's programs.

These and other factors have diminished the diversification of FHA's business, the foundation on which actuarial soundness is based.

How can we stabilize costs to lower income home buyers without the participation of lower risk borrowers in the FHA program?

Third, I am disturbed by what amounts to a total collapse of FHA's multifamily operations. Let us be brutally honest. The 1980's essentially witnessed a systematic destruction of FHA's capacity to expand, rehab and preserve the Nation's supply of affordable rental housing. FHA's share of total multifamily mortgage originations fell from 30 percent in the early 1980's to only 3 percent in 1989. FHA's share of origination on new properties dropped from more than 52 percent in 1982 to less than 8 percent by 1989, and 6 percent in 1990.

The withdrawal of FHA from the multifamily market occurred at the same time that the gap between the supply of affordable housing and the demand of low income renters grew at a very alarming rate. By 1989, the mismatch between supply and demand had exploded to 4.1 million apartments.

We have learned all too well the consequences of such market dynamics: Higher rents, higher rent burdens, higher evictions and higher numbers of homeless.

Fourth, I am puzzled by FHA's persistent inability to correct "material weaknesses" in its internal controls. These weaknesses are cited year after year by the Inspector General of the General Accounting Office and the administration's own contractors. If this trend is allowed to continue, the Federal Government runs the real risk of facing additional and significant losses to the FHA fund, losses that responsible actors would strive to avoid.

Finally, I strongly believe the absence of adequate information systems and monitoring controls masks what is a more fundamental problem. That in the aftermath of the HUD scandals, a new bureaucratic culture appears to have taken root at FHA. This culture places a high premium on avoiding tough decisions, on reducing the risk of future embarrassments to a bare minimum, and are not performing the functions that Government must perform.

Today's hearing will examine these five areas of concern in more detail.

We have an outstanding group of witnesses to explore this important subject.

I would like to assure each of you that your written testimony will appear in the record in full.

This morning's hearing represents a cross between a traditional Congressional hearing and the type of roundtable discussions that this subcommittee routinely holds.

We find that we learn much more by this kind of a format than when it's a more stilted presentation by one person, then somebody else, questions in the formal sense, one after another, and a time limit from the Senators.

The cross current of your discussion, expressing disagreements, when you have them, with somebody else's statement, will help us sharpen the issues and understand them better.

We will hear first from the administration's Assistant Secretaries, John Weicher and Arthur Hill, who will update us on the two most recent reports of the financial condition of the FHA's Mutual Mortgage Insurance Fund.

Then we will engage in what I hope will be a real free-for-all, and I urge all of you to participate in this discussion.

After this discussion has run it's course, we'll hear testimony from the General Accounting Office and the National Task Force on Financing Affordable Housing.

These two groups recently concluded major studies on multifamily housing finance, and will present their recommendations for new forms of Federal credit enhancement in this area.

So, Secretary Weicher and Secretary Hill, thank you for being with us.

STATEMENT OF ARTHUR HILL, ASSISTANT SECRETARY FOR HOUSING, FHA COMMISSIONER; AND JOHN WEICHER, ASSISTANT SECRETARY FOR POLICY DEVELOPMENT AND RESEARCH, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Mr. WEICHER. Thank you, Mr. Chairman. We're pleased to have this opportunity to discuss the new actuarial study and the new audit, with you and the subcommittee.

When Secretary Kemp came to HUD, he commissioned the first independent actuarial study of the Mutual Mortgage Insurance Fund. That study, by Price Waterhouse was completed in June of 1990. And Secretary Kemp presented the results to this subcommittee at that time.

Price Waterhouse concluded that the MMI Fund had a positive net worth at the end of 1989, but that it has been losing money since 1980, and was continuing to lose money at the rate of $350 million a year.

The Fund's capital had fallen dangerously, from over 5 percent of insurance in force in 1979, to 1 percent in 1989. That level of capital was well below the minimum of 1.25 percent identified by Price Waterhouse as essential to protect the Fund against normal insurance risks.

The administration proposed a series of reforms to restore the financial integrity of the MMI Fund so FHA could continue to serve low- and moderate-income first time homebuyers.

Under your leadership, Mr. Chairman, and that of Senator D'Amato, reforms achieving these purposes were ultimately adopted by Congress, and the key equity and premium reforms became effective on July 1, 1991.

Congress also required an annual actuarial study of the MMI Fund. Price Waterhouse has completed that study. And finds, as of

the end of fiscal year 1990, the economic value of the Fund was a negative $2.7 billion.

The first actuarial study calculated the economic value of the Fund at a positive $2.6 billion.

Now, there's one basic reason for this new finding, Mr. Chairman. The FHA reform was designed to ensure that the MMI Fund had adequate reserves to protect against economic recession, and Price Waterhouse estimated that the Fund needed a net economic value of $3.75 billion to achieve that objective. The reforms were intended to meet that goal by the end of 1992.

However, the recession occurred before the reforms could become operational and rebuild the Fund. FHA's experience should come as no surprise. Since the recession started, there have been more defaults on conventional and VA mortgages, as well as FHA. Foreclosures on conventional mortgages are up by almost 50 percent from 2 years ago.

The result of the study is a cause for concern, but as Secretary Kemp said, in testimony 2 weeks ago, it is not an excuse for overreaction.

The 1991 audited financial statements of FHA show that the Fund has a capital of $871 million, just slightly less than it had in 1990. This means that the Fund has assets which exceed its short term liabilities and can pay its bills as they come due.

In 1992 and later years, capital and net worth will improve, as reform becomes fully effective.

I want to stress that this study does not reflect the impact of reform. It does mean the Fund's current resources would not be sufficient to pay all of the expected claims over the life of the prereform loans.

Price Waterhouse continues to show the post-reform FHA business will be profitable, bringing the Fund out of its current negative position.

Price Waterhouse finds that the 1990 reforms will allow the Fund to build equity at the rate of about $900 million per year beginning in 1992.

But without the reforms, Mr. Chairman, Price Waterhouse indicates that the Fund's net worth would continue to erode, even as the economy recovers. By the year 2000, the economic value of the Fund would be a negative $5.3 billion.

Mr. Chairman, the recession has dangerously eaten away at FHA's net worth, and reform is more essential than ever. Yet, some of our critics say the reform is making things worse.

Let me briefly set the record straight.

Our critics have said that new insurance activity is declining because of reform. That's not correct. FHA's decline in business in 1991 has mirrored the housing market as a whole. Reform didn't cause the decline. In fact, FHA applications have risen sharply in the first 2 months of this year, and we expect that an increase in endorsements will follow.

Critics have claimed that lower income families have been hit hardest by the changes. FHA reform treated low cost homes and high cost homes alike, preserving the lower cash requirement for homes under $50,000, but making sure that these homebuyers have some equity in their home.

Since the reforms were implemented last July, the share of the loans under $50,000 as a percentage of FHA's total business has remained constant. In short, reforms have had no particular effect on this business.

Finally, critics say that FHA is losing its low risk loans. In point of fact, FHA insured mortgages with less than 90 percent loan-tovalue today constitute about 20 percent of new business, the same as before the reform.

Now, the Department plans to take two actions, quickly, to enhance the reforms that have already been enacted.

First, FHA will begin to exempt streamline refinancings from the risk based premium. Streamline refinancings allow a borrower to lower the monthly payment, and therefore reduce the risk of default.

Also applying the old premium to streamline refinancings may prevent FHA from losing sound borrowers to the conventional market.

Mr. Chairman, Secretary Kemp has requested that the Banking Committees of both the House and the Senate waive the statutory 30-day Congressional review requirement, and allow this change to become effective now.

In addition, the Department intends to implement a lower premium structure for 15-year mortgages which build equity faster and are less risky than 30-year mortgages. This will be done through administration rulemaking.

Mr. Chairman, FHA provides an important route for low- and moderate-income families to realize the dream of homeownership. The MMI Fund today ensures more than 6 million homes and more than 500,000 families use FHA. Most of these families are first time homebuyers.

Two years ago, Congress, led by this subcommittee and the administration, worked together to put FHA on a firm foundation of financial soundness and financial integrity. Those essential 1990 reforms have been in effect for only 9 months. We believe they should have the chance to work.

However, Secretary Kemp has expressed his willingness to listen to any ideas on how, consistent with reform, we can improve FHA's ability to serve low- and moderate-income families. And he will consult with interested parties, before seeking any further changes. We have begun to have discussions about the Price Waterhouse findings with some of those parties, and will certainly continue to do so.

In the meantime, on behalf of Secretary Kemp, we urge you to maintain the 1990 reforms and resist proposals for unsound and premature changes.

Thank you, Mr. Chairman.

My statement discusses only the Price Waterhouse actuarial study.

Senator CRANSTON. Thank you very much for your statement. I appreciate it very much.

Senator Bryan, do you have any opening remarks?

Senator BRYAN. Mr. Chairman, let me just commend you for holding this hearing. And I ask unanimous consent that my statement be made a part of the record.