Think Tanks Continue Feuding Over FHA

It would be a Hansel and Gretelian task to follow the back and forth between the American Enterprise Institute (AEI) and the Department of Housing and Urban Development (HUD) as the former has attacked and the latter has defended the history, efficacy, and future of FHA. In November 2011 the conservative think tank published a paper by Joseph Gyourko of Wharton titled Is FHA the Next Housing Bailout? This was followed by a rebuttal from HUD and a rejoinder, again published by AEI. Then in December 2012 AEI published a major position paper which MND covered entitled How the FHA Hurts Working Families, by Steven J. Pinter. Since then representatives of AEI have been invited to present testimony primarily assailing the role and especially the recent history of FHA in meeting the nation's housing needs at several Congressional hearings on housing finance reform.

On June 20, 2013 AEI published another Gyourko paper titled "Rethinking the FHA in which he made the following claims:

• FHA is a policy failure: Far too many of FHA's intended beneficiaries fail to achieve sustainable homeownership. Between 15 and 30 percent of mortgages guaranteed by FHA since 2007 will default.
• FHA is a financial failure: FHA's main mortgage insurance guarantee fund does not have sufficient funds to cover its expected losses, and its most recent actuarial review puts its net worth at a -$13.5 billion. Gyourko said his research concludes it will take $50 to $100 billion to put it on a sound financial footing.
• FHA's business model is fundamentally flawed: Both FHA and its borrowers are leveraged by more than 30 to 1. To be viable, such a highly leveraged business model virtually requires that housing values never fall which we have learned is not a realistic expectation.

Now a senior fellow from the Center for American Progress (CAP), AEI's equivalent on the left, has taken on Gyourko assumptions. Jim Carr's remarks in which he laid out five key points refuting Gyourko, came at an event entitled "Rethinking FHA", sponsored by the two politically opposite policy centers.

Carr says that Gyourko's paper provides significant information on which to debate the current conditions and future directions for FHA but that "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."

Car said that FHA has, by many measures, been an exceptional success. In its 80 years it has insured 40 million mortgages and revolutionized the way Americans buy homes. It popularized the fully-amortizing mortgage and its 30-year fixed-rate variation, reliably served the populations the mainstream mortgage market underserves, and has played a key countercyclical role in the recent housing crisis. At that time it lent heavily into the markets that suffered the largest decrease in home prices and kept the recession from becoming even more devastating. According to Moody's Analytics, without FHA, home prices would have fallen another 25 percent, new home construction another 60 percent and home sales 40 percent. The economy would have contracted another 2 percent.

Carr said that, while FHA has financial challenges, the sky is not falling. Those challenges are being managed in a responsible manner and the agency continues to operate without a single dollar of taxpayer subsidy to support its mortgage funds.

The 2012 independent actuarial report of the agency indicated it faces a capital shortfall of $16.3 billion, 17 percent or $2.8 billion of which is due to the Home Equity Conversion Mortgage (HECM) program which insures reverse mortgages and that the seller funded downpayment program had cost the fund $15 billion. More recent estimates put the capital shortfall at $943 million. Carr said that even if the fund requires a $1 billion infusion from Treasury it 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 has $30 billion to continue paying claims, enough to cover the next 7 to 10 years.

Carr said that 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 financial firms that did not have a projected loss went broke and were closed or sold at the cost of billions in taxpayer bailouts. Also FHA loans are performing far better than the subprime loans the private sector pioneered.

Carr said there is reason to think the situation is getting better: The single-family early period delinquency rate is one-seventh what it was in the height of the crisis and home prices have been rising rapidly and interest rates have remained below what was projected in the actuarial report.

Most importantly, Carr said, it's not yet clear whether the FHA will require a treasury draw. 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 changes were proposed then too and they proved to be unnecessary.

Carr said that Gyourko paper and other critics misdiagnose the cause of FHA's financial problems. The main problem is not that FHA supports low-down-payment lending but rather their losses come from the two programs mentioned earlier, seller-financed down-payment-assistance loans and HECM loans, neither of which Gyourko mentions in his analysis. FHA has taken and is taking major steps to reform these programs.

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

Carr contradicts a central thrust of the Gyourko paper, saying that FHA's financial challenges are not due to its "government status" per se.  "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."  Carr accuses both Gyourko and Pinto, of being transparently biased in linking financial problems to government status.  He cites an assertion in Pinto's paper presenting a correlation between FHA lending and high foreclosure rates in distressed neighborhoods implying 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.

Carr says FHA has implemented a fair number of policy changes that are designed to reduce its losses and make its lending programs more sustainable in addition to changes in HECM and seller financed down payment assistance.  The agency has improved its oversight of lenders, made its underwriting stricter and crucially has increased mortgage insurance premiums five times since 2009 and has begun to collect annual premiums for the life of a loan. All, he says, 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.

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.

Carr concedes that improvements in FHA's management could enhance its financial well-being.  He agrees with Pinto that FHA could adopt some of the practices of the Veterans Affairs mortgage program such as imposing a residual income requirements, employing its appraisal process and its program of early intervention with troubled borrowers.  He also suggests further restrictions on seller-funded downpayments, and improvements to FHA's loss mitigation requirements. 

In his paper Gyourko suggested replacing FHA with a subsidized savings plan which would allow qualified households to pay into a special savings vehicle and receive a match from the government.  Funds would accumulate on a tax free basis until large enough to provide a 10 percent downpayment on a home.  This, Gyourko said, would eliminate a large bureaucracy, make sure the benefits accrued to households and incentivize families to save and "inculcate values that will decrease a household's likelihood of default."

Carr calls a federally subsidized savings program for moderate-income families an exceptional idea, however not as a substitute for FHA.  Americans do not save sufficiently and lower- and moderate-income families face particularly large barriers to savings.  He suggests placing the accounts with local banks and credit unions rather than the mutual funds Gyourko suggested, taking away the tax-free status as it is likely to benefit only higher-income households, and making the plan available for other uses as well, such as starting a business or saving for a child's tuition.