Reassessing FHA Risk
As the Federal Housing Administration edges closer to a taxpayer bailout due to the large number of risky mortgage loans it has insured, it continues to insist that no such bailout will be required. However, a new study from a group of economists at New York University finds that the FHA’s assurances might not be based in reality.
According to the study, the actuarial analysis FHA used to determine it won’t need a bailout seriously understates its exposure to risk:
- More FHA mortgages are underwater than the FHA’s analysis identifies, and unemployment is naturally particularly high in areas where FHA borrowers are furthest underwater. Therefore, potential default costs are underestimated.
- FHA’s analysis relies on house values that are inaccurate. Overvalued houses means the FHA could end up recouping less than expected on defaults.
- Underwater FHA mortgages that were “streamlined” into new FHA mortgages are not properly accounted for, which further underestimates risk.
- The FHA got clobbered on a previous no-downpayment assistance program. However, the current homebuyer tax credit can effectively eliminate downpayments on FHA loans, but its analysis doesn’t take this into consideration.
One of the study’s authors, Prof. Andrew Caplin, writes the following on his website:
Rather than looking to structure the markets of the future, they [policymakers] have stumbled along in business as usual mode, waiting for kind fate to save them. It may. Then again, it may not. Either way, this is not a good way to run a business, or a government for that matter.
How does he see this story playing out?
My best guess is that it will end with a crash in the housing finance sector, with the federal government forced by popular revulsion at mushrooming losses to remove itself almost entirely from the housing finance equation. The Resolution Trust Corporation will look like an amateur warm-up act…
The bottom line is simple. The continuation of “business as usual” is re-creating the essential problem that made the sub-prime crisis so disastrous. Once again, taxpayers have been forced to subsidize the private purchase of massive amounts of residential housing, and to offer guarantees against future losses, without any effort to reduce costs should their funding help turn some markets around. Warren Buffett made huge profits for his shareholders by investing in under-valued assets. By contrast, our leaders are making massive losses for taxpayers by investing in over-valued assets.
See this essay for more on the problems with housing finance and government intervention.
Filed under: Finance, Banking & Monetary Policy; Tax and Budget Policy
Housing Market on Government Crutches
My house has been on the market for a month and it has drawn a lot more looks than I expected. I’ve been quizzing realtors as they come through, and each one tells me the same story: the government is single-handedly propping up the demand for housing. In addition to the homebuyer tax credit and government-induced low mortgage interest rates, most sales are being done with Federal Housing Administration backing.
As a seller, I’m looking to get out before the tax credit expires and interest rates starting ticking upward. But when I do sell, I certainly won’t be looking to buy a house, particularly since I’ll be selling at a loss. If my situation is representative of other current sellers, the housing market could be in for another tumble if the government crutches are removed. However, if the government instead continues trying to prop up the housing market, the risk that taxpayers will take another bath goes up. It’s a nasty Catch-22 that demonstrates the problems with the government distorting the housing market to begin with.
A recent New York Times article looked at the housing market in the “beleaguered” manufacturing city of Elkhart, Indiana, which has twice served as a prop for President Obama. The Times says Elkhart “symbolizes the failure of federal efforts to turn around the housing slump at the heart of the economic crisis” and that “[h]ousing in this community has become almost entirely dependent on a string of federal support programs.”
The situation in Elkhart described by the Times matches perfectly with what realtors are telling me:
To the extent that the real estate market is functioning at all, people here say, it is doing so only because of the emergency programs, which have pushed down interest rates on mortgages and offered buyers a substantial tax credit. Equally important is an expanded mortgage insurance program run by the Federal Housing Administration, which encourages private lenders to accept borrowers with small down payments. The government takes the risk of default.
The one problem with the Times piece is that it doesn’t completely connect the dots. Namely, the problem the government is trying to solve is a problem that its housing policies instigated: the housing boom and bust. For instance, the article cites a good example of government policies mimicking the irresponsible lending that helped create this mess in the first place:
The programs favor first-time buyers, who have the fewest resources to bring to a deal. Heather Stevens, a 23-year-old nurse here, is closing on a three-bedroom house this week. Since her loan was insured by the Federal Housing Administration, she had to put down only 3.5 percent of the $74,900 purchase price.
“It was a breeze to get approved,” she said.
The sellers are covering her closing costs, which agents say is often the case here. That meant Ms. Stevens had to come up with only the $2,600 down payment, which still took all her savings.
But the best part is the $7,500 tax credit. She will use that to remodel the kitchen. “If it wasn’t for the credit, we would have waited to buy,” said Ms. Stevens, who is getting married this year.
Buying houses with no money down was a feature of the latter stages of the housing bubble. It gave prices a final push into the stratosphere. But buyers with no equity were the first to abandon their properties as the market turned south.
But there’s no mention of the role Fannie and Freddie, HUD, or the FHA played in fostering that bubble.
The article continues:
With housing prices stagnant, bolstering the market by again letting people buy with hardly any money down is viewed in some quarters as a bad bet.
Neil Barofsky, the special inspector general for the government’s Troubled Asset Relief Program, wrote in his most recent report to Congress that “the federal government’s concerted efforts to support” housing prices “risk reinflating” the bubble.
He noted one difference from the last bubble: taxpayers, rather than banks, are now directly at risk in these new mortgages.
I would argue that the mere existence of TARP is proof that taxpayers were directly at risk to begin with. The risk may be more explicit now, but that’s only because the bubble’s bursting washed away a lot of the private sector’s bad actors. But the ultimate bad actor, Uncle Sam, who encouraged the private sector’s risky lending activities, has stepped in to fill the void. Just how badly this turns out for taxpayers remains to be seen.
Filed under: Finance, Banking & Monetary Policy; Tax and Budget Policy
This Week in Government Failure
Over at Downsizing Government, we focused on the following issues this week:
- Will Obama’s deficits turn out to be as low-balled as Bush’s?
- Obama blames Bush for his problems, but his new budget is worse.
- Obama’s budget would kill the Constellation program, but his budget still goes to the moon.
- The Federal Housing Administration bailout watch continues.
- There’s nothing “fiscally responsible” about Sen. Kent Conrad.
- The government is creating jobs — federal government jobs.
FHA’s New Stringent Standards
The Federal Housing Administration will reportedly announce more stringent lending requirements and higher borrowing fees. The move comes in response to growing concerns that rising losses on mortgages it insures will require a taxpayer bailout. Although any credit tightening is welcome, the agency will not propose an increase in the minimum downpayment, currently 3.5 percent. (Borrowers with credit scores below 580 will be required to put down a minimum of 10 percent, but most FHA lenders already require a 620 minimum score.)
Yesterday, the Wall Street Journal noted that “home builders are worried” the FHA would propose raising the minimum downpayment. The CEO of a Texas builder said it would be a “game changer,” meaning that it would hinder the nascent housing recovery. However, other industry observers believe otherwise:
In markets where home values are still falling, buyers who put little money down could see their equity wiped out quickly. The FHA is “just manufacturing more upside-down homeowners by the truckload in Arizona, California, and Nevada,” says Brett Barry, a Phoenix real-estate agent who specializes in selling foreclosed homes.
FHA commissioner David Stevens counters that inhibiting lending by increasing downpayment requirements would “perpetuate” price declines. But falling prices are a painful, but necessary, correction needed to bring the housing market back into equilibrium. Government interventions in the wake of the housing bubble’s burst have created an artificial cushion. Thus, any alleged housing recovery could prove illusory when the cushion is removed. In addition, the longer the government tries to prop up the housing market, the greater the economic distortions and risk to taxpayers.
The article cites the example of a 42-year-old air-conditioning repairman who just bought a house with the FHA minimum 3.5 percent downpayment. To meet the requirement he had to borrow part of the money from his father-in-law, which he then repaid with the $8,000 first time homebuyer tax credit. He now has a $1,466 monthly mortgage payment on a $50,000 salary. Factoring in utilities and other homeownership costs, it’s not inconceivable that half of his pre-tax salary will be devoted to just his home. Is it any wonder the FHA is experiencing large default rates?
Filed under: Finance, Banking & Monetary Policy; Tax and Budget Policy
New HUD Same as Old
U.S. Department of Housing and Urban Development Secretary Shaun Donovan recently gave a speech in New York in which he spoke of a “new direction in housing.” If there’s one constant with cabinet secretaries, it’s that they all promise that their department will be new and improved. The following are a few of Donovan’s lines that deserve comment.
The Federal Housing Administration is providing another critical bridge to economic stability…And with nearly half of first-time buyers using FHA loans, it is clear that the FHA has been central to recovery.
Thanks to his predecessor, Alphonso Jackson, who was “absolutely emphatic about winning back our share of the market,” the FHA’s willingness to pick up the subprime lending slack when the housing bubble burst has opened the door for a potentially huge taxpayer bailout. In fact, the government hasn’t just come to dominate the housing finance market — it practically is the housing finance market. Thus, there are plenty of doubts as to whether the housing “recovery” Donovan speaks of is sustainable without the government crutch.
In crisis comes enormous opportunity for change — as Rahm Emanuel says, ‘a crisis is a terrible thing to waste.’ Ensuring we don’t starts with getting the government back into the business of building and preserving affordable housing. Homeownership is incredibly important. But if this crisis has taught us anything, it’s that it is long past time we had a balanced, comprehensive national housing policy – one that supports homeownership, but also provides affordable rental opportunities, and ensures nobody falls through the cracks.
Like his boss, Donovan’s use of the word “change” is just a euphemism for bigger government. His contention that the government needs to get “back” into affordable housing is laughable. When did it leave?
This crisis has illustrated that only the Federal government has the scale and mechanisms to deal effectively with some of the forces that caused it.
It was the federal government’s “scale and mechanisms” that helped cause the crisis! Only powerful institutions with national “scale” such as the Federal Reserve, Fannie and Freddie, and HUD had the power and potential to create such a nation-wide bubble, bust, and recession. Donovan wants the arsonist to put out the fire.
The Federal government can be a key partner in helping communities foster the kinds of synergies between housing, education, public safety, and health you’ve helped nurture at the neighborhood level.
Words like “synergy”, “nurture”, and “foster” are vacuous bureaucratic rhetoric. They are supposed to imply that the federal government can turn decaying urban centers into utopias with gobs of taxpayer money and bureaucratic meddling. That’s just bunk.
In my recent paper on three decades of scandals, mismanagement, and policy failures at HUD, I show that little has changed at HUD other than the individuals occupying the throne. The history of Shaun Donovan’s tenure is yet to be written, but his speech makes me pessimistic.
The Week in Government Failure
Over at Downsizing Government, we focused on failures in the following departments and agencies this week:
- Export-Import Bank: Call it the “Boeing Bank”
- HUD: Federal Housing Administration woes continue and housing subsidies for the dead
- Transportation: High-speed rail lobbyists squabble over taxpayer loot
Also, in addition to losing more money, Fannie Mae and Freddie Mac lose their inspector general.
Government Housing Adventures
The Wall Street Journal is reporting that Fannie Mae and Freddie Mac, which have already consumed $112 billion in taxpayer bailouts, may have additional losses if they can’t recoup claims from struggling private mortgage insurers.
From the Journal:
Fannie Mae has about $109.5 billion of mortgage-insurance coverage in force, which represents 4 percent of all single-family home loans it owns or guarantees. Freddie Mac had $63.4 billion in mortgage insurance and $12.2 billion in bond insurance. Private mortgage insurance is required for any home loan with less than a 20 percent down payment, and the policies typically cover 12 percent to 35 percent of losses in the event of a default, according to HSH Associates, a financial publisher. Mortgage insurers have been forced to pay up as loan defaults escalate.
Escalating loan defaults are also likely to bite taxpayers through the Federal Housing Administration, which covers 100 percent of losses. The FHA is in deep trouble:
The reduction in private insurance coverage has contributed to the rise in the volume of loans backed by the Federal Housing Administration, a government mortgage insurer that backs loans with as little as 3.5 percent down payments. It could be required to ask for a federal subsidy for the first time in its 75-year history if the housing market deteriorates further.
Who is looking out for taxpayers here?
A Bankrupt FHA: It’s Only Money, Part XXVI
Think the bailouts are over? Think again! The Federal Housing Administration could become the next Fannie Mae.
Problems at the Federal Housing Administration, which guarantees mortgages with low down payments, are becoming so acute that some experts warn the agency might need a federal bailout.
Running questions about the F.H.A.’s future — underscored by interviews with policy makers, analysts and home buyers — came to the fore on Thursday on Capitol Hill. In testimony before a House subcommittee, the F.H.A. commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was managing its risks.
But he acknowledged that some 20 percent of F.H.A. loans insured last year — and as many as 24 percent of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances.
We’ve already spent about $13 trillion bailing out banks, financial institutions, automakers, insurance companies, and most everyone else. So what’s another few billion dollars among friends? As they say, it’s only money!
Housing Bailouts: Lessons Not Learned
The housing boom and bust that occurred earlier in this decade resulted from efforts by Fannie Mae and Freddie Mac — the government sponsored enterprises with implicit backing from taxpayers — to extend mortgage credit to high-risk borrowers. This lending did not impose appropriate conditions on borrower income and assets, and it included loans with minimal down payments. We know how that turned out.
Did U.S. policymakers learn their lessons from this debacle and stop subsidizing mortgage lending to risky borrowers? NO. Instead, the Federal Housing Authority lept into the breach:
The FHA insures private lenders against defaults on certain home mortgages, an inducement to make such loans. Insurance from the New Deal-era agency has enabled lending to buyers who can’t make a big down payment or who want to refinance but have little equity. Most private lenders have sharply curtailed credit to those borrowers.
In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.
And what is the result of this surge in FHA insurance?
The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.
This is madness. Repeat after me: TANSTAAFL (There ain’t no such thing as a free lunch).
C/P Libertarianism, from A to Z
HUD Helps to Set the Ground for Next Round of Mortgage Fraud
Just when you were thinking it was safe to go back into the mortgage market, today’s Wall Street Journal is highlighting the next source of mortgage fraud, the Federal Housing Administration’s (FHA) reserve mortgage program. In a typical reverse mortgage, the bank sends the borrower a monthly check (or a lump sum payment at the beginning of the loan).
It seems that some creative individuals have figured they could deed a run-down house to an elderly individual, and then get a reserve mortgage on that property; leaving them with the cash and the government with the run-down worthless property. Of course, this requires getting an appraiser to go along with the value of the home, but since the Clinton HUD decided to do away with FHA control of appraisers and let the lender pick the appraiser, that sadly hasn’t been much of an obstacle.
The great thing for lenders is that if the loan goes bad, or the value of the house falls below the mortgage amount, FHA – backed by the taxpayer – picks up the tab. Of course, the borrower is required to pay an insurance premium to cover any potential shortfalls. But just like in any other federal insurance program, when these’s a shortfall beyond funds collected via premiums, we taxpayers are left on the hook. I could go on about what a great job Washington does running insurance programs; suffice to say, Washington does a pretty poor job.
If Washington were serious about cracking down on predatory lending and mortgage fraud, Congress should end the practice of allowing lenders to put 100% of their losses to the taxpayer. Maybe that would provide the correct incentives for the lender to actually make sound loans.
Administration Reform Plan Misses the Mark
The Obama Administration is presenting a misguided, ill-informed remake of our financial regulatory system that will likely increase the frequency and severity of future financial crises. While our financial system, particularly our mortgage finance system, is broken, the Obama plan ignores the real flaws in our current structure, instead focusing on convenient targets.
Shockingly, the Obama plan makes no mention of those institutions at the very heart of the mortgage market meltdown – Fannie Mae and Freddie Mac. These two entities were the single largest source of liquidity for the subprime market during its height. In all likelihood, their ultimate cost to the taxpayer will exceed that of TARP, once TARP repayments have begun. Any reform plan that leaves out Fannie and Freddie does not merit being taken seriously.
Instead of addressing our destructive federal policies aimed at extending homeownership to households that cannot sustain it, the Obama plan calls for increased “consumer protections” in the mortgage industry. Sadly, the Administration misses the basic fact that the most important mortgage characteristic that is determinate of mortgage default is the borrower’s equity. However, such recognition would also require admitting that the government’s own programs, such as the Federal Housing Administration, have been at the forefront of pushing unsustainable mortgage lending.
While the Administration plan recognizes the failure of the credit rating agencies, it appears to misunderstand the source of that failure: the rating agencies’ government-created monopoly. Additional disclosure will not solve that problem. What is needed is an end to the exclusive government privileges that have been granted to the rating agencies. In addition, financial regulators should end the outsourcing of their own due diligence to the rating agencies.
The Administration’s inability to admit the failures of government regulation will only guarantee that the next failures will be even bigger than the current ones.
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