Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation on Legislative Proposals
On
Reforming Mortgage Practices,
before the
Financial Services Committee,
U.S. House of Representatives
October 24, 2007
2128 Rayburn House Office Building
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 legislation to address recent practices in the mortgage
market. In its prior hearings this year, this Committee has carefully documented
developments in the mortgage market that have resulted in harm to consumers and the
economy.
As I have testified previously, the events that have led up to the recent market
disruptions and problems in the mortgage market demonstrate how weak credit
practices in one sector can lead to a wider set of credit market uncertainties that can
affect the broader economy. Although these events have yet to fully play out, they
underscore my longstanding view that consumer protection and safe and sound lending
are really two sides of the same coin. Failure to uphold uniform high standards in these
areas across our increasingly complex mortgage lending industry has resulted in
serious adverse consequences for consumers, lenders, investors, and, potentially, the
U.S. economy.
For borrowers, there are 2.07 million subprime first-lien hybrid adjustable rate
mortgages (ARMs) outstanding that were made in 2005 and 2006, most of which have
or will reset in 2007 or 2008. While about 311,000 of these are currently seriously
delinquent or in foreclosure, the size and volume of resets also suggests the potential
for serious financial distress among the remaining 1.75 million households whose loans
are subject to reset1. For investors, the uncertainty that now pervades the mortgage
market -- which is directly attributable to underwriting practices that are unsafe,
unsound, predatory and/or abusive -- has seriously disrupted the functioning of the
securitization market and the availability of mortgage credit.
The FDIC recognizes the importance of home ownership. We also recognize that
responsibly underwritten loans to consumers with less than perfect credit profiles can be
prudent and profitable assets, provided that institutions have the necessary expertise
and capital support to manage them in a safe and sound manner. Moreover, the FDIC is
committed to the goals of the Community Reinvestment Act of 1977, which has long
encouraged extending home mortgage credit to low and moderate income communities.
Clear, balanced, common sense standards regarding mortgage lending practices will
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation on Legislative Proposals
On
Reforming Mortgage Practices,
before the
Financial Services Committee,
U.S. House of Representatives
October 24, 2007
2128 Rayburn House Office Building
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 legislation to address recent practices in the mortgage
market. In its prior hearings this year, this Committee has carefully documented
developments in the mortgage market that have resulted in harm to consumers and the
economy.
As I have testified previously, the events that have led up to the recent market
disruptions and problems in the mortgage market demonstrate how weak credit
practices in one sector can lead to a wider set of credit market uncertainties that can
affect the broader economy. Although these events have yet to fully play out, they
underscore my longstanding view that consumer protection and safe and sound lending
are really two sides of the same coin. Failure to uphold uniform high standards in these
areas across our increasingly complex mortgage lending industry has resulted in
serious adverse consequences for consumers, lenders, investors, and, potentially, the
U.S. economy.
For borrowers, there are 2.07 million subprime first-lien hybrid adjustable rate
mortgages (ARMs) outstanding that were made in 2005 and 2006, most of which have
or will reset in 2007 or 2008. While about 311,000 of these are currently seriously
delinquent or in foreclosure, the size and volume of resets also suggests the potential
for serious financial distress among the remaining 1.75 million households whose loans
are subject to reset1. For investors, the uncertainty that now pervades the mortgage
market -- which is directly attributable to underwriting practices that are unsafe,
unsound, predatory and/or abusive -- has seriously disrupted the functioning of the
securitization market and the availability of mortgage credit.
The FDIC recognizes the importance of home ownership. We also recognize that
responsibly underwritten loans to consumers with less than perfect credit profiles can be
prudent and profitable assets, provided that institutions have the necessary expertise
and capital support to manage them in a safe and sound manner. Moreover, the FDIC is
committed to the goals of the Community Reinvestment Act of 1977, which has long
encouraged extending home mortgage credit to low and moderate income communities.
Clear, balanced, common sense standards regarding mortgage lending practices will
reinforce market discipline and preserve an adequate flow of capital to fund responsible
lending.
Returning to Fundamentals
The financial system has changed dramatically in recent years. Changes in technology,
delivery channels and funding sources have resulted in financial products that are more
complex and marketed through increasingly sophisticated methods. In addition, there
has been increased participation in the mortgage market by providers other than
insured banks and thrift institutions. For example, approximately half of subprime
mortgage originations in 2005 and 2006 were carried out by companies that were not
subject to examination by a federal supervisor. The proliferation of securitization as a
funding method also has changed the financial system by moving large volumes of
assets off the balance sheets of federally-insured financial institutions.
Unfortunately as the industry changed, many risk management fundamentals were
ignored or weakened. To be sure, fraud has played a role in some portion of troubled
loans, particularly those that exhibited early payment default. However, the core of the
problem lies with lax lending standards and inadequate consumer protections resulting
in a widespread failure to underwrite loans to borrowers based on their ability to repay.
The impact of poor underwriting practices has spread throughout the economy in recent
months, harming consumers and investors while creating volatility in the financial
markets. Legislative action by this Committee and rulemaking by the Federal Reserve
Board under the Home Ownership and Equity Protection Act (HOEPA) hold out promise
that mortgage originations will return to the standards and fundamentals that have
served us well for many years.
In my June testimony before this Committee, I listed several elements that should be
included in national standards for mortgage lending. Among other things, I suggested
these standards should include the following elements:
Underwriting at the fully indexed rate, which would go a long way toward helping
borrowers avoid loans they cannot repay, and would improve the quality of lender
portfolios and mortgage backed securities;
A "bright line" presumption against affordability if the loan, including taxes and
insurance, exceeds a debt-to-income ratio of 50 percent;
A prohibition on stated income loans in the absence of strong mitigating factors;
Restrictions on prepayment penalties;
A requirement for a system of licensing and registering mortgage originators that
addresses activities by entities that operate outside the supervision of the federal
banking regulators or on a multi-state or nationwide basis.
In addition, any legislation or regulation to improve mortgage standards should address
misleading or confusing marketing that prevents borrowers from properly evaluating
loan products. The standards should require that marketing information for adjustable
lending.
Returning to Fundamentals
The financial system has changed dramatically in recent years. Changes in technology,
delivery channels and funding sources have resulted in financial products that are more
complex and marketed through increasingly sophisticated methods. In addition, there
has been increased participation in the mortgage market by providers other than
insured banks and thrift institutions. For example, approximately half of subprime
mortgage originations in 2005 and 2006 were carried out by companies that were not
subject to examination by a federal supervisor. The proliferation of securitization as a
funding method also has changed the financial system by moving large volumes of
assets off the balance sheets of federally-insured financial institutions.
Unfortunately as the industry changed, many risk management fundamentals were
ignored or weakened. To be sure, fraud has played a role in some portion of troubled
loans, particularly those that exhibited early payment default. However, the core of the
problem lies with lax lending standards and inadequate consumer protections resulting
in a widespread failure to underwrite loans to borrowers based on their ability to repay.
The impact of poor underwriting practices has spread throughout the economy in recent
months, harming consumers and investors while creating volatility in the financial
markets. Legislative action by this Committee and rulemaking by the Federal Reserve
Board under the Home Ownership and Equity Protection Act (HOEPA) hold out promise
that mortgage originations will return to the standards and fundamentals that have
served us well for many years.
In my June testimony before this Committee, I listed several elements that should be
included in national standards for mortgage lending. Among other things, I suggested
these standards should include the following elements:
Underwriting at the fully indexed rate, which would go a long way toward helping
borrowers avoid loans they cannot repay, and would improve the quality of lender
portfolios and mortgage backed securities;
A "bright line" presumption against affordability if the loan, including taxes and
insurance, exceeds a debt-to-income ratio of 50 percent;
A prohibition on stated income loans in the absence of strong mitigating factors;
Restrictions on prepayment penalties;
A requirement for a system of licensing and registering mortgage originators that
addresses activities by entities that operate outside the supervision of the federal
banking regulators or on a multi-state or nationwide basis.
In addition, any legislation or regulation to improve mortgage standards should address
misleading or confusing marketing that prevents borrowers from properly evaluating
loan products. The standards should require that marketing information for adjustable