Questions toMr. Edward PintoRe a hearing of the Financial ServicesSubcommittee on Housing and CommunityOpportunityHearing entitled “The Future of the Federal Housing Administration’s CapitalReserves: Assumptions, Predictions and Implications for Homebuyers”On October 8, 2009Mr. Edward Pinto, Real Estate Financial Services Consultant

•In your testimony,you make the case that FHA loans are tremendously risky and thatFHA will require a $54 billion bailout.To support your argument, you note thatFHA will perform like Fannie Mae’s 2006 high loan-to-value book (page 8).Youmake this assumption, then apply the default rates of Fannie Mae’s 2006 high loan-to-value book to FHA’s portfolio, and come up with a $54 billion figure.◦How do you come to the conclusion that Fannie Mae’s high loan-to-value2006 book of business is the same as FHA’s current book of business giventhat FHA requires full documentation on all of its purchase and newrefinance transactions, FHA does not allow zero downpayment or piggyback loans and FHA stopped investor loans many years ago?

Fannie’s book ofhigh loan-to-valueloans isor has:

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93% fixed rate;

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97% principal residence;

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An average FICO of 690;

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An average loan size of $130,000;

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An average LTV (1

mortgage) at origination of 97.4%;A “normal” interestrate;92% were not classified as Alt-A;0% were negatively amortizing; and94%were fully amortizing.It is my opinion that this is areasonableproxy for FHA’s book.

◦Please provide the data and methodology you used to calculate the estimated$54 billion needed by FHA.

In my opinion, it is reasonable to assume that FHA’s book will performsimilarly to Fannie Mae’s 2006 high LTV book of business.I estimateFannie’s ultimate cumulative default rate on its 2006 high LTV book beabout 20% of insured loans.Thisestimateis based on Fannie’s publisheddata on the development of the cumulative default rate for its 2006 book,

with further analysis done by me to compute a projected cumulativedefault rate for Fannie’s 2006 high LTV book.Commissioner Steven’s largely confirmed my projected cumulativedefault rate of 20% when he indicated that the 2007 and 2008 books wereprojected at 24% and 20% respectively.Applying thisestimate of a 20%default rate to FHA’s current book of 5.8million loans yields 1.2 million new foreclosures.Fannie is experiencing aloss rate per default of an estimated 50% of principal on its high LTVdefaults.It is my opinion that FHA’s loss rate per default will equal orexceed 50%of the insured loan balance.This would amount to totallosses of 10% on its $725 billion book of insurance or $72billion in losses.FHA’s average premium stream per loan is about 4.5% (based on 1.5%paid at origination and an average life of 6 years).This yields a shortfallof about 5.5%on its $725 billion book or$40 billion.FHA also has aCapital Reserve account requirement of 2%or $14.5 billion.

•You note that your assessment of FHA’s capital reserves will likely differ fromFHA’s independent actuarial analysis because FHA’s independent actuarial analysisuses overly optimistic assumptions.Which assumptions do you believe are overlyoptimistic?Have the independent actuarial reviews of FHA’s capital reserve ratio, asrequired under the Cranston-Gonzalez National Affordable Housing Act, historically been overly optimistic?

I am of the opinion that the review’s assumptions will be overly optimisticrelative to:

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The expected delinquency rate on the FY2009 book;

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The cure rate on defaulted loans (all books);

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The success rate on loan modifications(all books); and

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The positive impact of FHA’srecent and expected underwritingchanges.

•You estimate that FHA’s foreclosure start rate is approximately 4.4 percent for 2009.However, Mortgage Bankers Association data published at the end of August indicates that FHA’s foreclosure startrate was 1.15 percent as of the end of the second quarter of 2009.That is compared to a foreclosure start rate for prime loans of 1.01 percent and a foreclosure start rate for subprime loans of 4.13 percent.How did you arrive at your figure of 4.4 percent?

The MBA reports a quarterly foreclosure start rate, which is not annualized.Iestimated FHA’s annualized rate for 2009 at 4.4%, based on a Q.1:09 rate of 1.1% and a Q.2:09 rate of 1.15%.Based on the first 2 quarters, my estimate of 4.4% seems reasonable.

•If FHA’s downpayment requirement were increased to your recommendation of 10 percent, how many current FHA borrowers would not have qualified for homeownership?◦What would be the current level of the FHA capital reserve ratio if downpayment requirements had historically been 10 percent?◦What research have you conducted to support your assessment?

I would raise the minimum FHA downpayment on home purchase loans to 10%,reduce seller concessions from 6% to 2%,and tighten other gimmicks thatdistort home values.A major goal of single familyaffordable housing programsiswealth building through homeownership and equity build-up.Many will say,be reasonable – only drop to a 95% LTV but not to 90%.It is the lack of skin inthe gameby large numbers of borrowers in neighborhoodsthatis both a majorcause and a continuing contributor to housing price instability– both in creatinga bubble on the way up and a bust on the way down.This explains why FHA’sforeclosure rate has been increasing for 60 years.Unprecedented levels of riskyFHA financing have now spread to virtually every neighborhood in theU.S.Twenty years ago I dubbed the impact FHA has on neighborhoods, “the FHAeffect”.Real estate is fundamentally cyclical and borrowers (particularly lowand moderate incomeones) need staying power in the form of equity,fixedinterest rates, good credit habits, and debt ratios that allow for some cushion.With FHA lending becoming more and more the norm, it will impact the pricestability of more and more neighborhoods.When a neighborhood comes understress, foreclosures rapidly soar if there is little in the way of collective equityamong all households.When a homeowner with little equity looks out thewindow, he sees a sea of for sale signs.As distressed homeowners and propertiesincrease and demand plummets, prices have nowhere to go but down. Those withequity have staying power, those without must join the rush to the exits.I have also suggested thatFHA’s dollar limitbe reducedto a level commensuratewith its low and moderate income housing mission.In my opinion, FHA shouldserve households with an income less than or equal to 80% of the median.Whileregional adjustments would be appropriate, nationally this equates to an incomeof $54,000 and below.A household with an income of $54,000 getting a 6% fixedrate 30-year mortgage could afford the median priced house in theUS– about$175,000.I have also suggested thatprospective homeowners without the requisite 10%down be encouraged to participate in a 5-year downpayment savings plan. Theywould be asked to establish a five year savings plan based on saving $25 - $35/week.Over 5 years a total of $6500 - $9100 would be saved.Add in interestearnings at 3% and an employer match perhaps through a 401k or a foundationgrant and the total grows to $15,000 - $20,000 at the end of 5 years, enough for a10% downpayment on the median priced home ($175,000).At the end of fiveyears, this prospective homeowner has accomplished much, having saved a