WASHINGTON — Housing and Urban Development Secretary Shaun Donovan on Thursday laid out a series of potential options for shoring up the Federal Housing Administration's dwindling reserves, telling members of Congress that he expects to release a specific proposal in the coming months.
Donovan's testimony followed the release of a report that found FHA's capital reserve ratio at a perilously low level. By law, the agency's capital reserve ratio is required to be at least 2%, but it has fallen to roughly one-eighth of that minimum standard.
The most recent actuarial report, released in November, found that under a base-case scenario, where housing prices begin rising slowly next year, the FHA's capital reserve ratio will be back up to 2% by 2014. The ratio measures FHA's reserves beyond those needed to cover projected losses over the next 30 years.
Donovan faced a series of skeptical questions from Republicans and some Democrats on the House Financial Services Committee, who noted that many of the past projections regarding FHA's financial condition proved to be too optimistic. Several lawmakers expressed concern that the agency will eventually require a taxpayer-funded bailout.
"There seems to be a pattern of denial," said Rep. Stephen Lynch, D-Mass. "You're going to need a bailout, or you're going to need to take drastic measures, and that's a problem."
Rep. Ed Royce, R-Calif., made a similar argument, recalling that some lawmakers asked tough questions of FHA officials back in 2008 and 2009.
"We had hearings like this, and we were told not to worry," he told Donovan.
Donovan, whose department includes the FHA, acknowledged the possibility that home prices will not bounce back as quickly as the agency currently projects.
"Obviously none of us has a crystal ball, and there is a real risk that home prices could perform worse than that," he said.
But he emphasized the steps that Congress and the Obama administration have taken since early 2009 to shore up FHA's finances. He noted, for example, that the premiums paid by FHA borrowers have increased three times since President Obama took office. For the first time in FHA's history, a chief risk officer was hired, who put a risk-management team in place, he said.
Borrowers with low credit scores must now make a 10% down payment in order to qualify for an FHA mortgage, far higher than the 3.5% down payment standard for borrowers with better credit histories, Donovan said.
Donovan repeatedly noted during Thursday's hearing that the losses for FHA are the result of mortgages originated prior to 2009, and that more recent loans are turning a profit.
"We can't go back and unmake those loans. Unfortunately they were made," Donovan said. "But we can do as much as possible to enforce and recover on those loans."
But another witness, New York University economics professor Andrew Caplin, testified that he is concerned that the methodology used in HUD's actuarial report paints an overly optimistic picture, because it doesn't account for the fact that many of the recent FHA borrowers are refinancing older FHA loans.
"It's not surprising that those who couldn't refinance are doing worse," Caplin stated.
The HUD secretary did not commit to any specific new steps that would shore up FHA's finances. But he did say that the agency is evaluating five options that could be used to help avert a taxpayer bailout under a scenario where future home prices do not meet current expectations.
Those options, some of which may be included in next HUD's budget proposal, expected to be released around February, are:
• Premium increases. Borrowers who receive FHA mortgages are currently paying annual premiums of 1.15% of the loan amount, and Congress has given the Obama administration the authority to raise those premiums to 1.5%. Donovan testified that the financial benefit to the agency of such a step will be weighed against the cost to borrowers who would be unable to afford a mortgage as a result of higher premiums.
• Lender enforcement. Donovan outlined a set of actions that FHA is already taking to allow it to recover more funds from lenders who did not meet the agency's guidelines, or engaged in fraud. He also said there are additional steps that could be taken, but that such moves would require action by Congress.
• Loss mitigation. Donovan said that FHA is assessing additional loss mitigation strategies, but he provided few details. During the last fiscal year, about 142,000 FHA borrowers received loan modifications that reduced their monthly payments, a figure that's roughly on par with the agency's current inventory of properties in foreclosure.
• Recovery from foreclosures. The FHA has embarked on an initiative, along with the Treasury Department and the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, to explore whether converting foreclosed properties into rental units might yield better returns. Donovan did not provide any new details about this effort.
• Requirements for borrowers. Although Donovan stated that FHA will look for problem areas with regard to the credit quality of borrowers, he strongly suggested that the existing requirements are unlikely to change, saying that the existing rules provide adequate protection against losses.