Elements of these considerations are already reflected in the discussion draft. For example, Title I of the discussion draft includes exit fees and shared appreciation mortgages to address concerns about borrower moral hazard. It also contains features to protect the taxpayer, such as widening the range of insurance premiums and creating a meaningful amount of borrower home equity. As for adverse selection, risk-based insurance premiums paid by the servicer are crucial, and Title I could be clearer about the FHA's authority to use risk-based premiums. Other steps to guard against adverse selection could include a loan seasoning requirement or other forms of warranties given by the lender to the government about loan performance.

Given the magnitude of the potential foreclosures on the horizon, more steps should be taken to modernize the FHA and to deal with the junior lien holders. The FHA needs the resources and the incentives to manage the risks to the government well and to offer mortgage insurance products that will be attractive to servicers. As for junior lien holders, despite the government's best efforts, it may be difficult for servicers or lenders to negotiate with junior lien holders on the borrowers' behalf. The FHA needs substantial flexibility to provide incentives to servicers to negotiate with junior lien holders to address this difficult problem.

The Congress may be concerned that the loan-by-loan approach could prove insufficient. Title II of the discussion draft would permit substantial flexibility to expand the program if needed by introducing a bulk-refinance mechanism if economic conditions warrant such action. This mechanism would rely on an auction-based process to price and deliver mortgages for refinancing. Note that an auction-based approach would still have to contend with some of the problems mentioned above, including moral hazard, adverse selection and the resolution of junior liens. Title II would grant authority to the implementing agencies to build in features needed to address these and other issues. If you move forward with this legislation, it will be important that the implementing agencies have full latitude to exercise such authority.

In the design and details of a principal write-down program based on a government-insured refinancing, it is critical to strike the right balance between the interests of borrowers, servicers, investors, and taxpayers. For example, the larger the required principal reduction on a troubled loan, the fewer loans that lenders or servicers will offer voluntarily for refinancing into an FHA-insured product, thereby reducing the "take up" rate for the program. However, a larger principal write-down better protects taxpayers from future losses and gives the borrower a greater incentive to stay current on the refinanced mortgage.

As another example, the more incentives given to servicers to use an FHA refinancing program, either through direct payments or through shared appreciation agreements, the more they would be willing to incur the costs of refinancing borrowers. Such incentives might increase the number of borrowers who might be considered for a government-backed program. But such incentives also would raise the cost of the program for the borrower and possibly for the government as well.

As a final example, providing investors with some of the benefits of any shared-appreciation agreements might encourage them to allow servicers to write down principal and refinance borrowers into a government-backed program. However, providing the government with such agreements could be one means of compensating taxpayers for shouldering the risks associated with the program.

Even if the right balance for the program can be struck, obstacles remain to the successful implementation of a government program designed to forestall preventable foreclosures. For example, even though workouts may often be the best economic alternative, mortgage securitization and the constraints faced by servicers may make such workouts less likely. Trusts vary in the type and scope of modifications that are explicitly permitted, and these differences raise operational compliance costs and litigation risks for the servicer. So that servicers do not try to unduly avoid litigation risks, leadership is needed to clarify their duties.

Conclusion
FHA modernization and GSE reform are needed to address the ongoing shortcomings of current mortgage-oriented government initiatives. In addition, the GSEs should be strongly encouraged to raise additional capital so that they can fulfill the expanded role that the Congress has recently extended to them.

Separately, the Congress should carefully evaluate whether to take additional actions to reduce the rate of preventable foreclosures. Properly designed, such steps could promote economic stability for households, neighborhoods, and the nation as a whole. Although lenders and servicers have scaled up their efforts and have adopted a wider variety of loss-mitigation techniques, more can, and should, be done.

The fact that many troubled borrowers have properties that are now worth less than the principal amounts remaining on their mortgages suggests that lenders and servicers should give greater consideration to the use of principal reductions as one of the loan modification options in their tool kit. Principal write-downs would be facilitated by providing the FHA the flexibility to insure a broad range of refinancing products for a larger number of at-risk borrowers, including products that offer borrowers an affordable, restructured mortgage if their lender voluntarily agrees to write-down the principal amount of the borrower's mortgage. The voluntary nature of the program assures that only borrowers who the servicer or lender believes cannot successfully carry their current mortgage contract would be considered for such a program. If the Congress decides to move down this road, it should carefully consider the steps that should be taken to mitigate moral hazard, avoid adverse selection, and ensure that the financial interests of the taxpayer are adequately safeguarded.

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