Finance Committee Chair Suggests FHA Could be Next Countrywide

by devteam February 7th, 2013 | Share

OnrnWednesday the House Financial Services Committee held the first of a scheduled seriesrnof hearings on the financial condition of the Federal Housing Administrationrn(FHA).  A memo released by the Committee’srnchairman Jeb Hensarling (R-TX) says that the FHA’s single-family insurance fundrnwhich insures more than $1 trillion worth of home mortgages, has a negativerneconomic value of $16.3 billion, according to an independent actuarial reportrnreleased in November which means that if the FHA stopped writing new businessrntoday, it could not cover the losses anticipated on loans it has alreadyrninsured.<br /<br /Hensarling opened the February 6 hearing saying that, while the recentlyrnreported negative economic growth in the last quarter does not necessarilyrnindicate a trend, subpar economic growth of 1-1/2 to 2 percent is now expectedrnand millions of Americans lay awake at night worrying about insecure financialrnfutures.  "Hardworking Americansrndemand a healthy economy and we cannot have a healthy economy until we have arnhousing finance system that is both sustainable and competitive.  In its current form FHA is clearly anrnimpediment to such a system. " The Chairman said FHA had strayed far from its original purpose and no longerrnfocuses on low and moderate income Americans but rather caters to a riskyrnmarket with high loan limits and extremely low down payment requirements thatrnput it in direct competition with the private sector.  “In addition, we know that as bad asrnthat is, its single family insurance fund is flat broke.<br /<br /"Finally, given their high Loan-To-Value, low credit score policies andrnhigh rates of default, it is an open question whether FHA has now morphed intornCountrywide. Arguably, the FHA has now become the nation’s largest subprimernlender, all with the blessing of the Administration.” </p

Four experts spoke to the panel, threernof which were highly critical of FHA’s current practices.  The hearing and Hensarling’s openingrnstatement to it included a number of references to a report written in Decemberrnby Edward J. Pinto, Resident Fellow of the American Enterprise Institute titledrnHow the FHA Hurts Working Families. Pinto’s appearance before therncommittee was based onrnthat paper.  </p

Pintornsaid his study identified specific reforms to focus the FHA on responsiblernlending and return it to its traditional mission of serving low and middlernincome, minority, or first time buyers.  </p<ol

  • Step 1: Do not knowingly insurerna loan with arnprojected claim termination rate greater than 10 percent, assuming no house price appreciation or depreciation.</li
  • Step 2: Target anrnaverage 5 percent projected claim termination raternwith the same assumption. </li
  • Step 3: Stop guaranteeing lower-risk loans and high-dollar-balance borrowers,rnas this allows for cross-subsidization ofrnthose loans with excessivernrisk. This will also let the FHA step back fromrnmarkets that canrnbe served by the private sectorrnso it can concentrate on home buyers whorntrulyrnneed help.</li
  • Step 4: Price forrnrisk, since not doing so deprives the borrowerrnof the price informationrnneeded to understand the true riskrnof the loan. Until this is done, the FHA shouldrndisclose to the borrower his or her expectedrnclaim rate, assumingrnno house price appreciation or depreciation.</li
  • Step 5: Implementrnunderwriting that results in the extension of responsible mortgage credit, byrnbalancing down payment,rnloan term, FICO score, and debt-to-income ratio to achievernmeaningful equity.</li</ol

    AnthonyrnB. Sanders, Senior Scholar, The Mercatus Center ProfessorrnofrnReal Estate and Finance, School ofrnManagement George Mason University told the committee members that the first step towards shrinking the FHA’srnfootprintrnis to reduce thernloan limit to $625,000 and then reduce it by another $100,000 perrnyear. rnHe quoted a George Mason study that concluded that current FHA policiesrnare unlikely to assist the agency in reaching its historical constituencies,rnfirst time, minority, and low-income homebuyers, and that FHA’s current marketrnshare exceeds what is needed to serve those markets.  In light of the significant decline in homernvalues FHA could reduce its loan limits by about 50 percent and still almostrnentirely satisfy its target market.</p

    Sandersrnrecommended installing a credit score floor at 660 as loan performancerndeteriorates rapidly below that level and cap LTV at 95 percent; 90 percent forrnFICO scores below 680.  A maximumrnmortgage debt-to-income ratio of 31 percent should also be established. </p

    The FHA hasrnthe highest spread of FHA 30 mortgage ratesrntornGNMA 30 yearrncurrentrncoupon ratern(the rate paid to GNMA investors) of any of therngovernment finance entities, and considerablyrnabove levels priorrntorn2008. “”In other words, thernFederal Reserve’s manic pushing of interest rates and mortgage ratesrndownwardsrnis NOT getting passedrnthrough to borrowers asrnhadrnbeen hoped.””</p

    Basil N. Petrou,rnManaging Partner of Federal Financial Analytics, Inc. presented the Committeernwith a laundry list of recommendations for the agency.</p<ul class="unIndentedList"

  • Congressrnshould reduce the 100 percent guarantee provided by the FHA tornparallel the limited coverage ofrn25%rnto 50% successfully usedrnby the Veterans Administration (VA) for the mortgagesrnit guarantees. This will effectively caprnthe severity ofrnloss on FHA loans and improve their underwriting by puttingrnthe lender at risk.rn</li
  • The FHA shouldrnbe targeted to borrowers based onrnincome, not home price.rnBy supporting mortgage finance for higher-income borrowersrnthe government supplants private capital andrncreates market distortionsrnbecause of the lack of market disciplinernapplicable to these larger loans.rn</li
  • FHA policy with regard to delegatingrnunderwriting to thernloan originator andrnreviewing underwriter performance onlyrnafterrnthe fact should be revised so FHA shares risk with regulated, capitalized providers of private credit Â

  • About the Author


    Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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