Origination Views

The FHA's Role Today

Perspectives by Shaun Donovan

Mr. Donovan, Secretary of Housing and Urban Development, spoke on the role the Federal Housing Administration plays in today's origination market and mortgage reforms he sees a need for during a speech at the National Association of Real Estate Editors Annual Conference on June 18, 2009.

FHA is once again playing a critical "countercyclical" role during a downturn in our housing markets - just as it did when President Franklin Roosevelt created it 75 years ago during the Great Depression. And while today's circumstances are very different, FHA is again stepping in to ensure access to homeownership for families when banks can't - or won't.

And if we needed any evidence of that, we need only look at FHA's share of the mortgage market. As of 2006, it was less than 2% - today, it's 23.7%.

Obviously we'd prefer the private market to be playing a bigger role than it is today. And even though we've seen a substantial uptick in FHA borrowers' credit quality - from 626 a year ago to 692 today -we will continue to monitor the situation very closely.

That said, given that our expectation that FHA loan volumes will continue to be high until the credit crisis passes, while we have requested expanded loan commitment authority for both FHA and Ginnie Mae, we will not be asking the American taxpayer to support FHA's single family program in the FY 2010 budget.

We are asking Congress for the authority to endorse up to $400 billion in authorization for FHA insurance, in light of the substantial increase volume we've seen in the last two years.

We expect that increased authority will allow HUD to endorse approximately two and a quarter million mortgages.

Regardless, I'm committed to reforming and modernizing FHA - the viability of which is essential to the long-term stability of our housing markets.

That means investment in new technology.

It means additional resources for personnel and monitoring capabilities.

And it means products and pricing structures that drive innovation.

It was FHA that pioneered the 30-year mortgage. Today, they need to do the same with energy-efficient mortgages.

When you buy a car, you know very clearly what the energy efficiency of it is because there's a sticker on the window - we need the same thing for our homes and our buildings.

If in the long run there's a cost of $5,000 to upgrade a house that will produce $10,000 in savings over time for utilities, the perfect tool to realize those savings is a mortgage.

My hope is that FHA once again can be a leader in developing innovations that can become industry standards.

But for me the bottom line is this:

Changing the way FHA does business is essential to changing the way that HUD does business - and it is essential to building the strong communities we need in the 21st century.

At the same time we reform FHA and implement the Recovery Act and Making Home Affordable plan, we need to take steps to ensure the kind of behavior that got us into this situation never happens again.

Yesterday, I stood with the President as he introduced his plan to modernize the rules governing our financial system.

And it comes not a moment too soon. With Americans across the country struggling with unemployment, layoffs, falling home prices, and declining savings, we need to act with urgency to fix a system that is, fundamentally, broken.

We can't allow promising signs of economic recovery to encourage complacency.

The Administration's plan will build a new foundation of for our financial system rooted in protections for consumers.

The financial crisis revealed devastating inadequacies in consumer protection across a wide range of financial products - but nowhere was that clearer than mortgages.

To give you but one example, the Wall Street Journal reported in December of 2007 that 61% of those in subprime mortgages could have qualified for prime mortgages but were pushed into riskier mortgages by lenders and brokers.

That's why I'm so pleased that the President's plan will create a federal regulator - the sole focus of which is to look out for ordinary Americans.

Instead of the patchwork of regulations spread across multiple agencies we saw in the run-up to the crisis that allowed so much bad behavior to go unchecked, the Consumer Financial Protection Agency will have broad authority to protect consumers from unfair and deceptive practices.

I believe it will promote fairer, more efficient and innovative mortgage products for consumers, and improve access to financial services in general.

The Consumer Financial Protection Agency will have the authority to reform our mortgage laws. Those reforms will be based on five fundamental principles.

The first is requiring transparency. Every consumer will receive a single, simple, integrated federal mortgage disclosure that is reasonable, clearly written, and concise.

Communications with consumers will be required to adequately present risks and benefits of a mortgage product. It also requires the timely collection and publication of data on how loans perform, so the agency can quickly learn what steps to take to protect consumers.

Whether we are regulators or consumers, we can only make informed choices if we have all the information.

The second principle is promoting simplicity - simple products that make consumer choices easier. Firms will be required to offer consumers a "plain vanilla" mortgage product with straightforward terms, such as a 30-year fixed mortgage. The consumer will be free to opt-out for other products, but for the first time those will be subject to stringent protections.

The third principle we will see in our mortgage markets is fairness, which we will demand. That means requiring mortgage brokers to owe a "duty of best execution" to avoid conflicts of interest between themselves and the homeowners. They will also be required to determine whether the mortgages they sell to borrowers are affordable.

Unfair practices such as "yield spread premiums"- those side payments from lenders that encourage mortgage brokers to push consumers into riskier, higher priced loans than they qualify for-will be banned outright. Brokers will be required to be paid over time based on continued loan performance rather than in a lump sum at closing.

We will also restrict or ban prepayment penalties, which we've learned can trap borrowers in bad loans.

One of the most important restrictions will be to require loan originators and sponsors of securitizations to retain 5% of the credit risk.

Bundling and packaging mortgages to sell on Wall Street not only fed the housing boom - it also led to an erosion of lending standards that deepened the housing bust.

With this plan, brokers and loan originators will have a vested interest in the performance of the loans they make, rewarding responsibility, not recklessness. No longer will homeowners and investors be the only ones with skin in the game.

Fourth, we will require real accountability. That means leveling the playing field so that financial players - banks, nonbanks, and independent mortgage brokers - all play by the same rules. The days of lenders and brokers shopping for the most lenient regulator will be over.

And lastly, the plan will increase access. Access and inclusivity are part of HUD's core mission. And this plan will insist that we strongly enforce the Community Reinvestment Act and fair lending laws, ensuring that underserved consumers and communities have access to financial services, lending and investment.

Obviously, this is just one component of what is a robust, comprehensive reform plan to modernize and protect the integrity of our financial system.

But with the failures to properly regulate the mortgage markets devastating to Wall Street and Main Street alike, I'm optimistic about what the President's plan means for HUD, for our housing markets in general and for the confidence we need to get our economy moving again.