FHA Repudiates Housing Rescue Bill

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.

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  1. Erik

    Here’s a hint, if a seller gives me money for a down payment, that is the same as 0 down.

    It’s not my money being risked! Hello! That is an integral part of the down payment, that the buyer has significant exposure so they won’t default.

    If the FHA thinks a paltry 3% seller assisted DP will make a borrower think twice about defaulting, I have some air to sell them.

    And, a seller assisted DP is not a value boost for prices either. If Chrysler gives rebates on their cars then resale values get punished more than they would have been without the assistance. Same with housing. If I get 3% free assistance then my cost basis is 3% lower.

    But, none of this applies to the real world for the FHA.

  2. jm

    It was successful and turned a profit, but the key to its success cannot be replicated today.

    You need to be more imaginative. In the ’30s they extended the mortgage term from 5 to 30 years; using the same concept, if we extend it to 90 years, and have the Fed commit to keeping the interest rate at, say, 2% (quite consistent with Bernanke’s famous helicopter speech, and the willingness to take whatever needs to be taken onto the Fed’s balance sheet), monthly payments will come down to sustainable levels, and market prices will be able to rise back to bubble-peak levels. It won’t matter that no one will ever pay such a mortgage off — according to my mortgage broker friend, nowadays sophisticated buyers look upon home ownership as “renting from the bank with an income tax deduction”, and don’t plan ever to pay off.

    The 90-year term will have the added advantage that throughout the homeower’s life the principal will hardly even be dented, effectively making the entire payment tax-deductible interest.

    Continuing to think out of the box, if we were to make mortgage interest and real estate taxes a tax-credit item instead of a deduction, we would greatly expand the number of people willing and able to pay $500k for a 3-br, 2-1/2 bath home.

    And this wouldn’t have to be funded byUS taxpayers — if we were to stop pestering the Chinese government about upvaluing the renminbi, and instead greatly expand our imports, China could easily afford to buy all the securities issued to fund this. And they could all be backed by the full faith and credit of the US government.

    Problem solved.

  3. jkiss

    while it is surprising to me, fha’s own data shows that seller financed 3% down loans default at 3x the rate of real 3% down loans. 3x is a big deal.

    the difference in actual payment between a 30 year loan and a 90 year loan is very little – even the thirty year loan payment is almost entirely interest, very little principal. THere was, of course, an enormous difference between a loan amortized over 5 years vs. 30.

  4. Anonymous

    I read recently somewhere that the Depression-era HOLC refinanced mortgages that were 40 to 50 percent down payment (standard for that time), and thus were MUCH lower risk than anything being proposed today. This fact, if correct, is studiously ignored by the DC pols and housing interests.

  5. Yves Smith

    Anon of 8:12 PM,

    I have read that as well, but didn’t want to put it in the post without having a source…..

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