By any number of indicators, the nation’s housing market is in recovery. But that may be the last thing the Federal Housing Administration (FHA) wants to hear right now. Last Friday, the mortgage insurance agency, part of the U.S. Department of Housing and Urban Development, announced the results of an independent annual audit projecting that reserves of FHA’s main fund, as of September 30, were $16.3 billion less than its obligations for the current operating year. The estimate, far more grim than what had been forecast only months earlier, has renewed debate in Washington and elsewhere as to the need for a special infusion of funds – i.e., a bailout. It would be the first in the agency’s 75-plus years. What should be debated is whether FHA even should exist as a government entity or at the very least whether it should operate on the scale that it has during the last half-decade.
Congress created the Federal Housing Administration in 1934 to insure home mortgages. This was the Depression and the housing market was at a near standstill. Lawmakers, prodded by the Roosevelt administration, believed such an agency was needed to restore confidence among banks and saving & loan institutions that they would not go broke making loans. FHA would protect lenders against the risk of borrower default. In this way, homeownership, especially for first-time house seekers, once again would be achievable for the many. FHA also would serve as the testing ground for a new type of mortgage: self-amortizing; written over 30 years; and requiring only a small down payment. The agency would be self-financing. Rather than receive a public subsidy, it would function as an insurance agency, deriving revenues from the risk-based premiums it charged lenders. In turn, lenders would pass the cost onto borrowers. And if cash reserves ran low, the agency could cover itself by raising the premiums. Until recently, such action rarely had been necessary.
These, however, are unusual times. National Legal and Policy Center explained in a lengthy analysis last month why FHA became the insurer of the first, rather than the last, resort once the conventional mortgage meltdown was underway. Congress, rather than curb FHA’s scope, expanded it last November by raising the loan limit on mortgages eligible for coverage to $729,750. Historically, FHA mortgages have accounted for about 5 to 10 percent of all home purchase loan originations in a given year. But during 2008-10 that share rose to about 35 percent before coming down to slightly under 30 percent in 2011.
A disproportionate number of the loans made during and immediately before this high-volume period, predictably, are in default if not foreclosure. And FHA has had to dig into its reserves to cover all claims. That’s put the agency in a bind. By law, at least 2 percent of its assets must be in the form of cash reserves. That’s actually only half the private mortgage insurance industry standard of 4 percent. Yet a year ago HUD’s annual financial status report to Congress noted that FHA’s Mutual Mortgage Insurance Fund (MMIF), which insures single-family home loans, had a capital reserve level of only 0.24 percent as of September 30, 2011, well below even the 0.50 percent it registered a year before. FHA a couple months ago projected it would wind up fiscal 2012 with $3 billion in reserve, far lower than the $11.5 billion figure projected in its fiscal year 2011 actuarial report.
The latest audit (see pdf), released November 16, reveals that even this was excessively optimistic. As of late September, FHA had a portfolio of 7.6 million mortgages representing about $1.1 trillion. More than one in six loans were at least 30 days delinquent, while 9.4 percent were 90 days or more past due. The looming likelihood of even deeper losses from nonperforming loans has put the agency’s capital reserves in negative territory. The audit, conducted by the Rockville, Md.-based consulting firm of Integrated Financial Engineering Inc., concluded that FHA, as of September 30, 2012, had reserves of $30.4 billion, but will experience a net loss of $46.7 billion on existing loans in its primary account, the Mutual Mortgage Insurance Fund (MMIF). In other words, reserves of the MMIF entering fiscal year 2013 stood at negative $16.3 billion, a figure which translates to -1.44 percent.
The report emphasizes that the $16.3 billion deficit doesn’t mean that FHA can’t pay claims in the here and now. But it does strongly imply that a bailout would be an option should the agency’s balance sheets further deteriorate. Rep. Spencer Bachus, R-Ala., chairman of the House Financial Services Committee, fears the worst. The day before the release of the report, he announced: “They (FHA) have indicated they will have to come to the American people and ask for money.” Thomas Lawler, an independent housing economist in Leesburg, Va., stated flatly, “If [FHA] were a private company, it would be declared insolvent and probably put under conservatorship like Fannie Mae and Freddie Mac.”
Astute housing finance specialists saw this coming. Joseph Gyourko, a professor of real estate finance at the University of Pennsylvania’s Wharton School, argued in a paper for the Washington, D.C.-based American Enterprise Institute (AEI) that by picking up a lot of would-be conventional loans, FHA was setting itself up for a fall. “Depending on how much one wanted to be above the 2 percent ratio guideline, between $50 billion and $100 billion likely is needed to recapitalize the MMIF [Mutual Mortgage Insurance Fund] in a safe manner,” he wrote. “That range is based solely on correcting error in estimation strategy and techniques, as well as data organization. If the economy and housing markets deteriorate unexpectedly, we need to be ready to infuse even more capital into the MMIF.” Likewise, Edward Pinto, an AEI resident fellow who more than 20 years ago was Fannie Mae’s chief credit officer, wrote in the November issue of The Atlantic Online following the release of the consultant’s audit:
The implosion of the government-sponsored enterprises Fannie Mae and Freddie Mac in 2008 did not end the government’s massive – and distorting – role in the housing market. Instead, in the wake of their bailouts (taxpayers have forked over $180 billion and counting), much of the risk was simply shifted to the FHA. Indeed, FHA’s insurance portfolio quadrupled in the past five years to $1.1 trillion today. The result is that FHA now guarantees of all U.S. mortgages, and 30 percent of all new home purchase mortgages. This is not an accidental trend: The FHA deliberately tried to “grow” its way out of trouble, essentially betting the house on housing’s recovery. Friday’s numbers confirm that like Fannie and Freddie, it’s easy to gamble when the taxpayer covers your losses.
Two factors may worsen matters. First, if interest rates remain at record lows – and the Federal Reserve has been on bond-buying binge to ensure just that – existing FHA-insured homeowners will have every reason to refinance their loans through conventional means. That would leave FHA with the poorest-performing mortgages. The consultant’s report estimated that prolonged interest rates could drive the reserve shortfall above $30 billion. Second, the agency faces an unprecedented foreclosure backlog. That’s mainly the result of a $25 billion settlement (actually a little more, including side agreements) that mortgage servicing operations of five major banks reached in February with state attorneys general over allegations of overly hasty processing (“robo-signing”) of deluges of foreclosure documents. The agreement, based on specious evidence, will be a bonanza to homeowners facing or already in foreclosure. It also will fill the coffers of state housing programs. Because about two-thirds of all foreclosure cases require a court order for approval, the backlog should more resemble a steady stream than a flood.
HUD Secretary Shaun Donovan, acknowledges difficulties ahead, but insists the situation remains manageable. FHA, he remarked, “has weathered the storm of the recent economic and housing crisis by taking the most aggressive and sweeping actions in its history to reform risk management, credit policy, lender enforcement and consumer protections.” He and Acting FHA Commissioner Carol Galante each assert FHA is monitoring the situation on a daily basis.
While ending or curbing unsound policies is essential to stemming future losses, FHA’s biggest ace in the hole is the resurgence of the housing market after severe declines during 2007-11. Karl Case, professor emeritus at Wellesley College and co-originator of the widely respected Standard & Poor’s/Case-Shiller House Price Indices, at the start of this year went so far as to call the housing situation “a complete depression.” Yet unexpectedly or not, the situation has stabilized over the past year. Indeed, it has significantly improved. Consider the following:
• House prices again are rising. The Standard & Poor’s/Case-Shiller Index of 20 metro areas, after hitting a trough in March, rose by about 8 percent through July. The National Association of Realtors median price index for existing single-family homes also has increased. In Third Quarter 2012 it was 7.6 percent higher than during Third Quarter 2011.
• Housing starts rose 15 percent in September to their highest level in over four years.
• According to Fannie Mae’s monthly survey of homebuyer attitudes, 72 percent of respondents recently said it was a good time to buy a home. Many people are putting conviction into action. Several months ago in Delray Beach, Fla., for example, potential buyers at a new home development could be seen lining up at 6 A.M. They wound up buying 44 homes by the end of the weekend.
• The nationwide average discount on a foreclosed home in September was only 7.7 percent below market value, notes the real estate tracking firm Zillow. This was a significant improvement over the 23.7 percent average markdown three years earlier.
• The number of homes either seriously delinquent or in foreclosure has been dropping. After peaking at roughly 4.5 million during late 2009/early 2010, this combined figure declined to 3.6 million during First Quarter 2012. That’s still way up from 800,000 six years earlier, but it’s an undeniable improvement.
These indicators are significant because future FHA foreclosures resulting in property repossessions are likely to produce substantially higher revenues than during the last few years. But will this upward trend be enough to avert a public bailout? The Federal Housing Administration, to its credit, is exploring other options. First, FHA is raising insurance premiums. This past February, the agency announced it would raise premiums by 10 basis points (i.e., 0.10 percentage points)for loans less than $625,500 and by 35 basis points for loans at or above that amount. It also would raise upfront premiums by 75 basis points. And last Friday, concurrent with the audit’s release, FHA announced its intent to further raise premiums, the effect of which would raise monthly borrower payments on average by $13. Second, FHA has stepped up sales of distressed properties. HUD Secretary Donovan’s Friday press conference included an announcement that FHA during the next year would put up for sale at least 10,000 delinquent loans per quarter. Beginning this past July the agency already had boosted its distressed quarterly loan sales goal from 5,000 to 9,000. Third, the agency has tightened certain lending standards. As a result, the average FHA buyer’s credit score, notes Moody’s Analytics chief economist Mark Zandi, is now higher than that of the average U.S. household.
If a taxpayer-funded rescue becomes necessary despite these steps, it would not necessarily require congressional action. Funds could come directly from the U.S. Treasury Department at the discretion of President Obama and the treasury secretary. That doesn’t mean, however, Congress can’t authorize funding on its own. And some lawmakers, especially from heavily minority districts, may favor such action. The likelihood of a rescue, by reliable accounts, won’t be known until well into next year.
The more important point, one which eludes all too many people, is that the long-run goal should be to reduce FHA’s profile, not expand or maintain it. As the economy improves – assuming it does – more borrowers presumably would qualify for a home loan without FHA’s help. FHA shouldn’t be competing with private mortgage insurers. It should be what it was set up to be: an insurer of the last or at least the late resort. What got FHA into its current $16.3 billion hole was its aggressive expansion during a period of extreme downturn when the risk of default was high. One wonders about the need for FHA itself. By reaching marginally qualified buyers in large numbers, it runs the risk of a wave of foreclosures. Yet by reaching progressively higher layers of homebuyer demand, it would be replicating much of what private mortgage insurers do. Privatizing FHA would make sense. Yet because this has no support from Capitol Hill let alone the White House, scaling back agency operations would seem a reasonable course of action.
FHA isn’t likely to give its seal of approval to this. Commissioner Galante puts it this way: “We will continue to take aggressive steps to protect FHA’s health while ensuring that FHA continues to perform its historic role of providing access to homeownership for underserved communities and supporting the housing market during tough economic times.” Her boss, HUD Secretary Donovan, similarly argues, “With its dual mission of providing access to homeownership for underserved populations and supporting the housing market during tough times, there’s little doubt that FHA helped prevent a much deeper crisis.” Notice the words “access” and “underserved” in each statement. This is Leftspeak for low-income households, and more specifically, black and Hispanic low-income households. The internal reforms of FHA, while laudable, don’t challenge the core assumptions that homeownership is a moral entitlement and that rejecting applications for credit in sizable numbers is somehow an injustice. Such assumptions are what led to the mortgage meltdown in the first place. Loose mortgage lending practices created today’s “tough times.”
Sen. Bob Corker, R-Tenn., a member of Senate Banking Committee, while perhaps not grasping this point, at least knows FHA’s current condition is a consequence of the agency attempting to do too much. He explains the situation this way: “The recognition that FHA’s economic value is now negative is a stark reminder that we have put off fundamental housing finance reform for too long. FHA has strayed a long way from its original mission, and it’s time for us to return to fundamentals in housing, recognizing that having the federal government making loans to people who can’t pay them back isn’t good for homeowners, communities or the country.” That sounds like a talking point for lasting reform.