November 11, 2009
Over the past decade, the Federal Housing Administration has been insuring riskier mortgages in an attempt to regain “market share” lost to private competitors during the housing boom. But after the housing bubble burst and private firms either went out of business or reduced their risk profile, the FHA continued to plow ahead insuring risky mortgages. This could all backfire on taxpayers.
The Washington Post reports that the FHA is getting closer to needing a Treasury infusion:
The Federal Housing Administration, which has played a crucial role supporting American home buyers after the collapse of the mortgage market, has burned through a huge cash reserve in less than a decade and could soon wind up with what amounts to an automatic taxpayer bailout if the agency's fortunes don't improve, according to a review of FHA finances.
With a looming crisis at FHA, Congress and the administration are again asleep at the switch because they continue to be obsessed with the political appeal of maximizing the number of homeowners regardless of whether it makes any economic sense:
But the agency's complex funding mechanisms -- little understood in Washington, including on Capitol Hill…
The Post describes how we’ve arrived at this situation:
The FHA had been accumulating money ever since its emergency reserve fund was set up in 1992. The premiums collected by the agency from borrowers taking out FHA-backed loans regularly exceeded its liabilities. But the trend turned sour even as the housing market flourished. Leading up to the boom, private lenders started offering no-down payment and low-down payment mortgages to reasonably low-risk borrowers, effectively luring away some of the FHA's most reliable borrowers with less expensive loans.
‘FHA could not compete as well for the best borrowers, and it was left with some of the riskier borrowers,’ said Mathew Scire, a director at the Government Accountability Office. Some of the loans left on FHA's books started going bad during the first half of this decade.
In each of the past seven years, the FHA has had to take money from its reserves to replenish the financing fund. In fiscal 2004, it transferred $7 billion in reserves -- a record high at the time -- to cover losses on loans from 1992 through 2003.
This recalculation prompted a study by the GAO, which attributed the reestimate to the FHA's financing of increasingly risky borrowers from 1995 onward as it lost ground to private lenders and loosened lending guidelines. Many of the losses were also attributed to a now-defunct program that encouraged defaults by allowing home sellers to help cover down payments for buyers.
As home prices fell, the downward trend continued. In fiscal 2009, when the agency recalculated its expected losses for loans made in previous years, it found it needed to transfer $10.3 billion from its reserves to its financing fund to cover losses, topping its previous record.
Then, when the housing market swooned and prices fell, many borrowers who suddenly owed more than their homes were worth fell behind on their mortgages. Defaults spiked. About 24 percent of FHA loans were in default in 2007 and 20 percent in 2008, according to the agency. The agency's reserves kept tumbling.
If the FHA does end up requiring an infusion of general fund money to cover its foolish lending, policymakers should at the very least use the bailout as an excuse to rein the agency in. Of course, this won’t sit well with the realtor, mortgage banking, and homebuilder lobbyists. And it won’t sit well with the militant “affordable housing” groups. Unfortunately, the two form a powerful bloc that neither Congress nor the Obama administration seems willing to challenge.
Defenders of the FHA brag that the agency is self-funded and that it has never taken a dime of taxpayer money. If that’s true, then a profit opportunity exists and the role of insuring mortgages can be left to the private sector. Either way, the FHA should be abolished.
See here for more on federal housing finance and the financial crisis.