Think Tanks Continue Feuding Over FHA

It would be a Hansel andrnGretelian task to follow the back and forth between the American EnterprisernInstitute (AEI) and the Department of Housing and Urban Development (HUD) asrnthe former has attacked and the latter has defended the history, efficacy, andrnfuture of FHA. In November 2011 the conservative think tank published a paperrnby Joseph Gyourko of Wharton titled Is FHA the NextrnHousing Bailout? This was followed by a rebuttal from HUDrnand a rejoinder, again published by AEI. Then in December 2012 AEIrnpublished a major position paper which MND covered entitled Howrnthe FHA Hurts Working Families, by Steven J. Pinter. Since thenrnrepresentatives of AEI have been invited to present testimony primarilyrnassailing the role and especially the recent history of FHA in meeting the nation’srnhousing needs at several Congressional hearings on housing finance reform. </p

OnrnJune 20, 2013 AEI published another Gyourko paper titled “Rethinking the FHA in which he made the followingrnclaims:</p<ul class="unIndentedList"<liFHA is a policyrnfailure: Far too many of FHA’s intended beneficiaries fail tornachieve sustainable homeownership. Between 15 and 30 percent of mortgagesrnguaranteed by FHA since 2007 will default. </li<liFHA is a financialrnfailure: FHA’s main mortgage insurancernguarantee fund does not have sufficient funds to cover its expected losses, andrnits most recent actuarial review puts its net worth at a -$13.5 billion.rnGyourko said his research concludes it will take $50 to $100 billion to put itrnon a sound financial footing. </li<liFHA’s businessrnmodel is fundamentally flawed: Both FHArnand its borrowers are leveraged by more than 30 to 1. To be viable, such arnhighly leveraged business model virtually requires that housing values neverrnfall which we have learned is not a realistic expectation. </li</ul

Now a seniorrnfellow from the Center for American Progress (CAP), AEI’s equivalent on thernleft, has taken on Gyourko assumptions. Jim Carr’s remarks in which he laid outrnfive key points refuting Gyourko, came at an event entitled “RethinkingrnFHA”, sponsored by the two politically opposite policy centers. </p

Carr says that Gyourko’s paper provides significant information on which torndebate the current conditions and future directions for FHA but that “The paper’s first sentence that ‘The Federal HousingrnAdministration (FHA) has failed by any reasonable metric’ makes it clear thernwriting is not about offering a fair and balanced review of the FHA but ratherrnto proclaim that the sky is falling and to elicit a radical and dramaticrnresponse.” </p

Car said that FHA has, by many measures, been an exceptional success.rnIn its 80 years it has insured 40 million mortgages and revolutionized the wayrnAmericans buy homes. It popularized the fully-amortizing mortgage and itsrn30-year fixed-rate variation, reliably served the populations the mainstreamrnmortgage market underserves, and has played a key countercyclical role in thernrecent housing crisis. At that time it lent heavily into the markets thatrnsuffered the largest decrease in home prices and kept the recession fromrnbecoming even more devastating. According to Moody’s Analytics, without FHA,rnhome prices would have fallen another 25 percent, new home construction anotherrn60 percent and home sales 40 percent. The economy would have contracted anotherrn2 percent.</p

Carr said that, while FHA has financialrnchallenges, the sky is not falling. Those challenges are being managed in arnresponsible manner and the agency continues to operate without a single dollarrnof taxpayer subsidy to support its mortgage funds. </p

The 2012 independent actuarial report of thernagency indicated it faces a capital shortfall of $16.3 billion, 17 percent orrn$2.8 billion of which is due to the Home Equity Conversion Mortgage (HECM)rnprogram which insures reverse mortgages and that the seller funded downpaymentrnprogram had cost the fund $15 billion. More recent estimates put the capitalrnshortfall at $943 million. Carr said that even if the fund requires a $1rnbillion infusion from Treasury it would “be a bargain compared to the negativernfinancial and economic consequences likely to have occurred if FHA hadn’trnplayed its key countercyclical role during the crisis.” Moreover, FHA has $30rnbillion to continue paying claims, enough to cover the next 7 to 10 years. </p

Carr said that the FHA’s losses also pale inrncomparison to those of the private sector, “the very financial institutionsrnthat Gyourko implicitly and AEI explicitly suggests should run our futurernhousing finance market.” Major financial firms that did not have a projectedrnloss went broke and were closed or sold at the cost of billions in taxpayerrnbailouts. Also FHA loans are performing far better than the subprime loans thernprivate sector pioneered. </p

Carr said there is reason to think the situationrnis getting better: The single-family early period delinquency rate is<bone-seventh what it was in the height of the crisis and home prices have beenrnrising rapidly and interest rates have remained below what was projected in thernactuarial report. </p

Most importantly, Carr said, it’s not yet clearrnwhether the FHA will require a treasury draw. It is possible that the numerousrnpolicy changes implemented by the Federal Housing Administration will give thernfund a positive economic value, as happened the last time the fund had arnnegative economic value in 1990. Draconian changes were proposed then too andrnthey proved to be unnecessary.</p

Carr said that Gyourko paper and other criticsrnmisdiagnose the cause of FHA’s financial problems. The main problem is not thatrnFHA supports low-down-payment lending but rather their losses come from the twornprograms mentioned earlier, seller-financed down-payment-assistance loans andrnHECM loans, neither of which Gyourko mentions in his analysis. FHA has takenrnand is taking major steps to reform these programs.</p

Low downpayment lending in fact is not arnsignificant problem. Studies have estimated that raising the downpaymentrnrequirement to 10 percent would drop the default rate for so-called QualifiedrnMortgage loans from 5.8 percent to 4.7 percent but would have eliminated 30rnpercent of mortgages originated between 2000 and 2008. This would include 60rnpercent of loans given to African Americans, 50 percent of loans to Latinos, 50rnpercent to low and moderate income borrowers, and 40 percent to middle income borrowers.rn</p

Carr contradicts a central thrust of thernGyourko paper, saying that FHA’s financial challenges are not due to itsrn”government status” per se.  “The most direct connection between FHA’s financial woes and itsrngovernment status is that congressional oversight limits FHA’s flexibility tornterminate programs or make major revisions to its programs.”  Carr accuses both Gyourko and Pinto, of beingrntransparently biased in linking financial problems to government status.  He cites an assertion in Pinto’s paper presentingrna correlation between FHA lending and high foreclosure rates in distressedrnneighborhoods implying that the FHA is causing these foreclosure rates. Inrntruth, these foreclosures are driven by the predatory lending pushed in theserncommunities during the housing bubble.</p

Carr says FHA has implemented a fair number ofrnpolicy changes that are designed to reduce its losses and make its lendingrnprograms more sustainable in addition to changes in HECM and seller financedrndown payment assistance.  The agency hasrnimproved its oversight of lenders, made its underwriting stricter and cruciallyrnhas increased mortgage insurance premiums five times since 2009 and has begunrnto collect annual premiums for the life of a loan. All, he says, will have arnpositive effect on the agency’s financial position. The agency has alsornannounced it will improve its loss mitigation policies, streamline its shortrnsale policy, and move forward with housing counseling incentives orrnrequirements. </p

Moving forward, FHA needs additional authorityrnfrom Congress to manage its risk as effectively as possible. For example, thernagency needs better authority to terminate lenders who show excessive rates ofrndefault or claims and to mandate the transfer of servicing rights fromrnineffective servicers.</p

Carr concedes that improvements in FHA’srnmanagement could enhance its financial well-being.  He agrees with Pinto that FHA could adoptrnsome of the practices of the Veterans Affairs mortgage program such as imposingrna residual income requirements, employing its appraisal process and its programrnof early intervention with troubled borrowers. rnHe also suggests further restrictions on seller-funded downpayments, andrnimprovements to FHA’s loss mitigation requirements.  </p

In his paperrnGyourko suggested replacing FHA with a subsidized savings plan which wouldrnallow qualified households to pay into a special savings vehicle and receive arnmatch from the government.  Funds wouldrnaccumulate on a tax free basis until large enough to provide a 10 percent downpaymentrnon a home.  This, Gyourko said, wouldrneliminate a large bureaucracy, make sure the benefits accrued to households andrnincentivize families to save and “inculcate values that will decrease arnhousehold’s likelihood of default.” </p

Carr calls a federally subsidized savingsrnprogram for moderate-income families an exceptional idea, however not as a substitute forrnFHA.  Americans do not save sufficientlyrnand lower- and moderate-income families face particularly large barriers tornsavings.  He suggests placing thernaccounts with local banks and credit unions rather than the mutual fundsrnGyourko suggested, taking away the tax-free status as it is likely to benefitrnonly higher-income households, and making the plan available for other uses asrnwell, such as starting a business or saving for a child’s tuition.

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