Rethinking the Federal Housing Administration
The following remarks were delivered by Jim Carr at the American Enterprise Institute at an event entitled “Rethinking the FHA—An AEI-CAP Discussion” on June 20, 2013.
Thank you for inviting me to join you for this important discussion and, in particular, to offer perspectives on the paper recently released by Dr. Joseph Gyourko titled “Rethinking the FHA.” Given the Federal Housing Administration’s, or FHA’s, long and significant role in the U.S. home mortgage market, its recent financial challenges, and the continuing struggling condition of the housing finance system, reaching consensus on the appropriate role for FHA as part of an overall restructuring of our home loan market is essential.
My general response to the paper can be summarized in five points that I will summarize first and then discuss in more detail. Those five observations are:
- FHA by many measures has been an exceptional success.
- FHA has financial challenges, but the sky is not falling.
- FHA’s financial challenges are not due to its “government status” per se.
- Improvements in FHA’s management could enhance its financial well-being.
- A federally subsidized savings program for moderate-income families is an exceptional idea.
1. FHA by many measures has been an exceptional success
The first sentence of Gyourko’s paper reads: “The Federal Housing Administration (FHA) has failed by any reasonable metric.” This statement is belied by the facts. Founded in 1934 with the goal of keeping credit available during crises, the FHA has—in the 80 years since its founding—insured 40 million mortgages. This has given millions of American families an opportunity to build wealth though sustainable and safe mortgage products. And over all of these years, it has never cost taxpayers a single dollar.
Before the Great Depression, most mortgages were short‐term—typically only 5 to 10 years—interest‐only loans that had to be repeatedly refinanced. FHA initially popularized the fully amortizing mortgage and over time popularized the 30-year, fixed-rate, low-down-payment product. These products drove the increase in homeownership that was a hallmark of the American Dream and wealth creation for the American public throughout the remainder of the 20th century. Further, FHA has reliably served populations that the mainstream mortgage market underserves, whether these markets are rural areas, regions suffering economic downturns, people of color, or low-wealth borrowers.
FHA’s essential role to the U.S. housing finance market is not only of historic significance. The FHA has and continues to play a key countercyclical role. While private mortgage insurers either went bankrupt or dramatically scaled back their lending during our housing crisis, FHA was, due to its governmental status, able to ramp up its role in the market. FHA lent heavily into the markets that suffered the largest decrease in home prices during the bust. In fact, its market share rose from roughly 3 percent to more than 30 percent. For home purchase loans, the FHA’s market share shot as high as nearly 40 percent.
Without FHA’s countercyclical role, the recession would have been even more devastating. According to the best estimate that we have (from Moody’s Analytics), if FHA had stopped insuring mortgages in October 2010, by the end of 2011 house prices would have fallen an additional 25 percent, new home construction would have fallen 60 percent, and home sales would have fallen another 40 percent. What’s more, we would have lost another 3 million jobs, the unemployment rate would have been 12 percent, and the economy would have contracted another 2 percent.
During the crisis, FHA has also supported home purchases, especially by serving first-time homebuyers and borrowers of color. While Fannie Mae and Freddie Mac have devoted much of their activity to refinances—72 percent of their originations in 2012 were for refinances—FHA has continued to support home purchase loans—62 percent of FHA originations in 2012 served this purpose. Over three-quarters of FHA endorsements in 2012 supported first-time homebuyers. And FHA insurance supported half of home purchase loans made to African American and Latino households in 2012.
As a result, the paper’s assertion that “FHA has failed by any reasonable metric” is a confusing observation that is at odds with reality.
If FHA cannot serve the market, we will lose not only a crucial countercyclical stabilizer but also a key driver in the availability of mortgage credit. And the market will likely severely underserve the very borrowers who are the future of homeownership in America: lower-wealth and borrowers of color homebuyers.
2. FHA has financial challenges, but the sky is not falling
Gyourko’s paper is only the latest in a series that has warned that FHA is essentially bankrupt, sputtering on its last leg, and ready to collapse at any moment. FHA has legitimate financial challenges, but they are being managed in a responsible manner, and the agency continues to operate without a single dollar of taxpayer subsidy to support its mortgage insurance fund—the fund that is used to pay claims on essentially all of FHA’s single-family insurance.
The 2012 actuarial report indicated that the fund faces a capital shortfall of $16.3 billion, or 1.44 percent. The report showed that 17 percent, or $2.8 billion, of this shortfall was due to the Home Equity Conversion Mortgage, or HECM, program—the program through which the FHA insures reverse mortgages. The report also shows that the Fund would have $15 billion more in reserves if the seller-funded down-payment-assistance program had never existed. The more recent estimates in the president’s budget indicate that the capital shortfall is $943 million—not an insignificant sum of money but a substantial improvement from the earlier estimate. Moreover, even if the fund needs a draw of $1 billion from the U.S. Treasury, that would be a bargain compared to the negative financial and economic consequences likely to have occurred if FHA hadn’t played its key countercyclical role during the crisis. Moreover, FHA’s shortfall is not a cash-on-hand problem; the agency has $30 billion to continue paying claims, which is enough to cover the next 7 to 10 years. Its most recent books of business are highly profitable, and FHA has taken numerous steps that I’ll detail later that will limit its losses and increase its capital reserves.
The FHA’s losses also pale in comparison to those of the private sector—the very financial institutions that Gyourko implicitly and AEI explicitly suggests should run our future housing finance market. Major Wall Street firms and major mortgage lenders—including Bear Stearns, Lehman Brothers, Merrill Lynch, CountryWide, Washington Mutual, and others—did not have a projected loss over the next 30 years. They went broke and were shuttered or sold at the cost of billions of dollars of taxpayer bailouts. The FHA was needed to step in to fill the void for these and other bankrupt private firms. What’s more, FHA loans are performing far better than the subprime loans the private sector pioneered. According to the Mortgage Bankers Association’s data for the first quarter of 2013, subprime fixed-rate loans had a delinquency rate of 20 percent and subprime adjustable-rate mortgages had a delinquency rate of 24 percent, while FHA loans had a delinquency rate of 11 percent. The FHA number would be even lower if it didn’t include loans with seller-finance down-payment assistance, as I’ll detail later.
And there’s reason to think the situation is getting better: The single-family early period delinquency rate, an indicator of the strength of new loans, is one-seventh of what it was in the height of the crisis. Home prices have been rising quickly—at their fastest pace in seven years, according to the Case-Shiller index. And interest rates have remained lower than what the actuaries assumed in the 2012 actuarial report.
Most importantly, it’s not yet clear whether the FHA will require a treasury draw; we won’t know for sure until September. It is possible that the numerous policy changes implemented by the Federal Housing Administration will give the fund a positive economic value, as happened the last time the fund had a negative economic value in 1990. Draconian pricing and underwriting changes were also proposed during that period, which proved to be unnecessary.
Moreover, the Gyourko paper and similar reports offer a misdiagnosis of the cause of FHA’s financial problems. In their take, the main problem is the fact that the FHA supports low-down-payment lending.
That diagnosis is in error. FHA’s losses come from two programs: seller-financed down-payment-assistance loans and HECM loans. Curiously, Gyourko does not mention these programs in his analysis.
The seller-financed program was a fraud-riddled program that essentially used FHA insurance to finance down payments through artificially high sales prices and loan amounts. These loans accounted for 19 percent of FHA endorsements between 2001 and 2008 but drive huge amounts of FHA’s losses—as of the 2011 actuarial review, 41 percent. Today they account for 4 percent of the outstanding portfolio but 13 percent of seriously delinquent loans. Without these loans, the net economic value of the forward loans fund would be a positive $1.77 billion. Research shows that the lifetime default rate of FHA loans originated between 2000 and 2008 would be almost 5 percent lower without these loans—9.7 percent versus 14.4 percent as of February 2011. These loans are ultimately expected to cost the FHA over $15 billion.
HUD attempted to eliminate these loans many times but was prevented by political opposition in Congress until the Housing and Economic Recovery Act of 2008 banned them starting in the second fiscal quarter of 2009.
Similarly, FHA is facing $5 billion in losses from reverse mortgages insured through its HECM program. Although the HECM program takes up just 7 percent of FHA’s portfolio, it accounts for 17 percent of its losses. Without the HECM program, the fund would have a positive value, according to the president’s budget. Instead, there is now the projected negative $943 million value.
There are three reasons FHA is facing losses on the HECM program. First, historic home price declines have meant that banks cannot recover the full amount of reverse mortgages when houses are sold, leaving FHA liable for the shortfall. Additionally, borrowers are having problems meeting their tax and insurance obligation, leading to default. This has become a serious problem: As of February 2012, 9.4 percent of active HECM loans were in default on insurance and/or taxes.Third, in recent years larger numbers of estate executors have chosen to have HUD dispose of properties, driving up costs for the agency.
As I’ll detail, FHA is taking steps that address these problems. The House of Representatives has also recently voted to allow FHA additional authority to prevent losses in the HECM program.
The losses FHA is facing due to seller-financed down-payment assistance and HECM loans exist primarily because of congressional inaction, not any failure on the part of the FHA. These losses demonstrate that FHA’s core business model of low-down-payment lending is not the source of its financial challenges. They also don’t show that government agencies price risk any worse than the private sector.
Because the Gyourko paper assumes—but does not prove—that low down payments are the cause of FHA’s financial problems, its conclusions are at odds with the reality of low-down-payment lending as with the facts of FHA’s financial problems. Many affordable homeownership programs, other than FHA, have demonstrated the viability of low-down-payment lending.
The UNC Center for Community Capital has studied a large portfolio of loans originated to low- and moderate-income households. These loans are safe, sustainable mortgages underwritten for the ability-to-repay, and many of them have low down payments. These loans have performed remarkably well through the crisis with delinquency rates only slightly higher than that of prime loans.
We can glean more insight on the wisdom of eliminating the FHA—the major source of low-down-payment lending in America—from other studies. For example, the UNC group has also examined the effects implementing a down-payment requirement in mortgage rules that are currently being finalized. If regulators implement a 10 percent down-payment requirement, the default rate for a category of safe mortgages, so-called “Qualified Mortgage” loans, drops from 5.8 percent to 4.7 percent. But this sort of requirement means that 30 percent of the loans originated between 2000 and 2008 would be excluded from the market deemed as safe by these new regulations. With a 10 percent LTV [loan-to-value] requirement, nine borrowers are excluded from this market for every one default that is prevented. What’s more, this requirement excludes 60 percent of loans given to African Americans, 50 percent given to Latinos, 50 percent given to low- and moderate-income borrowers, and 40 percent of loans given to middle-income borrowers during this period.
3. FHA’s financial challenges are not due to its “government status” per se
A central thrust of the Gyourko paper is that FHA’s major problem is that it is a government agency. Yet none of the analyses of the paper justify this claim. In fact, curiously, the most direct connection between FHA’s financial woes and its government status is that congressional oversight limits FHA’s flexibility to terminate programs or make major revisions to its programs.
The Gyourko paper pays significant attention to various modeling challenges such as the manner in which the FHA estimates the effects of unemployment. But those financial management decisions are not due to the FHA’s government status; they are due to the management team’s professional expertise and experience.
The Gyourko paper as relies on research of his AEI colleague Edward Pinto, but Pinto’s critiques also do not establish that FHA’s financial problems are per se related to its government status. Moreover, much of Pinto’s work rests on assumptions that are transparently biased and therefore undermine much of its value. An example of this framing can been seen in a recent report that examines the FHA 2009 and 2010 book years, a period Pinto considers to be “well after the market’s collapse.” In reality, his data set begins months after the bailout of the country’s major financial institutions, the beginning of Fannie and Freddie’s conservatorship, and the freezing of the nation’s credit markets. Housing prices were still in free fall, and the 2009 book also includes a number of seller-finance down-payment-assistance loans. Additionally, Pinto presents a correlation between FHA lending and high foreclosure rates in distressed neighborhoods to imply that the FHA is causing these foreclosure rates. In truth, these foreclosures are driven by the predatory lending pushed in these communities during the housing bubble.
FHA has implemented a fair number of policy changes that are designed to reduce its losses and make its lending programs more sustainable. Beyond banning seller-financed down-payment assistance, the FHA has also improved its oversight of lenders, made its underwriting stricter—by requiring manual underwriting for borrowers with credit scores below 620 and DTI [debt-to-income] ratios over 43 percent and by increasing down-payment requirements for borrowers with credit scores below 580—and moved to sell its distressed assets more effectively. Crucially, the FHA has increased mortgage insurance premiums five times since 2009 and has begun to collect annual premiums for the life of a loan. All of these changes will have a positive effect on the agency’s financial position.
The agency has also announced it will improve its loss mitigation policies, streamline its short sale policy, and move forward with housing counseling incentives or requirements. All of these changes will likely save the agency money. Moving forward, FHA needs additional authority from Congress to manage its risk as effectively as possible. For example, the agency needs better authority to terminate lenders who show excessive rates of default or claims and to mandate the transfer of servicing rights from ineffective servicers.
In the HECM program, FHA is also moving forward with changes that will improve the program and prevent losses. The recently announced elimination of the fixed-rate standard HECM program will mean that borrowers should have a better ability to meet their tax and insurance obligations, thus preventing defaults. And the issuing of new incentives for estates to dispose of properties will also decrease the likelihood that HUD will have to bear costs related to property disposition.
What’s more, the Reverse Mortgage Stabilization Act of 2013, which the House recently passed, will give the FHA flexibility to implement changes to their programs using mortgagee letters rather than the often-lengthy rulemaking process. FHA plans to use this authority to make changes that will directly address the HECM program’s observed problems, such as limiting the amount of allowed upfront draws and mandating tax and insurance set-asides.The FHA may also require a financial and credit assessment at loan origination and implement protections for spouses—reforms that could further strengthen the HECM program.
The real problem for FHA relating to its government status is not what AEI implies; rather, it is that the FHA needs authority to make sound business decisions in real time rather than being constrained by congressional oversight.
4. Improvements in FHA’s management could enhance its financial well-being
In addition to the policy changes already being pursued by FHA to improve its financial position, further enhancements to FHA’s operations might be extremely valuable. Pinto has argued that the Veterans Affairs [or VA] mortgage program has a number of better practices than FHA. A number of these recommendations are worth considering. For example, we should examine the possible impact of imposing a residual income requirement at the FHA. We should also examine whether FHA’s seller concessions lead to higher default rates. It’s worth noting that HUD has been seeking to lower the amount of seller concessions since 2010. We should also study whether the VA property-appraisal process is more accurate than the process employed by FHA.
FHA can also learn from VA’s servicing procedures, which numerous commentators have argued is unique in its emphasis in intervening at the first indication a borrower might default. On a separate note, FHA could make improvements to its loss mitigation requirements. For example, by requiring servicers to provide clear proof that it complied with FHA’s loss mitigation guidelines before the agency pays out an insurance claim.
5. A federally subsidized savings program for moderate-income families is an exceptional idea
Gyourko’s paper proposes the establishment of a means-tested, government-subsidized savings program to replace FHA. Perhaps I am too much of a fiscal conservative, but replacing a government program—that has operated for more nearly 80 years, helped more than 40 million households to become homeowners, and has never cost the American taxpayer a single dollar to shore up its lending insurance fund—with a program that will cost taxpayers $1 billion per year while serving only a fraction of the current FHA program is an idea whose time will hopefully never come.
Having said that, the reality is that Americans do not save sufficiently and that lower- and moderate-income families face particularly large barriers to savings. As a result, we should consider a savings program with the general design features proposed in the Gyourko paper. And it is refreshing to have a conservative endorsing the importance of this idea.
Gyourko’s ideas to target the program to certain populations and to place restrictions on withdrawal are important components of his vision. Yet I do not agree that matched savings accounts should be managed through a mutual fund. Consumer savings would be safer and better managed through a less risky savings account at a local bank or credit union. Additionally, I believe there must be some flexibility regarding the government match; while restrictions are important, a borrower should not be penalized for missing his or her savings goal from time to time. I also believe the tax-free status is an unneeded tax expenditure that may inadvertently benefit higher-income participants. Lastly, I believe we should explore expanding such a program beyond housing. Lower-income households could use a wealth-building savings program for a variety of purposes, including starting a business, paying a child’s tuition, paying exceptional medical bills, and other necessities.
The paper “Rethinking the FHA” provides significant information on which to debate and discuss the current condition and future directions for the FHA. Unfortunately, the paper’s first sentence that “The Federal Housing Administration (FHA) has failed by any reasonable metric” makes it clear the writing is not about offering a fair and balanced review of the FHA but rather to proclaim that the sky is falling and to elicit a radical and dramatic response. If policymakers heed that message, they could undermine one of the most successful and important government programs enacted in the past century.
It’s unfortunate that in this great time of turmoil within the housing market, particularly given the importance of homeownership to achieving the American Dream for the typical American family, that our debates and discussions cannot more genuinely focus on the real problems we face and the opportunities that lay ahead. But by asking me to comment on this paper, perhaps this could be a first step to dropping the rhetoric and working together as Americans for America.
Jim Carr is a Senior Fellow with the Center for American Progress and distinguished scholar with The Opportunity Agenda. The author thanks David Sanchez and Jessica Kaushal for their invaluable assistance in preparing these remarks.
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