naked capitalism

We’ve taken a dim view of plans to use government sponsored enterprises like Freddie Mac and Fannie Mae, and the Federal Housing Administration as vehicles to prop up a housing market that, even with its decline to date, is still overpriced in many areas of the country relative to incomes.

Many have spoken in favor have argued in favor of the homeowner rescue plan wending its way through Congress. One of the observations often made in its favor is despite its nominally large exposure, up to $300 billion in loans, the final cost won’t be large, in part because uptake will be lower than expected, and the actual cost (aka losses) will be lower than the amount loaned. The CBO’s estimate was less than $5 billion, a mere trifle compared to the good it will do, right?

The FHA begs to differ. Now admittedly, this may simply be the agency acting as a good soldier, falling in with the Administration opposition to the proposal. But the FHA chief issued a surprisingly stern warning today based on the FHA’s experience with another high-risk product, downpayment assistance mortgages.

Recall that, heretofore, the FHA has largely escaped the mess that subprime lenders have suffered, despite the agency’s focus on first time homebuyers who cannot make what once was a normal downpayment, 20% to 25%. The FHA kept its standards, including documentary requirements, in place, and lost market share to the newcomers (keep this in mind as a case example for those who argue that the government is always and ever incompetent. Of course, the wisdom of America’s generous homeowner subsidies is a separate matter).

But despite the agency’s general caution, it has suffered unexpectedly large losses in a product designed to overcome its typical 3% downpayment requirement. Its seller financed downpayment program grew from less than 2% of its portfolio in 2000 to 35% in 2007, with foreclosure rates three times higher than for its traditional products. Of the agency’s annual estimated losses of $4.6 billion, an unexpectedly high number, 60% came from this product. The FHA is also seeing

FHA chief Brian Montgomery went on the offensive today, In a National Press Club speech today (hat tip Housing Wire), he characterized the program as a threat to the agency’s survival (it’s self-financed) and pointed out that similar efforts to make the FHA carry risky loan will produce similar failed outcomes:

Currently, FHA is solvent. In fact, we have a reserve of about $21 billion.

However, as a result of our annual re-estimate, we had to book an additional of $4.6 billion in unanticipated long-term losses, mostly due to the increased number of certain types of seller-funded loans in the FHA portfolio….

[N]o insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, FHA will soon either have to shut down or rely on appropriations to operate…..

Some of the proposed Congressional actions could actually weaken FHA and endanger the housing market by turning FHA into a less stable, less solvent, more bureaucratic entity.

There are some who want FHA to pick up all the potentially delinquent 2 million subprime loans.

This is a worrisome idea. FHA is designed to help stabilize the economy, operating within manageable, low-risk loans.

It is not designed to become the federal lender of last resort, a mega-agency to subsidize bad loans.

The speech itself hews very closely to the talking points that Paulson has made regarding housing, so clearly the agency does not have much in the way of an independent view. Nevertheless, that doesn’t mean that the key message can’t be valid. Having the FHA insure riskier mortgages is not likely to be the low cost operation that it is claimed to be. And the FHA, with an established business model that for the most part works (the agency has said loudly and clearly that it wants to shut down the seller financed loan program) may not be the right vehicle for making guarnatees to riskier loans (in the private sector, trying to put two different business cultures under the same roof seldom works well).

Some economists have advocated reconstituting the Home Owners’ Loan Corporation, a Depression entity that refinanced mortgages. It was successful and turned a profit, but the key to its success cannot be replicated today. Mortgages then were short-term affairs, typically five years. HOLC refinanced them with 30 year mortgages. Now that might have seemed risky and untested at the time, but it was a brilliant fix, particularly since people were less mobile in those days (i.e., 30 years would not be vastly in excess of normal tenure in a home).

While we aren’t in favor of an idea like HOLC, if you want to go down that path,, it is better in the long run to create a new organization rather than adapt the operations of an agency that may appear to have the right skills but has the wrong mentality for the task. But so far, the focus is on quick fixes and expediencies rather than integrated approaches.