I welcome recent efforts to improve the regulatory oversight of the government-sponsored enterprises, Fannie Mae and Freddie Mac. If these firms are strong, well-regulated, well-capitalized, and focused on their mission, they will be better able to serve their function of increasing access to mortgage credit, without posing undue risks to the financial system or the taxpayer. Policymakers are also discussing the modernization of the Federal Housing Administration and the expansion of the products and programs it might offer to make mortgage credit available and to help prevent avoidable foreclosures.

With modernization and expansion, the FHA could play an important role in relieving stress in the mortgage and housing markets as well as in restarting securitization markets. Securitization markets are needed to help relieve capital stresses on banks and to provide more affordable mortgages to borrowers. To this end, more consideration needs to be given to how the FHA can scale up quickly and improve its processes and underwriting systems so that they are comparable in quality with those currently being used by Fannie Mae and Freddie Mac. In addition, providing the FHA with broad authority to offer innovative products that meet market needs and to outsource loan underwriting and other program elements to private-sector providers could allow the FHA to insure more mortgage borrowers and to do so more quickly. The FHA needs to be better able to compete in today's marketplace and it needs access to the best risk-management tools available when managing the risks to the government.

 The FHASecure plan, which the Federal Housing Administration (FHA) announced late last summer, offers qualified borrowers who are delinquent because of an interest rate reset the opportunity to refinance into an FHA-insured mortgage.  Recently, the Congress and Administration temporarily increased the maximum loan value eligible for FHA insurance, which should allow more borrowers, particularly those in communities with higher-priced homes, to qualify for this program and to be eligible for refinancing into FHA-insured loans more generally.  These efforts represent a step in the right direction.  Not all borrowers are eligible for this program, of course; in particular, some equity is needed to qualify.  In addition, second-lien holders must settle or be willing to re-subordinate their claims for an FHA loan, which has sometimes proved difficult to negotiate. 

Given falling housing prices, many financial institutions are likely less willing to be exposed to the mortgage market. One aspect of the current situation is the high LTV ratios facing many borrowers, as low down-payments and falling housing prices have made refinancing homes difficult. A possible solution would be shared appreciation loans with FHA guarantees. This approach, variants of which are currently being discussed, would provide the FHA and the lending institution with a portion of future appreciation in return for providing the FHA insurance on high LTV loans.

Fundamentally, we want to encourage refinancing before a problematic reset. Banks may not have viewed this market as an engaging opportunity when mortgage brokers were going aggressively after the business, but banks may now find profitable lending opportunities in the current environment perhaps, in some cases, with guarantees provided by Federal Housing Administration (FHA) loan guarantees, or state programs.

There are also opportunities for FHA to look for ways to better meet subprime borrowers needs.[11] Greater outreach to borrowers and lenders seems needed. Potentially, FHA may want to raise loan amounts, if they are binding, in high cost markets. And of course there seems to still be a need to simplify and streamline the program for both borrowers and lenders. I should stress that our focus on the opportunities for the FHA program to play a role in alleviating this crisis does not represent advocating a government bailout of lenders, investors, or reckless borrowers. Rather, I am advocating using existing programs for what they were designed to do provide an option for low- and moderate-income borrowers to obtain financing at more affordable rates.

Given the substantial number of resets from now through the end of 2008, however, I believe it would behoove the industry to join together and explore collaborative, creative efforts to develop prudent loan modification programs and other assistance to help large groups of borrowers systematically.

Second, I believe that modernization of programs administered by the Federal Housing Administration, which has considerable experience helping low- and moderate-income households obtain home financing, could also help avoid foreclosures. FHA modernization could give the agency the flexibility to work with private-sector lenders to expedite the refinancing of creditworthy subprime borrowers and to design products that improve affordability through such features as variable maturities or shared appreciation.

Third, we must pursue initiatives to prevent these problems from recurring, and the Federal Reserve is making strides in this direction. ... For example, as I mentioned earlier, failure to escrow for taxes and insurance can lead to a situation akin to payment shock for borrowers. It is a common practice for these payments to be escrowed in the prime markets, and I see no reason that escrows should not be standard practice in the subprime markets too.

Modernizing the programs administered by the Federal Housing Administration (FHA) is one promising direction.  The FHA has considerable experience in providing home financing for low- and moderate-income borrowers.  It insures mortgages made to borrowers who meet certain underwriting criteria and who pay premiums into a reserve fund that is designated to cover the costs in the event of default.  This insurance makes the loans less risky for lenders and investors, and it makes the loans eligible for securitization through the Government National Mortgage Association (Ginnie Mae).

Historically, the FHA has played an important role in the mortgage market, particularly for first-time home buyers.  However, the FHA's share of first-lien home purchase loans declined substantially, from about 16 percent in 2000 to about 5 percent in 2006, as borrowers who might have sought FHA backing instead were attracted to nontraditional products with more-flexible and quicker underwriting and processing.  In addition, maximum loan values that the FHA will insure have failed to keep pace with rising home values in many areas of the country.  

In modernizing FHA programs, Congress might wish to be guided by design principles that allow flexibility and risk-based pricing...