Statement Of
Michael H. Krimminger,
Special Advisor For Policy,
Office Of The Chairman;
Federal Deposit Insurance Corporation
On
The Private Sector And Government Response
To The Mortgage Foreclosure Crisis
Committee On Financial Services
U.S. House Of Representatives
2128 Rayburn
House Office Building
December 8, 2009
Chairman Frank and Ranking Member Bachus, I appreciate the opportunity to testify on
behalf of the Federal Deposit Insurance Corporation (FDIC) regarding the private sector
and government response to the mortgage foreclosure crisis. My testimony will focus on
the FDIC's efforts to promote financial stability by identifying and implementing
sustainable solutions to preserve homeownership. I will describe the rationale for these
efforts, the process by which we developed our modification proposals, our loan
modification program at IndyMac Federal Bank, and our ongoing efforts to promote loan
modifications through our roles as bank supervisor and as receiver for failed banks. I
will close by outlining some lessons learned in this process that may be useful in
furthering private and public loan modification efforts in the future.
Background
The Crisis in Homeownership. Before and during the financial crisis, the FDIC has
acted on a number of fronts to preserve public confidence in banking and to restore the
strength of our financial markets and institutions. Early on, Chairman Bair expressed
concern about consumer protection abuses and distortions in our housing and mortgage
markets. To respond to those problems, the FDIC proposed specific action to
strengthen consumer protection, address problems in mortgage underwriting and
prevent avoidable foreclosures.
There is no question that mortgage credit distress and declining home prices have been
fundamental sources of uncertainty for financial markets and institutions in this crisis.
According to the Standard and Poors/Case-Shiller home price index for 10 large U.S.
cities, average U.S. home prices rose by 192 percent in the 10 year period ending in
mid-2006, and have fallen by a net total of 31 percent since that time. Home price
declines in some of the hardest hit metropolitan markets now approach or exceed 50
percent from peak levels. The combination of far too many structurally unsound
mortgages and historic home price declines – which precluded refinancing – led to
historic increases in mortgage defaults and foreclosures. Total U.S. foreclosures rose
from around 938,000 in 2006 to 1.5 million in 2007 and 2.3 million in 2008.1 Despite
increased efforts this year to modify delinquent and at-risk mortgages, the number of
Michael H. Krimminger,
Special Advisor For Policy,
Office Of The Chairman;
Federal Deposit Insurance Corporation
On
The Private Sector And Government Response
To The Mortgage Foreclosure Crisis
Committee On Financial Services
U.S. House Of Representatives
2128 Rayburn
House Office Building
December 8, 2009
Chairman Frank and Ranking Member Bachus, I appreciate the opportunity to testify on
behalf of the Federal Deposit Insurance Corporation (FDIC) regarding the private sector
and government response to the mortgage foreclosure crisis. My testimony will focus on
the FDIC's efforts to promote financial stability by identifying and implementing
sustainable solutions to preserve homeownership. I will describe the rationale for these
efforts, the process by which we developed our modification proposals, our loan
modification program at IndyMac Federal Bank, and our ongoing efforts to promote loan
modifications through our roles as bank supervisor and as receiver for failed banks. I
will close by outlining some lessons learned in this process that may be useful in
furthering private and public loan modification efforts in the future.
Background
The Crisis in Homeownership. Before and during the financial crisis, the FDIC has
acted on a number of fronts to preserve public confidence in banking and to restore the
strength of our financial markets and institutions. Early on, Chairman Bair expressed
concern about consumer protection abuses and distortions in our housing and mortgage
markets. To respond to those problems, the FDIC proposed specific action to
strengthen consumer protection, address problems in mortgage underwriting and
prevent avoidable foreclosures.
There is no question that mortgage credit distress and declining home prices have been
fundamental sources of uncertainty for financial markets and institutions in this crisis.
According to the Standard and Poors/Case-Shiller home price index for 10 large U.S.
cities, average U.S. home prices rose by 192 percent in the 10 year period ending in
mid-2006, and have fallen by a net total of 31 percent since that time. Home price
declines in some of the hardest hit metropolitan markets now approach or exceed 50
percent from peak levels. The combination of far too many structurally unsound
mortgages and historic home price declines – which precluded refinancing – led to
historic increases in mortgage defaults and foreclosures. Total U.S. foreclosures rose
from around 938,000 in 2006 to 1.5 million in 2007 and 2.3 million in 2008.1 Despite
increased efforts this year to modify delinquent and at-risk mortgages, the number of
homes entering foreclosure in the first three quarters of 2009 exceeded 2.2 million.
However, as troubling as these statistics are, they only provide a pale reflection of the
devastating personal consequences of this crisis for millions of Americans and their
communities.
Meetings with Servicers and Investors. As the crisis began to unfold in early 2007,
some questioned whether restructuring for troubled mortgages was even possible under
the pooling and servicing agreements (PSAs) that controlled servicing for millions of
securitized mortgages. To answer these questions, in April 2007, the FDIC began
hosting discussions with a range of mortgage servicers, investors, accountants,
attorneys, and regulators to identify impediments and explore avenues to restructure
problem loans instead of foreclosing. We learned that most PSAs provide considerable
leeway for modifications. Similarly, according to the participants, applicable accounting
rules and the requirements for Real Estate Mortgage Investment Conduits (REMICs) do
not generally preclude modifications for mortgages that are either in default or where
default is reasonable foreseeable. The key requirement for the servicer modifying the
troubled mortgage was that by modifying, instead of foreclosing, the servicer would
maximize the expected net present value (NPV) of the mortgages. In a declining
housing market with growing losses in foreclosure, a sustainable modification of the
mortgage frequently provided better value than foreclosure and was well within the
power of servicers. These lessons were later confirmed in guidance provided by leading
accountants, the SEC, and mortgage industry associations. Later in 2007, the federal
banking regulators provided guidance to insured banks and thrifts confirming that
modifications normally were permitted by applicable standards.2
Early Efforts by the FDIC to Promote Loan Modifications on a Mass Scale. In
a New York Times op-ed published in October 2007, FDIC Chairman Sheila Bair
summarized the problems facing subprime borrowers and the potential benefits of
restructuring at-risk loans where borrowers were facing large resets in their interest rate
and monthly payment.3 Chairman Bair's proposal rested on two premises: 1) that most
subprime borrowers could not afford the large increases in their monthly payment after
reset, and 2) that simply foreclosing on defaulted loans would only add to the excess
supply of housing, push down home prices, and make the mortgage credit problem
worse. The proposal relied upon the fundamental obligation of servicers to maximize the
value of the securitized loans for investors. Where mortgage restructuring is the best
strategy to do this – as shown by a well-developed NPV analysis – then servicers
should modify the loan rather than foreclose. Unfortunately, as the crisis has shown,
there are many contradictory incentives in the servicers' role and in the structure of
securitizations that complicate this beneficial result. Going forward, these misaligned
incentives should be addressed in the structure of future securitizations.
Loan Modification at IndyMac Federal Bank. The FDIC was soon faced with the need
to implement these principles when it was named conservator for IndyMac Federal
Bank, F.S.B., Pasadena, California on July 11, 2008. At IndyMac, the FDIC inherited
responsibility for servicing a pool of approximately 653,000 first lien mortgage loans,
including over 60,000 mortgage loans that were more than 60 days past due, in
bankruptcy, in foreclosure, or otherwise not currently paying. Of the entire pool of
However, as troubling as these statistics are, they only provide a pale reflection of the
devastating personal consequences of this crisis for millions of Americans and their
communities.
Meetings with Servicers and Investors. As the crisis began to unfold in early 2007,
some questioned whether restructuring for troubled mortgages was even possible under
the pooling and servicing agreements (PSAs) that controlled servicing for millions of
securitized mortgages. To answer these questions, in April 2007, the FDIC began
hosting discussions with a range of mortgage servicers, investors, accountants,
attorneys, and regulators to identify impediments and explore avenues to restructure
problem loans instead of foreclosing. We learned that most PSAs provide considerable
leeway for modifications. Similarly, according to the participants, applicable accounting
rules and the requirements for Real Estate Mortgage Investment Conduits (REMICs) do
not generally preclude modifications for mortgages that are either in default or where
default is reasonable foreseeable. The key requirement for the servicer modifying the
troubled mortgage was that by modifying, instead of foreclosing, the servicer would
maximize the expected net present value (NPV) of the mortgages. In a declining
housing market with growing losses in foreclosure, a sustainable modification of the
mortgage frequently provided better value than foreclosure and was well within the
power of servicers. These lessons were later confirmed in guidance provided by leading
accountants, the SEC, and mortgage industry associations. Later in 2007, the federal
banking regulators provided guidance to insured banks and thrifts confirming that
modifications normally were permitted by applicable standards.2
Early Efforts by the FDIC to Promote Loan Modifications on a Mass Scale. In
a New York Times op-ed published in October 2007, FDIC Chairman Sheila Bair
summarized the problems facing subprime borrowers and the potential benefits of
restructuring at-risk loans where borrowers were facing large resets in their interest rate
and monthly payment.3 Chairman Bair's proposal rested on two premises: 1) that most
subprime borrowers could not afford the large increases in their monthly payment after
reset, and 2) that simply foreclosing on defaulted loans would only add to the excess
supply of housing, push down home prices, and make the mortgage credit problem
worse. The proposal relied upon the fundamental obligation of servicers to maximize the
value of the securitized loans for investors. Where mortgage restructuring is the best
strategy to do this – as shown by a well-developed NPV analysis – then servicers
should modify the loan rather than foreclose. Unfortunately, as the crisis has shown,
there are many contradictory incentives in the servicers' role and in the structure of
securitizations that complicate this beneficial result. Going forward, these misaligned
incentives should be addressed in the structure of future securitizations.
Loan Modification at IndyMac Federal Bank. The FDIC was soon faced with the need
to implement these principles when it was named conservator for IndyMac Federal
Bank, F.S.B., Pasadena, California on July 11, 2008. At IndyMac, the FDIC inherited
responsibility for servicing a pool of approximately 653,000 first lien mortgage loans,
including over 60,000 mortgage loans that were more than 60 days past due, in
bankruptcy, in foreclosure, or otherwise not currently paying. Of the entire pool of