A 1975 HUD audit of Advance Mortgage Company reveals how spread out a company's operations can be. And also, it gave some indication of the number of personnel that a large firm (second largest in the country) utilized for servicing purposes. In 1975, Advance maintained 38 field production offices across the country. It employed approximately 200 workers to service over 136,000 outstanding mortgages. Of the 200, 150 worked in the central office and only 50 were maintained in the field. It was their job to contact delinquent homebuyers and care for vacated properties. With an average of one person to service each 680 mortgages and with most of them in Southfield, Michigan at Advance's home office, it is easy to understand why one group referred to Advance as "faceless, hard to contact and uninvolved with local residents."

Computers have greatly transformed the nature of mortgage banking operations. One reason why Advance required so few field servicers is that its entire computer operation allowed considerable centralization. Computers are especially well suited to meet the needs of often far away institutional investors. They increase the speed with which a loan can be processed, closed and shipped out. Furthermore, they greatly reduce personnel costs, the one expense which has risen most quickly in the industry. It is no wonder that one mortgage banker wrote: "Electronic data processing has had more impact on the mortgage banking industry than any other single technological advancement in this century."

The mortgage industry is highly concentrated. Seven hundred and thirty mortgage companies are responsible for over 85 percent of the industry's activity. Compared with their mortgage lending competitors in the savings and loan industry, mortgage bankers are far more concentrated. In 1976, the combined origination of all MBA members totaled $23 billion, an average of $32 million per firm. On the other hand, 4,855 savings and loan associations in this country each averaged $10 million in mortgage loans.

Mortgage companies are thinly capitalized. They do not have a large reserve of cash which can cushion losses or expense overruns. Historically, when working with 100 percent insured FHA loans there was little reason to maintain a large equity reserve, and, in this competitive industry, keeping large cash reserves on hand was considered uneconomical. A commercial banker observed in one article that "Mortgage companies as a rule, tend to have relatively nominal capital in relation to the amount of money needed to finance their . . . activities." The less capital they use, the cheaper they can operate.

MORTGAGE BANKERS—FROM THE HOMEOWNER'S SIDE

Up to this point, we have examined how mortgage companies serve the needs of one side of the housing market equation-the investor's side. Their operations are centralized, computerized, and national in scope, and they work close to margin. How well do these characteristics meet the needs of homeowners?

We can take one example. For instance, while working close to the margin makes mortgage banking operations relatively inexpensive for investors, it also makes mortgage companies vulnerable to adverse economic conditions. This vulnerability can result in unfortunate consequences for homeowners and communities.

In the early seventies, the sudden volatility in interest rates coupled with many firms' diversification into risky real estate ventures placed many in a precarious economic position. The sudden rise in interest rates in mid-1973 left many firms holding mortgages that they could only sell at a loss. This cut into earnings and meager reserves. Even more important, however, were losses associated with stymied real estate developments and uncompleted construction projects.

The MBA reported that the average loss per firm in 1974 was $304,000. By 1975, the entire industry recorded a working capital deficit. After two years of losses they did not have enough collateral to cover borrowing expenses. Simply put, the industry was starved for cash-cash with which to pay rent and labor, and operating cash to meet the day-to-day costs of running a business.

To keep companies afloat, drastic action was necessary. In the words of the country's largest mortgage banking firm: "We have whittled away at our or ganization. so that every superfluous man and every unprofitable activity has been eliminated or reduced to bare bones * * *".

An FNMA study found that industry "austerity measures" led to massive cuts in operating expenses. Servicing personnel were laid off or transferred to loan production staff because "making collection calls and property inspection *** (is)

time-consuming and do (es) not render commission income." If "branch offices were not closed, servicing staffs were often reduced or eliminated."

What we have is a business which works close to the margin and is responsible for servicing the most marginal housing market-that of the FHA buyer. The following example of mortgage company servicing abuse illustrates how the various characteristics described above all combine to the detriment of the FHA homebuyer.

In 1970 a local nonprofit housing sponsor rehabilitated some 25 homes and sold them with FHA insurance. Beginning in late 1975, the housing sponsor uncovered repeated examples of poor servicing on the part of the mortgage company. In some cases, insurance premiums were unpaid for over a year and policies cancelled without the knowledge of the homeowners. Then the mortgage company would inform the homeowners that new insurance, often costing two or three times more than the original rates, was necessary. In these cases, the sponsor was able to convince the original insurer to reinstate the lower cost policies.

In another case, the mortgage company failed to pay taxes on a home. When served with a tax delinquency notice, the mortgagee paid the fines and overdue interest from the homeowner's escrow account. The following year, the homeowner's escrow payments were significantly increased to cover back taxes and fines. In this situation, the sponsor noted in its community newspaper that "the individual continued to work several jobs to make payments which were extraordinarily high, against the advice of her doctor."

Some aspects of this mortgagee negligence are particularly disturbing. Many homeowners were unaware that they were being overcharged. According to a staff member of the housing group, the computerized printouts appeared so official that the uninformed homeowner felt ill-equipped to challenge them. Further, it required weeks of the housing group's staff time to straighten out the various negligent servicing activities of the mortgagee. City tax records and insurance files had to be reviewed, and numerous calls and letters had to be exchanged with the mortgage company's Washington, D.C. office. The company's toll-free telephone line was often busy, staff assigned to the case were often changed frequently requiring that the community housing staff reexplain the entire case to new staff.

Frustrated and overworked, in late 1976 the nonprofit sponsor contacted HUD for assistance. To their disappointment, they were told that HUD would only investigate the mortgagee if all the evidence were assembled, itemized, and sent to the HUD central office. When this was done, HUD responded by criticizing the housing sponsor for having, in effect, assumed too much authority in the matter and confused the mortgagee. When the new Administration entered office, help was again requested, with the same lack of response. The group finally turned to their U.S. Senator for assistance in resolving the dilemma.

As of October 1977, it appears that the mortgage company will agree to sell their servicing contract to a local St. Louis savings institution. Ironically, the mortgages had been originated by the St. Louis office of the D.C. mortgage company, but several years later the office was shut down.

Fortunately, the homeowners in this case had the support and assistance of a knowledgeable local community organization which could commit time and resources to representing their interests. This situation clearly illustrates that without this near professional help, homeowners would not have received a fair shake. One might also wonder how many other homeowners not fortunate to have a local service organization are being overcharged perhaps without even knowing it.

We have attempted to briefly illustrate that the servicing abuses attributed to some mortgage banks are not an aberration: they are instead a predictable consequence of the way the federal programs are structured and the way the industry operates. The point is not that lending practices are universally poor in the industry. Indeed, foreclosure statistics show that many, if not most, firms are good lenders. While some choose to exploit the opportunities for abuse open to them, others resist the temptation and act responsibly. The central point is that the industry and the FHA programs are now structured in a way which invites mortgage bankers to cut corners and abuse the programs, and leaves them ineffectively regulated. Industry abuses can only be eliminated through rather fundamental reforms and systematic changes, rather than through occasional policing and unsystematic regulation.

REGULATION

The key question to be dealt with is whether HUD can appropriately regulate the activities of mortgage bankers. The Neighborhood Revitalization Project has

concluded that HUD is highly unlikely to provide the tough, independent, focused regulation which is essential if abuses are to be eliminated. The ties between mortgage bankers and FHA are close and virtually inextricable. As one MBA economist has observed: "Throughout long years of working with FHA and VA programs, mortgage bankers had developed valuable contacts and insights about the federal bureaucracy that helped turn their proposals into operating procedures." For forty years, mortgage bankers and FHA have developed a close relationship, united by a common desire to speed up production and make low downpayment, long-term financing as available as possible.

A decision to strengthen and rationalize HUD regulation could lead to improvements, but FHA's primary concern must always be with facilitating loans rather than restricting them. During his confirmation hearing, Assistant Secretary for Housing/FHA Commissioner Simons stated "I'm here to get housing built." He went on to explain that he wanted to move FHA from a nonproductive enterprise to the sort of dynamic mortgage market force that it once was. These are courageous and important objectives, but the question is whether an Assistant Secretary who must have those primary aims can be required to temper them by his position as Chairperson of the Mortgagee Review Board.

A single Department cannot encompass the checks and balances which are essential if the interests in production and regulation are both to be represented adequately. Apparently the State of Illinois believes this for it has recently taken regulation of mortgage bankers into its own hands. A bill was recently introduced in Pennsylvania to regulate mortgage banking operations. The New York Commissioner of Banks has requested that the state legislature give it regulatory power over mortgage companies. The Project believes it is time for the U.S. Congress to seriously consider shifting the responsibility for regulating bankers to another agency, thus avoiding the current conflict between the Department's production goals and its regulatory duties. In particular, the regulation of mortgage bankers and other FHA mortgagees should involve a far greater emphasis on consumer/community representation than currently found in federal depository regulatory bodies. Solvency, liquidity, and risk aspects of loan portfolios are not the prime consideration here. Instead, we must shape a regulatory approach which functions as a consumer/community protection agency.

The CHAIRMAN. Let me ask you, Mr. Maier-Mr. Rothchild has based his hopes for the future of FHA on the need for the agency to come to grips with its administrative problems and do a proper underwriting and policing of its loans. Mr. Zinsmeyer has said he believes it is impossible for the FHA to in effect police itself because it is in the business of trying to support housing production and loan output. That's just what he finished saying, as I understand it. And he recommends a separate agency to regulate mortgage bankers the way Illinois and New York and other States have already acted.

You, on the other hand, proposed that HUD set up a stronger internal control system. Are you confident that this can be done effectively in view of the documentation?

Mr. MAIER. Yes, sir. The proposal that we have presented would provide for significant increases in staffing for HUD's operations. It would also mandate the agency to monitor effectively. It would set a specific schedule for monitoring visits. It would require them to audit lenders who have high foreclosure rates and so forth.

Now we understand Mr. Zinsmeyer's concern with the tension within HUD between production and supervision. However, given the existence of at least the beginnings of a supervision system within HUD, we think it makes more sense to build upon that system rather than to start an entirely new one.

The CHAIRMAN. I would like to ask both Mr. Zinsmeyer and Mr. Maier to give me your views on coinsurance. We have heard Mr. Rothchild's views on the potentials of coinsurance. I would like to ask each of you to comment on the prospect of coinsurance to meet the problems of unsound lending in cities.

Mr. ZINSMEYER. In our research one problem we found with coinsurance is that mortgage companies cannot inherently accept the contingent liability that comes from 10- or 20-percent risk with the coinsured loan. They come out and say that. That is a result, as I pointed out earlier, of their very thin capital margin. They are not an institution which has been created to accept or hold risks. You're going to have a real problem unless you get into a very complicated scheme of reinsurance and the like for mortgage companies to take on an effective coinsurance program.

The CHAIRMAN. Mr. Maier.

Mr. MAIER. To us, the idea of FIA coinsurance is conceptually attractive for the reasons you set forth earlier, but we think the implementation problems must be addressed before it's put in place.

One of the most serious is that an optional program will be rejected by most FHA lenders. The existing coinsurance plan has resulted in only 1,700 coinsurance loans since Congress set it up in 1974. So the program has to be mandatory for part or all of the loans. But that's a problem because if you have a mandatory program, then you run the risk of driving FHA lenders from the FHA market. That's a problem particularly with thinly capitalized mortgage bankers.

Now I don't think that problem is insoluble though. I think with some hard thinking about it we can devise a scheme for reinsurance, for example, with built-in merit ratings so you have the incentive for proper lending. I think one thing that this committee could do which would be very useful would be to ask HUD to look very closely at some of these implementation problems we see with coinsurance. To my knowledge, HUD has not done so.

Mr. STANTON. Mr. Chairman, one of the implementation problems that has to be addressed is the percentage of coinsurance. Mortgage lenders can add so many fees and points up front as to bear virtually no risk if coinsurance is limited to a moderate percentage. On the other hand, if coinsurance becomes a very steep percentage so that mortgage lenders are bearing a much more serious proportion of the risk, then we run the danger of systematic redlining. Again, this is one of the classic problems that HUD must address very squarely before coming forward with implementation of what, as Mr. Maier said, is theoretically a very attractive concept.

The CHAIRMAN. Mr. Rothchild, you testified that coinsurance authority enacted in 1974 was basically workable but that the way it was administered by HUD was not, in your judgment, workable, as I understand it.

For the record, would you describe what these administrative problems were and is there any reason why coinsurance, if properly structured and administered, could not be used by mortgage bankers?

Mr. ROTHCHILD. Let me start with the last point and work back to the specific structural problems.

I think my colleagues here at the table have been very realistic about looking at the tradeoffs that are involved in coinsurance as against noncoinsurance, recognizing there are problems and recognizing it's going to take a lot of work to get to the right solution.

As you recall, I pointed out in our proposed legislation that we think a VA-type of risk-sharing is what HUD ought to look at. If you look at the record of the VA loan-and it is a risk-sharing loan-you will see that the losses to the VA are less than what would have been paid

out of one-quarter of 1 percent insurance fee. Now that's a very, very good record. In other words, if the VA had had a quarter of a percent insurance premium, the losses that they have taken with their risk-sharing program would have been paid out of that minor type of fee. So that's what we've asked HUD to look at.

The things that did not work well under their proposed coinsurance program simply had to do with the failure to price participation according to the risk. The FHA kept in their program much more of the proceeds of the fees and the premiums for their part of the risk and left far too little for mortgage bankers for their considerable portion of the risk. That was one of the problems.

The second problem had to do with property disposition and the considerable risk that was visited upon the mortgage lenders as a consequence of that.

Those are the two really major issues that kept FHA's coinsurance program from being universally accepted.

The CHAIRMAN. Also, Mr. Rothchild, let me give you an opportunity to respond to Mr. Maier's proposal that mortgage bankers be assessed a fee to be used for lender monitoring. I wonder if that's feasible and would it prevent your members from dealing with FHA?

Mr. ROTHCHILD. Mortgage bankers are on record with HUD and, as a matter of fact, on record in this proposed legislation in favor of there being an effective mortgagee monitoring system. Let me remind you that the mutual mortgage insurance fund has never cost the U.S. Government any money. Basically, the 203 (b) program has paid all of its losses and, in addition to that, has delivered resources back to HUD for its use in other programs. That is a fundamental fact of the 203 (b) program.

Our proposal says that all the insurance premiums ought to be available to do all the things that protect the program. That's why we have proposed that, under the Secretary's direction the FHA be a separately constituted line organization with full control of all its resources, part of which we think should be directed toward mortgage monitoring. It does not do the consumer any good-it does not do mortgage bankers any good-to have the system under attack because of the acts of a few, and on that we very much agree with those who are here at the table today.

So we think that the resources are already there, that if the premiums that are available to the mutual mortgage insurance fund were made available to mortgage monitoring that the job would be done.

The CHAIRMAN. You don't agree that a fee ought to be assessed against mortgage bankers? You say the resources are there. You say it's not costing money to do this. I would like to ask Mr. Maier to respond to that.

Mr. MAIER. Our testimony has already shown that in fact the resources are not there. I think a good example is the lack of staffing in the approval section of HUD, which not only hurts government in terms of not having enough staff to scrutinize, carefully, the approval applications but also hurts mortgage bankers because the approval applications are often held up for a period of months. So I think in view of the systematic understaffing of the review offices over the years-this is not a recent problem-that they need a different kind of funding mechanism so that we do have effective supervision.