Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Accelerating Loan Modifications,
Improving Foreclosure Prevention
and
Enhancing Enforcement
before the
Financial Services Committee;
U.S. House Of Representatives;
2128 Rayburn House Office Building
December 6, 2007
Chairman Frank, Ranking Member Bachus, and members of the Committee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) regarding loan modifications of subprime hybrid adjustable rate
mortgages (ARMs). Problems in the subprime mortgage markets are affecting the
broader U.S. housing markets and the economy as a whole and pose a significant
policy challenge for the industry and regulators.
Between now and the end of 2008, subprime hybrid ARMs representing hundreds of
billions of dollars in outstanding mortgage debt will undergo payment resets. Our
calculations based on owner-occupied subprime mortgages included in private
mortgage-backed securitizations (MBS) indicate that almost 1.3 million hybrid loans are
scheduled to undergo their first reset during 2008.1 An additional 422,000 subprime
hybrid loans are scheduled to reset in 2009, which means these problems will not end
anytime soon. The combination of declining home prices and scarce refinancing options
will stress these mortgage holders and could result in hundreds of thousands of
additional mortgage foreclosures over the next two years. These foreclosures will inflict
financial harm on individual borrowers and their communities as they potentially drive
down home values. Studies show that property sales associated with foreclosures tend
to reduce average home prices in the surrounding neighborhood, placing stress on
remaining homeowners and their communities.
My testimony will provide some brief background on the current situation and describe
an approach that I believe provides the best means we have at this juncture to avoid
unnecessary foreclosures and provide for long-term, sustainable solutions. I also will
comment on legislative proposals that address the issues of servicer liability for
participating in loan modifications and penalties for market participants who engage in a
pattern or practice of making loans that borrowers cannot repay.
U.S. Housing Markets and Mortgage Credit Performance Have Deteriorated
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Accelerating Loan Modifications,
Improving Foreclosure Prevention
and
Enhancing Enforcement
before the
Financial Services Committee;
U.S. House Of Representatives;
2128 Rayburn House Office Building
December 6, 2007
Chairman Frank, Ranking Member Bachus, and members of the Committee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) regarding loan modifications of subprime hybrid adjustable rate
mortgages (ARMs). Problems in the subprime mortgage markets are affecting the
broader U.S. housing markets and the economy as a whole and pose a significant
policy challenge for the industry and regulators.
Between now and the end of 2008, subprime hybrid ARMs representing hundreds of
billions of dollars in outstanding mortgage debt will undergo payment resets. Our
calculations based on owner-occupied subprime mortgages included in private
mortgage-backed securitizations (MBS) indicate that almost 1.3 million hybrid loans are
scheduled to undergo their first reset during 2008.1 An additional 422,000 subprime
hybrid loans are scheduled to reset in 2009, which means these problems will not end
anytime soon. The combination of declining home prices and scarce refinancing options
will stress these mortgage holders and could result in hundreds of thousands of
additional mortgage foreclosures over the next two years. These foreclosures will inflict
financial harm on individual borrowers and their communities as they potentially drive
down home values. Studies show that property sales associated with foreclosures tend
to reduce average home prices in the surrounding neighborhood, placing stress on
remaining homeowners and their communities.
My testimony will provide some brief background on the current situation and describe
an approach that I believe provides the best means we have at this juncture to avoid
unnecessary foreclosures and provide for long-term, sustainable solutions. I also will
comment on legislative proposals that address the issues of servicer liability for
participating in loan modifications and penalties for market participants who engage in a
pattern or practice of making loans that borrowers cannot repay.
U.S. Housing Markets and Mortgage Credit Performance Have Deteriorated
The U.S. housing boom of the first half of this decade ended abruptly in 2006. Housing
starts, which peaked at over 2 million units in 2005, have plummeted to just over half of
that level, with no recovery yet in sight. Home prices, which were growing at double-digit
rates nationally in 2004 and 2005, are now falling in many metropolitan areas and for
the nation as a whole. With declining home prices, there are large increases in problem
mortgages, particularly in subprime and Alt-A portfolios.2 The deterioration in credit
performance began in the industrial Midwest, where economic conditions have been the
weakest, but has now spread to the former boom markets of Florida, California and
other coastal states.
Over the past year, investors and ratings agencies have repeatedly downgraded their
assumptions about subprime credit performance. A study published over the summer by
Merrill Lynch estimated that if U.S. home prices fell by just 5 percent, subprime credit
losses to investors would total just under $150 billion and Alt-A credit losses would total
$25 billion. Subsequent to this report came news that the Case-Shiller Composite Home
Price Index for the 10 large U.S. cities had fallen in August to a level that is already 5
percent lower than a year ago, with futures traded on this index now pointing to the
likelihood of a similar decline over the coming year.
The complexity of many mortgage-backed securitization structures has heightened the
overall risk aversion of investors, resulting in what has become more generalized
illiquidity in global credit markets. These disruptions have led to the precipitous decline
in subprime lending, a significant reduction in the availability of Alt-A loans, and higher
interest rates on jumbo loans. The reduced availability of mortgage credit has placed
further downward pressure on home sales and home prices in a self-reinforcing cycle
that now threatens to derail the U.S. economic expansion.
Subprime Hybrid Mortgages and Securitization
The current problem in subprime mortgage lending arose with the rapid growth of 2- and
3-year adjustable rate subprime hybrid loans after 2003. Between year-end 2003 and
mid-2007, some 5 million of these loans were originated. Of these, just over 2.5 million
loans with outstanding balances of $526 billion remain outstanding.
The typical structure of these loans is to provide for a starter rate (usually between 7
and 9 percent), followed in 24 or 36 months by a steep increase in the interest rate
(typically 300 basis points within the first year after the reset) and a commensurate rise
in the monthly payment. Almost three quarters of subprime mortgages securitized in
2004 and 2005 were structured in this manner, as were over half the subprime loans
made in 2006. Most of these loans also imposed a prepayment penalty if the loan was
repaid while the starter rate was still in effect.
Despite the steep "payment shock" these loans impose on subprime borrowers, they
actually performed reasonably well in recent years. Rapid home price appreciation in
many areas of the U.S. allowed even highly-leveraged borrowers to refinance or to sell
their home if necessary when the loans reset without a loss to themselves or mortgage
starts, which peaked at over 2 million units in 2005, have plummeted to just over half of
that level, with no recovery yet in sight. Home prices, which were growing at double-digit
rates nationally in 2004 and 2005, are now falling in many metropolitan areas and for
the nation as a whole. With declining home prices, there are large increases in problem
mortgages, particularly in subprime and Alt-A portfolios.2 The deterioration in credit
performance began in the industrial Midwest, where economic conditions have been the
weakest, but has now spread to the former boom markets of Florida, California and
other coastal states.
Over the past year, investors and ratings agencies have repeatedly downgraded their
assumptions about subprime credit performance. A study published over the summer by
Merrill Lynch estimated that if U.S. home prices fell by just 5 percent, subprime credit
losses to investors would total just under $150 billion and Alt-A credit losses would total
$25 billion. Subsequent to this report came news that the Case-Shiller Composite Home
Price Index for the 10 large U.S. cities had fallen in August to a level that is already 5
percent lower than a year ago, with futures traded on this index now pointing to the
likelihood of a similar decline over the coming year.
The complexity of many mortgage-backed securitization structures has heightened the
overall risk aversion of investors, resulting in what has become more generalized
illiquidity in global credit markets. These disruptions have led to the precipitous decline
in subprime lending, a significant reduction in the availability of Alt-A loans, and higher
interest rates on jumbo loans. The reduced availability of mortgage credit has placed
further downward pressure on home sales and home prices in a self-reinforcing cycle
that now threatens to derail the U.S. economic expansion.
Subprime Hybrid Mortgages and Securitization
The current problem in subprime mortgage lending arose with the rapid growth of 2- and
3-year adjustable rate subprime hybrid loans after 2003. Between year-end 2003 and
mid-2007, some 5 million of these loans were originated. Of these, just over 2.5 million
loans with outstanding balances of $526 billion remain outstanding.
The typical structure of these loans is to provide for a starter rate (usually between 7
and 9 percent), followed in 24 or 36 months by a steep increase in the interest rate
(typically 300 basis points within the first year after the reset) and a commensurate rise
in the monthly payment. Almost three quarters of subprime mortgages securitized in
2004 and 2005 were structured in this manner, as were over half the subprime loans
made in 2006. Most of these loans also imposed a prepayment penalty if the loan was
repaid while the starter rate was still in effect.
Despite the steep "payment shock" these loans impose on subprime borrowers, they
actually performed reasonably well in recent years. Rapid home price appreciation in
many areas of the U.S. allowed even highly-leveraged borrowers to refinance or to sell
their home if necessary when the loans reset without a loss to themselves or mortgage