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The Federal Housing Administration is expected to report this week it could exhaust its reserves because of rising mortgage delinquencies, according to people familiar with the agency’s finances, a development that could result in the agency needing to draw on taxpayer funding for the first time in its 78-year history.
This isn’t your granddaddy’s FHA. Back in the 1930s, it insured 20-year term loans combined with a 20% down payment. What’s more, FHA lending was backed by a rigorous property appraisal process. Not surprisingly, defaults resulting in claims were super low. From 1934 through 1954, notes AEI’s Ed Pinto, the FHA insured 2.9 million mortgages. During this period, FHA paid claims on 5,712 properties for a cumulative claims rate of 0.2%.
But these days, Timiraos writes, it’s backing borrowers with downpayments “of as little as 3.5%—loans that most private lenders won’t originate without a government guarantee.” And although it guarantees fewer mortgages than Fannie or Freddie, it has more seriously delinquent loans than either of them. Again, Timiraos:
Overall, the FHA insured nearly 739,000 loans that were 90 days or more past due or in foreclosure at the end of September, an increase of more than 100,000 loans from a year ago. That represents about 9.6% of its $1.08 trillion in mortgages guaranteed. … The FHA never relaxed its underwriting rules during the housing boom, and its market share plunged as private lenders offered loans on much easier terms. But the agency saw business soar as the housing bust deepened, first in 2007, as private lenders retreated, and later in 2008 and 2009, as Fannie and Freddie tightened standards. Most of the agency’s losses now stem from loans made as the housing bust deepened. About 25% of mortgages guaranteed in 2007 and 2008 are seriously delinquent, compared with about 5% in 2010.
Every year the FHA’s annual audit estimates how much money the agency would need to pay off all claims on projected losses versus how much it has in reserves. Last year, that represented 0.12% of its loan guarantees. Federal law requires the agency to stay above a 2% level. But as Pinto and Peter Wallison explain in an paper earlier this year, that ratio actually understates the severity of the problem:
To put this in perspective, as recently as 2006, the FHA’s capital ratio was 7.38 percent. If this were a real capital ratio, a decline of this size would be bad enough, but the “capital” in the FHA’s capital ratio is not even made up entirely of tangible assets. It is primarily expected future insurance losses subtracted from current net assets and expected future insurance premiums over the next thirty years.
In fact, if the FHA were treated like a private insurer, it would already be insolvent with a total capital shortfall of nearly $60 billion. Also note that Congress poured fuel on the fire last year when it raised the FHA’s conforming loan limit to $729,750.
Clearly the FHA desperately needs reform with the overriding principle being that it should return to its traditional mission of being a targeted provider of sustainable mortgage credit to low- and moderate-income Americans and first-time homebuyers. Among Pinto’s suggestions:
1. The FHA needs to return to its traditional market share of 10% versus today’s 30%.
2. The worst performing 25% of its mortgages will likely have a claim rate of at least 15%. FHA should limit the worst credit risk categories to a maximum claim rate of half that.
3. The FHA should focus on homebuyers who truly need help purchasing their first home.The homes it finances should cost less than the median priced home for an area. And first-time homebuyers should be limited to an income of less than 100% of area median income and repeat home buyers to an income of less than 80% of area median income.
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